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DEPARTMENT OF THE TREASURY Background Summary of Comments and Explanation of Revisions Internal Revenue Service Section 951A was added to the Internal Revenue Code (the ‘‘Code’’) 1 by I. Overview 26 CFR Part 1 the Tax Cuts and Jobs Act, Public Law The final regulations retain the basic 115–97, 131 Stat. 2054, 2208 (2017) (the approach and structure of the proposed [TD 9866] ‘‘Act’’), which was enacted on December regulations and foreign tax credit 22, 2017. On October 10, 2018, the proposed regulations, with certain revisions. This Summary of Comments RIN 1545–BO54; 1545–BO62 Department of the Treasury (‘‘Treasury Department’’) and the IRS published and Explanation of Revisions section Guidance Related to Section 951A proposed regulations (REG–104390–18) discusses those revisions as well as (Global Intangible Low-Taxed Income) under sections 951, 951A, 1502, and comments received in response to the and Certain Guidance Related to 6038 in the Federal Register (83 FR solicitation of comments in the notices Foreign Tax Credits 51072) (the ‘‘proposed regulations’’). A of proposed rulemaking accompanying public hearing on the proposed those regulations. AGENCY: Internal Revenue Service (IRS), regulations was held on February 13, II. Comments and Revisions to Treasury. 2019. The Treasury Department and the Proposed § 1.951–1—Amounts Included ACTION: Final and temporary IRS also received written comments in Gross Income of United States regulations. with respect to the proposed Shareholders regulations. A. Hypothetical Distribution of SUMMARY: This document contains final In addition, on December 7, 2018, the Allocable E&P regulations that provide guidance to Treasury Department and the IRS A United States shareholder (‘‘U.S. determine the amount of global published proposed regulations (REG– intangible low-taxed income included shareholder’’) who owns stock of a 105600–18) relating to foreign tax in the gross income of certain United foreign corporation on the last day of credits in the Federal Register (83 FR States shareholders of foreign the foreign corporation’s taxable year on 63200) (‘‘foreign tax credit proposed corporations, including United States which the foreign corporation is a shareholders that are members of a regulations’’). A public hearing on these controlled foreign corporation (‘‘CFC’’) consolidated group. This document also regulations was scheduled for March 14, includes in gross income its ‘‘pro rata contains final regulations relating to the 2019, but it was not held because there share’’ of the CFC’s subpart F income (as determination of a United States were no requests to speak. However, the defined in section 952) for the taxable shareholder’s pro rata share of a Treasury Department and the IRS year. See section 951(a)(1) and § 1.951– controlled foreign corporation’s subpart received written comments with respect 1(a). In general, a U.S. shareholder’s pro F income included in the shareholder’s to the foreign tax credit proposed rata share of subpart F income is gross income, as well as certain regulations. Certain rules in the foreign determined based on its proportionate reporting requirements relating to tax credit proposed regulations are share of a hypothetical distribution of inclusions of subpart F income and being finalized in this Treasury decision all the current earnings and profits global intangible low-taxed income. to ensure that the applicability dates of (‘‘E&P’’ and ‘‘current E&P’’) of the CFC. Finally, this document contains final these rules coincide with the See section 951(a)(2)(A) and § 1.951– regulations relating to certain foreign tax applicability dates of the statutory 1(b)(1)(i) and (e)(1). A U.S. shareholder’s credit provisions applicable to persons provisions to which they relate. See pro rata share of tested income (as that directly or indirectly own stock in section 7805(b)(2). The rules being defined in section 951A(c)(2)(A) and foreign corporations. finalized relate to §§ 1.78–1, 1.861– § 1.951A–2(b)(1)), tested loss (as defined in section 951A(c)(2)(B)(i) and DATES: 12(c)(2), and 1.965–7(e). See part XI of the Summary of Comments and § 1.951A–2(b)(2)), qualified business Effective date: These regulations are Explanation of Revisions section. asset investment (‘‘QBAI’’) (as defined effective on June 21, 2019. in section 951A(d)(1) and § 1.951A– Applicability dates: For dates of Comments outside the scope of this 3(b)), tested interest expense (as defined applicability, see §§ 1.78–1(c), 1.861– rulemaking are generally not addressed in § 1.951A–4(b)(1)), and tested interest 12(k), 1.951–1(i), 1.951A–7, 1.1502– but may be considered in connection income (as defined in § 1.951A–4(b)(2)) 51(g), 1.6038–2(m), and 1.6038–5(e). with future guidance projects. In this (each a ‘‘tested item’’) generally are also regard, the Treasury Department and the FOR FURTHER INFORMATION CONTACT: determined based on a hypothetical IRS expect that future guidance will distribution of current E&P, with certain Concerning the regulations §§ 1.951–1, address issues concerning the allocation 1.951A–0 through 1.951A–7, 1.6038–2, modifications to account for the and apportionment of expenses in order differences between each tested item and 1.6038–5, Jorge M. Oben at (202) to determine a taxpayer’s foreign tax 317–6934; concerning the regulations and subpart F income. See section credit limitation under section 904. All §§ 1.951A–1(e) and 1.951A–3(g), 951A(e)(1) and § 1.951A–1(d). written comments received in response Jennifer N. Keeney at (202) 317–5045; For purposes of the hypothetical to the proposed regulations and the concerning the regulations §§ 1.1502– distribution, the proposed regulations foreign tax credit proposed regulations 12, 1.1502–32, and 1.1502–51, define ‘‘current E&P’’ for a taxable year Katherine H. Zhang at (202) 317–6848 or are available at www.regulations.gov or as the greater of (i) the E&P of the Kevin M. Jacobs at (202) 317–5332; upon request. Terms used but not corporation for the taxable year concerning the regulations §§ 1.78–1, defined in this preamble have the determined under section 964, or (ii) the 1.861–12, 1.861–12T, and 1.965–7, meaning provided in these final sum of the subpart F income (as Karen J. Cate at (202) 317–6936 (not toll regulations. determined under section 952, as free numbers). increased under section 1 Except as otherwise stated, all section references 951A(c)(2)(B)(ii) and proposed SUPPLEMENTARY INFORMATION: in this preamble are to the Internal Revenue Code. § 1.951A–6(d)) and the tested income of

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the corporation for the taxable year. See The Treasury Department and the IRS that is, to deter the development and proposed § 1.951–1(e)(1)(ii). One agree that the scope of the pro rata share implementation of new transactions or comment asserted that using the term anti-abuse rule should be clarified. arrangements intended to avoid the ‘‘current earnings and profits’’ for this Accordingly, the final regulations clarify operative rule. purpose is confusing because the that the rule applies only to require Another comment recommended an definition differs significantly from the appropriate adjustments to the exception to the pro rata share anti- definition of ‘‘earnings and profits’’ allocation of allocable E&P that would abuse rule for transactions entered into provided in section 964(a), and be distributed in a hypothetical with unrelated parties and for therefore suggested using a different distribution with respect to any share transactions entered into with related term for this purpose. In response to this outstanding as of the hypothetical parties located in the same country of comment, the final regulations replace distribution date. See § 1.951–1(e)(6). tax residence as the relevant CFC. The the term ‘‘current earnings and profits’’ Thus, under the rule, if applicable, comment also recommended a ‘‘small with ‘‘allocable earnings and profits’’ adjustments will be made solely to the business’’ exception for U.S. (‘‘allocable E&P’’). allocation of allocable E&P in the shareholders with worldwide gross hypothetical distribution between receipts under $25 million. The B. Pro Rata Share Anti-Abuse Rule shareholders that own, directly or Treasury Department and the IRS have The proposed regulations provide that indirectly, stock of the CFC as of the determined that the policy concerns any transaction or arrangement that is relevant hypothetical distribution date. underlying the rule can be implicated part of a plan a principal purpose of As clarified, the rule will not apply to by transactions that involve unrelated which is the avoidance of Federal adjust the allocable E&P allocated to a parties, such as accommodation parties income taxation, including, but not shareholder by reason of a transfer of (for instance, a financial institution) that limited to, a transaction or arrangement CFC stock, except by reason of a change hold stock with certain distribution to reduce a U.S. shareholder’s pro rata to the distribution rights with respect to rights in order to reduce an unrelated share of the subpart F income of a CFC, stock in connection with such transfer U.S. shareholder’s pro rata share of which transaction or arrangement (for example, an issuance of a new class subpart F income or tested items. would otherwise avoid Federal income of stock, including by recapitalization). Further, these concerns can arise taxation, is disregarded in determining Other comments suggested that the regardless of whether the parties such U.S. shareholder’s pro rata share of final regulations limit the pro rata share involved are located in the same the subpart F income of the corporation anti-abuse rule to transactions or country of tax residence as the CFC. (the ‘‘pro rata share anti-abuse rule’’). arrangements that lack economic Finally, the Treasury Department and See proposed § 1.951–1(e)(6). The pro substance or are artificial, or only to the IRS have concluded that the level of rata share anti-abuse rule also applies in transactions or arrangements that result gross receipts of the shareholders is not determining the pro rata share of each in non-economic allocations that shift relevant to, and therefore does not subpart F income or tested items away justify, an exception to the rule. Any tested item of a CFC for purposes of from a U.S. shareholder. One comment administrative burden on small determining a U.S. shareholder’s global suggested that the rule should apply businesses would not stem from the rule intangible low-taxed income (‘‘GILTI’’) only to enumerated transactions itself but rather from engaging in a inclusion amount under section 951A(a) identified by the Treasury Department transaction a principal purpose of and § 1.951A–1(b). See id. and the IRS as being abusive, and which is to avoid Federal income Several comments suggested that the another comment suggested that the taxation. Accordingly, these pro rata share anti-abuse rule is regulations should include examples recommendations are not adopted. overbroad and could be interpreted to illustrating transactions to which the C. Facts and Circumstances Approach apply to nearly all transactions, pro rata share anti-abuse rule would or arrangements, or tax elections that would not apply. Section 1.951–1(e)(3)(ii) of the reduce the pro rata share amounts of a The Treasury Department and the IRS existing regulations provides special U.S. shareholder. In particular, do not adopt these recommendations. rules applicable to CFCs with two or comments noted that, under one Transactions that lack economic more classes of stock with discretionary interpretation of the rule, a U.S. substance or are artificial would distribution rights. Under these rules, shareholder that disposes of CFC stock typically be disregarded under general the allocation of current E&P is could be required indefinitely to tax principles, and non-economic primarily based on the relative fair include its ‘‘pro rata share’’ of the CFC’s allocations would generally be market value of the stock with subpart F income or tested items with addressed through the facts and discretionary distribution rights. The respect to such stock. These comments circumstances approach of § 1.951– preamble to the proposed regulations recommended that the final regulations 1(e)(3) (as discussed in part II.C of this notes that this fair market value clarify the scope of the rule and, in Summary of Comments and Explanation allocation method had been the basis of particular, provide that the rule applies of Revisions section), such that limiting certain attempted avoidance structures. only to reallocate subpart F income and the pro rata share anti-abuse rule in the Accordingly, the proposed regulations tested items of a CFC as of a manner recommended could render it adopt a facts and circumstances hypothetical distribution date among superfluous. Moreover, the concerns approach in allocating current E&P in a persons that own, directly or indirectly, underlying the rule may arise in non- hypothetical distribution between shares of the CFC on such date. artificial transactions, or transactions multiple classes of stock, including According to these comments, the rule, with substance, that would be respected stock with discretionary distribution as narrowed in this manner, could not under general tax principles. In rights. See proposed § 1.951–1(e)(3). The apply to cause a U.S. person that addition, attempting to specifically proposed regulations provide that, disposes of stock of a CFC before a identify all the transactions covered by where appropriate, the relative fair hypothetical distribution date to be the rule or to specify such transactions market value of the stock may still be treated as having a pro rata share of the by example would be impractical and taken into account, but as one of several CFC’s subpart F income or tested items inconsistent with one of the purposes factors, none of which is dispositive. as of such date by reason of such stock. underlying any anti-avoidance rule— See id.

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A comment asserted that the facts and approach can distort the determination distributions during the taxable year) as circumstances approach set forth in the required under section 951(a)(2) and of the hypothetical distribution date. proposed regulations is a vague and § 1.951–1(b)(1). A more flexible facts E. Application of Section 951(a)(2)(B) to and circumstances approach that subjective standard that would create Subpart F Income and Tested Income in uncertainty, while the fair market value considers fair market value as a factor the Same Taxable Year approach in the existing regulations for can also take into account other factors stock with discretionary distribution related to the expected distributions of Under section 951(a)(2)(B), a U.S. rights is a long-standing and objective allocable E&P with respect to such shareholder’s pro rata share of subpart standard. The comment further noted stock, without taking into account F income with respect to stock for a that the preamble to the 2005 Treasury capital liquidation rights and other taxable year (as determined under decision that adopts the fair market factors that are not relevant to the section 951(a)(2)(A)) is reduced by the value approach specifically rejects the distribution of allocable E&P. amount of distributions received by any facts and circumstances approach, Accordingly, the final regulations do not other person during the year as a stating that ‘‘the interests of sound tax adopt this recommendation. dividend with respect to the stock, policy and administration are served by subject to a limitation based on the D. Modifications to Example 4 requiring the value-based allocation.’’ period of the taxable year in which the TD 9222, 70 FR 49864 (August 25, The proposed regulations provide that shareholder owned the stock within the 2005). The comment recommended that no amount of current E&P is distributed meaning of section 958(a). Section the fair market value approach be in the hypothetical distribution with 951A(e)(1) provides that the pro rata retained in the final regulations, in lieu respect to a particular class of stock to share of tested income, tested loss, and of the proposed facts and circumstances the extent that a distribution of such QBAI is determined under the rules of approach, for purposes of determining amount would constitute a redemption section 951(a)(2) in the same manner as the pro rata share of subpart F income of stock (even if the redemption would such section applies to subpart F income. Accordingly, the proposed and tested items. be treated as a dividend under sections regulations provide that a U.S. 301 and 302(d)), a distribution in The Treasury Department and the IRS shareholder’s pro rata share of tested liquidation, or a return of capital. See have determined, based on experience income is determined under section proposed § 1.951–1(e)(4)(i). The administering the fair market value 951(a)(2) and § 1.951–1(b) and (e), proposed regulations include an approach, that a facts and circumstances generally substituting ‘‘tested income’’ example to illustrate the application of approach, in which the fair market for ‘‘subpart F income’’ each place it this rule. See proposed § 1.951– value of stock is relevant but not appears. See proposed § 1.951A–1(d)(2). determinative, would be a more reliable 1(e)(7)(v) Example 4. A comment Because section 951(a)(2)(B) applies method for determining a U.S. asserted that proposed § 1.951–1(e)(4)(i) for purposes of determining the pro rata shareholder’s pro rata share of subpart and the example illustrating the rule are share of both subpart F income and F income (and tested items) than the fair confusing because, given the definition tested income, the proposed regulations market value approach. While fair of current E&P in the proposed could be interpreted as permitting a market value is easily determinable for regulations, the hypothetical dollar-for-dollar reduction under section publicly traded stock, determining the distribution would typically not give 951(a)(2)(B) in both a U.S. shareholder’s fair market value of privately-held stock rise to a return of capital (other than pro rata share of subpart F income and is more difficult and typically requires through a redemption). its pro rata share of tested income. The a determination of the stock’s rights to This rule is not intended to refer to Treasury Department and the IRS have distributions of current and the consequences of the hypothetical determined that this would be an accumulated E&P and capital, as well as distribution itself (for example, the inappropriate double benefit that is not the voting rights with respect to such extent to which it could give rise to a contemplated under section 951(a)(2)(B) stock. In contrast, under section return of capital), but rather is intended and section 951A(e)(1). Accordingly, the 951(a)(2) and § 1.951–1(b)(1), a to provide that terms of the stock or regulations under section 951(a)(2)(B) shareholder’s pro rata share of subpart related agreements and arrangements are revised to clarify that a dividend F income is determined based solely on that could give rise to redemptions, received during the taxable year by a a hypothetical distribution of subpart F liquidations, or returns of capital if person other than the U.S. shareholder income for the taxable year. actually exercised (or otherwise taken reduces the U.S. shareholder’s pro rata Furthermore, the amount of subpart F into account) are not taken into account share of subpart F income and its pro income treated as distributed in the for purposes of the hypothetical rata share of tested income in the same hypothetical distribution is determined distribution. The final regulations and proportion as its pro rata share of each under § 1.951–1(e) based on a the related example are clarified to amount bears to its aggregate pro rata distribution of allocable E&P. Thus, the reflect this intent. See § 1.951–1(e)(4)(i) share of both amounts. See § 1.951– most relevant attribute of any share of and § 1.951–1(e)(7)(v) Example 4. 1(b)(1)(ii). CFC stock for purposes of the Similarly, the final regulations clarify The examples in § 1.951–1(b)(2) are hypothetical distribution is its economic that the facts and circumstances taken modified solely to illustrate the rights with respect to the allocable E&P into account in determining the application of the revised rule in of the CFC, which is generally distribution rights of a class of stock do § 1.951–1(b)(1) and to conform to the determined by reference to its current not include actual distributions (or any terminology in the final regulations. The E&P. Generally, a share’s voting rights, amount treated as a dividend) made Treasury Department and the IRS are rights to distributions of E&P during the taxable year that includes the studying the application of section accumulated before the current year, hypothetical distribution date. See 951(a)(2)(A) and (B) in certain cases that and rights to capital, all of which are § 1.951–1(e)(3). Such distributions (or may lead to inappropriate results, for also taken into account in determining dividends) are not relevant in example, due to the concurrent fair market value, are not relevant to the determining a class of stock’s economic application of the provisions. In hypothetical distribution of allocable rights and interest in the allocable E&P addition, the Treasury Department and E&P, and therefore a fair market value (which are not reduced by actual the IRS are studying the application of

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section 951(a)(2)(B) with respect to partnership to determine stock inclusion year’’ means any taxable year dividends paid to foreign persons, ownership in a CFC by a U.S. person for of a foreign corporation beginning after dividends that give rise to a deduction purposes of section 958(a) if certain December 31, 2017, at any time during under section 245A(a), and dividends conditions are met. See proposed which the corporation is a CFC. See paid on stock after the disposition of § 1.951–1(h). A comment suggested that proposed § 1.951A–1(e)(1), (2) and (4). such stock by a U.S. shareholder. because the proposed regulations define Several comments noted that, under Comments are requested in this regard. a ‘‘controlled domestic partnership’’ by certain circumstances, the requirement reference to a specific U.S. shareholder, that a U.S. shareholder take into account F. Revisions to Cumulative Preferred its pro rata share of a CFC’s tested items Stock Rule the rule could be read to apply only with respect to that shareholder but not for a U.S. shareholder inclusion year The proposed regulations provide a with respect to other partners of the that includes a CFC inclusion date special rule applicable to preferred controlled domestic partnership, for could have the effect of requiring a U.S. shares with accrued but unpaid which the partnership would therefore shareholder to take into account its pro dividends that do not compound still be treated as domestic. The rata share of the CFC’s tested items for annually at or above the applicable comment requested that the final a U.S. shareholder inclusion year that Federal rate (‘‘AFR’’) under section regulations clarify that the treatment as does not include the last day of the CFC 1274(d)(1) (‘‘cumulative preferred stock a foreign partnership is with respect to inclusion year. This could happen, for rule’’). See proposed § 1.951–1(e)(4)(ii). all partners of the partnership. The rule, instance, if a U.S. person with a taxable If the cumulative preferred stock rule if applicable, is intended to treat a year ending December 31, 2019, sells a applies with respect to stock, the domestic partnership as a foreign wholly-owned foreign corporation with current E&P allocable to the stock may partnership with respect to all its a taxable year ending November 30, not exceed the amount of dividends partners. The final regulations revise the 2020, to a foreign person on December actually paid during the taxable year definition of controlled domestic 1, 2019 and, as a result of the sale, the with respect to the stock plus the partnership to clarify the scope of the foreign corporation ceases to be a CFC; present value of the unpaid current rule. See § 1.951–1(h)(2); see also in that case, under the proposed dividends with respect to the stock § 1.965–1(e)(2). A change is also made to regulations, the CFC inclusion date with determined by using the AFR that § 1.951–1(h) to conform to the change in respect to the foreign corporation would applies on the date the stock is issued the final regulations to the treatment of be December 1, 2019, whereas the CFC for the term from such issue date to the domestic partnerships for purposes of inclusion year of the foreign corporation mandatory redemption date and section 951A. See part VII.C of this would not end until November 30, 2020. assuming the dividends will be paid at Summary of Comments and Explanation The comments raised several concerns, the mandatory redemption date. See id. in particular, that the U.S. person in this A comment stated that it is unclear of Revisions section. Finally, certain regulations have been example would be unable to determine whether the applicability of the revised to reflect the repeal of section its pro rata share of any tested item of cumulative preferred stock rule is 954(f) (regarding foreign base company the foreign corporation as of December determined based on the AFR as of the shipping income) and section 955 31, 2019, since the foreign corporation’s issuance date or, alternatively, the AFR (regarding foreign investments in less tested items could not be determined for the current year. The comment developed countries). See Public Law until November 30, 2020. The suggested that, because the amount of 108–357, 415(a)(2) (2004) and Public comments also noted that the proposed the preferred dividend determined Law 115–97, 14212(a) (2017). The regulations’ definition of CFC inclusion under the cumulative preferred stock date was inconsistent with section rule is based on the AFR as of the issue Treasury Department and the IRS intend to revise other regulations to reflect the 951A(e)(1), which provides that the pro date, for consistency, the applicability rata share of certain amounts is taken of the rule should be determined by repeal of these provisions in future guidance projects. into account in the taxable year of the reference to the AFR as of the issue date U.S. shareholder in which or with as well. The Treasury Department and III. Comments and Revisions to which the taxable year of the CFC ends. the IRS agree with this comment, and Proposed § 1.951A–1—General The comments recommended that the the final regulations are revised Provisions relevant definitions be revised to accord accordingly. See § 1.951–1(e)(4)(ii). A. CFC Inclusion Date with section 951A(e)(1). The proposed regulations provide that The Treasury Department and the IRS the amount of any arrearage on The proposed regulations provide agree with these comments. cumulative preferred stock is that, for purposes of determining the Accordingly, the final regulations determined taking into account the time GILTI inclusion amount of a U.S. provide that a U.S. shareholder takes value of money principles in the shareholder for a U.S. shareholder into account its pro rata share of a tested cumulative preferred stock rule. See inclusion year, the U.S. shareholder item of a CFC in the U.S. shareholder proposed § 1.951–1(e)(4)(iii). A takes into account its pro rata share of inclusion year that includes the last day comment recommended that the rule be a tested item with respect to a CFC for of the CFC inclusion year. See § 1.951A– clarified to reference the calculation of the U.S. shareholder inclusion year that 1(d)(1). However, consistent with the present value of the unpaid current includes a CFC inclusion date with sections 951(a)(2) and 951A(e)(1), a U.S. dividends described in the cumulative respect to the CFC. See proposed shareholder’s pro rata share of each preferred stock rule. The Treasury § 1.951A–1(d)(1). Under the proposed tested item of a CFC is still determined Department and the IRS agree with this regulations, the term ‘‘U.S. shareholder based on the section 958(a) stock owned comment, and the final regulations are inclusion year’’ means a taxable year of by the shareholder on the last day of the revised accordingly. See § 1.951– a U.S. shareholder that includes a CFC CFC’s taxable year on which it is a CFC 1(e)(4)(iii). inclusion date of a CFC of the U.S. (the ‘‘hypothetical distribution date’’). The proposed regulations contain a shareholder, the term ‘‘CFC inclusion See §§ 1.951–1(e)(1)(i) and 1.951A– special rule for purposes of sections 951 date’’ means the last day of a CFC 1(f)(3). The term ‘‘hypothetical through 964 to treat a controlled inclusion year on which a foreign distribution date’’ in the final domestic partnership as a foreign corporation is a CFC, and the term ‘‘CFC regulations has the same meaning as the

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term ‘‘CFC inclusion date’’ in the reversed in future years when the CFC (to the extent of the dividend and proposed regulations. generates more tested income. liquidation preference) and common The Treasury Department and the IRS stock (to the extent that the B. Pro Rata Share of Certain Tested agree with the comment that the participation right is ‘‘in the money’’), Items approach in the proposed regulations and then allocating QBAI to each 1. Pro Rata Share of QBAI achieves the correct result over a multi- component separately. This issue has year period. Accordingly, the final been mooted because the determination The proposed regulations provide regulations generally adopt the QBAI of a U.S. shareholder’s pro rata share of that, in general, a U.S. shareholder’s pro allocation rule of the proposed QBAI no longer depends on whether the rata share of the QBAI of a tested regulations, with certain modifications stock owned by the shareholder is income CFC is proportionate to the U.S. to the excess QBAI rule to better common or preferred. Accordingly, the shareholder’s pro rata share of the tested effectuate the purposes of the rule. final regulations do not adopt this income of the tested income CFC for the Specifically, the final regulations recommendation. CFC inclusion year. See proposed provide that, in the case of a tested Finally, for the avoidance of doubt, § 1.951A–1(d)(3)(i). However, the income CFC with tested income that is the final regulations clarify that the proposed regulations provide that, to less than ten percent of its QBAI (the aggregate amount of any tested item the extent the amount of a tested income tested income CFC’s ‘‘hypothetical (including QBAI) of a CFC for a CFC CFC’s QBAI is greater than ten times its tangible return’’), a shareholder’s pro inclusion year allocated to the CFC’s tested income for the year (that is, the rata share of QBAI is determined based stock cannot exceed the amount of such point at which the shareholder’s on the shareholder’s pro rata share of tested item of the CFC for the CFC deemed tangible income return this hypothetical tangible return. See inclusion year. See § 1.951A–1(d)(1). § 1.951A–1(d)(3)(ii)(A) and (C). A U.S. (‘‘DTIR’’) attributable to the QBAI would 2. Pro Rata Share of Tested Loss fully offset its pro rata share of the shareholder’s pro rata share of the tested income CFC’s tested income), the hypothetical tangible return is The proposed regulations provide that excess QBAI is allocated solely to determined under the rules for a CFC’s tested loss is allocated based on common shares (and not to preferred determining the shareholder’s pro rata a hypothetical distribution of an amount shares) (the ‘‘excess QBAI rule’’). See share of tested income, for this purpose of current E&P equal to the amount of proposed § 1.951A–1(d)(3)(ii). The treating the hypothetical tangible return tested loss, except that, in general, excess QBAI rule is intended to ensure as tested income. See § 1.951A– tested loss is allocated only to common that a shareholder cannot obtain an 1(d)(3)(ii)(B). In most cases, the excess stock. See proposed § 1.951A– increase in its DTIR by reason of QBAI rule in the final regulations will 1(d)(4)(i)(C). The general rule that tested preferred stock that exceeds the increase produce the same results as the excess loss is allocated only to common stock in its aggregate pro rata share of tested QBAI rule in the proposed regulations. is subject to two exceptions. First, the income from the ownership of the stock. However, unlike the excess QBAI rule proposed regulations allocate tested loss to preferred shares to the extent the Without the excess QBAI rule, U.S. in the proposed regulations, the tested loss reduces the E&P accumulated persons would be incentivized to application of the excess QBAI rule in since the issuance of those preferred acquire debt-like preferred stock of the final regulations is not limited to 2 shares to an amount below the amount CFCs that have significant amounts of preferred stock. Further, with respect necessary to satisfy any accrued but QBAI and minimal tested income in to common stock, by untethering the unpaid dividends with respect to such order to effectively exempt some or all allocation of excess QBAI from the preferred shares. See proposed of the U.S. person’s pro rata shares of allocation of tested income, and instead § 1.951A–1(d)(4)(ii). Second, when the tested income from other CFCs from applying a hypothetical distribution common stock has no liquidation value, taxation under section 951A. The model to the excess QBAI, the rule ensures that the reduction under section the proposed regulations allocate tested preamble to the proposed regulations loss to classes of preferred stock with requested comments on the approach in 951(a)(2)(B) and § 1.951A–1(b)(1)(ii) to a U.S. shareholder’s pro rata share of liquidation value in reverse order of the proposed regulations, including the priority. See proposed § 1.951A– excess QBAI rule, for determining a U.S. tested income does not result in an excessive reduction to the U.S. 1(d)(4)(iii). These two exceptions result shareholder’s pro rata share of a CFC’s in tested loss allocations corresponding QBAI. shareholder’s pro rata share of QBAI. See § 1.951A–1(d)(3)(iii)(C) Example 3. to changes in the economic value of the The only comment received with One comment recommended that the CFC stock. The preamble to the respect to the QBAI allocation approach final regulations allocate QBAI to proposed regulations requested in the proposed regulations agreed that convertible preferred stock or comments on the proposed approach for it was appropriate to limit the allocation participating preferred stock by determining a U.S. shareholder’s pro of QBAI to a preferred shareholder, bifurcating the stock into preferred stock rata share of a CFC’s tested loss, because the debt-like claim that a including how (or whether) to allocate preferred shareholder has on a CFC 2 When the excess QBAI rule in the final tested loss of a CFC when no class of should not entitle it to an amount of regulations applies to a CFC with preferred stock, CFC stock has positive liquidation QBAI that could be used to effectively the increase to the preferred shareholder’s DTIR by reason of the preferred stock generally will be value. exempt tested income of the limited to an amount equal to its pro rata share of Comments were supportive of the shareholder’s other CFCs. The comment tested income, consistent with the purpose of the approach taken in the proposed noted that, in cases where a CFC has rule in the proposed regulations. This is the case regulations to determine pro rata shares because the formula for determining the preferred minimal tested income and substantial shareholder’s pro rata share of QBAI (that is, of tested loss because the approach QBAI, the approach in the proposed multiplying the CFC’s QBAI by the ratio that such avoids complexity, minimizes the regulations could result in a common shareholder’s pro rata share of the hypothetical potential for abusive allocations of shareholder receiving a pro rata share of tangible return bears to the CFC’s total hypothetical tested loss, and is consistent with the tangible return) will yield a product that equals 10 QBAI that is disproportionate to its pro times that shareholder’s pro rata share of tested economic reality that common stock rata share of tested income, but income. For an illustration, see § 1.951A– generally bears the risk of loss before acknowledged that this effect would be 1(d)(3)(iii)(B) Example 2. preferred stock. One comment that was

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supportive of the approach in the income and taxable income of a foreign which, if it were a domestic corporation proposed regulations suggested a corporation. For this purpose, and engaged in such business, would be possible alternative approach of subject to certain exceptions, these rules taxable as a life insurance company to allocating tested loss to preferred shares generally treat foreign corporations as which subchapter L applies, is generally to the extent the preferred shares were domestic corporations. See § 1.952– determined by treating such corporation allocated subpart F income. However, 2(a)(1) and (b)(1). as a domestic corporation taxable under the comment noted that the approach of The preamble to the proposed subchapter L and by applying the the proposed regulations is simpler and regulations requested comments on the principles of §§ 1.953–4 and 1.953–5 for that the suggested approach would application of § 1.952–2 for purposes of determining taxable income. These require additional rules to ensure that determining subpart F income, tested regulations, which were promulgated in corresponding allocations of tested income, and tested loss, including 1964, have not been updated to reflect income were made in future periods to whether other approaches for current sections 953(a), 953(b)(3), and the preferred shares to reflect an actual determining tested income and tested 954(i). A comment requested that the payment of a dividend to the preferred loss, or whether additional final regulations confirm that the rules shares. The Treasury Department and modifications to § 1.952–2 for purposes of current sections 953 and 954(i) apply the IRS agree with the comment that the of calculating tested income and tested in determining the tested income or approach for allocating tested loss in the loss, would be appropriate. Several tested loss of a CFC described in proposed regulations is simpler and that comments were received in response to § 1.952–2(b)(2). The Treasury the suggested approach would require this request. The comments generally Department and the IRS agree that the adjustments to the pro rata share rules supported applying § 1.952–2 for tested income or tested loss of a CFC for tested income as well, resulting in purposes of determining tested income. described in § 1.952–2(b)(2) is more complex tracking of previous year However, a number of comments calculated in the same manner as its pro rata allocations for CFCs and their requested modifications to, or insurance income under sections 953 shareholders to determine current year clarifications regarding, the application and 954(i), and the rule is revised allocations. Accordingly, the suggestion of § 1.952–2. Some comments suggested accordingly. See § 1.951A–2(c)(2)(i). is not adopted. that § 1.952–2 be revised for purposes of However, no inference is intended that One comment recommended that if determining tested income and tested a CFC may determine reserve amounts no class of stock has liquidation value, loss to allow the use of net operating based on foreign statement reserves in the tested loss should be allocated first loss carryforwards under section 172 the absence of a ruling request. See to any shareholders that hold and net capital losses subject to limits section 954(i)(4)(B)(ii). In this regard, guaranteed debt of the CFC, and then to under section 1212. Another comment the Treasury Department and the IRS the most senior class of common stock, requested that the Treasury Department intend to address, in separate guidance, unless another class of stock will in fact and the IRS provide a list of specific the use of foreign statement reserves for bear the economic loss. The Treasury deductions allowed to a CFC that would purposes of measuring qualified Department and the IRS have be disallowed to a domestic corporation, insurance income under section 954(i). determined, based on experience with such as under section 162(m) or 280G. The same comment requested B. Gross Income Excluded by Reason of pro rata share rules in the subpart F Section 954(b)(4) context, that the facts and circumstances clarification that carryforwards of a Section 951A(c)(2)(A)(i)(III) provides approach provides a flexible and CFC’s disallowed interest deduction that gross tested income does not appropriate allocation of tested loss, under section 163(j)(2) are not subject to include any item of gross income including in cases where no class of any limitation or restrictions. Several excluded from foreign base company stock has liquidation value. Therefore, comments suggested that section 245A income (as defined in section 954) this comment is not adopted. should apply to determine a CFC’s subpart F income and tested income and (‘‘FBCI’’) or insurance income (as IV. Comments and Revisions to tested loss under § 1.952–2. There is defined in section 953) ‘‘by reason of Proposed § 1.951A–2—Tested Income also a concern that § 1.952–2 could be section 954(b)(4)’’ (the ‘‘GILTI high tax and Tested Loss interpreted so expansively as to entitle exclusion’’). The proposed regulations clarify that the GILTI high tax exclusion A. Determination of Gross Income and a CFC to a deduction expressly limited applies only to items of gross income Allowable Deductions to domestic corporations, such as a deduction under section 250. that are excluded from FBCI or For purposes of determining tested The Treasury Department and the IRS insurance income solely by reason of an income or tested loss, gross tested intend to address issues related to the election under section 954(b)(4) and income is reduced by deductions application of § 1.952–2, taking into § 1.954–1(d)(5). See proposed § 1.951A– (including taxes) properly allocable to account these comments, in connection 2(c)(1)(iii). Thus, this exclusion does not the gross tested income (or which would with a future guidance project. This apply to any item of gross income be properly allocable to gross tested guidance is expected to clarify that, in excluded from FBCI or insurance income if there were such gross income) general, any provision that is expressly income by reason of an exception other under rules similar to the rules of limited in its application to domestic than section 954(b)(4), regardless of the section 954(b)(5). See section corporations, such as section 250, does effective rate of foreign tax to which 951A(c)(2)(A)(ii). The proposed not apply to CFCs by reason of § 1.952– such item is subject. regulations provide that, for purposes of 2. The Treasury Department and the IRS One comment noted that this determining tested income and tested continue to study whether, and to what clarification is consistent with the loss, the gross income and allowable extent, section 245A should apply to language of the GILTI high tax deductions of a CFC for a CFC inclusion dividends received by a CFC and exclusion, which is limited by its terms year are determined under the rules of welcome comments on this subject. to income subject to the high tax § 1.952–2 for determining the subpart F Section 1.952–2(b)(2) provides that exception of section 954(b)(4). Several income of a CFC. See proposed the taxable income of a CFC engaged in comments, however, requested that the § 1.951A–2(c)(2). Section 1.952–2 the business of reinsuring or issuing final regulations expand the GILTI high provides rules for determining gross insurance or annuity contracts and tax exclusion to exclude additional

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categories of high-taxed income. These loan to its U.S. shareholder, resulting in taxpayers should be permitted to make comments asserted, based on the an inclusion under section 956, or could an election under section 954(b)(4), with legislative history of the Act, that intentionally structure its operations in respect to income that would not be Congress intended that income of a CFC a manner that causes income to be FBCI or insurance income, to exclude would be subject to tax under the GILTI characterized as FBCI. The comment such income from gross tested income regime only if it is subject to a low rate also asserted that a rule that effectively under the GILTI high tax exclusion of foreign tax. Some of these comments permits a taxpayer to elect into subpart using authority other than section suggested that the exclusion be F income is consistent with the 951A(f)(1)(B). In that regard, existing expanded to apply to high-taxed income regulations under section 954, which § 1.954–1(d)(1) does not provide the that would be FBCI or insurance income permit an election to be made with necessary framework for applying the but for the application of one or more respect to high-taxed income under exception under section 954(b)(4) to exceptions in section 954(c), (h), or (i). section 954(b)(4) notwithstanding that income that would be gross tested Others recommended that the final that provision, similar to section 954(a) income, such as rules to determine the regulations apply the GILTI high tax itself, is expressed as a mandatory rule. scope of an item of gross tested income exclusion to any item of gross income See § 1.954–1(d). to which the election applies and rules subject to a sufficiently high effective The final regulations do not adopt to determine the rate of foreign tax on foreign tax rate, regardless of whether these comments. The Treasury such items. Therefore, the Treasury such income would be FBCI or Department and the IRS have declined Department and the IRS are issuing a insurance income but for an exception. to exercise regulatory authority under notice of proposed rulemaking Comments suggested that the Treasury section 951A(f)(1)(B) because that published in the same issue of the Department and the IRS could exercise authority relates to the treatment of a Federal Register as these final their authority under section GILTI inclusion amount, rather than an regulations that will propose a 951A(f)(1)(B) to treat a GILTI inclusion item of gross tested income. A GILTI framework under which taxpayers as a subpart F inclusion that could inclusion amount is determined based would be permitted to make an election potentially be excludible, on an elective on a U.S. shareholder’s pro rata share of under section 954(b)(4) with respect to basis, from FBCI (or insurance income) all the tested items of one or more CFCs income that would otherwise be gross under section 954(b)(4). and, as a result, the determination of the tested income in order to exclude that Comments recommending an extent to which foreign tax is imposed income from gross tested income by expansion of the GILTI high tax on any single item of net income for reason of the GILTI high tax exclusion. exclusion to any item of high-taxed purposes of section 954(b)(4) cannot be However, until the regulations income suggested various methods to made by reference to a GILTI inclusion described in the separate notice of determine the appropriate foreign tax amount. The final regulations also do proposed rulemaking are effective, a rate for this purpose. One comment not permit taxpayers to elect to treat taxpayer may not exclude any item of recommended the same threshold as income that would otherwise be gross income from gross tested income under used for the high tax exception for tested income as subpart F income in section 951A(c)(2)(A)(i)(III) unless the subpart F income under section order to qualify for the exception under income would be FBCI or insurance 954(b)(4)—that is, a rate that is 90 section 954(b)(4). Unlike section income but for the application of section percent of the maximum rate specified 954(b)(4), nothing in section 954(a) or 954(b)(4) and § 1.954–1(d). in section 11 (21 percent), or 18.9 the legislative history suggests that percent. Another comment taxpayers should be permitted to treat C. Gross Income Taken Into Account in recommended a 13.125 percent rate, income that is not described in section Determining Subpart F Income citing the conference report 954(a), such as gross tested income, as 1. In General accompanying the Act that indicated FBCI through a rebuttable presumption that, in general, no residual U.S. tax or otherwise. In addition, this type of Section 951A(c)(2)(A)(i)(II) provides would be owed on GILTI subject to a rebuttable presumption could give rise that gross tested income is determined foreign tax rate greater than or equal to to significant administrability concerns. without regard to any gross income that rate. H.R. Rep. No. 115–466, at 627 These concerns are discussed further in taken into account in determining the (2017) (Conf. Rep.) (‘‘Conference a notice of proposed rulemaking subpart F income of the corporation (the Report’’). published in the same issue of the ‘‘subpart F exclusion’’). Section 952(a) Other comments suggested that even Federal Register addressing an election defines ‘‘subpart F income’’ as the sum if the GILTI high tax exclusion is not under section 954(b)(4) with respect to of certain categories of income, expanded to take into account all high- income that would otherwise qualify as including FBCI and insurance income. taxed income, taxpayers should be tested income. Other than with respect to the permitted to elect to treat income that The Treasury Department and the IRS coordination between the subpart F would otherwise be gross tested income continue to believe that the GILTI high exclusion and section 952(c) (discussed as subpart F income in order to qualify tax exclusion, as articulated in the in part IV.C.2 of this Summary of for the exception under section proposed regulations, reflects a Comments and Explanation of Revisions 954(b)(4), for example, through a reasonable interpretation of section section), the proposed regulations do rebuttable presumption that all income 951A(c)(2)(A)(i)(III) and section not provide guidance on income that is (or alternatively, all high-taxed income) 954(b)(4), for the reasons stated in the ‘‘taken into account in determining the of a CFC is subpart F income. One notice of proposed rulemaking subpart F income’’ of a CFC within the comment asserted that such a rule accompanying the proposed regulations. meaning of the subpart F exclusion. In would be consistent with taxpayers’ Accordingly, the final regulations retain this regard, the final regulations provide historical ability to elect through the the GILTI high tax exclusion without rules for determining gross income choice of transactional or operational modification. See § 1.951A–2(c)(1)(iii). included in FBCI and insurance structure to subject their CFC income to However, the Treasury Department and company for purposes of the subpart F current taxation under subpart F. For the IRS are studying, in light of the exclusion, including by reason of the example, the comment stated that a addition of section 951A by the Act, the application of the de minimis and full taxpayer could cause a CFC to make a appropriate circumstances under which inclusion rules in section 954(b). See

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§ 1.951A–2(c)(4)(ii)(A), (B), and account’’ in determining subpart F E&P recapture rule of section 952(c)(2). § 1.951A–2(c)(4)(iii)(C); see also part income to the extent, and only to the Under that approach, both the subpart F IV.C.3 of this Summary of Comments extent, that the item would be included income subject to E&P limitation in a and Explanation of Revisions section. in subpart F income absent the prior year and gross income in a The final regulations also clarify the application of section 952(c). subsequent year that generates E&P circumstances in which the subpart F The proposed regulations include an giving rise to recapture of subpart F exclusion applies to less common items example that illustrates this rule. See income would be excluded from gross included in subpart F income under proposed § 1.951A–2(c)(4)(ii)(A). In the tested income. section 952(a)(3) through (5) (subpart F example, in Year 1, FS, a CFC wholly The Treasury Department and the IRS income resulting from participation in owned by a U.S. shareholder, has $100x have determined that the section 952(c) or cooperation with certain of foreign base company sales income, coordination rule is consistent with the international boycotts, payments of a $100x loss in foreign oil and gas relevant statutory provisions and results illegal bribes, kickbacks, or other extraction income, and no E&P. In Year in the appropriate amount of income payments, or income derived from any 2, FS has gross income of $100x that is that is subject to tax under sections 951 country during which section 901(j) not otherwise excluded from the and 951A. Gross income that would be applies to that country). See § 1.951A– definition of gross tested income in subpart F income during the current 2(c)(4)(ii)(C) through (E). proposed § 1.951A–2(c)(1)(i) through year but for the application section (v), and no allowable deductions, and 2. Coordination With Section 952(c) 952(c)(1)(A) is literally ‘‘taken into $100x of E&P. The example concludes account’’ in determining subpart F that in Year 1 FS has no subpart F a. In General income in that it potentially gives rise income because of the E&P limitation in The amount of subpart F income for to future subpart F income by reason of section 952(c)(1)(A) and no gross tested a taxable year is subject to the E&P section 952(c)(2). Furthermore, gross income because gross tested income is tested income is not subject to an E&P limitation and recapture provisions in determined without regard to section limitation analogous to the E&P section 952(c). Section 952(c)(1)(A) 952(c). In Year 2, the example concludes limitation on subpart F income under provides that a CFC’s subpart F income that, because FS’s E&P ($100x) exceed section 952(c)(1)(A). In this regard, the for any taxable year cannot exceed its its Year 2 subpart F income ($0), the determination of tested income under E&P for that year. See also § 1.952– subpart F income of Year 1 is recaptured the GILTI regime is based on a taxable 1(c)(1). However, section 952(c)(2) in Year 2 under section 952(c)(2), and provides that, to the extent subpart F FS also has $100x of gross tested income income concept, similar to the income is reduced by reason of the E&P in Year 2 because gross tested income is determination of income earned directly limitation in any taxable year, any determined without regard to section by a U.S. taxpayer, whereas the subpart excess of the E&P of the corporation for 952(c). F regime is rooted in a distributable any subsequent taxable year over the One comment agreed that the section dividend model, and thus predicated on subpart F income for that year is 952(c) coordination rule was an the existence of E&P. Therefore, for recharacterized as subpart F income. appropriate interpretation of the statute, example, a CFC may have $100x of gross See also § 1.952–1(f)(1). An amount noting that the rule preserves the ability tested income but no E&P in a taxable recaptured under section 952(c)(2) is for section 952(c)(2) to recapture subpart year (due, for instance, to a loss in treated as subpart F income in the same F income generated in prior years, while foreign oil and gas extraction income), separate category (as defined in § 1.904– preventing recapture under section and the U.S. shareholder of the CFC 5(a)) as the subpart F income that was 952(c)(2) from permanently exempting (assuming no QBAI or other CFCs) will subject to the E&P limitation in a prior gross tested income generated in nonetheless have a $100x GILTI taxable year. See § 1.952–1(f)(2)(ii). subsequent years. However, several inclusion amount for the taxable year. The Code does not provide a rule that comments suggested that the section This is the result under section 951A explicitly coordinates the subpart F 952(c) coordination rule be withdrawn. notwithstanding that the CFC in this exclusion with section 952(c), which These comments asserted that the case has no net economic income and commenters identified as a source of section 952(c) coordination rule can no E&P for the year. If the same CFC for confusion and potential inconsistency. lead to double taxation because the rule the same taxable year also has $100x of In order to resolve this ambiguity, the can result in the taxation of an aggregate foreign base company sales income and proposed regulations set forth such a amount of CFC income in excess of the $100x of E&P related to such income, in coordination rule by providing that the net economic CFC income over a multi- addition to the $100x GILTI inclusion gross tested income and allowable year period. Some comments further amount, the CFC’s U.S. shareholder deductions properly allocable to gross suggested that the section 952(c) would have a $100x subpart F tested income are determined without coordination rule is contrary to the inclusion. Under these facts, the U.S. regard to the application of section language of the subpart F exclusion, on shareholder is taxed on an aggregate 952(c) (the ‘‘section 952(c) coordination the grounds that any income of a CFC amount of taxable income of the CFC rule’’). See proposed § 1.951A–2(c)(4)(i). that generates E&P that are ($200x) that exceeds the CFC’s net Thus, income that would be subpart F recharacterized as subpart F income by economic income and E&P ($100x). In income but for the application of the reason of the E&P recapture rule is this example, the U.S. shareholder is not E&P limitation in section 952(c)(1)(A) is ‘‘taken into account in determining the subject to tax twice with respect to a excluded from gross tested income by subpart F income’’ of the CFC and single item of income, but rather is reason of the subpart F exclusion. In should therefore be excluded from gross subject to tax once with respect to each addition, income that gives rise to E&P tested income under the subpart F of two items—the CFC’s subpart F that results in subpart F recapture under exclusion. Other comments income of $100x and the CFC’s gross section 952(c)(2) is not excluded from recommended that the section 952(c) tested income of $100x. The section gross tested income by reason of the coordination rule be retained as it 952(c) coordination rule merely ensures subpart F exclusion. In effect, the pertains to the E&P limitation rule that the same result obtains whether all section 952(c) coordination rule treats under section 952(c)(1)(A), but be items of income and loss arise in a an item of gross income as ‘‘taken into modified to exclude from its scope the single year (as in this example) or arise

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in different taxable years (as in the A comment recommended, as an generally pertained to the application of example in proposed § 1.951A– alternative to taking into account the E&P limitation in section 2(c)(4)(ii)(A)). section 952(c)(2) recapture in 952(c)(1)(A), the same issues as The Treasury Department and the IRS determining gross tested income, that discussed in respect to section have also determined that it is not the recapture rules of section 952(c)(2) 952(c)(1)(A) arise with respect to appropriate to exclude the E&P be modified so that E&P derived from application of the qualified deficit rule recapture rule from the scope of the gross tested income does not trigger in section 952(c)(1)(B) and the chain section 952(c) coordination rule. recapture under section 952(c)(2). deficit rule in section 952(c)(1)(C). Because section 951A contains no Although such amount would not be Accordingly, the final regulations revise analog to the E&P limitation in section recaptured as subpart F income, the the section 952(c) coordination rule to 952(c)(1)(A), it also contains no analog comment recommended that, in order to apply also to disregard the effect of a to the E&P recapture rule in section avoid double taxation of the same qualified deficit or a chain deficit in 952(c)(2). Without a GILTI recapture earnings, any recapture account should determining gross tested income. See rule, the approach recommended by nonetheless be reduced by the amount § 1.951A–2(c)(4)(ii). comments would effectively allow prior treated as gross tested income. The One comment requested clarification year losses in categories of income Treasury Department and the IRS have that income subject to the high tax excluded from gross tested income (for determined that this recommendation is exception of section 954(b)(4) is not example, subpart F income or foreign oil inconsistent with the language and included in gross tested income even if and gas extraction income) to purpose of section 952(c)(2). Section such income would also be excluded permanently exempt gross tested 952(c)(2) requires recapture in any from subpart F income by reason of income in subsequent years. For taxable year in which E&P exceed section 952(c)(1)(A). The comment instance, if, in a taxable year, a CFC has subpart F income, and the provided an example in which a CFC $100x of foreign base company sales recommendation would not result in has $100x of foreign base company income, a $100x loss in foreign base recapture in these circumstances. services income, a $100x loss in another company services income, and thus no Further, the purpose of section 952(c)(2) category of subpart F income, no E&P, subpart F income by reason of the E&P is to postpone the inclusion of subpart and thus no subpart F income by reason F income to a subsequent taxable year limitation of section 952(c)(1)(A), any of the E&P limitation of section in which the CFC has sufficient E&P. gross tested income earned by the CFC 952(c)(1)(A). According to the comment, The recommendation, by reducing a in a subsequent year would recapture if the election under section 954(b)(4) is recapture account without recapture of the foreign base company sales income made with respect to the foreign base subpart F income, would result in the from the previous year, and thus such company services income, one permanent exemption of subpart F gross income would never be subject to interpretation of the proposed income. Finally, as illustrated in this section 951A. regulations is that the $100x of foreign part IV.C of the Summary of Comments In excluding certain categories of base company services income is not and Explanation of Revisions section, excluded from gross tested income by income from gross tested income the simultaneous recapture of subpart F (namely, subpart F income, foreign oil income and the inclusion of gross tested either the subpart F exclusion under and gas extraction income, and income does not amount to double section 951A(c)(2)(A)(i)(II) (because effectively connected income), Congress taxation of a single item of income, but such income is not included in subpart not only ensured that such income rather the single taxation of each of two F by reason of the high tax exception of would not be subject to the GILTI items of income. Accordingly, this section 954(b)(4)) or the GILTI high tax regime, but also that losses with respect recommendation is not adopted. exclusion under section to such income would not be permitted A comment recommended as another 951A(c)(2)(A)(i)(III) (because such to reduce income subject to the GILTI alternative that the section 952(c)(2) income is not excluded from subpart F regime. Likewise, section coordination rule not be applied with income ‘‘solely’’ by reason of the high 951A(c)(2)(B)(ii) provides that a loss in respect to recapture accounts that tax exception of section 954(b)(4)). The a category of income subject to the existed before the Act. The comment Treasury Department and the IRS have GILTI regime (that is, tested loss) cannot asserted that it would be inappropriate determined that such clarification is reduce the income subject to the subpart for income that triggers recapture under unnecessary because an election under F regime by reason of the E&P limitation section 952(c)(2) based on pre-Act section 954(b)(4) cannot be made with rule of section 952(c)(1)(A). See also recapture account balances to also be respect to a net item eliminated by § 1.951A–6(b) and part VIII.A of this treated as gross tested income because reason of section 952(c)(1)(A). Section Summary of Comments and Explanation section 951A did not exist before 2018 1.954–1(d)(4)(ii) provides that the net of Revisions section. It is apparent, and therefore no tested losses could item of income to which the high tax based on the purpose and structure of have reduced subpart F income. The exception of section 954(b)(4) applies is section 951A, that Congress intended for final regulations do not adopt this the subpart F income of a CFC the GILTI and subpart F regimes to act recommendation. Nothing in the statute determined after taking into account the as parallel, independent systems of or legislative history suggests that pre- earnings and profits limitation of taxation with respect to prescribed Act recapture account balances should section 952(c)(1)(A). Therefore, the net categories of CFC income, and losses be treated differently than post-Act item of income that can be excluded with respect to one regime (or subject to account balances. Further, there appears under the high tax exception is neither regime) should not be permitted to be no stronger policy rationale for determined after the application of to permanently exempt the income permitting losses that arose before the section 952(c)(1)(A). Indeed, in the subject to another regime. Therefore, an Act to permanently exempt gross tested example presented by the comment, interpretation of section 952(c) that income from taxation than for because the subpart F income of the permits losses related to GILTI-exempt permitting GILTI-exempt losses that CFC after application of the E&P categories of income to reduce gross arise after the Act to do the same. limitation is zero, there is no net item tested income would be contrary to the While the comments with respect to of income for which an election under purpose and structure of section 951A. the section 952(c) coordination rule section 954(b)(4) and § 1.954–1(d)(5) can

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be made. Accordingly, the $100x of section 952(c)(1)(B)(vii)(I). Accordingly, excluded from FBCI or insurance foreign base company services income is the final regulations modify the section income under the de minimis rule or the excluded from gross tested income 952(c) coordination rule to apply only high tax exception of section 954(b)(4), solely by reason of the subpart F with respect to the E&P limitation rules but generally does include any item of exclusion under section of section 952(c)(1) (including the gross income included in FBCI or 951A(c)(2)(A)(i)(II). qualified deficit and chain deficit rules) insurance income under the full and the E&P recapture rule of section inclusion rule. In addition, for purposes b. Coordination With Qualified Deficit 952(c)(2). of the subpart F exclusion, gross income Rule in Section 952(c)(1)(B) taken into account in determining 3. Coordination With De Minimis Rule, The qualified deficit rule in section subpart F income does not include gross Full Inclusion Rule, and High Tax 952(c)(1)(B) reduces a U.S. shareholder’s income that qualifies for an exception to Exception subpart F inclusion attributable to a a category of FBCI described in section qualified activity (defined in section Section 954(a) provides that FBCI for 954(a), including amounts excepted 952(c)(1)(B)(iii)) to the extent of that a taxable year is equal to the sum of from the definition of FPHCI, such as shareholder’s pro rata share of any foreign personal holding company rents and royalties derived from an qualified deficit (defined in section income (as determined under section active business under section 952(c)(1)(B)(ii)). A comment suggested 954(c)) (‘‘FPHCI’’), foreign base 954(c)(2)(A) and § 1.954–2(b)(5) and (6) that a tested loss could, in some cases, company sales income (as determined or active financing income under also give rise to a qualified deficit that under section 954(d)) and foreign base section 954(h). could reduce subpart F income in a company services income (as Section 1.954–1(d)(6) provides that an subsequent taxable year. The comment determined under section 954(e)). item of gross income that is included in asserted that this could occur, for However, section 954(b)(3)(A) provides FBCI or insurance income under the full example, if certain deductions and that if the sum of FBCI (determined inclusion rule (‘‘full inclusion FBCI’’) is losses that make up a qualified deficit without regard to allocable deductions) excluded from subpart F income if more are also properly allocable to gross (‘‘gross FBCI’’) and gross insurance than 90 percent of the gross FBCI and tested income. Accordingly, the income for the taxable year is less than gross insurance income for the taxable comment recommended that the final the lesser of five percent of gross income year (determined without regard to the regulations deny a U.S. shareholder the or $1,000,000, then no part of the gross full inclusion rule) is attributable to net ability to both reduce its net CFC tested income for the taxable year is treated as amounts excluded from subpart F income and increase a qualified deficit FBCI or insurance income (the ‘‘de income under the high tax exception of by reason of the same economic loss. minimis rule’’). Conversely, section section 954(b)(4). The Treasury The Treasury Department and the IRS 954(b)(3)(B) provides that if the sum of Department and the IRS have agree that the same deduction or loss gross FBCI and gross insurance income determined that it would be should not result in a double benefit for the taxable year exceeds 70 percent inappropriate for an item of gross under section 951A and the qualified of gross income, the entire gross income income that would be included in gross deficit rule, but have not identified a for the taxable year is treated as gross tested income but for the full inclusion situation in which a single deduction or FBCI or gross insurance income, as rule to be excluded from both gross loss can both reduce tested income (or appropriate (the ‘‘full inclusion rule’’). tested income (by reason of the subpart increase tested loss) and also give rise One comment requested that the de F exclusion) and subpart F income (by to or increase a qualified deficit. A minimis and full inclusion rules be reason of § 1.954–1(d)(6)). Accordingly, deduction or loss that is properly taken into account for purposes of the final regulations provide that full allocable to gross tested income cannot determining ‘‘gross income taken into inclusion FBCI excluded from subpart F also be attributable to a qualified account’’ in determining subpart F income by reason of § 1.954–1(d)(6) is activity that gives rise to subpart F income within the meaning of the not excluded from gross tested income income, and the same deduction cannot subpart F exclusion. The comment by reason of the subpart F exclusion. be taken into account more than once asserted that such a rule would prevent See § 1.951A–2(c)(4)(iii)(C). The final under sections 954(b)(5) and double taxation because full inclusion regulations further clarify that income 951A(c)(2)(A)(ii). Nevertheless, for the subpart F income would be taxed solely excluded from subpart F income under avoidance of doubt, the final regulations under section 951 (and not section § 1.954–1(d)(6) is also not excluded provide that deductions that are 951A), whereas de minimis subpart F from gross tested income by reason of allocated and apportioned to gross income would be taxed solely under the GILTI high tax exclusion (discussed tested income are not attributable to a section 951A (and not section 951). in part IV.B of this Summary of qualified activity and thus do not also The Treasury Department and the IRS Comments and Explanation of Revisions increase or give rise to a qualified agree with this comment. Accordingly, section). See id. Accordingly, income deficit. See § 1.951A–2(c)(3). subject to the application of the section excluded from subpart F income by 952(c) coordination rule, discussed in reason of § 1.954–1(d)(6) is included in c. Coordination With Section part IV.C.2 of this Summary of gross tested income. 952(c)(1)(B)(vii) Comments and Explanation of Revisions Section 952(c)(1)(B)(vii)(I) contains an section, the final regulations provide D. Effect of Basis Adjustments Under election to apply section 953(a) without that the subpart F exclusion applies to Section 961(c) regard to the same country exception in gross income included in FBCI (adjusted Section 961(c) provides that, under section 953(a)(1)(A). Comments net FBCI as defined in § 1.954–1(a)(5)) regulations prescribed by the Secretary, requested that the section 952(c) or insurance income (adjusted net if a U.S. shareholder is treated under coordination rule be modified to clarify insurance income as defined in § 1.954– section 958(a)(2) as owning stock of a that gross tested income is determined 1(a)(6)). See § 1.951A–2(c)(4)(i). Thus, CFC which is owned by another CFC, after giving effect to the election in for purposes of the subpart F exclusion, then adjustments similar to those section 952(c)(1)(B)(vii)(I). The rule in gross income taken into account in provided under section 961(a) and (b) proposed § 1.951A–2(c)(4) was not determining subpart F income does not are made to the basis in such stock, and intended to address the election in include any item of gross income the basis in stock of any other CFC by

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reason of which the U.S. shareholder is taxable portion of any unrealized last taxable year that is not a CFC considered under section 958(a)(2) as appreciation in the upper-tier CFC inclusion year. See proposed § 1.951A– owning the stock. The provision further stock, to the extent attributable to 3(h)(2)(ii)(D). Income generated by provides, however, that these unrealized appreciation in assets of the fiscal-year CFCs during the disqualified adjustments are made only for the upper-tier CFC, would effectively be period is subject to neither the purposes of determining the amount reduced in an amount equal to the transition tax under section 965 nor the included under section 951 in the gross dividend, either because of a dividend tax on GILTI under section 951A. income of such U.S. shareholder (or any distribution that reduces the value in In response to comments, the successor U.S. shareholder). There are the upper-tier CFC stock without a Treasury Department and the IRS have no regulations in effect under section corresponding basis reduction (section revised these rules in a manner 961(c). 961(d) applies only to the extent loss consistent with the purpose of the rule Comments have questioned whether would otherwise be recognized) or by in the proposed regulations, as basis adjustments under section 961(c) reason of a disposition to the extent the discussed in this part IV.E of the should be taken into account for gain is recharacterized under section Summary of Comments and Explanation purposes of determining gross tested 1248(j) as a dividend for purposes of of Revisions section. Certain comments income of a CFC upon the CFC’s applying section 245A. Comments are and revisions related to the disposition of stock of another CFC. One requested on this issue, including the determination of disqualified basis for comment noted that, while section extent to which adjustments should be purposes of both proposed §§ 1.951A– 951A(f)(1)(A) treats a GILTI inclusion in made to minimize the potential for the 2(c)(5) and 1.951A–3(h)(2) are discussed the same manner as a subpart F same item of income being subject to tax in part IV.E.3 and 4 of this Summary of inclusion for purposes of basis more than once and to minimize the Comments and Explanation of Revisions adjustments under section 961, the inappropriate reduction of gain in CFC section. For a discussion of additional resulting basis under section 961(c) only stock held by corporate U.S. comments and revisions related to the applies for purposes of determining shareholders. determination of disqualified basis for amounts included in gross income purposes of both proposed §§ 1.951A– under section 951. The comment E. Deduction or Loss Attributable to 2(c)(5) and 1.951A–3(h)(2), see part V.G recommended nonetheless that Disqualified Basis of this Summary of Comments and regulations provide that section 961(c) 1. In General Explanation of Revisions section. basis adjustments apply both for 2. Authority purposes of determining subpart F The proposed regulations include a income and gross tested income to rule that generally disallows, for Several comments recommended that prevent certain items of income from purposes of calculating tested income or the rule in proposed § 1.951A–2(c)(5) be being inappropriately taxed twice; the tested loss, any deduction or loss withdrawn or substantially narrowed comment further noted, however, that attributable to disqualified basis in and re-proposed. Some of these unintentional non-taxation should also depreciable or amortizable property comments recommended that the rule be avoided. (including, for example, intangible be revised to apply only to ‘‘non- The interaction of basis adjustments property) resulting from a disqualified economic’’ transactions or transactions under section 961(c) and section 951A transfer of the property. See proposed engaged in with a tax-avoidance will be further considered in connection § 1.951A–2(c)(5). The relevant terms for purpose, or that avoidance-type with a guidance project addressing purposes of applying the rule in transactions be addressed through previously taxed E&P (‘‘PTEP’’) under proposed § 1.951A–2(c)(5) are defined existing statutory or judicial doctrines. sections 959 and 961. See Notice 2019– by reference to certain provisions and One comment recommended that the 1, 2019–2 I.R.B. 275, section 3 terms in proposed § 1.951A–3(h)(2) rule continue to be limited to transfers (announcing an intention to address (disregarding disqualified basis for between related persons because third- PTEP in forthcoming proposed purposes of determining QBAI), with party sales are fundamentally different regulations). The Treasury Department certain modifications. See proposed from the ‘‘non-economic transactions’’ and the IRS are sensitive to the concern § 1.951A–2(c)(5)(iii). In general, the term described in the legislative history. expressed in the comment but are also ‘‘disqualified basis’’ is defined as the However, one comment opposed any aware that taking into account section excess of a property’s adjusted basis additional limitations or weakening of 961(c) basis adjustments for purposes of immediately after a disqualified the anti-abuse rules in the proposed determining gross tested income could transfer, over the sum of the property’s regulations. inappropriately reduce the amount of adjusted basis immediately before the Several comments questioned the stock gain subject to tax. This may occur disqualified transfer and the amount of Treasury Department and the IRS’s because, as was the case before the Act, gain recognized by the transferor in the authority for issuing the rule. Many of section 961(c) adjustments are not taken disqualified transfer that is subject to these comments asserted that section into account for purposes of tax as subpart F income or effectively 951A(d)(4), which provides authority to determining E&P, and thus a disposition connected income. See proposed issue regulations that are ‘‘appropriate of lower-tier CFC stock may generate § 1.951A–3(h)(2)(ii)(A) and (B). The to prevent the avoidance of the purposes E&P for the upper-tier CFC to the extent term ‘‘disqualified transfer’’ is defined of this subsection,’’ does not authorize of the amount of the gain in the stock as a transfer of property by a transferor the Treasury Department and the IRS to determined without regard to section CFC during the transferor CFC’s promulgate rules that apply for any 961(c). If the resulting E&P give rise to disqualified period to a related person purpose other than for purposes of a dividend (including by reason of a in which gain was recognized, in whole determining QBAI under section disposition under section 1248) to a or in part. See proposed § 1.951A– 951A(d). Also, two comments stated corporate U.S. shareholder, the 3(h)(2)(ii)(C). Finally, the term that the disallowance of deductions dividend may result in an offsetting ‘‘disqualified period’’ is defined with under proposed § 1.951A–2(c)(5) is dividends received deduction. See respect to a transferor CFC as the period contrary to, and therefore not authorized sections 245A(a) and 1248(j). If section that begins on January 1, 2018, and ends by, section 951A(c)(2)(A)(ii), which 245A(a) applies to the dividend, the as of the close of the transferor CFC’s requires that the deductions of the CFC

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be allocated to gross tested income income corporation that begins before allocable’’ to gross tested income, under rules similar to the rules of January 1, 2018, which is that foreign subpart F income, or effectively section 954(b)(5) for purposes of corporation’s last taxable year before the connected income of the CFC (‘‘residual calculating tested income or tested loss. transition to the new corporate tax CFC gross income’’). See § 1.951A– In response to these comments, the regime elsewhere in the bill goes into 2(c)(5)(i). Treasury Department and the IRS have effect.’’). Because the final date for While the rules that allocate and revised the proposed rule in a manner measuring the E&P of a CFC for apportion expenses generally depend on that better reflects the source of its purposes of section 965 is December 31, the factual relationship between the authority. Section 7805(a) provides that 2017 (the ‘‘final E&P measurement item of expense and the associated gross ‘‘the Secretary shall prescribe all date’’), and the effective date of section income, the relevant statutory language needful rules and regulations for the 951A is the first taxable year of a CFC in sections 882(c)(1)(A), enforcement of this title, including all beginning after December 31, 2017, all 951A(c)(2)(A)(ii), and 954(b)(5) does not rules and regulations as may be the earnings of a calendar year CFC are constrain the Secretary from taking into necessary by reason of any alteration of potentially subject to taxation under account other considerations in law in relation to internal revenue.’’ either section 965 or section 951A. determining whether it is ‘‘proper’’ for Section 951A(c)(2)(A) defines ‘‘tested However, a fiscal year CFC (for example, a certain item of expense to be allocated income’’ by reference to certain items of a CFC with a taxable year ending to, and therefore reduce, a particular gross income, reduced by ‘‘the November 30) may have a gap between item of gross income. Indeed, the deductions (including taxes) properly its final E&P measurement date under Treasury Department and the IRS are allocable to such gross income under section 965 (December 31, 2017) and the not required to issue rules that rules similar to the rules of section date on which section 951A first applies mechanically allocate an item of 954(b)(5) (or to which such deductions with respect to its income (December 1, expense to gross income to which such would be allocable if there were such 2018, for a CFC with a taxable year expense factually relates if taxable gross income).’’ Section 954(b)(5) ending November 30). Congress was income would be distorted by reason of provides that FPHCI, foreign base aware that taxpayers could take such allocation. In this regard, the company sales income, and foreign base advantage of this period to create ‘‘cost- Treasury Department and the IRS have company services income are reduced, free’’ basis in assets that could be used determined that the rule in § 1.951A– ‘‘under regulations prescribed by the to reduce their U.S. tax liability in 2(c)(5) is necessary to ensure that Secretary,’’ by deductions ‘‘properly subsequent years, and expected the transactions during the disqualified allocable’’ to such income. Similarly, Treasury Department and the IRS to period, the income or earnings from section 882(c)(1)(A) provides that, for issue regulations to prevent this result. which are not subject to tax, are not purposes of determining a foreign See Conference Report, at 645 (‘‘The permitted to improperly reduce or corporation’s income which is conferees intend that non-economic eliminate a taxpayer’s income that effectively connected with the conduct transactions intended to affect tax would be subject to tax after the of a trade or business within the United attributes of CFCs and their U.S. disqualified period. This rule creates States (‘‘effectively connected income’’), shareholders (including amounts of symmetry between the category of ‘‘proper apportionment and allocation’’ tested income and tested loss, tested income generated by reason of a transfer of deductions of the foreign corporation foreign income taxes, net deemed during the disqualified period and the category of income to which any ‘‘shall be determined as provided in tangible income return, and QBAI) to regulations prescribed by the deduction or loss attributable to the minimize tax under this provision be Secretary.’’ The rule, as revised in the resulting basis is allocated. That is, a disregarded. For example, the conferees final regulations, provides guidance for disqualified transfer, by definition, expect the Secretary to prescribe determining whether certain deductions generates residual CFC gross income regulations to address transactions that or losses are ‘‘properly allocable’’ to (income that is not subpart F income, occur after the measurement date of gross tested income, subpart F income, tested income, or effectively connected post-1986 earnings and profits under or effectively connected income within income), and the rule in § 1.951A– amended section 965, but before the the meaning of section 951A(c)(2)(A), 2(c)(5) allocates the deduction or loss first taxable year for which new section section 954(b)(5), or section attributable to the disqualified basis to 951A applies, if such transactions are 882(c)(1)(A), respectively. See, for the same category of income. In the case example, Redlark v. Commissioner, 141 undertaken to increase a CFC’s QBAI.’’). of a depreciable or amortizable asset F.3d 936, 940–41 (9th Cir. 1998) and Consistent with the statute and the with disqualified basis that is held until Miller v. United States, 65 F.3d 687, 690 legislative history, the Treasury the end of its useful life, the aggregate (8th Cir. 1995) (determining that the Department and the IRS have amount of deduction or loss attributable term ‘‘properly allocable’’ in section determined that a deduction or loss to the disqualified basis allocated to 163(e) is ambiguous and therefore there attributable to basis (disqualified basis) residual CFC gross income under the is an implicit legislative delegation of created by reason of a transfer from a rule will equal the amount of residual authority to the Commissioner to define CFC to a related CFC (a disqualified CFC gross income generated in the the term). transfer) during the period between the disqualified transfer. The legislative history to the Act final E&P measurement date and the The rule in proposed § 1.951A–2(c)(5) indicates that section 965 was intended effective date of section 951A (the provides that any deduction or loss as a transition measure to the new disqualified period), to the extent no attributable to disqualified basis is territorial tax system in which section taxpayer included an amount in gross disregarded for purposes of determining 951A applies, and that Congress income by reason of such disqualified tested income or tested loss. In contrast, intended that all earnings of a CFC transfer, should not be permitted to the rule in the final regulations allocates would be potentially subject to tax reduce a taxpayer’s U.S. income tax and apportions any such deduction or under either section 965 or section liability in subsequent years. loss to gross income other than gross 951A. Conference Report, at 613 (‘‘The Accordingly, the final regulations treat tested income, subpart F income, or [transition tax applies in] the last any deduction or loss attributable to effectively connected income. With taxable year of a deferred foreign disqualified basis as not ‘‘properly respect to the determination of tested

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income or tested loss, whether an item inventory would rarely be relevant. CFC1 sells the property to an unrelated of deduction or loss is disregarded Accordingly, the rule in the final party in exchange for $100x of cash and, (under the proposed regulations) or regulations applies to deductions or without regard to proposed § 1.951A– allocated to income other than gross losses attributable to disqualified basis 2(c)(5), recognizes $20x of gain. The tested income (under the final in any property, other than property comments asked whether, under the regulations) does not provide a different described in section 1221(a)(1), rule, the disqualified basis of $70x in result. In either case, the deduction or regardless of whether the property is of the property is disregarded such that the loss is not permitted to reduce tested a type with respect to which a sale results in $90x (rather than $20x) of income or increase tested loss. However, deduction is allowable under section gross tested income to CFC1. by allocating an item of deduction or 167 or 197. See §§ 1.951A–2(c)(5)(iii)(A) The Treasury Department and the IRS loss to residual CFC gross income, the and 1.951A–3(h)(2)(ii). have determined that the rule in rule in the final regulations ensures that One comment asserted that the use of § 1.951A–2(c)(5) should apply only for any deduction or loss attributable to the phrase ‘‘non-economic transactions’’ purposes of determining whether a disqualified basis is also not taken into in the Conference Report means that the deduction or loss is properly allocable account for purposes of determining the authority to draft anti-abuse rules to gross tested income, subpart F CFC’s subpart F income or effectively pursuant to sections 7805 and income, or effectively connected connected income. The broadening of 951A(d)(4) is limited to non-economic income. Thus, disqualified basis is not the rule to allocate any deduction or transactions, which necessitates a facts disregarded for purposes of determining loss attributable to disqualified basis and circumstances test. The rule in income or gain recognized on the away from subpart F income and § 1.951A–2(c)(5) is not premised upon disposition of the property. However, effectively connected income is facts and circumstances, such as a because many taxpayers capitalize intended to ensure that taxpayers taxpayer’s intent; rather, the rule is depreciation or amortization expense to cannot simply circumvent the rule by based on an interpretation of the term other property, including inventory, and converting their gross tested income ‘‘properly allocable’’ in the context of a recover those costs through cost of into either subpart F income or deduction or loss attributable to goods sold or depreciation of the other effectively connected income, and thus disqualified basis. Moreover, the rule property, the final regulations also be permitted to use the deduction or applies only to a narrow subset of provide that any depreciation, loss attributable to the disqualified basis transactions—that is, transfers by fiscal amortization, or cost recovery against such income. The preamble to year CFCs to related parties that occur allowances attributable to disqualified the proposed regulations evidenced an between the final E&P measurement basis is not properly allocable to intention that taxpayers not be date under section 965 and the effective property produced or acquired for resale permitted to claim tax benefits with date of section 951A—and only has the under section 263, 263A, or 471. See respect to cost-free disqualified basis, effect of allocating a deduction or loss § 1.951A–2(c)(5)(i). This rule ensures and the rule in the final regulations attributable to the cost-free basis created that depreciation or amortization effectuates this intent by closing an in such transaction to residual CFC expenses attributable to disqualified obvious loophole. Furthermore, the rule gross income. The Treasury Department basis are not permitted to indirectly ensures that the words ‘‘properly and the IRS have concluded that these reduce taxable income through the allocable’’ are interpreted consistently narrowly circumscribed transactions depreciation expense of other property will in almost all cases be motivated by or from the disposition of inventory. across provisions—sections tax avoidance rather than business As discussed in part V.G of this 882(c)(1)(A), 951A(c)(2)(A)(ii), and exigencies, and that the allocation and Summary of Comments and Explanation 954(b)(5)—with respect to any apportionment of deduction or loss to of Revisions section, disqualified basis deduction or loss attributable to residual CFC gross income is an is generally reduced or eliminated to the disqualified basis. appropriately tailored measure to extent that such basis reduces taxable The rule in proposed § 1.951A–2(c)(5) address these transactions. income. Therefore, a sale of property applies only to deductions or losses Based on the foregoing, the Treasury with disqualified basis generally results attributable to disqualified basis in Department and the IRS have concluded in the elimination of the disqualified ‘‘specified property,’’ which is defined that the rule in § 1.951A–2(c)(5), with basis, because the basis is taken into as property that is of a type with respect the modifications discussed in this part account in determining the CFC’s to which a deduction is allowable under IV.E of the Summary of Comments and taxable income. As a result, absent a section 167 or 197. See proposed Explanation of Revisions section, special provision, a CFC could § 1.951A–2(c)(5)(ii). The Treasury represents an appropriate exercise of its ‘‘cleanse’’ the disqualified basis in Department and the IRS have authority under sections 951A and property by selling the property to a concluded, however, that the rule 7805. related person after the disqualified should not be limited to specified period; the related person would have property because deductions or losses 3. Effect of Disqualified Basis for no disqualified basis in the property, attributable to disqualified basis in other Purposes of Determining Income or Gain and the selling CFC would recognize property may also be used to Some comments noted that the rule in income only to the extent the amount inappropriately reduce a taxpayer’s U.S. proposed § 1.951A–2(c)(5) addresses realized exceeded its adjusted basis in income tax liability. On the other hand, only deductions or losses attributable to the property (for this purpose, including the Treasury Department and the IRS disqualified basis and does not address its disqualified basis). To address this have concluded that it would be unduly the effect of disqualified basis in obvious loophole, the final regulations burdensome to require CFCs to determining a CFC’s income or gain provide that, except to the extent that determine the disqualified basis in each upon the disposition of property. For any loss recognized on the transfer of item of inventory and that it is example, assume USP, a domestic such property is treated as attributable reasonable to expect that most inventory corporation, wholly owns CFC1, which to disqualified basis under § 1.951A– acquired during the disqualified period holds property with a fair market value 2(c)(5), or the basis is reduced or will be sold at a gain such that the of $100x and an adjusted basis of $80x, eliminated in a nonrecognition disqualified basis in an item of $70x of which is disqualified basis. transaction within the meaning of

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section 7701(a)(45), a transfer of are taxed under sections 882 and 951. reduced by the amount of the property with disqualified basis in the Accordingly, this recommendation is disqualified basis and the disqualified hands of a CFC to a related person does not adopted. basis is eliminated. See § 1.951A– not reduce the disqualified basis in the Section 901(m) disallows certain 3(h)(2)(ii)(B)(3). This reduction in hands of the transferee. See § 1.951A– foreign tax credits on foreign income not adjusted basis is for all purposes of the 3(h)(2)(ii)(B)(1)(ii). Thus, for example, if taken into account for U.S. tax purposes Code, including section 901(m). Thus, if a CFC sells property with an adjusted as a result of a ‘‘covered asset an election is made, a disqualified basis of $80x and disqualified basis of acquisition,’’ which includes an transfer of property that is also a $70x to a related person for $100x in a acquisition of assets for U.S. tax covered asset acquisition of a relevant fully taxable exchange, the selling CFC purposes that is treated as the foreign asset will result in neither would recognize $20x of gross income acquisition of stock of a corporation (or disqualified basis in the property within on the sale, which income may be is disregarded) for foreign tax purposes the meaning of § 1.951A–3(h)(2)(ii) nor included in gross tested income, and the and an acquisition of an interest in a a basis difference with respect to the disqualified basis in the property partnership which has an election in relevant foreign asset within the immediately after the transfer would effect under section 754. See section meaning of section 901(m)(3)(C). As a remain $70x in the hands of the related 901(m)(2)(B) and (C). One comment result, in the case of an election, the rule person. noted that a disqualified transfer subject in § 1.951A–2(c)(5) and section 901(m) to the rule in proposed § 1.951A–2(c)(5) will not apply concurrently with respect 4. Concurrent Application of the Rule could also constitute a covered asset With Other Provisions to a disqualified transfer that is also a acquisition under section 901(m), such covered asset acquisition. One comment asserted that if the as the sale of an interest in a disregarded Treasury Department and the IRS retain entity during the disqualified period. In F. Other Comments and Revisions the rule in proposed § 1.951A–2(c)(5), such a case, according to the comment, 1. Tested Loss Carryforward then the disqualified transfer should be a deduction or loss that is not taken into disregarded for all U.S. tax purposes, account for purposes of determining In determining a U.S. shareholder’s including for purposes of determining tested income or tested loss under the net CFC tested income for a taxable the gain or loss recognized by the rule may nevertheless be taken into year, the U.S. shareholder’s aggregate transferor CFC by reason of the transfer account for purposes of section 901(m) pro rata share of tested losses for the and the tax attributes of the transferor such that foreign tax credits under taxable year reduces the shareholder’s CFC created by reason of the transfer. section 960 might be disallowed. The aggregate pro rata share of tested income The comment expressed concern with comment asserted that the concurrent for the taxable year. See section potentially adverse consequences to the application of the rule and section 951A(c)(1). Comments recommended transferor CFC from the concurrent 901(m) could be unduly punitive to that the final regulations include a application of the rule and certain other taxpayers that engaged in disqualified provision allowing a U.S. shareholder’s provisions, such as incremental subpart transfers that were also covered asset aggregate pro rata share of tested losses F income generated by reason of the acquisitions and therefore in excess of the shareholder’s aggregate transfer, additional E&P that could recommended that a deduction or loss pro rata share of tested income for the dilute foreign tax credits with respect to attributable to disqualified basis also be taxable year to be carried forward to a subpart F inclusion, and immediate disregarded for purposes of section offset the shareholder’s net CFC tested U.S. taxation on any effectively 901(m). income in subsequent years. connected income under section 882 Disqualified basis could give rise to A GILTI inclusion amount is an from the transfer. policy concerns under section 901(m) annual calculation, and nothing in the As discussed in part IV.E.2 of this even when a deduction attributable to statute or legislative history suggests Summary of Comments and Explanation the disqualified basis is not taken into that unused items, such as a U.S. of Revisions section, the rule in account in determining tested income or shareholder’s aggregate pro rata share of § 1.951A–2(c)(5) is intended to provide tested loss (or subpart F income or tested losses in excess of the guidance on determining whether effectively connected income). For shareholder’s aggregate pro rata share of deductions of a CFC attributable to example, a deduction or loss tested income for the taxable year, can disqualified basis are properly allocable attributable to the disqualified basis can or should be carried to another taxable to gross tested income, subpart F reduce E&P for a taxable year, with the year. Accordingly, this recommendation income, and effectively connected result that subpart F income for the is not adopted. income. The rule is not intended to taxable year may be limited under 2. Deemed Payments Under Section disregard the transfer that created the section 952(c)(1)(A). Indeed, proposed 367(d) disqualified basis in its entirety. § 1.901(m)–5(b)(1) provides that basis Moreover, the Treasury Department and differences must be taken into account In general, section 367(d) provides the IRS have determined that under section 901(m) regardless of that if a U.S. person transfers intangible disregarding the transfer for all U.S. tax whether the deduction is deferred or property to a foreign corporation in an purposes is not appropriate because the disallowed for U.S. income tax exchange described in section 351 or property has in fact been transferred. In purposes. 361, the person is treated as having sold addition, disqualified basis in property Based on the foregoing, the Treasury the property in exchange for payments does not include basis resulting from Department and the IRS have contingent upon the productivity, use, ‘‘qualified gain,’’ which is gain from the determined that it is not appropriate to or disposition of such property. The transfer included by the transferor CFC disregard disqualified basis for purposes regulations under section 367(d) as effectively connected income or by a of section 901(m). However, in response provide that the deemed payment may U.S. shareholder as its pro rata share of to this comment, the final regulations be treated as an expense (whether or not subpart F income. See § 1.951A– permit taxpayers to make an election that amount is actually paid) of the 3(h)(2)(ii)(C)(3). Thus, the rule in pursuant to which the adjusted basis in transferee foreign corporation that is § 1.951A–2(c)(5) does not apply to basis each property with disqualified basis properly allocated and apportioned to created in connection with amounts that held by a CFC or a partnership is gross income subject to subpart F under

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the provisions of §§ 1.954–1(c) and the taxable year. See section 951A(b)(1) Thus, the statute, taking into account 1.861–8. See § 1.367(d)–1T(c)(2)(ii) and and § 1.951A–1(c)(1). A U.S. the footnote in the Conference Report, (e)(2)(ii). shareholder’s net DTIR is equal to 10 unambiguously provides that tested loss In response to comments, the final percent of its aggregate pro rata share of CFCs cannot have QBAI. Accordingly, regulations clarify that a deemed the QBAI of its CFCs. See section the final regulations retain the tested payment under section 367(d) is treated 951A(b)(2) and § 1.951A–1(c)(3). A loss QBAI exclusion. But cf. part VI.D of as an allowable deduction for purposes CFC’s QBAI is equal to its aggregate this Summary of Comments and of determining tested income and tested average adjusted basis in specified Explanation of Revisions section loss. See § 1.951A–2(c)(2)(ii). tangible property. See section 951A(1) regarding a reduction to tested interest Accordingly, consistent with the and proposed § 1.951A–3(b). Specified expense of a CFC for a ‘‘tested loss QBAI regulations under section 367(d), such tangible property is defined as tangible amount,’’ a new component in deemed payments may be allocated and property used in the production of computing specified interest expense. apportioned to gross tested income to tested income. See section One comment requested that, if the the extent provided under § 1.951A– 951A(d)(2)(A) and proposed § 1.951A– tested loss QBAI exclusion is retained, 2(c)(3). 3(c)(1). Consistent with the statute and proposed § 1.951A–3(b) and (c) should the Conference Report, the proposed be revised to clarify that the exclusion 3. Compute Tested Income in the Same regulations clarify that tangible property applies only for a CFC inclusion year Manner as E&P of a tested loss CFC is not used in the with respect to which a CFC is a tested A comment requested that the final production of tested income within the loss CFC. The final regulations do not regulations provide that tested income meaning of section 951A(d)(2)(A). See revise these provisions because it is and tested loss be determined under the Conference Report, at 642, fn. 1536. In sufficiently clear that the tested loss principles of section 964, which this regard, the proposed regulations QBAI exclusion rule applies only with provides rules for the calculation of E&P provide that tangible property of a respect to a CFC inclusion year of a CFC of foreign corporations. Another tested loss CFC is not specified tangible for which it is a tested loss CFC and that comment requested that the final property and thus a tested loss CFC’s a CFC is a tested loss CFC only for a regulations permit small CFCs to make QBAI is zero (the ‘‘tested loss QBAI CFC inclusion year in which the CFC an annual election to treat their tested exclusion’’). See proposed § 1.951A– does not have tested income. See income or tested loss for a CFC 3(b), (c)(1), and (g)(1). § 1.951A–2(b)(2). Comments recommended that the inclusion year to be equal to their E&P B. Determination of Depreciable final regulations eliminate the tested for such CFC inclusion year. Section Property 951A(c)(2) is clear that tested income or loss QBAI exclusion, such that a tested Section 951A(d)(1)(B) provides that tested loss for a CFC inclusion year is loss CFC could have specified tangible specified tangible property is taken into computed by subtracting properly property and therefore QBAI. One of the account in determining QBAI only if the allocable deductions from gross tested comments noted that the version of property is of a type with respect to income, and there is nothing in the section 951A in the House bill defined which a depreciation deduction is statute or legislative history that specified tangible property as any allowable under section 167. Similarly, indicates that tested income or tested tangible property to the extent such the proposed regulations define loss should be limited by, or otherwise property is used in the production of ‘‘specified tangible property’’ as tangible determined by reference to, E&P for tested income or tested loss. See H.R. 1, property used in the production of such year. Accordingly, these 115th Cong. § 4301(a) (2017). The tested income, and define ‘‘tangible recommendations are not adopted. comment posited that the text of the statute is ambiguous, the tested loss property’’ as property for which the 4. Effect of Losses in Other Categories of QBAI exclusion is otherwise depreciation deduction provided by Income inconsistent with section 951A, and the section 167(a) is eligible to be The proposed regulations provide that exclusion is not compelled by the determined under section 168 (even if allowable deductions are allocated and statute. The comment also asserted that the CFC has elected not to apply section apportioned to gross tested income this rule may be easily avoided by 168). See proposed § 1.951A–3(c)(1) and under the principles of section 954(b)(5) combining a tested loss CFC with a (2). A comment recommended that, for and § 1.954–1(c), by treating gross tested tested income CFC (including through purposes of determining QBAI, the final income within a single category (as an election under § 301.7701–3 to regulations take into account the entire defined in § 1.904–5(a)) as a single item change the classification of either entity adjusted basis in precious metals and of gross income, in addition to the items for U.S. tax purposes) because there is other similar tangible property that are in § 1.954–1(c)(1)(iii). See proposed no corollary to the tested loss QBAI used in the production of tested income, § 1.951A–2(c)(3). The final regulations exclusion for partnerships or even if only a portion of the adjusted clarify that losses in other categories of disregarded entities. The Treasury Department and the IRS basis in such property is depreciable in income (such as FBCI) cannot reduce reject this recommendation. The Senate calculating regular taxable income. The gross tested income, and that tested amendment to the House bill struck the comment suggested that if property is losses cannot reduce other categories of reference to ‘‘tested loss’’ in the depreciable in part, then the entire asset income. See § 1.951A–2(c)(3). definition of specified tangible property, is ‘‘of a type’’ with respect to which a V. Comments and Revisions to and the Conference Report explains that deduction is allowable under section Proposed § 1.951A–3—Qualified the term ‘‘used in the production of 167 within the meaning of section Business Asset Investment tested income’’ means that ‘‘[s]pecified 951A(d)(1)(B). tangible property does not include In defining QBAI, section 951A(d) A. Inability of Tested Loss CFCs To property used in the production of a distinguishes between depreciable Have QBAI tested loss, so that a CFC that has a tangible property and non-depreciable A U.S. shareholder’s GILTI inclusion tested loss in a taxable year does not tangible property, such as land. Section amount is equal to the excess of its net have QBAI for the taxable year.’’ See 951A(d) defines QBAI as specified CFC tested income over its net DTIR for Conference Report, at 642, fn.1536. tangible property ‘‘of a type’’ for which

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a deduction is allowable under section basis of the depreciable portion of the determined using cost depletion, rather 167. The proposed and final regulations metal generally should reflect the net than percentage depletion. interpret the phrase ‘‘of a type’’ present value of the expected returns Section 951A(d)(1)(B) limits property consistent with the interpretation of the generated by the metal. QBAI is a proxy taken into account in determining QBAI phrase ‘‘of a character’’ with respect to for the base upon which non- to tangible property of a type with section 168. See Rev. Rul. 2015–11, extraordinary, tangible returns should respect to which a deduction is 2015–21 I.R.B. 975. See § 1.951A–3(c)(2) be calculated. See S. Comm. on the allowable under section 167. Congress (defining tangible property as property Budget, Reconciliation did not extend the definition of QBAI to for which the depreciation deduction Recommendations Pursuant to H. Con. property of a type with respect to which provided by section 167(a) is eligible to Res. 71, S. Print No. 115–20, at 371 a deduction is allowed under section be determined under section 168 (with (2017) (‘‘Senate Explanation’’) (The 611 (the allowance of deduction for certain exclusions)). The Treasury provision approximates . . . tangible depletion). Although the comment Department and the IRS determined that income . . . as a 10-percent return on focused on the similarities between cost for consistency, the same standard for . . . the adjusted basis in tangible depletion and depreciation, there are determining whether property is depreciable property.’’). Therefore, only also similarities between cost depletion depreciable should apply for the depreciable portion of the precious of mineral properties and the determining whether property qualifies metal, which is associated with the acquisition cost of inventory. The as QBAI. tangible returns, should be taken into inventory cost of a severed mineral In Newark Morning Ledger Co. v. account in this measurement. Given that includes the cost depletion attributable United States, 507 U.S. 546 (1993), the liquid commodity markets exist for to the severed mineral. See section 263A Supreme Court provided that these precious metals, taxpayers could and § 1.263A–1(e)(3)(ii)(J). In essence, ‘‘[w]hether or not . . . a tangible asset, sell the future rights to the recoverable the acquisition cost of the mineral is depreciable for Federal income tax portion of the asset (thereby reducing property recovered through cost purposes depends upon the their economic outlay and exposure depletion is the inventory cost of the determination that the asset is actually with respect to the property). Cf. severed mineral, and QBAI does not exhausting, and that such exhaustion is Guardian Industries v. Commissioner, include inventory. Accordingly, the susceptible of measurement.’’ Newark 97 T.C. 308 (1991) (taxpayer regularly recommendation is not adopted. Morning Ledger Co. v. United States at sold silver waste from photographic 566. Although unrecoverable The proposed regulations define development process to refiners). Thus, ‘‘tangible property’’ as property for commodities used in a business are the depreciable portion of the asset depreciable, recoverable commodities which the depreciation deduction represents the taxpayer’s economic provided by section 167(a) is eligible to used in a business are not depreciable investment in generating tangible because they do not suffer from be determined under section 168 returns. Accordingly, the comment is without regard to section 168(f)(1), (2), exhaustion, wear and tear, or not adopted. obsolescence over a determinable useful or (5) and the date placed in service. See The comment also requested that in life. O’Shaughnessy v. Commissioner, proposed § 1.951A–3(c)(2). Section calculating the adjusted basis in 332 F.3d 1125 (8th Cir. 2003); Arkla, 168(k) increases the depreciation precious metals for QBAI purposes, the Inc. v. United States, 765 F.2d 487 (5th deduction allowed under section 167(a) final regulations provide that class lives Cir. 1985). The recoverable quantity of with respect to qualified property, a commodity used in the business applied to precious metals for purposes which includes tangible and certain suffers no change in its physical of the alternative depreciation system intangible property. The final characteristics or value as a result of its (‘‘ADS’’) are the same class lives regulations revise the definition of use in the business. The comment determined under the principles of Rev. tangible property in § 1.951A–3(c)(2) to seemed to imply that precious metals Rul. 2015–11, rather than the ADS class exclude certain intangible property to were a single unit of property that was lives of the equipment to which the which section 168(k) applies, namely, partially depreciable and partially non- precious metals attach. This computer software, qualified film or depreciable, rather than quantities of recommendation is not adopted because television productions, and qualified metal in separate categories of property, Rev. Rul. 2015–11 does not establish live theatrical productions described in one of which is depreciable. principles for determining class lives of section 168(k)(2)(A). The Treasury Department and the IRS the precious metals discussed therein, but rather addresses whether certain C. Determination of Basis Under have determined that it would not be Alternative Depreciation System appropriate for purposes of determining precious metals are depreciable under a CFC’s QBAI to take into account the the facts and circumstances described in For purposes of determining QBAI, CFC’s entire adjusted basis in an asset the ruling. the adjusted basis in specified tangible that is only partially depreciable. Taking One comment requested that all property is determined by using ADS into account basis that is not subject to expenditures paid or incurred with under section 168(g), and by allocating a depreciation allowance would respect to the acquisition, exploration, the depreciation deduction with respect overstate a CFC’s QBAI. For example, in and development of a mine or other to such property for the CFC inclusion the case of precious metals that are natural deposit should be taken into year ratably to each day during the partially depreciable, such as platinum account in determining QBAI. The period in the taxable year to which such used in a catalyst, a portion of the metal comment stated that such exploration depreciation relates. See section may be subject to exhaustion, wear and and development costs for mining 951A(d)(3) 3 and § 1.951A–3(e)(1). ADS tear, or obsolescence during its useful operations are ‘‘of a type’’ for which life. The remainder of the metal is depreciation is allowed, even though 3 As enacted, section 951A(d) contains two recoverable for reuse or sale. When the costs are recovered through paragraphs designated as paragraph (3). The section initially purchased, the value and tax depletion rather than depreciation. The 951A(d)(3) discussed in this part V.C of the Summary of Comments and Explanation of basis of the recoverable portion comment also recommended that the Revisions section relates to the determination of the generally should reflect the forward adjusted basis in a mine or other natural adjusted basis in property for purposes of price of such metal. The value and tax deposit included as QBAI should be calculating QBAI.

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applies to determine the adjusted basis warranted for CFCs that are not required of accounting used by the CFC for in property for purposes of determining to use ADS for purposes of computing purposes of determining its tested QBAI regardless of whether the property income and E&P. Accordingly, the final income and tested loss. See § 1.951A– was placed in service before the regulations provide that a CFC that is 3(e)(1). enactment of section 951A, or whether not required to use ADS for purposes of A change to ADS from another the basis in the property is determined computing income and E&P may elect, depreciation method for purposes of under another depreciation method for for purposes of calculating QBAI, to use computing tested income or tested loss other purposes of the Code. See section its non-ADS depreciation method to is a change in method of accounting 951A(d)(3) and § 1.951A–3(e)(2). In determine the adjusted basis in subject to section 446(e). The Treasury addition, for purposes of determining specified tangible property placed in Department and the IRS expect that income and E&P, a CFC is generally service before the first taxable year many CFCs that are not already using required to use ADS for depreciable beginning after December 22, 2017, ADS for purposes of computing income property used predominantly outside subject to a special rule related to and E&P will change their method of the United States. See section 168(g) salvage value. See § 1.951A–3(e)(3)(ii). accounting for depreciation to the and §§ 1.952–2(c)(2)(ii) and (iv) and The election also applies to the straight-line method, the applicable 1.964–1(a)(2). However, a CFC may determination of a CFC’s partner recovery period, or the applicable instead use for this purpose a adjusted basis under § 1.951A–3(g)(3) in convention under ADS to comply with depreciation method used for its books partnership specified tangible property § 1.952–2(c)(2)(iv) and § 1.964– of account regularly maintained for placed in service before the CFC’s first 1(c)(1)(iii)(c) and that most of such accounting to shareholders or a method taxable year beginning after December changes are already eligible for conforming to United States generally 22, 2017. See id. This transition rule automatic consent under Rev. Proc. accepted accounting principles (a ‘‘non- does not apply for purposes of 2015–13, 2015–5 I.R.B. 419. The ADS depreciation method’’) if the determining the foreign-derived Treasury Department and the IRS intend differences between ADS and the non- intangible income (‘‘FDII’’) of a to publish another revenue procedure ADS depreciation method are domestic corporation. Cf. section further expanding the availability of immaterial. See §§ 1.952–2(c)(2)(ii) and 250(b)(2)(B) (in calculating deemed automatic consent for depreciation (iv) and 1.964–1(a)(2). tangible income return for purposes of changes and updating the terms and A comment recommended that ADS FDII, QBAI is generally determined conditions in sections 7.07 and 7.09 of not be required under section 951A(d) under section 951A(d)). Rev. Proc. 2015–13 (related to the for specified tangible property placed in A comment requested that the final source, separate limitation service before the enactment of section regulations confirm that the use of ADS classification, and character of section 951A. This comment asserted that in determining the basis in specified 481(a) adjustments) to take into account section 951A(d)(3) does not compel the tangible property, whether placed in section 951A. After the change in conclusion that ADS must be used for service before or after the enactment of accounting method, the basis in assets placed in service before the section 951A, for purposes of specified tangible property will be the enactment of section 951A, and cited determining QBAI is not a change in correct basis for purposes of compliance concerns as a justification method of accounting or, if it is a determining income, E&P, and QBAI. for not requiring the use of ADS with change in method, that global approval The final regulations clarify the respect to such assets. Another under section 446(e) be given for such interaction between the daily proration comment recommended that the final a change. Another comment of depreciation rule in section regulations permit taxpayers to elect to recommended that a CFC switching to 951A(d)(3) and the applicable compute the adjusted basis in all ADS for property placed in service convention under ADS. Under section specified tangible property of a CFC— before the enactment of section 951A 951A(d)(3), the adjusted basis in not just specified tangible property should not be required to file Form 3115 property is determined by allocating the placed in service before the enactment to request an accounting method change depreciation deduction with respect to of section 951A—under the method that for depreciation, and that the property to each day during the period the CFC uses to compute its tested cumulative adjustment should be taken in the taxable year to which the income and tested loss, even if such into account for the adjusted basis in the depreciation relates. The half-year method is not ADS. specified tangible property as of the convention, mid-month convention, and Section 951A(d)(3) is clear that the CFC’s first day of the first year to which mid-quarter convention in section adjusted basis in specified tangible section 951A applies. 168(d) treat property as placed in property is determined using ADS The determination of the adjusted service (or disposed of) for purposes of under section 168(g), and therefore the basis in property under section 951A(d) section 168 at the midpoint of the final regulations do not adopt the is not a method of accounting subject to taxable year, month, or quarter, as recommendation to permit taxpayers an the consent requirement of section applicable, irrespective of when the election to compute the adjusted basis 446(e). As a result, a CFC does not need property was placed in service (or in all specified tangible property under the Commissioner’s consent to use ADS disposed of) during the taxable year. the CFC’s non-ADS depreciation for purposes of determining its adjusted The final regulations clarify that the method. However, recognizing the basis in specified tangible property in period in the CFC inclusion year to potential burden of re-determining the determining its QBAI. A CFC that uses which such depreciation relates is basis under ADS of all specified tangible ADS for purposes of determining QBAI determined without regard to the property held by a CFC placed in should determine the correct basis in applicable convention under section service before the enactment of section the property under ADS as of the CFC’s 168(d). See § 1.951A–3(e)(1). 951A, and given that a non-ADS first day of the first taxable year to Accordingly, in the year property is depreciation method is permissible only which section 951A applies and apply placed in service, the depreciation when there are immaterial differences section 951A(d)(3) accordingly. The deduction allowed for the taxable year between ADS and such other method, final regulations also clarify that the is prorated from the day the property is the Treasury Department and the IRS adjusted basis in property is determined actually placed in service, and, in the have determined that a transition rule is based on the cost capitalization methods year property is disposed of, the

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depreciation deduction allowed for the substantial uncertainty and controversy. the property for the entire taxable year. taxable year is prorated to the date of In addition, the Treasury Department In this regard, there is no ambiguity in disposition. Allocating depreciation to and the IRS have determined that the the language in the regulations, and each day during the period in which the rules under section 861 for allocating a therefore no need for additional property is used irrespective of the depreciation or amortization deduction clarification. applicable convention ensures that the attributable to property owned by a CFC The rules in § 1.951A–3 do not apply average of the aggregate adjusted basis to categories of income of the CFC in determining QBAI for purposes of as of the close of each quarter is represent a reliable and well-understood computing the deduction of a domestic properly adjusted to reflect the proxy for determining the type of corporation under section 250 for its depreciation allowed for the taxable income produced by the property, even FDII. See proposed § 1.250(b)–2 (REG– year. in circumstances where there is no 104464–18, 84 FR 8188 (March 6, 2019)) The Treasury Department and the IRS income that is ‘‘directly identifiable’’ for the QBAI rules related to the FDII continue to study issues related to the with the property. Accordingly, the final deduction. However, it is anticipated determination of QBAI for purposes of regulations provide that the dual use that, except as indicated in part V.D of section 951A. In particular, the Treasury ratio, with respect to tangible property this Summary of Comments and Department and the IRS are aware that for a CFC inclusion year, is the ratio Explanation of Revisions section with a CFC that is a partner in a foreign calculated as the sum of the amount of respect to the election to use a non-ADS partnership may have difficulty the depreciation deduction with respect depreciation method for assets placed in determining the basis in partnership to the property for the CFC inclusion service before the enactment of section property under ADS, particularly when year that is allocated and apportioned to 951A, revisions similar to the revisions the partnership is not controlled by U.S. gross tested income for the CFC to proposed § 1.951A–3 discussed in persons. Comments are requested on inclusion year under § 1.951A–2(c)(3) parts V.B through E of this Summary of methodologies for determining the basis and the depreciation with respect to the Comments and Explanation of Revisions in partnership property owned by a property capitalized to inventory or section will be made to proposed foreign partnership that is not other property held for sale, the gross § 1.250(b)–2. controlled directly or indirectly by U.S. income or loss from the sale of which E. Partnership QBAI persons. is taken into account in determining Section 951A(d)(3) 4 provides that, for tested income for the CFC inclusion D. Dual Use Property purposes of calculating QBAI, if a CFC year, divided by the sum of the total Section 951A(d)(2)(B) provides that if holds an interest in a partnership at the amount of the depreciation deduction property is used both in the production close of the CFC’s taxable year, the CFC with respect to the property for the CFC of tested income and income that is not takes into account its distributive share inclusion year and the total amount of tested income, the property is specified of the aggregate of the partnership’s depreciation with respect to the tangible property in the same proportion adjusted basis in depreciable tangible property capitalized to inventory or that the gross income described in property used in its trade or business other property held for sale, the gross section 951A(c)(1)(A) produced with that is used in the production of tested income or loss from the sale of which respect to such property bears to the income (determined with respect to the is taken into account for the CFC total gross income produced with CFC’s distributive share of income with inclusion year. See § 1.951A–3(d)(3). respect to such property. The proposed respect to such property). For this The dual use ratio also applies with regulations provide that if tangible purpose, a CFC’s distributive share of respect to partnership specified tangible property is used in both the production the adjusted basis in any property is the property, except, for this purpose, of gross tested income and other CFC’s distributive share of income with determined by reference to a tested income, the portion of the adjusted basis respect to such property. See section income CFC’s distributive share of the in the property treated as adjusted basis 951A(d)(3) (flush language). amounts described in the preceding in specified tangible property is The proposed regulations implement sentence. See § 1.951A–3(g)(3)(iii) and determined by multiplying the average the rule in section 951A(d)(3) by part V.E of this Summary of Comments of the adjusted basis in the property by providing that, if a tested income CFC and Explanation of Revisions section. the dual use ratio. See proposed holds an interest in one or more § 1.951A–3(d)(1). If the property A comment recommended that the partnerships as of the close of a CFC produces directly identifiable income final regulations clarify, through inclusion year, the QBAI of the tested for a CFC inclusion year, the dual use additional examples, that the method income CFC for the CFC inclusion year ratio is the ratio of the gross tested for determining the dual use ratio with is increased by the sum of the tested income produced by the property to the respect to specified tangible property income CFC’s partnership QBAI with total amount of gross income produced does not change if (i) the dual use respect to each partnership for the CFC by the property. See proposed § 1.951A– property becomes or ceases to be inclusion year. See proposed § 1.951A– 3(d)(2)(i). In all other cases, the dual use specified tangible property during the 3(g)(1). A tested income CFC’s ratio is the ratio of the gross tested year, or (ii) the dual use property gives partnership QBAI with respect to a income of the tested income CFC to the rise to increasing or decreasing gross partnership is the sum of the tested total amount of gross income of the tested income across quarters in a income CFC’s share of the partnership’s tested income CFC. See proposed taxable year. The Treasury Department adjusted basis in partnership specified § 1.951A–3(d)(2)(ii). and the IRS have determined that tangible property as of the close of a Under the proposed regulations, the additional examples are unnecessary. partnership taxable year that ends with dual use ratio requires a determination As the comment suggests, the dual use of whether and how much gross income ratio is not determined on the basis of 4 As enacted, section 951A(d) contains two is ‘‘directly identifiable’’ with particular the type and amount of gross income paragraphs designated as paragraph (3). The section specified tangible property. The produced by the property as of any 951A(d)(3) discussed in this part V.E of the Summary of Comments and Explanation of Treasury Department and the IRS particular quarter close, but rather is Revisions section relates to tangible property held recognize that application of the directly determined based on the type and the by a partnership taken into account in calculating identifiable standard could result in amount of gross income produced by the QBAI of a CFC partner.

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or within a CFC inclusion year. See QBAI—is generally, in the case of determine the proportionate share ratio proposed § 1.951A–3(g)(2)(i). A tested partnership specified tangible property with respect to partnership specified income CFC’s share of the partnership’s used in the production of only gross tangible property also by reference to adjusted basis in partnership specified tested income (‘‘sole use partnership the depreciation with respect to the tangible property is determined by property’’), the tested income CFC’s property, rather than the directly multiplying the partnership’s adjusted proportionate share of the partnership’s identifiable income attributable to the basis in the property by the tested adjusted basis in the property for the property or the gross income of the income CFC’s partnership QBAI ratio partnership taxable year. See § 1.951A– partner. See § 1.951A–3(g)(4)(ii). with respect to the property. See id. 3(g)(3)(ii). A tested income CFC’s A comment requested clarification Similar to the rule for dual use property, partner adjusted basis with respect to that the partnership QBAI ratio in the under the proposed regulations, the partnership specified tangible property proposed regulations, which references tested income CFC’s partnership QBAI used in the production of gross tested the amount of ‘‘gross income’’ produced ratio with respect to partnership income and gross income that is not by the property, is determined by specified tangible property depends on gross tested income (‘‘dual use reference to ‘‘gross taxable income,’’ whether the property produces directly partnership property’’) is generally the rather than gross section 704(b) income. identifiable income. In the case of tested income CFC’s proportionate share The comment also recommended that if partnership specified tangible property of the partnership’s adjusted basis in the the partnership QBAI ratio is that produces directly identifiable property for the partnership taxable determined by reference to a income for a partnership taxable year, a year, multiplied by the tested income partnership’s gross taxable income, that tested income CFC’s partnership QBAI CFC’s dual use ratio with respect to the section 704(c) allocations (including ratio with respect to the property is the property (determined by reference to the items of income under the remedial tested income CFC’s distributive share tested income CFC’s distributive share method) be taken into account in of the gross income produced by the of amounts described in § 1.951A– determining the CFC’s distributive share property for the partnership taxable year 3(d)(3)). See § 1.951A–3(g)(3)(iii). In of the gross income produced by the that is included in the gross tested either case, a tested income CFC’s property for the partnership taxable income of the tested income CFC for the proportionate share of the partnership’s year. The specific comment regarding CFC inclusion year to the total gross adjusted basis in partnership specified the calculation of gross income income produced by the property for the tangible property is the partnership’s produced by property has been mooted partnership taxable year. See proposed adjusted basis in the property for the by the change to determining the dual § 1.951A–3(g)(2)(ii)(A). In the case of partnership taxable year multiplied by use and proportionate share ratios by partnership specified tangible property the tested income CFC’s proportionate reference to the depreciation with that does not produce directly share ratio with respect to the property respect to the property. However, the identifiable income for a partnership for the partnership taxable year. comment remains relevant to the calculation of the depreciation with taxable year, a tested income CFC’s As discussed in part V.D of this partnership QBAI ratio with respect to respect to property for purposes of Summary of Comments and Explanation determining the dual use ratio and the property is the tested income CFC’s of Revisions section, a rule that distributive share of the gross income of proportionate share ratio. determines adjusted basis in specified For purposes of the proportionate the partnership for the partnership tangible property taken into account in share ratio, the final regulations do not taxable year that is included in the gross determining QBAI by reference to the adopt this recommendation. Section tested income of the tested income CFC ‘‘directly identifiable income’’ 704(b) income represents a partner’s for the CFC inclusion year to the total attributable to such property would lead economic interest in the partnership amount of gross income of the to substantial uncertainty and and therefore more closely aligns with partnership for the partnership taxable controversy, whereas the rules under the economic production of income year. See proposed § 1.951A– section 861 for allocating and from partnership property that QBAI is 3(g)(2)(ii)(B). apportioning depreciation attributable intended to measure. Accordingly, the The partnership QBAI ratio in the to property owned by a CFC to final regulations clarify that the proposed regulations is effectively an categories of income represent a proportionate share ratio is determined amalgamation of two ratios—a ratio that longstanding proxy for determining the by reference to the amount of describes the portion of the partnership types of income produced by the depreciation with respect to property specified tangible property that is used property. For this reason, the final (and a tested income CFC’s distributive in the production of gross tested income regulations determine the dual use ratio share of such amount) determined (that is, the dual use ratio) and a ratio by reference to the amount of under section 704(b). See § 1.951A– that describes a tested income CFC’s depreciation deductions allocated to 3(g)(4)(i). Therefore, items determined proportionate interest in all the income gross tested income under § 1.951A– under section 704(c) are not taken into produced by the property. The final 2(c)(3). Similarly, the Treasury account for purposes of determining a regulations disaggregate the partnership Department and the IRS have tested income CFC’s partner adjusted QBAI ratio into these two ratios—the determined that calculating partnership basis in partnership specified tangible dual use ratio (as defined in § 1.951A– QBAI by reference to the ‘‘directly property held by a partnership and thus 3(d)(3)) and a new proportionate share identifiable income’’ produced by the tested income CFC’s partnership ratio (as defined in § 1.951A–3(g)(4)(ii)). partnership specified tangible property QBAI with respect to the partnership. Accordingly, the final regulations would lead to substantial uncertainty However, because the dual use ratio is provide that a tested income CFC’s and controversy, and that a partner’s determined by reference to the ‘‘partner adjusted basis’’ with respect to share of a depreciation deduction with allocation and apportionment of partnership specified tangible respect to partnership specified tangible depreciation deductions to gross tested property—that is, the adjusted basis in property is a reliable proxy for income of a tested income CFC, and partnership specified tangible property determining a CFC’s distributive share thus is based on a taxable income taken into account in determining the of income with respect to such property. concept, items determined under tested income CFC’s partnership Accordingly, the final regulations section 704(c) are taken into account for

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purposes of determining the dual use the proposed regulations have a rule specified tangible property would, but ratio. that would allow a tested income CFC for the temporary ownership rule, The proposed regulations provide that to increase its QBAI for its share of reduce the GILTI inclusion amount of a partnership QBAI is the sum of the partnership QBAI if the tested income U.S. shareholder, then the property is tested income CFC’s share of the CFC owned the partnership interest for ‘‘per se’’ treated as temporarily held and partnership’s adjusted basis in part of the year but not at the close of acquired with a principal purpose of partnership specified tangible property. the CFC taxable year. However, a reducing the GILTI inclusion amount of See proposed § 1.951A–3(g)(2)(i). A partner that disposes of its entire a U.S. shareholder if the tested income comment recommended that the final partnership interest before the close of CFC holds the property for less than a regulations clarify that the adjusted the CFC taxable year could have a 12-month period that includes at least basis in partnership specified tangible distributive share of partnership income the close of one quarter during its property includes any basis adjustment if the partnership taxable year closes taxable year (the ‘‘12-month per se under section 743(b). In response to this before the close of the CFC taxable year, rule’’). See id. Therefore, the specified comment, the final regulations clarify including by reason of the disposition tangible property is disregarded under that an adjustment under section 743(b) itself. See section 706(c)(2)(A) (taxable the proposed regulations for purposes of to the adjusted basis in partnership year of partnership closes with respect determining QBAI. specified tangible property with respect to partner whose entire interest Although some comments supported to a tested income CFC is taken into terminates, including by reason of a the temporary ownership rule and, in account in determining the tested disposition). particular, stated that the principal income CFC’s partner adjusted basis in The Treasury Department and the IRS purpose standard was a reasonable the partnership specified tangible agree that a partner that has a interpretation of section 951A(d)(4), property. See § 1.951A–3(g)(3) and (7). distributive share of income from a many comments asserted that it was In addition, to ensure that the adjusted partnership should also be permitted overbroad. Comments expressed basis in property other than tangible partnership QBAI with respect to the particular concern with the scope of the property is not inappropriately shifted partnership. Therefore, the final 12-month per se rule, noting for to tangible property for purposes of regulations are revised to provide that a example that it could (i) apply to determining QBAI, the final regulations partner need only hold an interest in a transactions not motivated by tax provide that basis adjustments to partnership during the CFC inclusion avoidance such as ordinary course partnership specified tangible property year to have partnership QBAI with transactions, (ii) require burdensome under section 734(b) are taken into respect to the partnership. See asset-level tracking of CFC property, and account only if they are basis § 1.951A–3(g)(1). The final regulations (iii) lead to uncertain return filing adjustments under section 734(b)(1)(B) also provide that section 706(d) applies positions or financial accounting or 734(b)(2)(B) attributable to to determine a tested income CFC’s volatility if property acquired by a CFC distributions of tangible property or partner adjusted basis in partnership has not yet been held for 12 months basis adjustments under section specified tangible property owned by a when a U.S. shareholder files its return 734(b)(1)(A) or 734(b)(2)(A) by reason of partnership if there is a change in the or publishes a financial statement. gain or loss recognized by a distributee tested income CFC’s interest in the Comments suggested various ways to partner under section 731(a). See partnership during the CFC inclusion minimize the scope of the temporary § 1.951A–3(g)(6). year. See § 1.951A–3(g)(3)(i). ownership rule, including (i) A comment also requested that the eliminating the 12-month per se rule; final regulations clarify that a CFC’s F. Disregard of Basis in Specified (ii) converting the 12-month per se rule QBAI is increased not only for Tangible Property Held Temporarily into a rebuttable presumption; (iii) partnership specified tangible property Section 951A(d)(4) authorizes the providing an exception for property owned by partnerships in which the issuance of regulations or other transferred among related CFCs owned CFC is a direct partner, but also for guidance that the Secretary determines by a U.S. shareholder when there is no lower-tier partnerships in which the are appropriate to prevent the avoidance decrease in that shareholder’s GILTI CFC indirectly owns an interest through of the purposes of section 951A(d), inclusion amount (for this purpose, one or more upper-tier partnerships. including regulations or other guidance treating a consolidated group as a single The final regulations make this which provide for the treatment of entity); (iv) providing that, for purposes clarification. See § 1.951A–3(g)(1). property that is transferred, or held, of applying the 12-month per se rule, a Finally, a comment suggested that, temporarily. The proposed regulations CFC’s holding period in property under section 951A(d)(3) and the provide that if a tested income CFC received in a nonrecognition transaction proposed regulations, a disposition of a (‘‘acquiring CFC’’) acquires specified include a tacked holding period under partnership interest by a tested income tangible property with a principal section 1223(2); (v) providing de CFC could result in the CFC including purpose of reducing the GILTI inclusion minimis or ordinary course transaction its distributive share of partnership amount of a U.S. shareholder for any exceptions; (vi) excepting acquisitions income in its gross tested income, but U.S. shareholder inclusion year, and the of property that result in effectively not taking into account any of the tested income CFC holds the property connected income or subpart F income partnership’s basis in partnership temporarily but over at least the close of to the transferor; (vii) tailoring the rule’s specified tangible property for purposes one quarter, the specified tangible application depending on whether of calculating the CFC’s QBAI. Under property is disregarded in determining property is acquired from or transferred section 951A(d)(3) and proposed the acquiring CFC’s average adjusted to unrelated parties; and (viii) § 1.951A–3(g)(1), if a CFC holds an basis in specified tangible property for establishing a period of ownership that interest in a partnership at the close of purposes of determining the acquiring will not be considered temporary. the taxable year of the CFC, the CFC CFC’s QBAI for any CFC inclusion year In response to the comments, the takes into account its share of a during which the tested income CFC Treasury Department and the IRS have partnership’s adjusted basis in certain held the property (the ‘‘temporary determined that it is appropriate to tangible property for QBAI purposes. ownership rule’’). See proposed narrow the scope of the temporary However, neither section 951A(d)(3) nor § 1.951A–3(h)(1). If an acquisition of ownership rule, and that the following

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changes strike the appropriate balance disclosing that it rebuts the The final regulations do not adopt the between mitigating the compliance presumption. See id. In response to a comments requesting a de minimis or burden and identifying transactions that comment, the final regulations include ordinary course transaction exception. have the potential to avoid the purposes a second presumption that generally The Treasury Department and the IRS of section 951A(d). First, the final provides that property is presumed not have determined that these types of regulations make certain technical to be subject to the temporary exceptions are unnecessary due to the changes that are intended to refine and ownership rule if held for more than 36 narrowed and refined scope of the rule clarify the application of the temporary months. See § 1.951A–3(h)(1)(iv)(B). in the final regulations, including as a ownership rule. For example, the rule The final regulations clarify that the result of converting the 12-month per se applies, in part, based on a principal adjusted basis in property may be rule into a rebuttable presumption, purpose of increasing the DTIR of a U.S. disregarded under the rule for multiple adding the safe harbor, and illustrating shareholder (‘‘applicable U.S. quarter closes. See § 1.951A–3(h)(1)(ii). certain transactions that are targeted by shareholder’’) and, for this purpose, However, in the case that the temporary the rule through new examples. certain related U.S. persons are treated holding results in the property being Moreover, because the rule is limited to as a single applicable U.S. shareholder. taken into account for only one the temporary holding of depreciable See § 1.951A–3(h)(1)(i) and (vi). Further, additional quarter close of a tested property used in a CFC’s trade or in response to comments, the final income CFC in determining the DTIR of business (that is, specified tangible regulations clarify that property held a U.S. shareholder inclusion year, the property), the Treasury Department and temporarily over a quarter close is adjusted basis in the property is the IRS do not anticipate that many subject to the temporary ownership rule disregarded under this rule only as of such assets will be acquired and only if the holding of the property over the first tested quarter close that follows disposed of in the ‘‘ordinary course’’ of the quarter close would, without regard the acquisition. See id.; see also a CFC’s business, however that standard to the temporary ownership rule, § 1.951A–3(h)(1)(vii)(C) (Example 2) is defined. increase the DTIR of an applicable U.S. (disregarding the adjusted basis in Finally, the final regulations do not shareholder for its taxable year. See specified tangible property for a single adopt the comment requesting an § 1.951A–3(h)(1)(i). quarter due to differences in CFC exception for acquisitions of property The final regulations also clarify that taxable years). This rule ensures that the that result in effectively connected a CFC’s holding period for purposes of adjusted basis in property is not income or subpart F income to the this rule does not include the holding inappropriately disregarded in excess of transferor. The Treasury Department period for which the property was held the amount necessary to eliminate the and the IRS have concluded that, unlike by any other person under section 1223. increase in the DTIR of the applicable the rule that addresses disqualified basis See § 1.951A–3(h)(1)(v). The final U.S. shareholder by reason of the in § 1.951A–2(c)(5) and § 1.951A– regulations do not adopt the request to temporary holding. 3(h)(2), the treatment of gain recognized permit a tacking of holding periods for The final regulations also include a by the transferor (if any) is not relevant purpose of the temporary ownership safe harbor for certain transfers for purposes of determining whether it rule, because temporary acquisitions of involving CFCs. See § 1.951A– is appropriate to take into account property through nonrecognition 3(h)(1)(iii). Under the safe harbor, the specified tangible property held transactions, particularly between holding of property as of a tested quarter temporarily for purposes of determining related parties, can artificially increase close is not treated as increasing the QBAI. Nothing in section 951A(d)(4) or a U.S. shareholder’s DTIR by, for DTIR if certain conditions are satisfied. the legislative history suggests that instance, causing the property to be In general, the safe harbor applies to transfers of property that result in taken into account for an additional transfers between CFCs that are owned income or gain that is subject to U.S. tax quarter close for purposes of calculating in the same proportion by the U.S. should be exempt from the rule. Indeed, QBAI. shareholder, have the same taxable the policy concern underlying this The final regulations also modify the years, and are all tested income CFCs. rule—the temporary holding of 12-month per se rule to make it a The safe harbor is intended to exempt specified tangible property with a presumption rather than a per se rule. non-tax motivated transfers from the principal purpose of increasing the Therefore, under the final regulations rule when the temporary holding of the DTIR of a U.S. shareholder—is present the temporary ownership rule is property does not have the potential for regardless of whether the basis in the presumed to apply only if property is increasing the DTIR of an applicable specified tangible property reflects gain held for less than 12 months. See U.S. shareholder. The addition of the that is subject to U.S. tax. § 1.951A–3(h)(1)(iv)(A). This safe harbor responds to the comment presumption may be rebutted if the facts requesting that the rule be tailored G. Determination of Disqualified Basis and circumstances clearly establish that depending on whether the transfers The determination of disqualified the subsequent transfer of the property involve related or unrelated parties. basis is relevant for purposes of both the was not contemplated when the In addition, in response to comments, rule in § 1.951A–2(c)(5) (allocating property was acquired by the acquiring the final regulations include four new deductions attributable to disqualified CFC and that a principal purpose of the examples to illustrate the application of basis to residual CFC gross income) and acquisition of the property was not to the rule. See § 1.951A–3(h)(1)(vii). The the rule in § 1.951A–3(h)(2) increase the DTIR of the applicable U.S. examples identify a transaction that is (disregarding disqualified basis for shareholder. See id. As a result of this not subject to the rule due to the purposes of calculating QBAI). This part change, a taxpayer generally will know application of the safe harbor, and three V.G of the Summary of Comments and when it files its return whether the transactions that are subject to the rule, Explanation of Revisions section temporary ownership rule will apply. In including transfers of property between describes comments and revisions order to rebut the presumption, a CFCs that have different taxable years, related to the computation of taxpayer must attach a statement to the and an acquisition of property by a disqualified basis both for purposes of Form 5471 filed with the taxpayer’s tested income CFC from a tested loss § 1.951A–2(c)(5) and § 1.951A–3(h)(2). return for the taxable year of the CFC in CFC, which cannot have QBAI pursuant For other comments and revisions which the subsequent transfer occurs to § 1.951A–3(b) and (c)(1). related to the computation of

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disqualified basis discussed in the basis other than disqualified basis is income. Depreciation or amortization context of the application of § 1.951A– reduced or eliminated, then the that is allocated and apportioned to 2(c)(5), see part IV.E.3 and 4 of this disqualified basis in the property is residual CFC gross income continues to Summary of Comments and Explanation reduced or eliminated in the same reduce the adjusted basis in the of Revisions section. proportion that the disqualified basis property in accordance with section As described in part IV.E.1 of this bears to the total adjusted basis in the 1016(a)(2). Accordingly, clarification Summary of Comments and Explanation property. See proposed § 1.951A– that any depreciation or amortization of Revisions section, the proposed 3(h)(2)(ii)(A). The final regulations attributable to disqualified basis in regulations define ‘‘disqualified basis’’ adopt this rule without substantial property reduces adjusted basis in the in property as the excess of the modification, except that the final property is unnecessary. property’s adjusted basis immediately regulations provide a special rule where Disqualified basis in property is after a disqualified transfer, over the a loss is recognized on a taxable sale or generally an attribute specific to the sum of the property’s adjusted basis exchange. See §§ 1.951A–2(c)(5)(ii) and property itself, rather than an attribute immediately before the disqualified 1.951A–3(h)(2)(ii)(B)(1)(i). In the case of of a CFC or a U.S. shareholder with transfer and the qualified gain amount a loss recognized on a taxable sale or respect to the property. The final with respect to the disqualified transfer. exchange of the property, the loss is regulations, however, provide rules to See proposed § 1.951A–3(h)(2)(ii)(A). In treated as attributable to disqualified treat basis in other property as addition, the proposed regulations basis to the extent thereof. See id. disqualified basis if such basis was define ‘‘disqualified transfer’’ as a Therefore, to the extent of the determined, in whole or in part, by transfer of property by a transferor CFC disqualified basis, the loss on the sale is reference to the basis in property with during a transferor CFC’s disqualified allocated to residual CFC gross income disqualified basis. See § 1.951A– period to a related person in which gain and the disqualified basis in the 3(h)(2)(ii)(B)(2). These rules are was recognized, in whole or in part. See property is reduced. intended to prevent taxpayers from proposed § 1.951A–3(h)(2)(ii)(C). One A comment noted that the proposed eliminating disqualified basis in comment recommended that the regulations do not specify when the nonrecognition transactions that would definition of disqualified transfer not be proportion of the disqualified basis to otherwise have the effect of granting expanded to include transfers of the total adjusted basis in the property taxpayers the benefit of the disqualified property to unrelated persons. The final is determined for purposes of basis. This could occur, for example, if regulations do not modify the definition determining the reduction to property with disqualified basis is of disqualified transfer, and therefore disqualified basis. The comment transferred in a nonrecognition the term continues to be limited to recommended that the Treasury transaction, such as a like-kind transfers of property by a CFC to a Department and the IRS clarify that this exchange under section 1031, in related person. See § 1.951A– proportion is determined immediately exchange for other depreciable property. 3(h)(2)(ii)(C)(2). after the disqualified transfer and does In that case, a portion of the basis in the A comment noted that the proposed not change throughout the useful life of newly acquired property is treated as regulations do not explain whether the the property absent a subsequent disqualified basis. Also, disqualified computation of disqualified basis in disqualified transfer. The final basis may be duplicated through certain property takes into account basis regulations do not adopt this nonrecognition transactions. For adjustments under section 743(b) or recommendation, because the example, if property with disqualified section 734(b) allocated to that property proportion of disqualified basis to total basis is transferred in a section 351 under section 755 during the adjusted basis in property can change by exchange, both the stock received by the disqualified period. The final reason of one or more transactions transferor and the property received by regulations clarify that adjustments subsequent to a disqualified transfer. the transferee will have disqualified under sections 732(d), 734(b), and For instance, a loss recognized on a basis, in each case determined by 743(b) can create, increase, or reduce taxable sale of property with reference to the disqualified basis in the disqualified basis in property. See disqualified basis and adjusted basis property in the hands of the transferor § 1.951A–3(h)(2)(ii)(A) and (B). other than disqualified basis, which immediately before the transaction. See The proposed regulations provide that reduces disqualified basis to the extent § 1.951A–3(h)(2)(ii)(B)(2)(ii). The final disqualified basis may be reduced or of the loss under § 1.951A– regulations also provide that basis eliminated through depreciation, 3(h)(2)(ii)(B)(1)(i), will have the effect of arising from other transactions, such as amortization, sales or exchanges, section decreasing the proportion of distributions of property from a 362(e), and other methods. See disqualified basis to total adjusted basis. partnership to a partner, can create proposed § 1.951A–3(h)(2)(ii)(A). The See, generally, 1.951A–3(h)(2)(ii)(B) and disqualified basis in property to the final regulations clarify the this part V.G of the Summary of extent the transaction has the effect of circumstances under which disqualified Comments and Explanation of Revisions shifting disqualified basis from one basis is reduced. Specifically, the final for additional adjustments to property to another. See § 1.951A– regulations provide that disqualified disqualified basis. 3(h)(2)(ii)(B)(2)(i). This might occur, for basis in property is reduced to the A comment recommended that the example, if low-basis property is extent that a deduction or loss Treasury Department and the IRS clarify distributed in liquidation of a high-basis attributable to the disqualified basis in that depreciation or amortization that is partner under section 732(b) resulting in the property is taken into account in disregarded for purposes of determining a decrease to disqualified basis in other reducing gross income, including any tested income or tested loss under partnership property under section deduction or loss allocated to residual proposed § 1.951A–2(c)(5) nonetheless 734(b)(2)(B). See § 1.951A–3(h)(2)(iii)(D) CFC gross income by reason of the rule reduces the adjusted basis in the Example 4. in § 1.951A–2(c)(5). See § 1.951A– property. The final regulations do not The final regulations also clarify how 3(h)(2)(ii)(B)(1)(i). disregard a deduction or loss disqualified basis is disregarded under The proposed regulations provide attributable to disqualified basis, but § 1.951A–3(h)(2)(i) in the case of dual that, if the adjusted basis in property rather allocate and apportion such use property and partnership specified with disqualified basis and adjusted deduction or loss to residual CFC gross tangible property for purposes of

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determining QBAI and partnership interest expense is potentially more expense’’ is defined in the proposed QBAI, respectively. The portion of the favorable to taxpayers than permitted by regulations as interest expense paid or adjusted basis in dual use property with the statute because it provides that accrued by a CFC that is taken into disqualified basis that is taken into specified interest expense is reduced by account in determining the tested account for determining QBAI is the all interest income included in the income or tested loss of the CFC, average adjusted basis in the property, tested income of the U.S. shareholder reduced by the qualified interest multiplied by the dual use ratio, and (subject to certain exceptions), even if expense of the CFC. See proposed then reduced by the disqualified basis earned from unrelated parties. § 1.951A–4(b)(1)(i). For this purpose, in the property. See § 1.951A– The Treasury Department and the IRS ‘‘interest expense’’ is defined as any 3(h)(2)(i)(B); see also § 1.951A–3(d)(4) have determined that the netting expense or loss treated as interest Example. For purposes of determining approach appropriately balances expense under the Code or regulations, partnership QBAI, a CFC’s partner administrability concerns with the and any other expense or loss incurred adjusted basis with respect to purpose and language of section in a transaction or series of integrated or partnership specified tangible property 951A(b)(2)(B). As discussed in the related transactions in which the use of with disqualified basis is first preamble to the proposed regulations, funds is secured for a period of time if determined under the general rules of the netting approach avoids the such expense or loss is predominantly § 1.951A–3(g)(3)(i) and then reduced by complexity related to a tracing incurred in consideration of the time the partner’s share of the disqualified approach, under which a U.S. value of money. See proposed § 1.951A– basis in the property. See § 1.951A– shareholder’s pro rata share of each item 4(b)(1)(ii). The proposed regulations 3(h)(2)(i)(C). In either case, the of interest expense of a CFC would have include similar definitions for ‘‘tested allocation and apportionment rules of to be matched to the shareholder’s pro interest income’’ and ‘‘interest income.’’ § 1.951A–2(c)(5) are not taken into rata share of the interest income See proposed § 1.951A–4(b)(2)(i) and account for purposes of applying the attributable to such interest expense (ii). dual use ratio and the proportionate received by a CFC. Furthermore, the One comment asserted that the share ratio to determine the amount of amount of specified interest expense concepts of ‘‘predominantly incurred in the adjusted basis in property that is should, in most cases, be the same consideration of the time value of reduced by the disqualified basis. See whether determined under a netting money’’ and ‘‘predominantly derived § 1.951A–3(h)(2)(i)(B) and (C). approach or under a tracing approach. from consideration of the time value of The Treasury Department and the IRS In this regard, while the netting money’’ are new and unclear, and lack request comments on the application of approach does not require a factual link analogies in other authorities. The the rules that reduce or increase between the interest income and interest comment also stated that this new disqualified basis including, for expense, only interest income included standard is further complicated by example, how the rules should apply in in gross tested income, other than references to ‘‘a transaction or series of an exchange under section 1031 where income included by reason of section integrated or related transactions.’’ property with disqualified basis is 954(h) or (i) (that is, ‘‘qualified interest Other comments asserted that creating a exchanged for property with no income’’), is taken into account for this new standard for interest expense and disqualified basis. purpose. Because interest income is interest income specifically for specified generally FPHCI under section interest expense would result in VI. Comments and Revisions to 954(c)(1)(A) and qualified interest additional confusion and complexity. Proposed § 1.951A–4—Tested Interest income is not taken into account under Another comment questioned the Expense and Tested Interest Income the netting approach, interest income inclusion of interest equivalents in the A. Determination of Specified Interest taken into account under the netting definition of interest in the proposed Expense Under Netting Approach approach is generally limited to interest regulations and noted that, because the income that is excluded from subpart F definition covers both interest income Section 951A(b)(2)(B) reduces net income by reason of section 954(c)(3) or and interest expense, there is a DTIR of a U.S. shareholder by interest (6). Furthermore, because the exceptions particular risk of whipsaw to the expense that reduces tested income (or under section 954(c)(3) and (6) apply government unless the authority for the increases tested loss) for the taxable year only to interest income paid or accrued regulations is clear. Some comments of the shareholder to the extent the by related party foreign corporations, recommended that the final regulations interest income attributable to such both the interest income excluded by replace the definitions of interest expense is not taken into account in reason of section 954(c)(3) or (6) and the expense and interest income in the determining such shareholder’s net CFC interest expense attributable to such proposed regulations with references to tested income. The proposed regulations interest income will generally be taken interest expense or interest income adopt a netting approach to determine into account in determining the net CFC under any provision of the Code or the amount of interest expense of a U.S. tested income of either the same U.S. regulations, or as a consequence of shareholder described in section shareholder or a related U.S. issuing or holding an instrument that is 951A(b)(2)(B) (‘‘specified interest shareholder. Accordingly, the final treated as indebtedness for Federal expense’’), defining such amount as the regulations retain the netting approach income tax purposes, such as excess of such shareholder’s pro rata for determining specified interest instruments characterized as share of ‘‘tested interest expense’’ of expense, with certain modifications indebtedness under judicial factors or each CFC over its pro rata share of described in part VI.B through D of this administrative guidance, or payments ‘‘tested interest income’’ of each CFC. Summary of Comments and Explanation ‘‘equivalent to interest.’’ See proposed § 1.951A–1(c)(3)(iii). of Revisions section. See § 1.951A– The Treasury Department and the IRS Several comments agreed with the 1(c)(3)(iii). did not intend to create a new standard adoption of the netting approach, of interest solely for purposes of principally on the grounds of B. Definition of Tested Interest Expense determining specified interest expense. administrability and policy. However, and Tested Interest Income In this regard, the reduction of net DTIR one comment noted that the netting For purposes of determining specified by specified interest expense under approach for determining specified interest expense, ‘‘tested interest section 951A(b)(2)(B) and the limitation

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on business interest under section 163(j) C. Determination of Qualified Interest approach effectively treats all interest are meant to achieve similar policy Expense and Qualified Interest Income expense of a qualified CFC as goals, namely preventing certain interest The proposed regulations provide attributable ratably to the assets of the expense in excess of interest income that, for purposes of determining the qualified CFC that give rise to income from being taken into account in specified interest expense of a U.S. excluded from FPHCI by reason of determining taxable income. Further, shareholder, the tested interest expense section 954(h) and (i), but then traces because the amount of interest expense and tested interest income of a such interest expense, after attribution subject to each of these provisions is ‘‘qualified CFC’’ are reduced by its to such assets, to any interest income determined, in part, by reference to ‘‘qualified interest expense’’ and received from related CFCs to the extent interest income received, each of these ‘‘qualified interest income,’’ thereof. A comment indicated that the two- provisions need clear and consistent respectively. See proposed § 1.951A– step approach in the proposed definitions of both interest expense and 4(b)(1) and (2). The reduction for regulations can understate the amount interest income, including when and to qualified interest expense and qualified of qualified interest expense. what extent transactions that result in a interest income is intended to neutralize Specifically, the comment noted that the financing from an economic perspective the effect of interest expense and proposed regulations include related may be treated as generating interest interest income attributable to the active party receivables in the denominator of expense and interest income. Finally, conduct of a financing or insurance the fraction under the first step, thus the relevant terms used in each business on a U.S. shareholder’s net diluting the fraction and resulting in provision—‘‘interest expense’’ and DTIR. For example, absent the rule for less qualified interest expense, and then ‘‘interest income’’ in section qualified interest expense, the third- interest income from such receivables 951A(b)(2)(B) and ‘‘business interest’’ party interest expense of a captive further reduce qualified interest expense and ‘‘business interest income’’ in finance company—to the extent its dollar-for-dollar under the second step. section 163(j)—do not differ interest expense exceeds its interest The comment recommended that, to meaningfully in their respective income—could inappropriately increase avoid double counting, related party contexts and therefore do not specified interest expense (and thus receivables should be excluded from the necessitate different definitions. As a reduce the net DTIR) of its U.S. fraction in the first step. result of the foregoing, and in order to shareholder. Alternatively, under a The Treasury Department and the IRS reduce administrative complexity, the netting approach to calculating agree with the comment that, under the Treasury Department and the IRS have specified interest expense, the third- two-step approach to the proposed determined that taxpayers and the party interest income of a captive regulations, related party receivables are government would benefit from the finance company—to the extent its effectively double-counted, and application of a single definition of interest income exceeds interest therefore the final regulations eliminate interest for both section 951A(b)(2)(B) expense—could inappropriately reduce the second step reduction for interest and section 163(j) (rather than the the specified interest expense (and thus income included in the gross tested application of two partially overlapping, increase the net DTIR) of its U.S. income of a qualified CFC that is but ultimately different standards). shareholder. excluded from FPHCI by reason of Accordingly, the final regulations define For purposes of these rules, the section 954(c)(3) or (6). See § 1.951A– ‘‘interest expense’’ and ‘‘interest proposed regulations define a ‘‘qualified 4(b)(1)(iii)(A). This revision ensures that income’’ by reference to the definition CFC’’ as an eligible controlled foreign a related party receivable is not double- of interest expense and interest income corporation (within the meaning of counted in the determination of under section 163(j). See § 1.951A– section 954(h)(2)) or a qualifying qualified interest expense, and thus 4(b)(1)(ii) and (2)(ii). insurance company (within the meaning qualified interest expense as calculated of section 953(e)(3)). See proposed The regulations under section 163(j), under the final regulations more § 1.951A–4(b)(1)(iv). Further, ‘‘qualified when finalized, will address comments accurately reflects the interest expense interest income’’ is defined as interest incurred to earn income earned from on the validity of the definition of income included in the gross tested interest expense and interest income unrelated parties in an active financing income of the qualified CFC that is or insurance business. Further, the that are used in those regulations. excluded from FPHCI by reason of Because the final regulations adopt this Treasury Department and the IRS section 954(h) or (i). See proposed preferred the elimination of the second definition for purposes of determining § 1.951A–4(b)(2)(iii). The proposed specified interest expense, the step reduction for resolving the double- regulations define ‘‘qualified interest counting issue, rather than the discussion in the regulations under expense’’ as the portion of the interest recommended alternative of excluding section 163(j) will, by extension, expense of a qualified CFC, which related party receivables from the address the validity of the definitions as portion is determined based on a two- fraction in the first step, because the used in these final regulations. step approach. First, a qualified CFC’s elimination of an additional step Finally, the definition of tested interest expense is multiplied by a substantially simplifies the calculation interest expense is revised in the final fraction, the numerator of which is the of qualified interest expense. regulations to mean interest expense CFC’s average basis in assets which give In addition, with regard to the effect that is ‘‘allocated and apportioned to rise to income excluded from FPHCI by of related party receivables on the gross tested income’’ of a CFC under reason of section 954(h) or (i), and the computation of qualified interest § 1.951A–2(c)(3). See § 1.951A– denominator is the CFC’s average basis expense, the final regulations clarify 4(b)(1)(i). This revision does not reflect in all its assets. See proposed § 1.951A– that a receivable that gives rise to a substantive change to the definition in 4(b)(1)(iii)(A). Second, the product of income that is excludible from FPHCI the proposed regulations—interest the first step is reduced by the interest by reason of section 954(c)(3) or (6) is expense ‘‘taken into account in income of the qualified CFC that is excluded from the numerator of the determining the tested income or tested excluded from FPHCI by reason of fraction (that is, the receivable is not a loss’’—but rather is intended to more section 954(c)(3) or (6). See proposed ‘‘qualified asset’’ within the meaning of clearly articulate that definition. § 1.951A–4(b)(1)(iii)(B). This two-step § 1.951A–4(b)(1)(iii)(B), a new term in

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the final regulations), notwithstanding whether a CFC avails itself of the insurance business, the interest expense that such receivable may also give rise reduction for qualified interest expense, of the holding company may constitute to income excluded from FPHCI by the exclusion for qualified interest qualified interest expense and thus be reason of section 954(h) or (i). See income is mandatory. See § 1.951A– disregarded in determining specified § 1.951A–4(b)(1)(iii)(B)(2). Similarly, the 4(b)(2)(iii)(A). interest expense. In this regard, the final final regulations clarify that interest A comment recommended an regulations retain the rule that the income that is excludible from FPHCI exception from the qualified interest adjusted basis in stock of a subsidiary is by reason of section 954(c)(3) or (6) is rules for a CFC that is a qualified treated as basis in a qualified asset to excluded from qualified interest insurance company under section the extent that the assets of the income, notwithstanding that such 954(i), or in the alternative, an subsidiary are qualified assets. See income may also be excluded from exception from the qualified interest § 1.951A–4(b)(1)(iii)(B)(3). In addition, FPHCI by reason of section 954(h) or (i). rules for any CFC that is part of a the final regulations provide a new rule See § 1.951A–4(b)(2)(iii)(B). These financial services group defined in that treats a CFC that owns 25 percent clarifications ensure that the section 904(d)(2)(C)(ii), with the result or more of the capital or profits interest computation of qualified interest that all interest income and interest in a partnership as owning its income and qualified interest expense is expense of such CFCs would be tested attributable share of any property held determined by reference only to interest interest income and tested interest by the partnership, as determined under expense and interest income attributable expense taken into account in the principles of § 1.956–4(b). See to a CFC’s active conduct of a financing determining a U.S. shareholder’s § 1.951A–4(b)(1)(iii)(B)(4). Therefore, or insurance business with unrelated specified interest expense. The under the final regulations, whether, persons. comment speculated that the qualified and to what extent, the interest expense A comment recommended that, for interest rules may have been crafted to of a CFC is qualified interest expense purposes of determining the amount of address a CFC involved in a financial depends entirely on the nature of the qualified interest expense of a CFC, services business that was not a member assets it holds directly and indirectly, instruments or obligations that give rise of a business group primarily engaged in and not on whether the CFC itself is to interest income derived by active a financial services business. The engaged in an active financing or securities and derivatives dealers that is Treasury Department and the IRS insurance business. excluded from FPHCI under section decline to adopt this recommendation. Finally, the definition of qualified 954(c)(2)(C) should also be included in The qualified interest rules are intended interest expense in the proposed the numerator for calculating qualified to neutralize the effect of an active regulations includes a parenthetical that interest expense. The final regulations finance business or an active business of indicates that the fraction for adopt this recommendation by a CFC on the specified interest expense determining qualified interest expense including such instruments or (and thus net DTIR) of its U.S. cannot exceed one. See proposed obligations in the definition of qualified shareholder, irrespective of whether the § 1.951A–4(b)(1)(iii). The Treasury assets. See § 1.951A–4(b)(1)(iii)(B)(1). CFC is a member of a business group Department and the IRS have Similarly, interest income excluded primarily engaged in such activities. In determined that, because the numerator from FPHCI under section 954(c)(2)(C) contrast, the recommended exception (average basis in qualified assets) is a is included in the definition of qualified would permit interest income from an subset of the denominator (average basis interest income. See § 1.951A– active finance business or active in all assets), this fraction can never 4(b)(2)(iii)(A). insurance business in excess of the exceed one, even without regard to the A comment suggested that the benefit associated interest expense to net parenthetical. Therefore, the final to some U.S. shareholders from the against other interest expense in the regulations eliminate the parenthetical exclusion for qualified interest expense computation of specified interest in the definition of qualified interest may not justify the difficulty and expense. expense as surplusage. See § 1.951A– expense to determine the amount The same comment also explained 4(b)(1)(iii)(A). excluded. Therefore, the comment that some foreign financial service recommended that the final regulations groups borrow externally through a D. Interest Expense Paid or Accrued by provide taxpayers the ability to either holding company to fund their a Tested Loss CFC establish the amount of their qualified qualifying insurance company Under the proposed regulations, interest expense or, alternatively, to subsidiaries that earn qualified interest tested interest expense includes interest assume that none of their interest income. The comment noted that the expense paid or accrued by a tested loss expense constitutes qualified interest proposed regulations create a mismatch CFC, notwithstanding that the proposed expense. The Treasury Department and between the treatment of the interest regulations provide that a tested loss the IRS agree that taxpayers should not income of the subsidiaries, which is CFC has no QBAI. See proposed be required to reduce their CFCs’ tested qualified interest income of a qualified § 1.951A–3(b) and § 1.951A–4(b)(1). As interest expense by their CFCs’ qualified CFC and thus not taken into account in discussed in part V.A of this Summary interest expense if the taxpayer calculating specified interest expense, of Comments and Explanation of determines that the value of such and the interest expense of the holding Revisions section, the final regulations reduction is outweighed by the cost of company, which is not qualified interest continue to provide that a tested loss compliance. Accordingly, the final expense of a qualified CFC and thus is CFC has no QBAI. See § 1.951A–3(b). regulations provide that a CFC’s taken into account in calculating Comments recommended that, if the qualified interest expense is taken into specified interest expense. To address rule excluding the QBAI of a tested loss account only to the extent established this mismatch, the final regulations CFC were retained, the final regulations by the CFC. See § 1.951A–4(b)(1)(iii)(A). eliminate the term ‘‘qualified CFC.’’ should also exclude all interest expense Thus, if a CFC does not establish an Therefore, if a holding company that is of a tested loss CFC from the calculation amount of qualified interest expense, not engaged in an active financing or of tested interest expense. Comments the taxpayer can assume that none of insurance business borrows to fund the asserted that exempting interest expense the CFC’s interest expense is qualified activities of subsidiaries that are of tested loss CFCs from the calculation interest expense. However, regardless of engaged in an active financing or of specified interest expense, in

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conjunction with the exclusion of the used in the production of gross tested Department and the IRS should provide QBAI of tested loss CFCs, would income. such an exception. Further, an produce appropriate results, though one exception for interest paid to U.S. E. Interest Expense Paid or Accrued to comment acknowledged that such a rule persons could permit taxpayers to a U.S. Shareholder might need to be accompanied by an circumvent section 951A(b)(2)(B) by anti-abuse rule. One comment asserted As discussed in part VI.A of this borrowing externally at the U.S. that excluding interest expense of a Summary of Comments and Explanation shareholder level and then on-lending tested loss CFC would be appropriate of Revisions section, the proposed the borrowed funds to CFCs. In this under section 951A(b)(2)(B), because regulations adopt a netting approach case, the borrowing by the U.S. that subparagraph refers only to interest with the result that specified interest shareholder would not reduce net DTIR, expense ‘‘taken into account under expense is the excess of a U.S. notwithstanding that the borrowing is subsection (c)(2)(A)(ii),’’ which, shareholder’s pro rata share of tested factually traceable to the acquisition by according to the comment, describes interest expense of each CFC over its the CFC of specified tangible property only deductions taken into account in pro rata share of tested interest income and net DTIR would have been reduced determining tested income. Another of each CFC. See proposed § 1.951A– if instead the CFC had borrowed comment recommended that, rather 1(c)(3)(ii). Several comments directly from the third party. recommended that the final regulations than excluding all the interest expense VII. Comments and Revisions to of a tested loss CFC, the final exclude interest expense paid by a CFC to a U.S. shareholder or a related U.S. Proposed § 1.951A–5—Domestic regulations should exclude the interest Partnerships and Their Partners expense incurred to fund acquisitions of person from the definition of tested tangible property held by the tested loss interest expense. One comment A. Proposed Hybrid Approach CFC. The comments suggested that recommended that this exclusion be applied to a payment of interest to any The proposed regulations provide including interest expense of a tested that, in general, a domestic partnership loss CFC (or incurred to acquire tangible U.S. person, whereas two comments suggested that this exclusion also apply that is a U.S. shareholder (‘‘U.S. property of the tested loss CFC), which shareholder partnership’’) of a CFC reduces net DTIR of a U.S. shareholder, to interest expense to the extent the related interest income is subject to U.S. (‘‘partnership CFC’’) determines a GILTI while excluding the QBAI of a tested inclusion amount, and partners of the loss CFC, which increases the net DTIR tax as effectively connected income or subpart F income. These comments partnership that are not also U.S. of a U.S. shareholder, results in unfair asserted that interest expense should shareholders of the partnership CFC and asymmetrical treatment of tested not generally increase specified interest take into account their distributive share loss CFCs. expense to the extent that the related of the partnership’s GILTI inclusion The final regulations do not adopt the interest income is subject to U.S. tax at amount. See proposed § 1.951A–5(b). recommendation to exclude all interest the regular statutory rate, at least in the Partners that are U.S. shareholders of a expense of a tested loss CFC, because hands of a U.S. shareholder or related partnership CFC (‘‘U.S. shareholder such exclusion would be inconsistent person. According to these comments, partners’’), however, do not take into with the text of section 951A(d)(2)(A) excluding interest expense under these account their distributive share of the and footnote 1563 of the Conference circumstance would be consistent with partnership’s GILTI inclusion amount to Report and could create an incentive to the policy of section 951A(b)(2)(B), the extent determined by reference to inappropriately shift interest expense to which does not reduce a U.S. the partnership CFC but instead are a tested loss CFC in order to avoid shareholder’s net DTIR for a CFC’s treated as proportionately owning the reducing a U.S. shareholder’s net DTIR. interest expense to the extent that the stock of the partnership CFC within the The reference to section related income increases the U.S. meaning of section 958(a) as if the 951A(c)(2)(A)(ii) in section shareholder’s net CFC tested income. domestic partnership were an aggregate 951A(b)(2)(B) encompasses all The final regulations do not adopt of its partners. To accomplish this deductions properly allocable to gross these recommendations. Section result, the proposed regulations, with tested income, including deductions 951A(b)(2)(B) generally reduces net respect to U.S. shareholder partners, taken into account in determining tested DTIR of a U.S. shareholder by the full treat the domestic partnership in the loss. See section 951A(c)(2)(B)(i) amount of its pro rata share of the same manner as a foreign partnership, (defining tested loss as the excess of interest expense of a CFC, but then which is treated as an aggregate of its deduction described in section provides a limited exception for the partners under section 958(a)(2). As a 951A(c)(2)(A)(ii) over gross tested CFC’s interest expense to the extent the result, a U.S. shareholder partner income described in section related interest income is taken into determines its GILTI inclusion amount 951A(c)(2)(A)(i)). account in determining the net CFC taking into account its pro rata share of However, in response to the tested income of the U.S. shareholder. any tested item of the partnership CFC. comments, the final regulations reduce In effect, the rule generally reduces net If the U.S. shareholder partnership a tested loss CFC’s tested interest DTIR of a U.S. shareholder by its pro holds other partnership CFCs in which expense by its tested loss QBAI amount, rata share of the net external interest the partner is not a U.S. shareholder, an amount equal to 10 percent of the expense incurred by its CFCs. Thus, then a separate GILTI computation is QBAI that the tested loss CFC would borrowing between commonly-owned made at the partnership level with have had if it were instead a tested CFCs generally does not reduce net respect to such partnership CFCs’ tested income CFC. See § 1.951A–4(b)(1)(i) and DTIR, whereas external borrowing items, and the partner includes its (iv) and (c) Example 5. This rule has the generally does. The statute does not distributive share of this separately effect of not taking into account the provide a similar exception for any determined GILTI inclusion amount as tested interest expense of a tested loss payment of interest to the extent the well. See proposed § 1.951A–5(c). This CFC to the extent that such tested related interest income is subject to U.S. hybrid approach (‘‘proposed hybrid interest expense is less than or equal to tax, nor is there any indication in the approach’’) of treating a domestic a notional 10 percent return on the legislative history of the Act that partnership as an entity with respect to tested loss CFC’s tangible assets that are Congress intended that the Treasury partners that are not U.S. shareholders,

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but as an aggregate of its partners with partnership audit regime enacted by Both comments primarily respect to partners that are U.S. section 1101 of the Bipartisan Budget recommended a pure aggregate shareholders, is intended to balance the Act of 2015, Public Law 114–74 (BBA) approach. Under a pure aggregate policies underlying GILTI with the as some determinations are made at the approach, a domestic partnership would relevant statutory provisions. In partnership level and others at the not have a GILTI inclusion amount, and particular, a domestic partnership is a partner level. thus no partner of the partnership U.S. person under sections 957(c) and The comments also raised concerns would have a distributive share of such 7701(a)(30) and thus a U.S. shareholder that the determination of a GILTI amount. Rather, for purposes of under section 951(b), which suggests inclusion amount at the partnership determining the partner’s GILTI that a domestic partnership should level and the disparate treatment of U.S. inclusion amount, a partner would be generally be treated as an entity for shareholder partners and non-U.S. treated as owning directly the stock of purposes of subpart F. On the other shareholder partners under the CFCs owned by a domestic partnership hand, if a domestic partnership were proposed hybrid approach leads to for purposes of determining its own treated strictly as an entity for purposes uncertainty regarding the application of GILTI inclusion amount. Thus, under a of section 951A, a domestic partnership sections 959 and 961 (regarding PTEP pure aggregate approach, unlike under with a GILTI inclusion amount would and corresponding basis adjustments) the proposed hybrid approach or a pure be ineligible for foreign tax credits with respect to domestic partnerships entity approach, a partner that is not a under section 960(d) or a deduction and partnership CFCs, basis adjustments U.S. shareholder of a partnership CFC under section 250 with respect to its with respect to partnership interests and would not have a pro rata share of the GILTI inclusion amount. partnership CFCs, and capital accounts partnership CFC’s tested items or a In the proposed regulations, the determined and maintained in distributive share of a GILTI inclusion Treasury Department and the IRS accordance with § 1.704–1(b)(2). For amount of the partnership. According to rejected an approach that would treat a instance, there are no rules in the comments, a pure aggregate approach domestic partnership as an entity with proposed regulations regarding whether would reduce complexities inherent in respect to all its partners (‘‘pure entity and to what extent a U.S. shareholder the proposed hybrid approach in terms approach’’) for purposes of section partner’s capital account in a of administration and compliance. A 951A, because treating a domestic partnership is adjusted when the U.S. pure aggregate approach would also partnership as the section 958(a) owner shareholder partner computes its GILTI avoid the disparate and arbitrary effects of stock in all cases would frustrate the inclusion amount based on its pro rata of a pure entity approach, under which GILTI framework by creating shares of tested items of partnership a U.S. shareholder’s GILTI inclusion unintended planning opportunities for CFCs. The comments noted that if the amount may vary significantly well-advised taxpayers and traps for the capital account of a U.S. shareholder depending on whether it owns CFCs unwary. However, the Treasury partner is not adjusted for its pro rata through a domestic partnership as Department and the IRS also did not shares of tested items of a partnership opposed to directly or through a foreign adopt an approach that would treat a CFC, then the economic arrangement partnership. The comments domestic partnership as an aggregate between the U.S. shareholder partner acknowledged that while domestic with respect to all its partners (‘‘pure and other partners could be distorted. partnerships have historically been aggregate approach’’) for purposes of treated as entities for purposes of GILTI, because such an approach would Neither comment recommended a pure entity approach as its primary subpart F, the enactment of section be inconsistent with the treatment of 951A and its reliance on shareholder- domestic partnerships as entities for recommendation. One comment level calculations justifies a purposes of subpart F. supported a pure entity approach over the proposed hybrid approach, although reconsideration of this approach. B. Comments on Proposed Hybrid it recommended a pure entity approach One comment recommended that the Approach only if a pure aggregate approach were pure aggregate approach apply also to Two comments were received on the not adopted. Another comment the determination of whether a foreign treatment of domestic partnerships and recommended that the pure entity corporation owned by a domestic their partners under the proposed approach not be adopted in any case. partnership is a CFC. Under this regulations. These comments raised Both comments noted that the pure approach, a domestic partnership would concerns regarding the procedural and entity approach would avoid the also be treated as a foreign partnership computational complexity of the complexities inherent in the proposed for purposes of determining whether a proposed hybrid approach. The hybrid approach and conform the domestic partnership is a U.S. comments highlighted the difficulty that treatment of domestic partnerships for shareholder of a foreign corporation and some partnerships would have in GILTI purposes with the treatment therefore whether the foreign determining whether and to what extent under subpart F before the enactment of corporation is owned in the aggregate its partners are U.S. shareholder section 951A. However, the comments more than 50 percent (by voting power partners of partnership CFCs in order to noted that a pure entity approach is or value) by U.S. shareholders. The determine whether and with respect to inconsistent with the purpose of section same comment suggested that if this which partnership CFCs to calculate a 951A, which is to compute a single approach were not adopted, the final partnership-level GILTI inclusion GILTI inclusion amount for a taxpayer regulations should either adopt the amount for each of its partners. In this by reference to the items of all the proposed hybrid approach or an regard, a partner of a U.S. shareholder taxpayer’s CFCs. The comments agreed aggregate approach that would require partnership may itself be a U.S. that the preamble to the proposed even non-U.S. shareholder partners to shareholder of one or more partnership regulations articulated valid policy take into account their pro rata shares of CFCs, but not a U.S. shareholder of one reasons for rejecting the pure entity tested items of CFCs owned by a or more others. According to the approach, namely, that such approach domestic partnership. This approach, in comments, the proposed hybrid presents both an inappropriate planning contrast to the pure entity approach and approach also raises administrability opportunity as well as a trap for the the proposed hybrid approach, would concerns under the centralized unwary. permit a partner that is not a U.S.

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shareholder with respect to a does not have a GILTI inclusion amount respect to the taxation of CFC earnings partnership CFC to nonetheless and thus no partner of the partnership after the Act, the Treasury Department aggregate its pro rata shares of the tested has a distributive share of a GILTI and the IRS have determined that it is items of such partnership CFC with its inclusion amount. Furthermore, because an appropriate occasion to reexamine pro rata shares of the tested items of any only a U.S. shareholder can have a pro whether a domestic partnership should non-partnership CFCs with respect to rata share of a tested item of a CFC be treated as an entity or an aggregate in which the partner is a U.S. shareholder under section 951A(e)(1) and § 1.951A– determining the owners of section for purposes of determining a single 1(d), a partner that is not a U.S. 958(a) stock for purposes of sections 951 GILTI inclusion amount for the partner. shareholder of a CFC owned by the and 951A. The 1954 legislative history The other comment recommended partnership does not have a pro rata makes clear that this determination that if the pure aggregate approach or share of any tested item of the CFC. For should be based on the policies of the the pure entity approach were not the reasons discussed in this part VII.C provision at issue. See H.R. Rep. No. adopted, the final regulations adopt an of the Summary of Comments and 83–2543, at 59 (1954) (Conf. Rep.). In approach under which a domestic Explanation of Revisions section, the this regard, the Act fundamentally partnership would be treated as an Treasury Department and the IRS have changed the policies relating to the entity for purposes of determining its determined that this approach best taxation of CFC earnings relative to GILTI inclusion amount and each reconciles the relevant statutory those in 1962. Moreover, an aggregate partner’s distributive share of such provisions, the policies underlying approach applies if it is appropriate to amount, but then each partner’s overall GILTI, and the administrative and carry out the purpose of a provision of GILTI inclusion amount would be compliance concerns raised by the the Code, unless an entity approach is adjusted by its separately-computed comments. specifically prescribed and clearly GILTI inclusion amount with respect to Since the enactment of subpart F, contemplated by the relevant statute. Cf. non-partnership CFCs of the partner. domestic partnerships have generally § 1.701–2(e). This adjustment would be positive to been treated as entities, rather than as As discussed in the preamble to the the extent of the partner’s net CFC aggregates of their partners, for purposes proposed regulations, an aggregate tested income with respect to CFCs of determining whether a foreign approach to domestic partnerships owned outside a domestic partnership, corporation is a CFC. See § 1.701–2(f) furthers the purposes of the GILTI but it could be negative if the partner Example 3 (concluding that a domestic regime. It is consistent with the general had a ‘‘net CFC tested loss’’ (that is, partnership that wholly owns a foreign aggregate pro rata shares of tested loss corporation is treated as an entity and intent of the GILTI regime to determine in excess of aggregate pro rata share of the U.S. shareholder of the foreign tax liability at the U.S. shareholder level tested income) with respect to such corporation, and that the foreign on an aggregate basis rather than on a CFCs. corporation is a CFC for section 904 CFC-by-CFC basis. See Senate purposes). In addition, domestic Explanation at 371 (‘‘The committee C. Adoption of Aggregate Treatment for partnerships have generally been treated believes that calculating GILTI on an Purposes of Determining GILTI as entities for purposes of determining aggregate basis, instead of on a CFC-by- Inclusion Amounts the U.S. shareholder that has the CFC basis, reflects the interconnected After consideration of the comments subpart F inclusion with respect to such nature of a U.S. corporation’s global received, the Treasury Department and foreign corporation. But cf. §§ 1.951– operations and is a more accurate way the IRS have decided not to adopt the 1(h) and 1.965–1(e) (treating certain of determining a U.S. corporation’s proposed hybrid approach in the final domestic partnerships owned by CFCs global intangible income.’’); see also regulations. Instead, the final as foreign partnerships for purposes of House Ways and Means Committee, regulations adopt an approach that determining the U.S. shareholder that 115th Cong., Rep. on H.R. 1, H.R. Rep. treats a domestic partnership as an has a subpart F inclusion with respect No. 115–409, at 389 (Comm. Print 2017) aggregate for purposes of determining to CFCs owned by such domestic (‘‘[I]n making this measurement, the the level (that is, partnership or partner) partnerships). Committee recognizes the integrated at which a GILTI inclusion amount is The GILTI rules employ the basic nature of modern supply chains and calculated and taken into gross income. subpart F architecture in several believes it is more appropriate to look Specifically, the final regulations regards, such as for purposes of at a multinational enterprise’s foreign provide that, in general, for purposes of determining a U.S. shareholder’s pro operations on an aggregate basis, rather section 951A and the section 951A rata share of tested items. See section than by entity or by country.’’). A pure regulations, and for purposes of any 951A(e)(1). Nevertheless, there is no entity approach undermines this overall other provision that applies by reference indication that Congress intended to framework in two ways. First, under a to section 951A or the section 951A incorporate the historical treatment of pure entity approach, well-advised regulations (for instance, sections 959, domestic partnerships under subpart F taxpayers might avail themselves of 960, and 961), a domestic partnership is into the GILTI regime, particularly given domestic partnerships to segregate not treated as owning stock of a foreign that respecting a domestic partnership tested items in a manner that is corporation within the meaning of as the owner under section 958(a) of the inconsistent with the overall framework section 958(a). See § 1.951A–1(e)(1). stock of a CFC for purposes of GILTI of section 951A. In this regard, Rather, the partners of a domestic would frustrate the statutory framework. taxpayers generally would lower their partnership are treated as owning In addition, no provision in the Code tax liability by separating through one proportionately the stock of CFCs prescribes the treatment of domestic or more domestic partnerships their owned by the partnership in the same partnerships for purposes of section CFCs with high-taxed tested income and manner as if the partnership were a 958(a) in determining GILTI. tested interest expense from their CFCs foreign partnership under section Given the silence in the statute with with low-taxed tested income, QBAI, 958(a)(2). See id. Because a domestic respect to the treatment of domestic and tested losses. Second, a pure entity partnership is not treated as owning partnerships for purposes of GILTI, the approach would represent a trap for an section 958(a) stock for purposes of Act’s legislative history, and the overall unwary taxpayer by, for example, section 951A, a domestic partnership significance of the GILTI regime with preventing the use of the tested losses

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of CFCs directly held by a taxpayer to partner’s GILTI inclusion amount by The final regulations also do not offset the tested income of CFCs held by reference to CFCs owned by the extend aggregate treatment to the the taxpayer through one or more domestic partnership. determination of the controlling domestic partnerships. This result The final regulations treat a domestic domestic shareholders (as defined in would not occur if the domestic partnership as an aggregate of its § 1.964–1(c)(5)) of a CFC for purposes of partnership were treated as an aggregate partners in determining section 958(a) any election made under the section of its partners. In this regard, the stock ownership by providing that, for 951A regulations. See § 1.951A– proposal to ‘‘adjust’’ a partner’s purposes of section 951A and the 3(e)(3)(ii) (election to use a non-ADS distributive shares of its domestic section 951A regulations, a domestic depreciation method for pre-enactment partnerships’ GILTI inclusion amount partnership is treated in the same property) and § 1.951A–3(h)(2)(ii)(B)(3) by the partner’s net CFC tested income manner as a foreign partnership. See (election to eliminate disqualified and the net CFC tested loss calculated § 1.951A–1(e)(1). For purposes of basis). As a result, a domestic with respect to the partner’s CFCs held subpart F, a foreign partnership is partnership that satisfies the ownership outside the partnership would not fully explicitly treated as an aggregate of its requirements of § 1.964–1(c)(5) with address these concerns. That is, the partners, and rules regarding respect to a CFC, and not its partners, partner would be permitted the full aggregation of foreign partnerships are is treated as the controlling domestic benefit of its aggregate pro rata share of relatively well-developed and shareholder of the CFC and the tested losses with respect to CFCs understood. See section 958(a)(2). partnership files the relevant elections outside the partnership, but the Therefore, rather than developing a new with respect to the CFC. The treatment specified interest expense with respect standard for the treatment of domestic of a domestic partnership as the to CFCs outside the partnership would partnerships as an aggregate, the controlling domestic shareholder be effectively segregated from the QBAI Treasury Department and the IRS have reduces the number of persons that need of CFCs inside the partnership (and determined that it would be simpler and to comply with the rules of § 1.964– therefore would not reduce the partner’s more administrable to incorporate the 1(c)(3), and ensures that any election net DTIR), and vice versa. aggregate approach by reference to the with respect to a CFC that could affect the tax consequences of a U.S. person In addition, an aggregate approach rules related to foreign partnerships that is a partner of a domestic with respect to section 958(a) furthers under section 958(a)(2). partnership is made by such the policies of other provisions related The final regulations do not adopt the partnership. Accordingly, the final to section 951A. The legislative history recommendation to extend the regulations provide that the aggregation makes clear that Congress intended for treatment of a domestic partnership as rule for domestic partnerships does not a domestic corporate partner of a an aggregate of its partners to the apply for purposes of determining domestic partnership to obtain the determination of U.S. shareholder and whether a U.S. person is a U.S. benefit of a foreign tax credit under CFC status. The Treasury Department shareholder, whether a U.S. shareholder and the IRS have determined that an section 960(d) and a deduction under is a controlling domestic shareholder (as section 250 with respect to a GILTI approach that treats a domestic defined in § 1.964–1(c)(5)), or whether a inclusion amount. See Conference partnership as an aggregate of its foreign corporation is a CFC. See Report, at 623, fn. 1517. However, only partners for purposes of determining § 1.951A–1(e)(2). domestic corporations (not domestic CFC status would not be consistent with The treatment of domestic partnerships) are eligible for a foreign the relevant statutory provisions. A partnerships as foreign partnerships in tax credit under section 960(d) or a domestic partnership is a U.S. person the final regulations is solely for deduction under section 250. Moreover, under section 957(c) and section purposes of section 951A and the absent treating a domestic partnership 7701(a)(30) and, therefore, can be a U.S. section 951A regulations and for as an aggregate for purposes of section shareholder under section 951(b). purposes of any other provision that 951A, a domestic corporate partner’s Indeed, when subpart F was enacted in applies by reference to a GILTI inclusion percentage under section 1962, the legislative history indicated inclusion amount (such as sections 959 960(d)(2) is determined without regard that domestic partnerships generally and 961). The rule does not affect the to any CFC owned by the partnership should be treated as U.S. shareholders. determination of ownership under because such partner has no pro rata See S. Rep. No. 1881, 87th Cong., 2d section 958(a) for any other provision of share of the tested income of such CFC. Sess. 80 n.1 (1962) (‘‘U.S. shareholders the Code (such as section 1248(a)), nor See section 960(d)(2)(B) (the are defined in the bill as ‘U.S. persons’ does it change whether such partner has denominator of the inclusion percentage with 10-percent stockholding. U.S. a distributive share of a domestic of a domestic corporation is the persons, in general, are U.S. citizens and partnership’s subpart F inclusion under corporation’s aggregate pro rata share of residents and domestic corporations, section 951(a). However, the Treasury tested income amount under section partnerships and estates or trusts.’’). Department and the IRS are proposing 951A(c)(1)(A)). Therefore, a strict entity Furthermore, sections 958(b) and in a notice of proposed rulemaking approach to section 960(d) might 318(a)(3) treat a partnership (including published in the same issue of the suggest that domestic corporate partners a domestic partnership) as owning the Federal Register as these final of a domestic partnership are ineligible stock of its partners for purposes of regulations to apply a similar aggregate for foreign tax credits with respect to a determining whether the foreign treatment to domestic partnerships for GILTI inclusion amount of the corporation is owned more than 50 purposes of section 951. partnership. On the other hand, an percent by U.S. shareholders, which Under section 1373(a), an S aggregate approach to domestic suggests that partnerships are treated as corporation is treated as a partnership partnerships furthers Congressional entities for purposes of determining and its shareholders as partners for policy by treating domestic corporate ownership under section 958(b). See purposes of subpart F, including section partners as owning (within the meaning also sections 958(b) and 318(a)(2) 951A. Therefore, for purposes of of section 958(a)) stock of CFCs owned (treating stock owned by a partnership, determining a GILTI inclusion amount by domestic partnerships and thus domestic or foreign, as owned of a shareholder of an S corporation, determining the domestic corporate proportionately by its partners). under § 1.951A–1(e), the S corporation

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is not treated as owning stock of a 951A(c)(2)(B)(ii) (‘‘Coordination with The Treasury Department and the IRS foreign corporation within the meaning subpart F to deny double benefit of have determined that it would be of section 958(a) but instead is treated losses’’), the provision is limited to inappropriate to treat any portion of a in the same manner as a foreign denying a double benefit from a tested GILTI inclusion amount as personal partnership. The Treasury Department loss (that is, a reduction in both net CFC holding company income. A GILTI and the IRS are studying the application tested income and subpart F income), inclusion amount is determined by of section 1373(a) with respect to and that there can be no such double reference to income that would have section 951A, as well as the broader benefit to the extent that the tested loss been taxed, if at all, as dividends from implications of treating S corporations does not reduce a U.S. shareholder’s net CFCs before the enactment of section as partnerships for purposes of subpart CFC tested income. These comments 951A, which are specifically excluded F. Comments are requested in this recommended that proposed § 1.951A– from the definition of personal holding regard. 6(d) be modified such that it applies company income under section Conforming changes are also made to only to a tested loss to the extent the 543(a)(1)(C). Further, there is no other aspects of the final regulations to tested loss is ‘‘used’’ within the meaning indication in the legislative history that account for the aggregate treatment of of proposed § 1.951A–6(e). Congress intended through the domestic partnerships under § 1.951A– The final regulations do not adopt this enactment of section 951A to 1(e). For instance, the proposed recommendation. Section substantially change the types of income regulations provide that, for purposes of 951A(c)(2)(B)(ii), by its terms, increases that would be taken into account in determining whether a U.S. shareholder E&P for purposes of section 952(c)(1)(A) determining personal holding company has a pro rata share of an accrual for by the amount of any tested loss. There status. Accordingly, the final regulations purposes of sections 163(e)(3)(B)(i) and is no indication in the provision or clarify that in determining whether a 267(a)(3)(B), a domestic partnership’s legislative history that limiting the corporate U.S. shareholder is a personal pro rata share of the accrual is taken application of section 951A(c)(2)(B)(ii) holding company, a GILTI inclusion into account only to the extent that U.S. to a tested loss that reduces net CFC amount is not treated as personal persons include in gross income a tested income would be appropriate, holding company income (as defined in distributive share of the domestic and the heading of the provision has no section 543(a)). See § 1.951A–5(d). partnership’s GILTI inclusion amount. legal effect. See section 7806(b). C. Adjustments to Basis Related to Net See proposed § 1.951A–5(c)(2). This rule Accordingly, the rule is adopted Used Tested Loss is no longer necessary under the final without modification in § 1.951A–6(b). regulations because a domestic To eliminate the potential for the partnership does not have a GILTI B. Treating GILTI Inclusion Amounts as duplicative use of a loss, the proposed inclusion amount, and partners that are Subpart F Inclusions for Purposes of the regulations set forth rules providing for U.S. shareholders have their own pro Personal Holding Company Rules downward adjustments to the adjusted basis in stock of a tested loss CFC to the rata shares of the accrual. Therefore, this A comment requested clarification rule is eliminated in the final extent its tested loss was used to offset regarding the treatment of a GILTI tested income of another CFC. See regulations. See § 1.951A–5(c). In inclusion amount for purposes of the proposed § 1.951A–6(e). These addition, the partnership blocker rule is personal holding company rules in adjustments are generally made at the modified such that it no longer applies sections 541 through 547. Section 541(a) time of a direct or indirect disposition for purposes of section 951A. See imposes a 20-percent tax on the of stock of the tested loss CFC. See § 1.951–1(h)(1). It is no longer necessary undistributed personal holding proposed § 1.951A–6(e)(1). Comments to apply the rule for purposes of section company income of a personal holding raised many significant issues with 951A because, for such purposes, a company. Section 542(a) defines a respect to these rules. domestic partnership is not treated as ‘‘personal holding company’’ as a The Treasury Department and the IRS owning stock of a foreign corporation corporation if at least 60 percent of its remain concerned that, absent basis within the meaning of section 958(a). adjusted ordinary gross income for the adjustments, a tested loss can result in VIII. Comments and Revisions to taxable year is personal holding the creation of uneconomic or Proposed § 1.951A–6—Treatment of company income and certain ownership duplicative loss, but have determined GILTI Inclusion Amount and requirements are satisfied. Section that the rules in the proposed Adjustments to E&P and Basis Related 543(a) defines ‘‘personal holding regulations related to basis adjustments to Tested Loss CFCs company income’’ by reference to should not be adopted in these final certain categories of passive income, regulations. Instead, the rules related to A. Increase of E&P by Tested Losses for including dividends. However, for this basis adjustments, including the Purposes of Section 952(c)(1)(A) purpose, dividends received by a U.S. comments received with respect to such Section 951A(c)(2)(B)(ii) provides that shareholder from a CFC are excluded rules, will be considered in a separate section 952(c)(1)(A) is applied by from the definition of personal holding project. Accordingly, the final increasing the E&P of a tested loss CFC company income. See section regulations reserve on the rules related by the amount of its tested loss. See also 543(a)(1)(C). The comment noted that to adjustments to stock of tested loss proposed § 1.951A–6(d). Comments the existing regulations under section CFCs. See § 1.951A–6(c). Any rules asserted that proposed § 1.951A–6(d) 951 provide that for purposes of issued under § 1.951A–6(c) will apply has the effect of increasing E&P by a determining whether a corporate U.S. only with respect to tested losses tested loss even if, and to the extent, the shareholder is a personal holding incurred in taxable years of CFCs and tested loss does not provide a benefit to company, the character of a subpart F their U.S. shareholders ending after the a U.S. shareholder because its aggregate inclusion of such domestic corporation date of publication of any future pro rata share of tested losses exceeds is determined as if the amount that guidance. its aggregate pro rata share of tested results in the subpart F inclusion were For a discussion of corresponding income. These comments argued that realized directly by the corporation from rules for basis adjustments within a this result is not appropriate because, the source from which it is realized by consolidated group, as provided for in based on the heading of section the CFC. See § 1.951–1(a)(3). proposed §§ 1.1502–13, 1.1502–32, and

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1.1502–51, see part IX.C of this purposes of determining a member’s net required to rationalize the priority Summary of Comments and Explanation CFC tested income, a member’s allocation approach. of Revisions section. aggregate pro rata share of tested income Two of the comments proposed is determined on a separate-entity basis similar methods for determining a IX. Comments and Revisions to by aggregating its pro rata share of the member’s GILTI inclusion amount. One Proposed §§ 1.1502–13, 1.1502–32, and tested income of each of its CFCs. See of these comments suggested calculating 1.1502–51—Consolidated Section 951A proposed § 1.1502–51(e)(1) and (12). the consolidated group’s GILTI A. Calculation of GILTI Inclusion However, a member’s aggregate pro rata inclusion amount as if members holding Amount share of tested loss and its net DTIR for CFC stock were divisions of a single Section 1502 provides that the taxable year is calculated in three corporation, then allocating the resulting consolidated group amount consolidated return regulations will be steps—first, each member’s pro rata among members based on each promulgated to clearly reflect the share of each tested item other than member’s net CFC tested income. For income tax liability of a consolidated tested income is determined on a this purpose, net CFC tested income is group and each member of the separate-entity basis by reference to its calculated in a manner consistent with consolidated group (a ‘‘member’’). pro rata share of each CFC; second, each the priority allocation approach, by However, in the context of section member’s pro rata share of each tested allowing the member’s tested losses to 951A, clear reflection of the GILTI item other than tested income is aggregated into a consolidated sum; and be used first to offset the same member’s inclusion amounts of both individual third, each member is then allocated a tested income. The other comment members and the consolidated group as portion of the consolidated sum of each suggested calculating and allocating the a whole is not feasible. Section 951A such tested item based on its relative consolidated group’s GILTI inclusion requires a U.S. shareholder-level amount of tested income (the amount in the same manner, but would calculation, where, for example, the ‘‘aggregation approach’’). See proposed extend application of this method to shareholder’s pro rata share of the tested § 1.1502–51(e)(2), (3), (4), (5), (7), and foreign tax credits with respect to tested income of one CFC may be offset by its (10). The aggregation approach has the income. This second comment proposed pro rata share of the tested loss or QBAI effect of determining the aggregate using the aggregation approach to of another CFC, to produce a smaller amount of GILTI inclusion amounts of determine the amount of such credits GILTI inclusion amount. Accordingly, members on a single-entity basis, but available to the consolidated group (and calculating a member’s GILTI inclusion then determining each member’s share the identity of the CFCs to whom the amount on a completely separate-entity of the consolidated group’s aggregate credits are attributable), but allocating basis, solely based on its pro rata share GILTI inclusion amount based on its certain basis adjustments in member of the items of its CFCs, would clearly relative pro rata share of tested income stock related to such credits under the reflect the income tax liability of the as determined on a separate-entity basis. priority allocation approach. As an member. However, such an approach The Treasury Department and the IRS alternative, the second comment would would mean that the consolidated received several comments addressing base the allocations on the relative group’s GILTI inclusion amount would the calculation of a member’s GILTI amounts of foreign tax credits paid by vary depending on which members own inclusion amount. These comments each member’s CFCs. each CFC, particularly in cases in which generally supported single-entity The Treasury Department and the IRS the CFCs held by some members treatment, but they expressed concern decline to adopt these comments produce tested income, but the CFCs about the lack of clear reflection of because they do not produce reasonable held by other members produce tested income at the member level. The results that are consistent with single- loss. This variability undermines the concern arises from the movement of entity treatment. In particular, the first clear reflection of the income tax the economic benefit (in the GILTI of these comments does not provide for liability of the consolidated group as a computation) of one member’s pro rata single-entity treatment when foreign tax whole. The Treasury Department and share of a tested loss with respect to credits are taken into account, instead the IRS determined in the proposed stock held by the member to other allowing for wide variation in the regulations that members’ GILTI members, including those not holding availability of foreign tax credits inclusion amounts should be such stock. The comments considered depending on which member of a determined in a manner that clearly whether alternative methods could be consolidated group owns the stock of reflects the income tax liability of the used that both provide for single-entity the CFCs. The variation arises because consolidated group and that creates treatment and minimize uneconomic a corporate U.S. shareholder is deemed consistent results regardless of which results to members. In particular, the to pay a portion of the foreign income member of a consolidated group owns comments raised the possibility that the taxes paid or accrued by its CFCs based the stock of the CFCs (‘‘single-entity tested loss of a CFC should first offset on the shareholder’s GILTI inclusion treatment’’). This approach removes the tested income of a CFC owned by amount. See section 960(d). A priority incentives for inappropriate planning the same member (the ‘‘priority allocation approach, like the separate and also eliminates traps for the allocation approach’’). entity calculations discussed in a unwary. One comment evaluated the merits of preceding paragraph, would change The proposed regulations accomplish the priority allocation approach versus members’ GILTI inclusion amounts these goals by providing that the GILTI the aggregation approach. The comment based on which member owns the stock inclusion amount of a member is identified the tension in the section of the CFCs. By extension, a priority determined pursuant to a multi-step 951A context between clearly reflecting allocation approach would also change process. As in the case of a non- income tax liability at the consolidated the amount of foreign tax credits that are member, the GILTI inclusion amount of group level and doing so at the member available to the consolidated group a member equals the excess (if any) of level, and it considered possible ways to based on which member owns the stock the member’s net CFC tested income alleviate this conflict. The comment of the CFCs. This disparity would allow over the member’s net DTIR for the ultimately endorsed maintaining the for tax planning to maximize the taxable year. See proposed § 1.951A– approach in proposed § 1.1502–51, due availability of foreign tax credits with 1(c)(1) and proposed § 1.1502–51(b). For to the additional rules and complexities respect to tested income.

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The second of these comments D. Portion of Proposed Regulations not language directly provides for the contains proposals that contravene Being Finalized dividends-received deduction, and longstanding foreign tax credit The proposed regulations would treat therefore the rule applying proposed principles, by divorcing a member’s a member as receiving tax-exempt § 1.78–1(c) to taxable years beginning income inclusion from the member’s income immediately before another before January 1, 2018, should be deemed payments of foreign tax. Absent member recognizes income, gain, eliminated. a GILTI inclusion amount and deduction, or loss with respect to a The Treasury Department and the IRS ownership of a CFC that has paid or share of the first member’s stock (the ‘‘F have determined that sections 7805(a), accrued foreign taxes on tested income, adjustment’’). See proposed § 1.1502– 7805(b)(2), and 245A(g) provide ample a U.S. shareholder can claim no foreign 32(b)(3)(ii)(F). The amount of the tax- authority for the rule and therefore tax credits with respect to tested exempt income would be determined finalize the proposed applicability date income. And yet under the proposed based in part on the aggregate tested without change. Section 7805(a) method, a consolidated group’s foreign income and aggregate tested losses of provides that the Treasury Department tax credits may reflect foreign taxes paid the member’s CFCs in prior taxable and the IRS shall prescribe all needful or accrued by CFCs of members that years. rules and regulations for the have no GILTI inclusion amount. For The Treasury Department and the IRS enforcement of title 26, including all these reasons, the Treasury Department have become aware of serious flaws rules and regulations as may be and the IRS do not adopt this method. with the F adjustment. Examples of the necessary by reason of any alteration of Based on the foregoing, the Treasury problems include unintended and law in relation to internal revenue. The Department and the IRS continue to duplicative tax benefits, distortive enactment of the Act and the addition believe that the aggregation approach effects, and possible avoidance of Code of section 245A necessitated regulations balances, to the greatest extent possible, provisions and regulations. Therefore, to ensure that section 78 continues to the clear reflection of the income tax the Treasury Department and the IRS serve its intended purpose. The purpose liability under section 951A of a have decided not to finalize the F of the section 78 dividend is to ensure consolidated group with reasonable adjustment. As a result, taxpayers may that a U.S. shareholder cannot results to its individual members. not rely on the F adjustment. The effectively both deduct and credit the Accordingly, the final regulations Treasury Department and the IRS foreign taxes paid by a foreign generally adopt the aggregation continue to study a number of issues subsidiary that are deemed paid by the approach from the proposed regulations regarding consolidated stock basis in U.S. shareholder. See Elizabeth A. without substantial changes. this area. Owens & Gerald T. Ball, The Indirect B. Applicability Date for Consolidated X. Comments and Revisions to Credit § 2.2B1a n.54 (1975); Stanley Groups Proposed §§ 1.78–1, 1.861–12(c)(2), and Surrey, ‘‘Current Issues in the Taxation For a discussion of the applicability 1.965–7(e) of the Foreign Tax Credit of Corporate Foreign Investment,’’ 56 date for § 1.1502–51, see part XI.A of Proposed Regulations Columbia Law Rev. 815, 828 (June 1956) this Summary of Comments and (describing the ‘‘mathematical quirk’’ Explanation of Revisions section. A. Special Applicability Date Under that necessitated enactment of section Section 78 78). Allowing a dividends-received C. Basis Adjustments to Member Stock The foreign tax credit proposed deduction for a section 78 dividend The proposed regulations contain regulations revise § 1.78–1 to reflect the would undermine the purpose of the special rules, applicable to consolidated amendments to section 78 made by the section 78 dividend because taxpayers groups, that reflect the downward basis Act, as well as make conforming would effectively be allowed both a adjustments set forth in proposed changes to reflect pre-Act statutory credit and deduction for the same § 1.951A–6(e) with respect to the stock amendments. In addition, the foreign foreign tax. For this reason, section 78 of tested loss CFCs. See proposed tax credit proposed regulations provide (as revised by the Act) provides that a §§ 1.1502–32(b)(3)(ii)(E) and that amounts treated as dividends under section 78 dividend is not eligible for a (b)(3)(iii)(C), and 1.1502–51(c) and (d). section 78 (‘‘section 78 dividends’’) that dividends-received deduction under As discussed above in part VIII.C of this relate to taxable years of foreign section 245A. Summary of Comments and Explanation corporations that begin before January 1, As noted in the preamble to the of Revisions section, the Treasury 2018 (as well as section 78 dividends foreign tax credit proposed regulations, Department and the IRS have that relate to later taxable years), are not the special applicability date rule under determined that the rules related to treated as dividends for purposes of § 1.78–1(c) is necessary to ensure that basis adjustments for tested loss CFCs section 245A. this principle is consistently applied should not be adopted in these final Comments questioned whether the with respect to a CFC that uses a fiscal regulations and will instead be Treasury Department and the IRS have year beginning in 2017 as its U.S. considered in a separate project. authority to treat section 78 dividends taxable year (a ‘‘fiscal year CFC’’) in Correspondingly, the special rules for relating to taxable years of foreign order to prevent the arbitrary disparate consolidated groups that reflect such corporations beginning before January 1, treatment of similarly situated rules are likewise reserved. See 2018, as ineligible for the dividends- taxpayers. Otherwise, a U.S. shareholder §§ 1.1502–32(b)(3)(ii)(E) and received deduction under section 245A, of a fiscal year CFC would effectively be (b)(3)(iii)(C), and 1.1502–51(c) and (d). which generally applies to certain able to take both a credit and a These special rules, along with related dividends paid after December 31, 2017. deduction for foreign taxes by claiming comments, will be considered in the Although some comments a section 245A deduction with respect same project as the rules related to basis acknowledged that allowing a to its section 78 dividend. In contrast, adjustments for tested loss CFCs and dividends-received deduction for section 78 (as revised by the Act) would will apply only to taxable years of U.S. section 78 dividends would provide apply correctly to a U.S. shareholder of shareholders that are members of a taxpayers with a double benefit that a CFC using the calendar year as its U.S. consolidated group ending after the date clearly was not intended by Congress, taxable year that was also subject to of publication of the final rules. the comments claimed that the statutory section 245A.

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The special applicability date is also for E&P to account for the increase to negative, and to account for the changes consistent with the grant of authority E&P of an E&P deficit foreign made to § 1.965–2(f)(2). Specifically, under section 245A(g) to provide rules corporation under section 965(b)(4)(B). § 1.861–12(c)(2)(i)(B)(1)(ii) now as may be necessary or appropriate to Alternatively, the comment requested provides that the taxpayer first adjusts carry out the provisions of section 245A. that the adjustment for E&P not include its basis in the 10 percent owned Section 245A was intended to provide PTEP. However, proposed § 1.861– corporation as if it did not make the for tax-exempt treatment of certain E&P 12(c)(2)(i)(B)(1)(ii) already accounts for election in § 1.965–2(f)(2)(i) and then, if earned through foreign subsidiaries as the increase in E&P of an E&P deficit applicable, adjusts the basis in the 10 part of a new participation exemption foreign corporation under section percent owned corporation by the system. See Conference Report, at 470 965(b)(4)(B) by providing for an amount described in § 1.965– (2017) (section 245A ‘‘allows an equivalent reduction in the adjusted 2(f)(2)(ii)(B)(1). These changes are not exemption for certain foreign income’’). basis of the foreign corporation. intended to alter the outcome of the Notably, the amount of a dividend Accordingly, the recommendation is not application of the rule to the taxpayer’s eligible for a dividends-received adopted. adjusted basis in the stock of the 10 deduction under section 245A is Another comment requested that the percent owned corporation as compared determined based on the amount of a rule in proposed § 1.861– to the rule articulated in the foreign tax foreign corporation’s ‘‘undistributed 12(c)(2)(i)(B)(1)(ii) be revised in light of credit proposed regulations; rather, the foreign earnings.’’ It would be the changes to § 1.965–2(f)(2) to changes are intended to make the rule incompatible with the purpose of similarly provide that any reductions in more straightforward for taxpayers to section 245A to exempt income arising basis be limited to the amount of the apply and to clarify any ambiguities by reason of a section 78 dividend, taxpayer’s basis in the 10 percent owned about the application of the rule where which is not paid out of a foreign corporation. This comment noted that in the adjustment exceeded the taxpayer’s corporation’s undistributed foreign the absence of such a rule, the adjusted basis in the stock. See § 1.861– earnings but instead represents earnings application of proposed § 1.861– 12(c)(2)(i)(C)(1) (Example 1) and (2) that could not be distributed since they 12(c)(2)(i)(B)(1)(ii) could reduce the (Example 2). were used to pay foreign tax. adjusted basis of the stock below zero, which would be inappropriate for C. Effect of Section 965(n) Election B. Application of Basis Adjustment for purposes of applying the expense Under section 965(n), a taxpayer may Purposes of Characterizing Certain allocation rules. The Treasury elect to exclude the amount of section Stock Department and the IRS agree that, for 965(a) inclusions (reduced by section Proposed § 1.861–12(c)(2) clarifies purposes of applying the expense 965(c) deductions) and associated certain rules for adjusting the stock allocation rules, a taxpayer should not section 78 dividends in determining the basis in a 10 percent owned corporation, have an adjusted basis below zero in the amount of the net operating loss including that the adjustment to basis stock of a 10 percent owned carryover or carryback that is deductible for E&P includes PTEP. Proposed corporation. However, rather than limit in the taxable year of the inclusions. § 1.861–12(c)(2)(i)(B)(2). Additionally, the reduction in stock basis to the Section 1.965–7(e)(1), as added by TD in order to account for the application amount of the taxpayer’s basis in the 10 9846, 84 FR 1838 (February 5, 2019), of section 965(b)(4)(A) and (B), relating percent owned corporation, the final provides that, if the taxpayer makes a to the treatment of reduced E&P of a regulations provide that § 1.861– section 965(n) election, the taxpayer deferred foreign income corporation and 12(c)(2)(i)(B)(1)(ii) may cause the does not take into account the amount increased E&P of an E&P deficit foreign taxpayer’s adjusted basis in the stock of of the section 965(a) inclusions (reduced corporation, proposed § 1.861– the corporation to be negative, as long by section 965(c) deductions) and 12(c)(2)(i)(B)(1)(ii) provides that, for as the adjustment for E&P provided for associated section 78 dividends in purposes of § 1.861–12(c)(2), a taxpayer in § 1.861–12(c)(2)(i)(A) increases the determining the amount of the net determines the basis in the stock of a taxpayer’s adjusted basis to zero or an operating loss for the taxable year. specified foreign corporation as if it had amount above zero. If the taxpayer’s Proposed § 1.965–7(e)(1)(i), included made the election under § 1.965–2(f)(2), adjusted basis in the 10 percent owned in the foreign tax credit proposed even if the taxpayer did not in fact make corporation is still below zero after regulations, provides that the amount by the election. However, the taxpayer does application of § 1.861–12(c)(2)(i)(A)(1) which the section 965(n) election not include the amount by which basis and (2), then for purposes of § 1.861–12, creates or increases the net operating with respect to a deferred foreign the taxpayer’s adjusted basis in the 10 loss for the taxable year is the ‘‘deferred income corporation is increased under percent owned corporation is zero for amount.’’ Proposed § 1.965– § 1.965–2(f)(2)(ii)(A), because the the taxable year. Section 1.861– 7(e)(1)(iv)(B) provides ordering rules to amount of that increase would be 12(c)(2)(i)(A)(3); see also § 1.861– coordinate the election’s effect on reversed if the increase were by 12(c)(2)(i)(C)(3) (Example 3) and (4) section 172 with the computation of the operation of section 961. After issuance (Example 4). The Treasury Department foreign tax credit limitations under of the foreign tax credit proposed and the IRS have determined that section 904. The foreign tax credit regulations, final regulations issued allowing the adjusted basis in stock to proposed regulations provide that the under section 965 (TD 9864, 84 FR 1838 be negative before the application of the deferred amount comprises a ratable (February 5, 2019)) altered the election adjustment for E&P most accurately portion of the deductions (other than under § 1.965–2(f)(2) to allow taxpayers reflects the value of the stock in the 10 the section 965(c) deduction) allocated to limit the reduction in basis with percent owned corporation. and apportioned to each statutory and respect to an E&P deficit foreign Additionally, these final regulations residual grouping for section 904 corporation under the election to the modify proposed § 1.861– purposes. amount of the taxpayer’s basis in the 12(c)(2)(i)(B)(1)(ii) to make clear that the Before the issuance of the foreign tax respective share of stock of the relevant adjustment in § 1.861– credit proposed regulations, the foreign corporation. 12(c)(2)(i)(B)(1)(ii) may cause a Treasury Department and the IRS were One comment requested a special rule taxpayer’s adjusted basis in stock in the aware that some taxpayers were taking with respect to the adjustment to basis 10 percent owned corporation to be the position that the source and separate

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category of the deferred amount consistent with sections 965(n) and 904. category of the deferred amount. See consisted solely of deductions allocated Section 965(n) does not modify the § 1.965–7(e)(1)(iv)(B)(2). and apportioned to the section 965(a) generally applicable rules concerning Separately, the Treasury Department inclusion. Under this approach, the the allocation and apportionment of and the IRS have determined that deferred amount would likely consist expenses for section 904 purposes, nor nothing in proposed § 1.965– primarily of deductions allocated and does it provide an ordering rule for 7(e)(1)(iv)(B)(2) suggests that the apportioned to foreign source general determining which deductions create or allocation and apportionment of category income because that is the increase the amount of a current year expenses is based on the section 965(a) likely source and separate category of net operating loss by reason of the inclusion net of the section 965(c) the section 965(a) inclusion; as a result, section 965(n) election. Section 965(n) deduction, as opposed to the section the electing taxpayer would generally applies solely to determine the amount 965(a) inclusion not reduced by the have a greater amount of foreign source of the net operating loss for the election section 965(c) deduction. All expenses general category income and thus be year and the amount of net operating are allocated and apportioned according to the regulations under §§ 1.861–8 able to credit more foreign taxes paid or loss carryover or carryback to that year. through 1.861–17. See proposed accrued with respect to general category It does not require or permit the § 1.965–7(e)(1)(iv)(B)(1). The section income (relative to the result under the reallocation of deductions that are foreign tax credit proposed regulations). 965(c) deduction is definitely related to After publication of the foreign tax allocated and apportioned to the the section 965(a) inclusion. See credit proposed regulations, a comment separate category containing the section § 1.861–8(b). Other deductions are recommended not finalizing the 965(a) inclusion and associated section allocated and apportioned according to proposed ordering rules because 78 dividends, regardless of whether any the regulations under §§ 1.861–8 taxpayers did not have a chance to deductions are deferred by reason of the through 1.861–17. For example, a consider those ordering rules before section 965(n) election. For example, if deduction that is not definitely related deciding to make an election under a taxpayer with only U.S. source and to any gross income must be ratably section 965(n). The comment also general category income has U.S. source apportioned between the statutory argued that the foreign tax credit taxable income exceeding the amount of grouping of gross income and the proposed regulations are inconsistent deductions allocated and apportioned to residual grouping. The gross income with the statutory language in section foreign source general category income utilized for such ratable apportionment 965(n), and with existing rules on the that includes a section 965(a) inclusion is not reduced by the section 965(c) allocation and apportionment of and associated section 78 dividends, a deduction. See § 1.861–8(c)(3). expenses under section 904, to the section 965(n) election would not result The final regulations also adopt the extent they defer deductions that would in a deferred amount and would not comment’s alternative suggestion to be taken against income other than the affect the calculation of the taxpayer’s allow taxpayers a limited period to section 965(a) inclusion. In addition, the foreign tax credit limitation. Similarly, a revoke a prior election under section comment stated that the foreign tax taxpayer with U.S. source income in 965(n) in order to account for the fact credit proposed regulations are excess of its net operating loss carryover that the foreign tax credit proposed inconsistent with the operation of would have no basis to prevent general regulations were issued after some section 965 and section 904 to the category income that includes a section taxpayers were required to make the extent they treat the section 965(a) 965(a) inclusion from being reduced by election under section 965(n). See inclusion net of the section 965(c) a general category section 172 § 1.965–7(e)(2)(ii)(B). For deduction, rather than the section 965(a) deduction. A pro rata convention for administrability reasons, in order to inclusion without reduction for the determining the source and separate minimize the number of amended section 965(c) deduction, as the gross category of the deferred amount is more returns that a taxpayer may need to file income in the statutory grouping for neutral and more consistent with the in connection with section 965, the section 904 purposes. The comment also operation of the expense allocation rules deadline for a revocation is based on the extended due dates for the taxpayer’s suggested that the exclusion of the in the absence of a deferred amount returns. In addition, in response to the section 965(c) deductions from the than a rule stacking the deferred amount comment’s request for clarification, deferred amount was inappropriate. The first out of deductions that would comment further stated that, if the proposed § 1.965–7(e)(1)(iv)(B)(1) is reduce the section 965(a) inclusion and regulations are finalized as proposed, revised in the final regulation to clarify associated section 78 dividends. taxpayers should be allowed to revoke that it refers to all deductions (other Therefore, the final regulations include the section 965(n) election. Finally, the than the net operating loss carryover or comment recommended that proposed the proposed rules applying the existing carryback to that year that is not § 1.965–7(e)(1)(iv)(B) be revised to refer rules on the allocation and allowed by reason of the section 965(n) to allocation of all deductions (other apportionment of expenses for purposes election). than the net operating loss carryover or of section 904, and determining the Another comment requested guidance carryback to that year that is not source and separate category of the providing that a taxpayer that had made allowed by reason of the section 965(n) deferred amount on a pro rata basis. a timely election under section 965(n) election), rather than refer solely to However, in response to the comment be treated as having made a timely allocation of deductions that would regarding the exclusion of the section election under section 965(h). Under have been allowed for the year but for 965(c) deductions from the deferred section 965(h), a taxpayer may elect to the section 965(n) election. amount, the Treasury Department and pay its section 965(h) net tax liability in The final regulations include the the IRS agree that section 965(n) does eight installments. Section 965(h)(5) ordering rules from the foreign tax not provide that the deferred amount provides that the election must be made credit proposed regulations, with some includes or excludes specific no later than the due date for the tax modifications to take into account the deductions for purposes of section 904. return for the inclusion year and in the comments. In general, the Treasury Therefore, the final regulations include manner prescribed by the Secretary. Department and the IRS have the section 965(c) deduction in Section 1.965–7(b)(2)(ii) provides that determined that these rules are determining the source and separate relief is not available under § 301.9100–

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2 or § 301.9100–3 to file a late election. Comments recommended that the pro certainty, would be less The comment explained that, as a result rata share anti-abuse rule in proposed administratively burdensome, and of the ordering rules in the foreign tax § 1.951–1(e)(6) not be applied to would not result in improper allocations credit proposed regulations, some transactions or arrangements entered of subpart F income because the method taxpayers will have a section 965(h) net into before the general applicability date is consistent with each shareholder’s tax liability in excess of amounts paid of § 1.951–1(e). Under this economic rights and interests. with respect to the tax year ending recommendation, transactions or The Treasury Department and the IRS December 31, 2017. Those taxpayers did arrangements entered into before the have determined that it would be not make a timely election under general applicability date of § 1.951– inappropriate to permit U.S. section 965(h) because they may have 1(e)(6), regardless of whether they shareholders the ability to choose determined that they did not have a would be subject to the pro rata share whether to rely on the new allocation section 965(h) net tax liability in excess anti-abuse rule, would be given effect rules under § 1.951–1(e)(3) for taxable of amounts paid because they calculated for purposes of determining a U.S. years of foreign corporations that end their section 904 foreign tax credit shareholder’s pro rata share of subpart within the U.S. shareholder’s taxable limitation in the inclusion year without F income and tested items for taxable year ending before October 3, 2018, the allocating or apportioning any expenses years ending after the general general applicability date of § 1.951– to reduce the amount described in applicability date. The Treasury 1(e). See § 1.951–1(i). Rather than § 1.965–7(e)(1)(ii), which is inconsistent Department and the IRS do not adopt simplifying the process of determining with the rules in the foreign tax credit this recommendation because it would their pro rata shares with respect to proposed regulations. have the effect of grandfathering their calendar year foreign subsidiaries, The final regulations do not adopt this existing transactions or arrangements the proposal would incentivize recommendation. The statute requires entered into with a principal purpose of taxpayers to invest additional time and that the election must be made not later avoiding Federal income taxation. resources to determine their U.S. tax liability under both sets of pro rata share than the due date for the tax return for A comment also recommended that rules in order to determine the rules that the inclusion year. See section taxpayers be permitted, but not result in the least amount of U.S. tax 965(h)(5); see also TD 9846, 84 FR 1838, required, to apply the facts and liability. In addition, because most tax 1868 (February 5, 2019) (denying a circumstances method under § 1.951– returns of U.S. shareholders that include similar request to permit late elections 1(e)(3), the substance of which is under section 965). Moreover, income from a foreign subsidiary with a discussed more fully in part II.C of this taxable year ending on December 31, regulations deeming an election to be Summary of Comments and Explanation made by default would not be 2017, by reason of section 965 have of Revisions section, to taxable years already been filed, the proposal would appropriate, because the statute requires ending on or after December 31, 2017, an affirmative election. Cf. 83 FR 39514, increase the number of amended returns and before October 3, 2018. The filed for those taxable years, thus 39533–39534 (August 9, 2018) (denying comment stated that, under section 965, a similar request to provide for default creating additional compliance burdens a U.S. shareholder with a taxable year for taxpayers and administrative costs section 965(h) elections). For these ending on December 31 may be required reasons, these regulations do not treat a for the government. Accordingly, the to determine its pro rata share of the final regulations do not adopt this taxpayer that has made a timely election increase to subpart F income of its under section 965(n) as having made a proposal. foreign subsidiaries in both its 2017 There were no comments related to timely election under section 965(h). taxable year with respect to foreign Finally, the final regulations include the applicability dates of other subsidiaries with a taxable year ending provisions of the proposed regulations. two new examples to illustrate the December 31, and its 2018 taxable year The final regulations adopt the application of § 1.965–7(e)(1). See with respect to foreign subsidiaries with applicability dates of the proposed § 1.965–7(e)(3). a taxable year ending November 30. regulations without substantial changes. Consistent with § 1.965–9, the final Accordingly, given the applicability regulations in § 1.965–7(e) apply to the Therefore, consistent with the date in the proposed regulations, for applicability date of section 951A, last taxable year of a foreign corporation purposes of determining such U.S. §§ 1.951A–1 through 1.951A–6, that begins before January 1, 2018, and shareholder’s inclusion under section including §§ 1.951A–2(c)(5) and with respect to a U.S. person, beginning 965, the U.S. shareholder could be –3(h)(2), apply to taxable years of the taxable year in which or with which required to apply, with respect to its foreign corporations beginning after such taxable year of the foreign calendar year foreign subsidiaries, the December 31, 2017, and to taxable years corporation ends. fair market value method under the of U.S. shareholders in which or with XI. Comments and Revisions Regarding existing regulations for classes of stock which such taxable years of foreign Applicability Dates with discretionary distribution rights, corporations end. The applicability but then apply, with respect to its fiscal dates with respect to the rules in A. Proposed Regulations year foreign subsidiaries, the facts and § 1.951–1 are as follows. Paragraphs (a), The proposed regulations provide that circumstances method for stock with the (b)(1)(ii), (b)(2), (e)(1)(ii)(B), and (g)(1) § 1.951–1(e), other than paragraph same characteristics. The comment apply to taxable years of foreign (e)(1)(ii)(B) (regarding the determination suggested that allowing U.S. corporations beginning after December of allocable E&P), applies to taxable shareholders to rely on the facts and 31, 2017, and to taxable years of U.S. years of U.S. shareholders ending on or circumstances method for taxable years shareholders in which or with which after October 3, 2018. Comments ending on or after December 31, 2017, such taxable years of foreign requested certain changes and guidance and before October 3, 2018, would corporations end. Paragraph (e), except related to the applicability date of enable taxpayers to apply a uniform for paragraph (e)(1)(ii)(B), applies to proposed § 1.951–1(e)(6), the substance method for allocating the section 965(a) taxable years of U.S. shareholders of which is discussed more fully in part earnings amounts of all relevant foreign ending on or after October 3, 2018. II.B of this Summary of Comments and subsidiaries among or between U.S. Paragraph (h) applies to taxable years of Explanation of Revisions section. shareholders, would provide more domestic partnerships ending on or after

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May 14, 2010. Sections 1.6038–2(a) and § 1.78–1(c) in order to apply the second regulations. OMB has designated this § 1.6038–5 apply to taxable years of sentence of § 1.78–1(a) to section 78 final regulation as economically foreign corporations beginning on or dividends received after December 31, significant under section 1(c) of the after October 3, 2018. 2017, with respect to a taxable year of Memorandum of Agreement. These final regulations modify a foreign corporation beginning before Accordingly, the final regulations have applicability dates in the proposed January 1, 2018. See part X.A of this been reviewed by OMB’s Office of regulations related to consolidated Summary of Comments and Explanation Information and Regulatory Affairs. For groups. Proposed § 1.1502–51 applies to of Revisions section regarding purposes of E.O. 13771 this rule is taxable years of foreign corporations comments received about the special regulatory. For more detail on the beginning after December 31, 2017, and applicability date in § 1.78–1(c). economic analysis, please refer to the to taxable years of U.S. shareholders in following analysis. which or with which such taxable years XII. Comment Regarding Special of foreign corporations end. The Analyses A. Need for the Final Regulations Treasury Department and the IRS have One comment asserted that in issuing The final regulations are needed to determined that for U.S. shareholders the proposed regulations, the Treasury address remaining open questions that are members of a consolidated Department and the IRS did not comply regarding the application of section group, the applicability date for with the Regulatory Flexibility Act 951A and comments received on the § 1.1502–51 should be postponed to (‘‘RFA’’) due to the number of small proposed regulations. In addition, taxable years of such members for business entities impacted. The certain rules in the foreign tax credit which the due date (without extensions) comment also stated that the Treasury proposed regulations need to be of the consolidated return is after the Department and the IRS did not comply finalized to ensure that the applicability date on which these final regulations are with the Paperwork Reduction Act dates of these rules coincide with the published in the Federal Register. (‘‘PRA’’) when they authorized the applicability dates of the statutory However, the final regulations provide collection of information. Lastly, the provisions to which they relate. that a consolidated group may apply the comment claimed that the Treasury B. Background rules of § 1.1502–51 in their entirety to Department and the IRS did not comply The Tax Cuts and Jobs Act (the Act) all of its members for all taxable years with Executive Orders 12866 and 13563, established a system under which described in § 1.951A–7. See § 1.1502– as well as the Memorandum of certain earnings of a foreign corporation 51(g). Understanding, Review of Tax can be repatriated to a corporate U.S. Regulations under Executive Order B. Foreign Tax Credit Proposed shareholder without U.S. tax. See Regulations 12866, when they issued the proposed section 14101(a) of the Act and section regulations. No significant changes were made to 245A. However, Congress recognized The Treasury Department and the IRS the applicability dates of the portions of that, without any base protection complied with the applicable the final regulations that relate to rules measures, this system, known as a requirements under the RFA, the PRA, that were in the foreign tax credit participation exemption system, could and Executive Orders 12866 and 13563 proposed regulations. Under § 1.965– incentivize taxpayers to allocate when issuing the proposed regulations. 9(a), the provisions of § 1.965–7 income—in particular, mobile income See 83 FR 51072, 51084 Special contained in this final regulation apply from intangible property—that would Analyses section. The comment’s beginning the last taxable year of a otherwise be subject to the full U.S. assertion regarding the number of small foreign corporation that begins before corporate tax rate to controlled foreign business entities impacted by the January 1, 2018, and with respect to a corporations (CFCs) operating in low- or United States person, beginning the proposed regulations is addressed in zero-tax jurisdictions. See Senate taxable year in which or with which part III of the Special Analyses section. Explanation at 365. Therefore, Congress such taxable year of the foreign Special Analyses enacted section 951A in order to subject corporation ends. In general, § 1.78–1 intangible income earned by a CFC to I. Regulatory Planning and Review— applies to taxable years of foreign U.S. tax on a current basis, similar to the Economic Analysis corporations that begin after December treatment of a CFC’s subpart F income 31, 2017, and to taxable years of U.S. Executive Orders 13563 and 12866 under section 951(a)(1)(A). However, in shareholders in which or with which direct agencies to assess costs and order to not harm the competitive such taxable years of foreign benefits of available regulatory position of U.S. corporations relative to corporations end, and § 1.861–12(c) alternatives and, if regulation is their foreign peers, the global intangible applies to taxable years that both begin necessary, to select regulatory low-taxed income (GILTI) of a corporate after December 31, 2017, and end on or approaches that maximize net benefits U.S. shareholder is taxed at a reduced after December 4, 2018. (including potential economic, rate by reason of the deduction under A special applicability date was environmental, public health and safety section 250 (with the resulting U.S. tax provided in proposed § 1.861–12(k) in effects, distributive impacts, and further reduced by a portion of foreign order to apply § 1.861– equity). Executive Order 13563 tax credits under section 960(d)). Id. 12(c)(2)(i)(B)(1)(ii) to the last taxable emphasizes the importance of Also, due to the administrative year of a foreign corporation beginning quantifying both costs and benefits, of difficulty in identifying income before January 1, 2018, since there may reducing costs, of harmonizing rules, attributable to intangible assets, be an inclusion under section 965 for and of promoting flexibility. intangible income (and thus GILTI) is that taxable year. In the final These final regulations have been determined for purposes of section regulations, this special applicability designated as subject to review under 951A based on a formulaic approach. date is extended to § 1.861–12(c)(2)(i)(A) Executive Order 12866 pursuant to the Intangible income for this purpose is to accommodate the changes that were Memorandum of Agreement (April 11, generally all net income (other than made to that rule to further implement 2018) between the Treasury Department certain excluded items) less a 10- the rule in § 1.861–12(c)(2)(i)(B)(1)(ii). A and the Office of Management and percent return (‘‘normal return’’) on special applicability date is provided in Budget (OMB) regarding review of tax certain tangible assets (‘‘qualified

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business asset investment’’ or ‘‘QBAI’’). similarly situated taxpayers might interpretation under the baseline and Id. at 366. interpret the statutory rules of section the final regulation. Thus it is not The final regulations address open 951A differently, potentially resulting in feasible for the Treasury Department questions regarding the application of inefficient patterns of economic activity and the IRS to quantify with any section 951A and comments received on or litigation in the event that a reasonable precision the difference in the proposed regulations. In addition, taxpayer’s interpretation of the statute economic activity that might be certain rules in the foreign tax credit differs from that of the IRS. For undertaken by those taxpayers based on proposed regulations are being finalized example, different taxpayers might those marginal GILTI inclusions.5 As in this Treasury decision to ensure that pursue income-generating activities data become available, the Treasury the applicability dates of these rules based on different assumptions about Department and the IRS will observe coincide with the applicability dates of whether that income will be counted as and monitor partner GILTI inclusions the statutory provisions to which they GILTI, and some taxpayers may forego resulting from the statute and these relate. The final regulations retain the specific investments that other supporting regulations. basic approach and structure of the taxpayers deem worthwhile based on With these considerations in mind, proposed regulations and foreign tax different interpretations of the tax part I.C.3.a.i of this Special Analyses credit proposed regulations, with consequences alone. If the foregone section explains the rationale behind certain revisions. activities would have been more the final regulations’ approach to the The final regulations relating to GILTI profitable than those that were treatment of partnerships and provides provide general rules and definitions, undertaken, U.S. economic performance a qualitative assessment of the guidance on the computation of a GILTI would be negatively affected. The alternatives considered. inclusion amount, rules regarding the guidance provided in these regulations The final regulations also include interaction of certain aspects of section helps to ensure that taxpayers face more provisions designed to curtail improper 951A with other provisions, guidance uniform incentives when making tax avoidance behavior. In the absence for consolidated groups and their economic decisions, thereby improving of these provisions, taxpayers could members and partnerships and their U.S. economic performance. This potentially reduce their GILTI by partners, information reporting guidance also helps to ensure that holding specified tangible property over requirements, and rules to prevent the taxpayers make tax-related decisions an additional quarter close. See part avoidance of GILTI. The regulations under interpretations that are more I.C.3.d.i of this Special Analyses under sections 78, 861, and 965 finalize consistent with the intent and purpose section. This activity is economically certain discrete provisions included in of the statute. inefficient to the extent that the the foreign tax credit proposed The Treasury Department and the IRS taxpayer acquires the property or holds regulations that relate to section 965. have not undertaken quantitative property longer than the taxpayer would estimates of these effects. Any such have held it in the absence of this tax- C. Economic Analysis quantitative estimates would be highly avoidance opportunity. The cost of this 1. Baseline uncertain because the mix of inefficiency (relative to the final interpretations that taxpayers might regulations, which reduce the incentives The Treasury Department and the IRS have pursued in the absence of this for such behavior) is roughly have assessed the economic effects of guidance and the mix of economic proportional to the amount of specified the final regulations relative to a no- behaviors stemming from those tangible property held longer than action baseline reflecting anticipated interpretations are not readily known. optimal, multiplied by the length of the Federal income tax-related behavior in More importantly, the relationship extra holding period, multiplied by the the absence of these final regulations. between a taxpayer’s interpretation difference between the use value of this 2. Summary of Economic Effects absent this guidance and the taxpayer’s property to the taxpayer and its GILTI inclusion under the final alternative use. The benefit of the final To assess the economic effects of regulations, a difference that is key to regulations is the reduction in this these final regulations, the Treasury understanding the economic effects of inefficiency. Department and the IRS considered the final regulations, is also not readily The Treasury Department and the IRS economic effects arising from three sorts known. have not undertaken a quantitative of provisions of these final regulations. For example, the final regulations estimate of this benefit but expect it to These are (i) effects arising from include provisions to address the be small because the difference between provisions that provide enhanced treatment of domestic partnerships and the use value to the taxpayer of property certainty and clarity; (ii) effects arising partners for purposes of section 951A held for tax avoidance purposes and its from provisions to prevent tax- and the section 951A regulations. Part alternative use is not likely to be large.6 avoidance behavior; and (iii) effects I.C.3.a.i of this Special Analyses section The Treasury Department and the IRS arising from other provisions. lays out some of the possible do not have readily available data on the These final regulations provide interpretations that taxpayers might amount of specified tangible property certainty and clarity to taxpayers have adopted in calculating their GILTI that might otherwise be used for tax regarding terms and calculations they inclusion with respect to CFCs owned avoidance purposes, the taxpayers who are required to apply under the statute. by a domestic partnership in the might hold this property, or the value Because a tax had not been imposed on absence of specific guidance. Because differential of the property that would GILTI before the enactment of section GILTI and the GILTI partnership be held for tax avoidance purposes. 951A and because the statute is silent provisions are new and because While it is not currently feasible for on certain aspects of definitions and taxpayers’ ownership shares of CFCs the Treasury Department and the IRS to calculations, taxpayers can particularly both through and separate from benefit from enhanced specificity domestic partnerships are not readily 5 Part I.C.3.a.ii of this Special Analyses section regarding the relevant terms and available, the Treasury Department and provides further discussion of data limitations in identifying the set of affected taxpayers. necessary calculations they are required the IRS cannot readily predict the 6 This claim refers solely to the economic benefit to apply under the statute. In the difference in taxpayers’ marginal GILTI arising from this provision and does not refer to any absence of this enhanced specificity, inclusion between any given estimate of the tax revenue effects of the provision.

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quantify these effects, part I.C.3.c.i of partially depreciable assets within the IRS re-evaluated this approach for the these Special Analyses explains the United States versus without relative to final regulations. rationale behind the final regulations’ an alternative of treating the entire The Treasury Department and the IRS approach to the temporary holding of adjusted basis of the asset as QBAI. considered a number of alternatives for specified tangible property and provides Because GILTI is new and because tax addressing the treatment of domestic a qualitative assessment of the filings do not report taxpayers’ partnerships in the final regulations. alternatives considered. accounting methods for assets placed in These alternatives were: (i) The hybrid This economic analysis further service before the enactment of section approach set forth in the proposed considered the economic effects of all 951A, the Treasury Department and the regulations; (ii) an approach under other provisions in the final regulations. IRS do not have readily available data which the domestic partnership would For example, the statute dictates that, to project which taxpayers are affected be treated as an entity for all purposes for the purpose of calculating QBAI, by these regulations or to project their of section 951A; and (iii) an approach taxpayers should depreciate assets marginal GILTI inclusion for current under which a domestic partnership placed in service before the enactment income-generating activities. Thus it is would be treated as an entity for of section 951A using the alternative not currently feasible for the Treasury purposes of determining whether any depreciation system (ADS) but grants Department and the IRS to estimate the U.S. person is a U.S. shareholder and authority to the Secretary under economic effects of the final regulations any foreign corporation is a CFC, but as 951A(d)(4) to issue regulations to relative to the baseline. an aggregate for purposes of determining prevent the avoidance of the purposes of whether, and to what extent, any U.S. section 951A(d). By providing taxpayers With these considerations in mind, person has a GILTI inclusion. A fourth an alternative to ADS, the final part I.C.3 of these Special Analyses option, to apply a pure aggregate regulations reduce taxpayers’ explains the rationale behind the final approach under which a domestic compliance burden and, by effecting regulations and provides a qualitative partnership would be treated as an changes in QBAI, change some assessment of the alternatives aggregate of all of its partners for all taxpayers’ marginal GILTI inclusion, an considered. purposes of section 951A, was rejected effect that may result in changes in 3. Economic Effects of Provisions because the Treasury Department and economic activity and the location of Substantially Revised From the the IRS determined that it is such activity. Furthermore, the final Proposed Regulations inconsistent with other sections of the regulations determine partnership QBAI Code. by reference to the depreciation a. Treatment of Domestic Partnerships The first option was to finalize the deductions generated by partnership Under Section 951A hybrid approach set forth in the specified tangible property because a i. Background and Alternatives proposed regulations. While the hybrid CFC partner’s share of these Considered approach is consistent with the depreciation deductions can be used as framework of section 951A, a number of a reliable proxy for determining a CFC’s Section 951A does not contain any comments pointed to administrative and distributive share of tested income specific rules on the treatment of a procedural complexities with the produced with respect to such property. domestic partnership and their partners approach of the proposed regulations, The use of the proxy simplifies, and that directly or indirectly own stock of including coordination with partners’ reduces the uncertainty in the CFCs. The proposed regulations contain capital accounts and basis adjustments computation for taxpayers, thereby a rule that requires a domestic with respect to partnership interests and reducing taxpayer burden relative to the partnership that is a U.S. shareholder of CFCs. In particular, comments noted the baseline. a CFC to determine its GILTI inclusion uncertainty under the hybrid approach The netting approach for specified amount. The proposed regulations then whether, and to what extent, a U.S. interest expense adopted in these final provide that partners of the partnership shareholder partner’s pro rata share of regulations also reduces uncertainty and that are not separately U.S. shareholders tested income or tested loss of a the complexity involved in of the CFC take into account their partnership CFC should increase or characterizing income and matching distributive share of the partnership’s decrease the partner’s capital account expense to income which would be GILTI inclusion amount. In contrast, with respect to the partnership or its required under a tracing approach. partners that are U.S. shareholders of basis in the partnership interest. Therefore, the netting approach the CFC are required to take into Comments also noted that the hybrid simplifies the taxpayers’ computations account their proportionate share of the approach can result in varied GILTI and reduces their compliance costs. partnership’s pro rata share of tested computations for partners depending on With respect to partially depreciable items of the CFC for purposes of whether the partner is a U.S. assets, such as platinum catalysts, the determining the U.S. shareholder’s own shareholder of a CFC owned by a final regulations treat a portion of the GILTI inclusion amount. The proposed domestic partnership. Finally, adjusted basis of the asset as giving rise regulations thus adopt a hybrid comments noted that the hybrid to QBAI, rather than the asset’s entire approach under which the domestic approach would result in disparate adjusted basis. The Treasury partnership is treated as an entity with treatment between partners that own Department and the IRS determined that respect to partners that are not stock in a CFC through a domestic applying the same standard for themselves U.S. shareholders of a CFC partnership and partners that own stock determining whether property qualifies but as an aggregate with respect to in a CFC through a foreign partnership. as QBAI and whether the property is partners that are themselves U.S. These latter outcomes have clearly depreciable is simpler for tax shareholders of the CFC. While the detrimental economic effects because administration and compliance hybrid approach is consistent with the they do not treat similar taxpayers in a purposes than having two standards. framework of section 951A, a number of similar fashion. Moreover, since QBAI generally is comments pointed to administrative and The second option was to adopt a determined for purposes of FDII under procedural complexities with the pure entity approach, meaning that the section 951A(d), it is expected that the approach of the proposed regulations. domestic partnership would determine final rule will incentivize the use of Thus the Treasury Department and the its own GILTI inclusion amount and

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each partner would take into account its that, in general, for purposes of section tested items of CFCs owned by the distributive share of the partnership’s 951A and the section 951A regulations, partnership nor include in their income GILTI inclusion amount. This approach a domestic partnership is treated in the a distributive share of the partnership’s is consistent with the historical same manner as a foreign partnership. GILTI inclusion amount. This latter treatment of domestic partnerships for The final regulations employ the group is likely to be a substantial purposes of subpart F. However, this existing framework for foreign portion of domestic partners given the approach is inconsistent with the partnerships (which are generally high number of partners per partnership policies underlying the GILTI treated as an aggregate of their partners and have lower compliance costs as a provisions and interrelated rules, such for purposes of subpart F), rather than result of the final regulations. Because it as the deduction under section 250 and creating new aggregation rules is not possible to readily identify these certain foreign tax credits for GILTI that specifically for the treatment of types of partners based on available are determined at the partner level domestic partnerships, because such data, this number is an upper bound of (rather than the partnership level). framework is relatively well-developed partners who would have been affected Further, under this approach, many and understood. Using the same by this rule had this rule been in effect taxpayers would be compelled to treatment for domestic and foreign in 2015 or 2016. reorganize their ownership structure— partnerships is more likely to result in b. Rule for Transfers During the for instance, by eliminating their market forces determining organization Disqualified Period ownership of CFCs through domestic form instead of tax law. In addition, by partnerships—to obtain full aggregation eliminating the complexity and traps for i. Background and Alternatives of tested items of their CFCs as the unwary associated with the hybrid Considered envisioned by Congress. Yet other and entity approaches, respectively, the The proposed regulations include a taxpayers would be incentivized to chosen approach reduces compliance rule in § 1.951A–2(c)(5) to address reorganize in an attempt to avoid full costs relative to the alternatives. transactions intended to reduce a GILTI aggregation so as to reduce their inclusion amount as a result of a inclusion below an amount that ii. Affected Taxpayers stepped-up basis in CFC assets accurately reflects their GILTI. For The Treasury Department and the IRS attributable to related party transfers instance, taxpayers could separate estimate that there were approximately that occur during the disqualified tested items that generally decrease a 7,000 U.S. partnerships with CFCs that period. The disqualified period of a CFC U.S. shareholder’s GILTI (for example, e-filed at least one Form 5471 as is the period between December 31, qualified business asset investment) Category 4 or 5 filers in 2015 and 2016.7 2017, which is the last earnings and from certain tested items that reduce the The identified partnerships had profits (E&P) measurement date under benefit of such tested items (for approximately 2 million partners, as section 965, and the beginning of the example, specified interest expense), indicated by the number of Schedules CFC’s first taxable year that begins after thus minimizing the U.S. shareholder’s K–1 filed by the partnerships. This December 31, 2017, which is the first aggregate GILTI inclusion amount. number includes both domestic and taxable year with respect to which Potentially reorganizing to realize a foreign partners, so it substantially section 951A is effective. A taxpayer specific GILTI treatment suggests that overstates the number of partners that that caused a CFC to sell its assets to a tax instead of market signals are would actually be affected by the final related party during the disqualified determining business structures. This regulations by including foreign period would not be subject to taxation can lead to higher compliance costs and partners.8 The final regulations affect on the income or earnings from such inappropriate investment. domestic partners that are U.S. sales under either section 965 (because The third option, which is adopted in shareholders of a CFC owned by the it was after the final E&P measurement the final regulations, is to apply an domestic partnership because such date) or section 951A (because it was approach that treats a domestic partners will determine their GILTI before its effective date). However, partnership as an entity for purposes of inclusion amount by reference to their absent a special rule, in subsequent determining whether any U.S. person is pro rata shares of tested items of CFCs years, the transaction would reduce a a U.S. shareholder and whether any owned by the partnership. Domestic U.S. shareholder’s GILTI, by either foreign corporation is a CFC, but treats partners that are not U.S. shareholders reducing the transferee CFC’s tested a domestic partnership as an aggregate of a CFC owned by the domestic income (or increase its tested loss) for purposes of determining whether, partnership will neither determine their through the depreciation or and to what extent, a partner of a own GILTI inclusion amount by amortization attributable to the ‘‘cost- domestic partnership has a GILTI reference to their pro rata shares of inclusion. Such an approach is free’’ basis (disqualified basis) in assets created by reason of such related party consistent with the framework of 7 Data are from IRS’s Research, Applied section 951A and gives effect to the Analytics, and Statistics division based on data transfer. Accordingly, the rule in the relevant statutory language that treats a available in the Compliance Data Warehouse. proposed regulations prevents the domestic partnership as a U.S. Category 4 filer includes a U.S. person who had benefits of the disqualified basis by control of a foreign corporation during the annual disallowing any deduction or loss shareholder and as owning stock for accounting period of the foreign corporation. purposes of determining U.S. Category 5 includes a U.S. shareholder who owns attributable to the disqualified basis for shareholder and CFC status. Moreover, stock in a foreign corporation that is a CFC and who purposes of determining tested income this approach eliminates the owned that stock on the last day in the tax year of or tested loss. the foreign corporation in that year in which it was Because the rule in proposed administrative complexity identified by a CFC. For full definitions, see https://www.irs.gov/ comments with respect to the hybrid pub/irs-pdf/i5471.pdf. § 1.951A–2(c)(5) only disallows the approach in the proposed regulations by 8 This analysis is based on the tax data readily stepped-up basis created by reason of a calculating a U.S. shareholder partner’s available to the Treasury Department at this time. disqualified transfer for purposes of GILTI inclusion amount solely at the Some variables may be available on tax forms that determining a CFC’s tested income and are not available for statistical purposes. Moreover, partner level. with new tax provisions, such as section 951A, tested loss, under the proposed The final regulations treat a domestic relevant data may not be available for a number of regulations, a taxpayer would have to partnership as an aggregate by providing years for statistical purposes. keep track of both a CFC’s disqualified

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basis in an asset for purposes of section not alone provide appropriate results, transferred during the disqualified 951A and the CFC’s adjusted basis in without taking into account the policies period. the asset for all other purposes of the underlying the specific provisions. Such The Treasury Department and the IRS Code. In addition, if the disqualified particular policy considerations could do not have data identifying CFCs that basis was not allowed for purposes of require additional special and detailed engaged in transactions with related determining tested income and tested rules or modifications to the general CFCs during the period after December loss, a comment noted that it would be disallowance rules. In addition, it 31, 2017 but before the effective date of unfair for the basis to still be taken into would be difficult to assess the effect section 951A. As an upper-bound account for purposes of section 901(m), that the disqualified basis would have estimate, there are approximately 3,000 which disallows foreign tax credits for on other provisions of the Code, or how U.S. shareholders of fiscal year CFCs foreign income not subject to U.S. tax by it could affect different taxpayers with with at least one related CFC that could reason of certain basis differences that different tax postures. potentially engage in a transaction.9 arise by reason of covered asset The third option, which is adopted in This is an overestimate since only those acquisitions. A transfer subject to the the final regulations, is to allow fiscal year CFCs with unrealized gains rule (a disqualified transfer) can also be taxpayers to make an election that could take advantage of this disqualified a covered asset acquisition, and eliminates disqualified basis in property period. The Treasury Department does therefore section 901(m) and proposed by reducing a commensurate amount of not have data readily available to § 1.951A–2(c)(5) could apply adjusted basis in the property for all estimate these unrealized gains. concurrently by reason of the same purposes of the Code. Although this c. Transition Rule To Determine Normal transaction. option was not as targeted as the second Return Using the Alternative The Treasury Department and the IRS option, it was the simplest of the three Depreciation System considered three options to address the options because it results in the treatment of disqualified basis. These i. Background and Alternatives property only having a single tax basis Considered options were: (i) Adopt the proposed for all purposes of the Code such that regulations without change; (ii) revise different bases need not be tracked for A U.S. shareholder’s GILTI inclusion the regulations to provide that different purposes. In addition, it does amount is based on a formulaic disqualified basis is also not taken into not result in additional complex rules, approach under which a 10-percent account for purposes of certain other as would be required in the second return attributed to certain tangible provisions (in addition to section 951A) option, because it simply applies for all assets (QBAI) is computed and then to ensure that the rule only prevents the purposes; once the basis is reduced, the each dollar of certain income above GILTI benefits that taxpayers were Code simply applies to the property as such ‘‘normal return’’ is effectively trying to achieve; or (iii) allow taxpayers if the basis were never stepped up. treated as intangible income. Under the to make an election that would Finally, this approach permits taxpayers statute, QBAI is measured by disregard the disqualified basis for all determining the adjusted basis in purposes of the Code. to decide whether the benefit of the additional adjusted basis associated certain tangible property using the The first option was to finalize alternative depreciation system (ADS). without change the rule contained in with the disqualified basis outweighs the cost of complexity in applying the Section 951A(d)(4) directs the Secretary the proposed regulations. On the one to issue regulations or other guidance hand, this approach could be viewed as rule or, alternatively, whether the value of simplicity outweighs the benefit of that is appropriate to prevent the simple and targeted, because this rule avoidance of the purposes of section would only disregard disqualified basis the additional adjusted basis. By allowing this flexibility and adopting a 951A(d), including with respect to the for purposes of determining GILTI, and treatment of temporarily held or the transactions subject to the rule were single adjusted basis for all purposes of the Code, the adopted approach reduces transferred property. primarily intended to reduce GILTI. On The proposed regulations require the complexity and compliance costs, the other hand, this rule could be adjusted basis of all specified tangible relative to both alternatives considered. considered unfair in certain cases property to be determined using ADS because the concurrent application of ii. Affected Taxpayers under section 168(g) for purposes of both the rule and section 901(m), determining the QBAI of a CFC. In The final regulations apply to any without a means for avoiding such general, the Code requires that tangible deduction or loss attributable to concurrent application, could be viewed property used by a CFC outside the disqualified basis. Disqualified basis is as unduly punitive to taxpayers that United States must be depreciated using created by reason of a disqualified engaged in such transactions. In ADS. Accordingly, in most instances, transfer, which is defined as a transfer addition, this option would require the depreciation method required under of property by a fiscal year CFC during taxpayers to track and maintain separate the proposed regulations will the disqualified period to a related bases in the property for purposes of correspond to the CFC’s depreciation person in which gain was recognized, in GILTI and all other purposes of the method used for computing income. whole or in part. A fiscal year CFC’s Code. However, under existing regulations disqualified period is the period that The second option was to not take under section 952, a CFC may compute begins on January 1, 2018, and ends as into account disqualified basis for its income and E&P using the of the close of the CFC’s last taxable certain other provisions (in addition to depreciation method used in keeping its year that is not a CFC inclusion year. section 951A) to ensure that the rule accounting books and records or a The taxpayer affected is a U.S. only prevented the GILTI benefits that method conforming to United States shareholder of any CFC that holds taxpayers were trying to achieve. Such generally accepted accounting property with disqualified basis. In an approach would result in additional principles (‘‘non-ADS depreciation general these final regulations affect and considerable complexity because method’’) if the differences between numerous other provisions would have U.S. shareholders with at least one fiscal to be considered. In addition, simply year CFC that has at least one other CFC 9 Based on IRS Statistics of Income 2014 study not taking into account the basis for where the fiscal-year CFC has property file of C corporations with Form 5471 category 4 purposes of these other provisions may with unrealized gains that can be filers. Includes full and part year returns.

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ADS and the non-ADS depreciation permitted to compute their income and special rule is required because method are immaterial. In the case of a E&P using their non-ADS depreciation otherwise the salvage value would be CFC that is permitted to use a non-ADS method for specified tangible property included in the CFC’s QBAI until the depreciation method, the proposed used outside the United States when the CFC disposed of the asset. This option regulations would nonetheless require differences between the non-ADS was the least administratively the CFC to determine its adjusted basis depreciation method and ADS are burdensome, and the least likely to in its assets for purposes of calculating immaterial. Therefore, the Treasury result in controversy between taxpayers QBAI based on ADS. In particular, with Department and the IRS determined that and the IRS. It reduces compliance costs respect to assets placed in service before some relief from the administrative relative to the two alternatives by the enactment of section 951A, the burden of re-determining the adjusted eliminating the need to redetermine the proposed regulations would require the basis of each property placed in service adjusted basis, class life and date placed CFC to determine the date the assets before December 22, 2017, should be in service of property for which good were placed in service, the ADS class available to CFCs that are not required records may not exist. As noted above, life, and other information about the to use ADS for computing income and it does not impact taxpayers’ incentives asset to correctly apply ADS as if the E&P. Such relief will alleviate this or cost of capital, because it applies to asset had been depreciated using ADS administrative burden, but will not property already placed in service. since the date the asset was placed in impact taxpayer incentives or cost of Further, because relief is provided in service. Several comments noted that capital, because it pertains only to instances in which the difference this requirement could be onerous for property already placed in service. between ADS and a non-ADS specified tangible property acquired The second option considered seeks depreciation method is immaterial, it is before the enactment of section 951A to relieve burden by requiring ADS for likely to result in only minimal and requested relief from this determining the adjusted basis in differences in depreciation deductions requirement for such property. specified tangible property, but on a and QBAI.10 Small changes in the QBAI Although section 951A(d)(3) ‘‘cut-off basis.’’ Under this option, the have an even more muted impact on the specifically requires use of ADS to CFC would apply ADS to the adjusted determination of GILTI, because net determine the adjusted basis in basis determined using its non-ADS DTIR, a component of the GILTI specified tangible property, section depreciation method as of the beginning calculation, is only 10 percent of QBAI. 951A(d)(4) authorizes the Secretary to of the first taxable year subject to Therefore, the impact of using a non- issue regulations that are appropriate for section 951A. This option eliminates the ADS depreciation method versus ADS purposes of determining QBAI. Thus, need to re-determine the adjusted basis for property placed in service before the the Treasury Department and the IRS in the property as if ADS had been used enactment of section 951A is minimal. considered three options to address the since the property was placed in Accordingly, this is the option adopted use of ADS for specified tangible service. This approach could be in the final regulations. property placed in service prior to the implemented by applying ADS for the enactment of section 951A. These remaining ADS class life of the property ii. Affected Taxpayers options were: (i) Require the use of ADS or by treating the property as newly The population of taxpayers for all property placed in service before placed in service and applying the full potentially affected by this aspect of the enactment of section 951A, ADS class life to the property. Each of these final regulations are the U.S. consistent with the proposed those options would still require the shareholders of CFCs that are not regulations; (ii) require ADS for CFC to determine when the property required to use ADS when computing determining the adjusted basis of was placed in service and its ADS class E&P, subpart F income, and tested specified tangible property, but on a life. In addition, applying ADS for the income or tested loss, because the ‘‘cut-off basis’’; or (iii) allow the CFC to remaining ADS class life of the property differences in the tax liability of such continue using its non-ADS would also require special rules for U.S. shareholders resulting from the use depreciation method for property placed situations in which the property would of the CFCs’ non-ADS depreciation in service prior to the enactment of have been fully depreciated under ADS method are immaterial relative to the section 951A, and to include a special before the first taxable year subject to use of ADS. Only those taxpayers whose rule that requires depreciation of the section 951A, and applying ADS to the CFCs use a non-ADS depreciation ‘‘salvage value.’’ These options apply property based on the full ADS class life method for property placed in service only where the CFC is not required to of the property would extend the period before December 22, 2017 instead of use ADS to compute its income under that the property is taken into account ADS when computing E&P would be § 1.952–2 or E&P under § 1.964–1 with in the computation of QBAI. The affected by these final regulations. respect to such property. Treasury Department and the IRS The Treasury Department and the IRS The first option considered was to concluded that applying ADS on a cut- have previously projected that between require the use of ADS for all property off basis under either approach did not 25,000 and 35,000 direct shareholders of placed in service before the enactment significantly reduce the administrative CFCs would be potentially subject to of section 951A, consistent with the burden of computing QBAI with respect GILTI and thus could be affected by this proposed regulations. However, to property placed in service prior to the rule. This is an upper-bound estimate of Treasury and the IRS recognize that re- enactment of section 951A. taxpayers affected because it is not determining the adjusted basis in assets The third option considered was to limited to those with CFCs that are using a new depreciation method could allow the CFC to elect to use its non- permitted to use a non-ADS be a difficult, uncertain, and time- ADS depreciation method for property depreciation method with respect to consuming process for CFCs that have acquired prior to the enactment of property placed in service before the numerous items of specified tangible section 951A, and to include a special property acquired before the enactment rule that requires depreciation of the 10 Treasury Depreciation Model tabulations of of section 951A, in part, because the ‘‘salvage value’’ (in other words, the depreciation rates by 2 digit industry indicate that, on average, book depreciation and ADS CFCs may not have kept the records portion of the basis of property that depreciation for property in the manufacturing, necessary to make the determinations. would not be fully depreciated under mining, construction, utilities, and wholesale trade Notably as described above, CFCs are the non-ADS depreciation method). The industries, are within 10 percent of one another.

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enactment of section 951A. Precise transactions subject to the rule relative years, and are all tested income CFCs. identification of these taxpayers is not to the first option, and would be Finally, this option would include possible from readily available data administrable for the IRS and taxpayers examples to indicate types of because taxpayers do not report on (because a taxpayer’s motivation for transactions that are, and are not, Form 5471 what depreciation method holding the property would not be subject to the rule. they used in computing E&P. relevant), it could still apply to This fourth option more accurately transactions that were not tax- identifies cases of potential abuse in d. Anti-Abuse Rule for Specified motivated. In addition, it could increase comparison to the proposed regulations Tangible Property Held Temporarily the burden on IRS to enforce and the other options discussed in this i. Background and Alternatives compliance because it would require part I.C.3.d.i of the Special Analyses Considered additional resources to assert the rule section. Because it more accurately identifies cases of potential abuse, it The proposed regulations include an for property held longer than six yields more efficient outcomes because anti-abuse rule to address property that months, even though the property may it does not penalize taxpayers with a is held temporarily over the quarter still be held temporarily for tax- legitimate business purpose for close of a CFC with a principal purpose motivated reasons. The third option was to eliminate the temporarily holding tangible property. of reducing the GILTI inclusion amount per se rule and rely on a principal This option provides flexibility to of a U.S. shareholder of the CFC. In the purpose rule. The rule would disregard taxpayers holding property less than 12 absence of an anti-abuse rule, taxpayers the adjusted basis in property for months to either accept the presumption could reduce their GILTI inclusion by purposes of computing QBAI if the (and thus disregard the basis of the having a CFC temporarily hold property property is held temporarily and is property under the anti-abuse rule) or, over an additional quarter close in order acquired with a principal purpose of if appropriate, to choose to rebut the to artificially increase the U.S. reducing a GILTI inclusion amount. presumption by filing the appropriate shareholder’s ‘‘normal return’’ on While this option would have the statement. Taxpayers will have the tangible assets. The anti-abuse rule for benefit of being flexible and, therefore, flexibility to make the choice that temporarily held property in the in theory could apply only to temporary appropriately balances the compliance proposed regulations included a ‘‘per holdings that were intended to reduce a costs related to rebutting the se’’ rule, which deemed property to be U.S. shareholder’s GILTI inclusion presumption with the tax cost of not held temporarily and acquired with a amount, it could create uncertainty for rebutting the presumption depending on principal purpose of reducing a GILTI both taxpayers and the IRS. This their particular circumstances. This inclusion amount if held by the CFC for uncertainty would result, in part, from option also relieves taxpayers of the less than a 12-month period. Comments the need to determine the taxpayer’s burden of monitoring assets that are asserted that the anti-abuse rule was principal purposes for each relevant held more than 36 months, relative to overbroad. In particular, comments acquisition and not having general the other options. In addition, the safe expressed concerns that the 12-month guidelines for when property is harbor would provide additional per se rule could affect transactions not considered to be held temporarily. It certainty to both taxpayers and the IRS, motivated by tax avoidance, such as would also increase administrative and and eliminate any resulting compliance ordinary course transactions, and create compliance costs for the IRS and and administrative costs, because these burdens resulting from having to track taxpayers because there could be more transactions, which generally do not how long the specified tangible property disputes over the taxpayer’s principal give rise to avoidance concerns, would is held. purpose and when a property is held be entirely excluded from the The Treasury Department and the IRS temporarily. application of the rule. Although the considered four options to address these The fourth option that was considered compliance costs associated with a concerns. These options were: (i) Adopt involved several components. First, this rebuttal based on facts and the proposed regulations without option would convert the per se rule to circumstances will likely be higher than change; (ii) shorten the per se rule; (iii) a rebuttable presumption. Under this under the first and second alternatives, eliminate the per se rule and rely on a rule, property would be presumed to be those alternatives do not provide principal purpose rule; or (iv) convert temporarily held and acquired with a taxpayers with an opportunity to the per se rule into a rebuttable principal purpose of reducing a GILTI demonstrate the economic substance of presumption, add a safe harbor, and inclusion amount if the property is held the transaction, and the electivity of the clarify the scope of the rule. for less than twelve months. However, rebuttal leaves taxpayers no worse off The first option was to finalize the presumption could be rebutted if, in than under the first and second options. without change the rule contained in general, the facts and circumstances It is not clear whether the adopted the proposed regulations. This approach clearly establish that the subsequent approach has higher or lower is a simple and administrable rule for transfer of the property by the CFC was compliance costs than the third the IRS and taxpayers because it would not contemplated when the property approach, but Treasury and IRS not consider the taxpayer’s motivation was acquired and that a principal determined the adopted approach to be for holding property for less than 12 purpose of the acquisition of the superior for the reasons discussed months; however, it would not address property was not to increase the normal above. the concern raised by comments that the return of a U.S. shareholder. This option The Treasury and the IRS determined rule can potentially apply to also would add a second presumption that these changes strike an appropriate transactions that were not tax motivated that generally provides that property is balance between (i) mitigating and could therefore lead to a reduction presumed to not be subject to the rule compliance burdens relative to the in otherwise economically valuable if held for more than 36 months. In proposed regulations and providing transactions. addition, this option would include a certainty and flexibility to taxpayers and The second option was to shorten the ‘‘safe harbor’’ that generally applies to (ii) identifying transactions that have 12-month per se rule to, for example, six transfers between CFCs that are owned the potential for abuse. Thus, this is the months. While this option could in the same proportion by U.S. approach adopted in the final significantly reduce the number of shareholders, have the same taxable regulations.

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ii. Affected Taxpayers 864(e)(4) is increased as a result of the Department and the IRS considered two In principle, this aspect of the final application of section 965(b)(4)(B), even options to address the concern regulations could apply to any tested though there has been no economic expressed by the comment. These income CFC that purchases tangible change to the value of the foreign options were: (i) Adopt the foreign tax property and holds it temporarily. corporation. Under final regulations credit proposed regulations described Therefore, this aspect of the regulations under section 965, in general, a taxpayer above with a statement that the could affect any of the 25,000–35,000 may elect to reduce the basis in the reduction in basis is limited to the persons with a potential GILTI inclusion stock of the foreign corporation, on a taxpayer’s adjusted basis in the stock of and should be treated as an upper- share by share basis, by the amount of the foreign corporation; or (ii) allow a bound estimate. In practice, however, it the increase to the E&P of the foreign taxpayer’s adjusted basis in the stock of would only apply to U.S. shareholders corporation under section 965(b)(4)(B). the foreign corporation to be reduced of CFC that temporarily hold tangible See § 1.965–2(f)(2)(i). However, the below zero as a result of the adjustment property for tax minimization purposes, election does not cause the taxpayer’s for section 965(b)(4)(B) as long as the which would only be a small subset of basis to be reduced below zero, even if adjustment for E&P provided in section sophisticated tax planners. The the amount of the increase to the E&P 864(e)(4) increased the adjusted basis of Treasury Department and the IRS do not of the foreign corporation under section the foreign corporation to or above zero. have readily available data to enable 965(b)(4)(B) exceeds the taxpayer’s basis The first option was to adopt the estimating how many taxpayers could in the stock. proposed regulations with a statement minimize tax in this way, nor which The foreign tax credit proposed that the reduction in basis is limited to taxpayers would likely undertake such regulations provide that, for purposes of the taxpayer’s adjusted basis in the behavior in the absence of these determining the adjusted basis of the stock of the foreign corporation. On one regulations. stock of the foreign corporation under hand, this would address the concerns section 864(e)(4), a taxpayer should that the adjustment could cause a e. Application of Basis Adjustment for determine its adjusted basis in the stock taxpayer’s adjusted basis in the stock of Purposes of Characterizing Certain of the foreign corporation as if the the foreign corporation to be less than Stock taxpayer had made in the election in zero for purposes of the expense i. Background and Alternatives § 1.965–2(f)(2)(i). See proposed § 1.861– allocation rules. On the other hand, this Considered 12(c)(2)(i)(B)(1)(ii). After this would perpetuate some of the distortion adjustment, the taxpayer then follows created by the application of section Under the Code, certain expenses, the existing rule under section 864(e)(4) 965(b)(4)(B). That is, because the including interest, must be allocated to increase or decrease the adjusted increase in the E&P of the foreign based on the adjusted basis of the assets basis in the stock by the E&P of the corporation would exceed the held by the taxpayer. For purposes of foreign corporation and its subsidiaries. allocating expenses to stock of certain A comment requested that the foreign downward adjustment in the basis of foreign corporations held directly by a tax credit proposed regulations be the foreign corporation, the adjusted taxpayer, section 864(e)(4) generally amended to make clear that, for basis in the stock of the foreign requires that a taxpayer adjust the purposes of section 864(e)(4), that the corporation would still be higher for adjusted basis of the stock by the reduction in basis under proposed purposes of section 864(e)(4) than if aggregate amount of E&P of the foreign § 1.861–12(c)(2)(i)(B)(1)(ii) does not section 965(b)(4)(B) had not applied. corporation and its subsidiaries. The cause the taxpayer’s basis in the stock The second option was to provide that combination of the adjusted basis of the in the foreign corporation to be less than the taxpayer’s adjusted basis in the stock of the foreign corporation and the zero. This could happen, for example, stock of the foreign corporation may be increase or decrease (if the foreign where the increase in the foreign reduced below zero as a result of the corporation and its subsidiaries have a corporation’s E&P under section adjustment for section 965(b)(4)(B) as deficit in E&P) in that amount by the 965(b)(4)(B) exceeded the taxpayer’s long as the adjustment for E&P provided E&P of the foreign corporation adjusted basis in the stock of that in section 864(e)(4) increased the approximate the value of the stock of foreign corporation. adjusted basis of the foreign corporation the foreign corporation for purposes of The Treasury Department and the IRS to or above zero. This option fully the expense allocation rules. See Joint agreed that, for purposes of applying the addresses the non-economic increase to Committee on Tax’n, General expense allocation rules, a taxpayer the E&P of the foreign corporation under Explanation of the Tax Reform Act of should not have an adjusted basis below section 965(b)(4)(B) because the 1986 (Pub. L. 99–514) (May 4, 1987), zero in the stock of a foreign adjusted basis of the foreign corporation JCS–10–87, at p. 946 (noting that ‘‘the corporation. When the adjusted basis of is reduced by the full amount of the failure to consider earnings and profits an asset is zero, no expenses are increase. However, it also still ensures caused significant distortion’’ for allocated to that asset and thus allowing that, for expense allocation purposes, purposes of expense allocation rules a negative adjusted basis would serve no the adjusted basis of the stock of the because the value of the earnings and purpose for the expense allocation rules. foreign corporation will not be below profits is reflected in the fair market However, because the adjustment to the zero, after accounting for the E&P value of the stock). stock of the foreign corporation in this adjustment in section 864(e)(4). The Under section 965(b)(4)(B), if a case is two steps—the adjusted basis is Treasury Department and the IRS taxpayer used a deficit in E&P to offset reduced to account for the application selected this option for the final its inclusion under section 965(a), the of section 965(b)(4)(B) and then regulations because it addressed the deficit is eliminated by increasing the increased or decreased by the amount of concerns regarding negative adjusted E&P of the foreign corporation with the E&P of the foreign corporation and its basis while most accurately reflecting deficit. However, because there is no subsidiaries—the adjusted basis could the value of the stock in the foreign offsetting reduction to the basis of the be less than zero after the initial corporation for purposes of the expense stock of the foreign corporation, the adjustment but still be positive after the allocation rules, and did not increase adjusted basis of that foreign second adjustment is taken into compliance costs relative to the corporation for purposes of section account. Accordingly, the Treasury alternatives.

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ii. Affected Taxpayers Form 1120 series, Form 1040 series, basis is held directly by a CFC or The taxpayers potentially affected by Form 1041 series, and Form 1065 series indirectly through a partnership in this aspect of the final regulations are (see chart at the end of this part II of this which the CFC is a partner. With respect those taxpayers that own at least 10 Special Analyses section for the status to property held directly by the CFC, percent of a foreign corporation that had of the PRA submissions for these forms). this election is made by controlling its E&P increased under section The collection of information in domestic shareholders of the CFC by 965(b)(4)(B). The Treasury Department § 1.951A–3(h)(1)(iv)(A) is a statement attaching a statement meeting the and the IRS have not estimated how that a U.S. shareholder must attach to a requirements of § 1.964–1(c)(3)(ii) with many taxpayers are likely to be affected Form 5471 with respect to a CFC in their income tax returns following the by these regulations because this level order to rebut the presumption that a notice requirements of § 1.964– of detail regarding taxpayer filings transfer of specified tangible property 1(c)(3)(iii). See § 1.951A– under section 965 is not readily held by the CFC for less than 12 months 3(h)(2)(ii)(B)(3)(ii). With respect to available. However, 100,000 taxpayers was held temporarily with a principal property held in a partnership in which were estimated to pay the section 965 purpose of increasing the DTIR of the the CFC is a partner, this election is one-time tax. This is an upper-bound U.S. shareholder. The information made by the partnership by filing a estimate of affected taxpayers since only included in the statement is required in statement as described in § 1.754–1(b)(1) those with an E&P adjustment under order for the IRS to be aware if the attached to the partnership return. See section 965(b)(4)(B) would be affected. taxpayer takes the position that the § 1.951A–3(h)(2)(ii)(B)(3)(iii). For Information on those taxpayers is not temporary ownership rule of § 1.951A– purposes of the PRA, the reporting readily available to the Treasury 3(h)(1) does not apply. Without this burden associated with § 1.951A– Department and the IRS. statement, there is a presumption that 3(h)(2)(ii)(B)(3)(ii) will be reflected in such property is held temporarily with the PRA submission associated with the II. Paperwork Reduction Act a principal purpose of increasing DTIR Form 990 series, Form 1120 series, Form In response to comments addressing of a U.S. shareholder and a portion of 1040 series, Form 1041 series, and Form the notices of proposed rulemaking the basis in the property may be 1065 series (see chart at the end of this preceding the final regulations, the disregarded for purposes of calculating part II of the Special Analysis section Treasury Department and the IRS have QBAI of the CFC that holds the property for the status of the PRA submissions for added new collections of information temporarily. The statement indicates these forms). For purposes of the PRA, with respect to section 951A and that the U.S. shareholder should be the reporting burden associated with revised a collection of information with allowed the benefit of basis that would § 1.951A–3(h)(2)(ii)(B)(3)(iii) will be respect to section 965(n). otherwise be disregarded for purposes of reflected in the PRA submission The new collections of information in calculating QBAI. For purposes of the associated with Form 1065 (see chart at these regulations with respect to section PRA, the reporting burden associated the end of this part II of the Special 951A are in § 1.951A–3(e)(3)(ii), with § 1.951A–3(h)(1)(iv)(A) will be Analysis section for the status of the (h)(1)(iv)(A), and (h)(2)(ii)(B)(3). The reflected in the PRA submission PRA submissions for this form). revised collection of information with associated with Form 5471, The collection of information in respect to the election under section ‘‘Information Return of U.S. Persons § 1.965–7(e)(2)(ii)(B) requires a taxpayer 965(n) is in § 1.965–7(e)(2)(ii)(B). With Respect to Certain Foreign revoking a section 965(n) election to The collection of information in Corporations’’ (OMB control number attach a statement to that effect to an § 1.951A–3(e)(3)(ii) is an election that 1545–0123). amended income tax return. The the controlling domestic shareholders of The collection of information in information is required in order for the a CFC may make in order for the CFC § 1.951A–3(h)(2)(ii)(B)(3) is an election IRS to be aware if a taxpayer revokes an to continue to use its book depreciation to disregard disqualified basis, which is election. The Treasury Department and method (rather than converting to ADS) certain basis that was created by reason the IRS have determined that the for purposes of determining the adjusted of a disqualified transfer during the reporting burden associated with basis in specified tangible property disqualified period of a transferor CFC, § 1.965–7(e)(2)(ii)(B) to revoke a section placed in service before its first taxable as those terms are defined in § 1.951A– 965(n) election is reflected in the year beginning after December 22, 2017 3(h)(2)(ii)(C). This election would reporting burden associated with if certain conditions are met. This simplify recordkeeping with respect to making the election. For purposes of the election is made by controlling domestic the property because a separate record PRA, the reporting burden associated shareholders by attaching a statement of the disqualified basis and total with § 1.965–7(e)(2)(ii)(B) will be meeting the requirements of § 1.964– adjusted basis in the property would not reflected in the PRA submission 1(c)(3)(ii) with their income tax returns have to be tracked. For purposes of associated with TD 9846, 84 FR 1838 following the notice requirements of determining disqualified basis, a (February 5, 2019) (OMB control § 1.964–1(c)(3)(iii). This election, if disqualified transfer includes both a number 1545–2280). made by a CFC, simplifies the direct transfer during the disqualified The estimates for the number of calculation of the QBAI for the CFC period by one CFC to a related person, impacted filers with respect to the attributable to property placed in and also an indirect transfer of property collections of information described in service before December 22, 2017, owned by a partnership through, for this part II of the Special Analysis which, and in turn, simplifies the example, a transfer by a CFC to a related section are based on filers of income tax calculation of the DTIR of the CFC’s person of an interest in the partnership, returns with a Form 5471 attached U.S. shareholders attributable to such for which a section 754 election is in because only filers that are U.S. property. For purposes of the Paperwork effect. Therefore, disqualified basis may shareholders of CFCs or that have at Reduction Act of 1995 (44 U.S.C. exist in both property held by a CFC and least a 10 percent ownership in a foreign 3507(d)) (‘‘PRA’’), the reporting burden property held by a partnership. corporation would be subject to the associated with § 1.951A–3(e)(3)(ii) will Accordingly, there are two methods for information collection requirements. be reflected in the PRA submission making this election based upon The IRS estimates the number of associated with the Form 990 series, whether the property with disqualified affected filers to be the following:

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TAX FORMS IMPACTED

Number of Collection of information respondents Forms to which the information may be attached (estimated)

§ 1.951A–3(e)(3)(ii) Election to continue to use income and 25,000–35,000 Form 990 series, Form 1120 series, Form 1040 series, Form E&P depreciation method for property placed in service be- 1041 series, and Form 1065 series. fore the first taxable year beginning after December 22, 2017. § 1.951A–3(h)(1)(iv)(A) Statement for less than 12 month prop- 25,000–35,000 Form 5471. erty. § 1.951A–3(h)(2)(ii)(B)(3) Election to disregard disqualified 25,000–35,000 Form 990 series, Form 1120 series, Form 1040 series, Form basis. 1041 series, and Form 1065 series. § 1.965–7(e)(2)(ii)(B) Statement to revoke section 965(n) elec- 25,000–35,000 Form 990 series, Form 1120 series, Form 1040 series, Form tion. 1041 series, and Form 1065 series. Source: MeF, DCS, and CDW.

The current status of the PRA forms and schedules for tax-exempt not estimated the burden, including that submissions related to the tax forms that organizations, of 50.450 million hours of any new information collections, will be revised as a result of the and total estimated monetized costs of related to the requirements under the information collections in the section $1,297,300,000 ($2017). The overall regulations. The Treasury Department 951A regulations is provided in the burden estimates provided for the OMB and the IRS estimate PRA burdens on a accompanying table. As described control numbers below are aggregate taxpayer-type basis rather than a above, the reporting burdens associated amounts that relate to the entire package provision-specific basis. Those with the information collections in the of forms associated with the applicable estimates would capture both changes regulations are included in the OMB control number and will in the made by the Act and those that arise out aggregated burden estimates for OMB future include, but not isolate, the of discretionary authority exercised in control numbers 1545–0123 (which estimated burden of the tax forms that the final regulations. represents a total estimated burden time will be revised as a result of the The Treasury Department and the IRS for all forms and schedules for information collections in the request comments on all aspects of corporations of 3.157 billion hours and regulations. These numbers are information collection burdens related total estimated monetized costs of therefore unrelated to the future to the final regulations, including $58.148 billion ($2017)), 1545–0074 calculations needed to assess the burden estimates for how much time it would (which represents a total estimated imposed by the regulations. These take to comply with the paperwork burden time, including all other related burdens have been reported for other burdens described above for each forms and schedules for individuals, of regulations related to the taxation of relevant form and ways for the IRS to 1.784 billion hours and total estimated cross-border income and the Treasury minimize the paperwork burden. monetized costs of $31.764 billion Department and the IRS urge readers to Proposed revisions (if any) to these ($2017)), 1545–0092 (which represents a recognize that these numbers are forms that reflect the information total estimated burden time, including duplicates and to guard against collections contained in these final all other related forms and schedules for overcounting the burden that regulations will be made available for trusts and estates, of 307,844,800 hours international tax provisions imposed public comment at https://apps.irs.gov/ and total estimated monetized costs of prior to the Act. No burden estimates app/picklist/list/draftTaxForms.html $9.950 billion ($2016)), and 1545–0047 specific to the forms affected by the and will not be finalized until after (which represents a total estimated regulations are currently available. The these forms have been approved by burden time, including all other related Treasury Department and the IRS have OMB under the PRA.

Form Type of filer OMB No.(s) Status

Forms 990 ...... Tax exempt entities (NEW 1545–0047 ...... Approved by OIRA 12/21/2018 until 12/31/2019. The Form will be Model). updated with OMB number 1545–0047 and the corresponding PRA Notice on the next revision.

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201811-1545-003

Form 1040 ...... Individual (NEW Model) .... 1545–0074 ...... Limited Scope submission (1040 only) approved on 12/7/2018 until 12/31/2019. Full ICR submission for all forms in 6/2019. 60 Day FRN not published yet for full collection.

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031

Form 1041 ...... Trusts and estates ...... 1545–0092 ...... Submitted to OIRA for review on 9/27/2018.

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201806-1545-014

Form 1065 and 1120 Business (NEW Model) .... 1545–0123 ...... Approved by OIRA 12/21/2018 until 12/31/2019.

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201805-1545-019

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Form Type of filer OMB No.(s) Status

Form 5471 ...... Business (NEW Model) .... 1545–0123 ...... Published in the FRN on 10/8/18. Public Comment period closes on 12/10/18.

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201805-1545-019

Individual (NEW Model) .... 1545–0074 ...... Limited Scope submission (1040 only) on 10/11/18 at OIRA for re- view. Full ICR submission for all forms in 3–2019. 60 Day FRN not published yet for full collection.

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031

In 2018, the IRS released and invited taxpayers who are at least 10-percent Examining the gross receipts of the e- comments on drafts of the above forms shareholders of a foreign corporation. filed Forms 5471 that is the basis of the in order to give members of the public The reporting burdens in § 1.951A– 25,000–35,000 respondent estimates, the advance notice and an opportunity to 3(e)(3)(ii), (h)(1)(iv)(A), and Treasury Department and the IRS have submit comments. The IRS received no (h)(2)(ii)(B)(3), and § 1.965–7(e)(2)(ii)(B) determined that the tax revenue from comments on the portions of the forms generally affect U.S. taxpayers that elect section 951A estimated by the Joint that relate to section 951A during the to make or revoke certain elections or Committee on Taxation for businesses of comment period. Consequently, the IRS rebut a presumption. In general, foreign all sizes is less than 0.3 percent of gross made the forms available in late 2018 corporations are not considered small receipts as shown in the table below. and early 2019 for use by the public. entities. Nor are U.S. taxpayers Based on data for 2015 and 2016, total considered small entities to the extent The IRS is contemplating making gross receipts for all businesses with the taxpayers are natural persons or additional changes to forms in order to gross receipts under $25 million is $60 implement these final regulations. entities other than small entities. For purposes of the PRA, the Treasury billion while those over $25 million is III. Regulatory Flexibility Act Department and the IRS estimate that $49.1 trillion. Given that tax on GILTI It is hereby certified that this final there are 25,000–35,000 respondents of inclusion amounts is correlated with regulation will not have a significant all sizes that are likely to file Form gross receipts, this results in businesses economic impact on a substantial 5471. Only a small proportion of these with less than $25 million in gross number of small entities within the filers are likely to be small business receipts accounting for approximately meaning of section 601(6) of the entities. This estimate was used in the 0.01 percent of the tax revenue. Data are Regulatory Flexibility Act (5 U.S.C. proposed regulations (REG–104390–18), not readily available to determine the chapter 6). and comments were requested on the sectoral breakdown of these entities. Sections 951 and 951A generally number of small entities that are likely Based on this analysis, smaller affect U.S. shareholders of CFCs. to be impacted by the section 951A businesses are not significantly Section 965 generally affects U.S. regulations. impacted by these final regulations.

2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 billion billion billion billion billion billion billion billion billion billion

JCT tax revenue...... 7.7 12.5 9.6 9.5 9.3 9.0 9.2 9.3 15.1 21.2 Total gross receipts...... 30,727 53,870 566,676 59,644 62,684 65,865 69,201 72,710 76,348 80,094 Percent ...... 0.03 0.02 0.02 0.02 0.01 0.01 0.01 0.01 0.02 0.03 Source: RAAS, CDW (E-filed Form 5471, category 4 or 5, C and S corporations and partnerships); Conference Report, at 689.

Although the Treasury Department readily available. However, businesses is hereby certified that the collection of and the IRS received one comment that are U.S. shareholders of CFCs are information requirements of § 1.951A– asserting that a substantial number of generally not small businesses because 3(e)(3)(ii), (h)(1)(iv)(A), and small entities would be affected by the the ownership of sufficient stock of a (h)(2)(ii)(B)(3) will not have a significant proposed regulations, that comment was CFC in order to be a U.S. shareholder economic impact on a substantial principally concerned with U.S. citizens generally entails significant resources number of small entities. living abroad that owned foreign and investment. Therefore, the Treasury With respect to § 1.965–7(e)(2)(ii)(B) corporations directly or indirectly Department and the IRS have regarding the revocation of the election under section 965(n), the Treasury through other foreign entities. U.S. determined that a substantial number of citizens living abroad are not small Department and the IRS have domestic small business entities will business entities; thus, no small entity determined that § 1.965–7(e)(2)(ii)(B) not be subject to § 1.951A–3(e)(3)(ii), is affected in this scenario. will not have a significant economic Specifically, the small business (h)(1)(iv)(A), and (h)(2)(ii)(B)(3). impact on a substantial number of small entities that are subject to the Moreover, as discussed above, smaller entities for the reasons described in part requirements of § 1.951A–3(e)(3)(ii), businesses are not significantly III of the Special Analyses section in TD (h)(1)(iv)(A), and (h)(2)(ii)(B)(3) of the impacted by the final regulations. 9864, 84 FR 1838 (February 5, 2019). final regulations are domestic small Consequently, the Treasury Department Accordingly, it is hereby certified that entities that are U.S. shareholders of one and the IRS have determined that the collection of information or more CFCs. The data to assess the § 1.951A–3(e)(3)(ii), (h)(1)(iv)(A), and requirements of § 1.965–7(e)(2)(ii)(B) number of small entities potentially (h)(2)(ii)(B)(3) will not have a significant will not have a significant economic affected by § 1.951A–3(e)(3)(ii), economic impact on a substantial impact on a substantial number of small (h)(1)(iv)(A), and (h)(2)(ii)(B)(3) are not number of small entities. Accordingly, it entities.

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Pursuant to section 7805(f), the in the effective date is unnecessary and Drafting Information proposed regulations preceding these contrary to the public interest. The The principal authors of the final regulations (REG–104390–18 and statutory provisions to which these regulations are Jorge M. Oben, Michael REG–105600–18) were submitted to the rules relate were enacted on December A. Kaercher, and Karen Cate of the Chief Counsel for Advocacy of the Small 22, 2017 and apply to taxable years of Office of Associate Chief Counsel Business Administration for comment foreign corporations and to the taxable (International), Jennifer N. Keeney of the on their impact on small business. years of United States persons in which Office of the Associate Chief Counsel or with which such taxable years of IV. Unfunded Mandates Reform Act (Passthroughs and Special Industries), foreign corporations end. In certain Section 202 of the Unfunded and Katherine H. Zhang and Kevin M. cases, these taxable years have already Jacobs of the Office of Associate Chief Mandates Reform Act of 1995 requires ended. This means that the statutory Counsel (Corporate). However, other that agencies assess anticipated costs provisions are currently effective, and personnel from the Treasury and benefits and take certain other taxpayers may be subject to Federal Department and the IRS participated in actions before issuing a final rule that income tax liability for their 2017 or the development of the regulations. includes any Federal mandate that may 2018 taxable years reflecting these result in expenditures in any one year provisions. In certain cases, taxpayers Effect on Other Documents by a state, local, or tribal government, in may be required to file returns reflecting The following publications are the aggregate, or by the private sector, of this Federal income liability during the obsolete as of June 21, 2019: $100 million in 1995 dollars, updated 60-day period that begins after this rule Notice 2009–7 (2009–3 I.R.B. 312). annually for inflation. In 2019, that is published in the Federal Register. Notice 2010–41 (2010–22 I.R.B. 715). threshold is approximately $154 These final regulations provide million. These regulations do not crucial guidance for taxpayers on how Statement of Availability of IRS include any Federal mandate that may to apply the relevant statutory rules, Documents result in expenditures by state, local, or compute their tax liability and IRS Revenue Procedures, Revenue tribal governments, or by the private accurately file their Federal income tax Rulings, notices, and other guidance sector in excess of that threshold. returns. These final regulations resolve cited in this document are published in statutory ambiguity, prevent abuse and V. Executive Order 13132: Federalism the Internal Revenue Bulletin (or grant taxpayer relief that would not be Cumulative Bulletin) and are available Executive Order 13132 (entitled available based solely on the statute. from the Superintendent of Documents, ‘‘Federalism’’) prohibits an agency from Because taxpayers must already comply U.S. Government Publishing Office, publishing any rule that has federalism with the statute, a 60-day delay in the Washington, DC 20402, or by visiting implications if the rule either imposes effective date of the final regulations is the IRS website at http://www.irs.gov. substantial, direct compliance costs on unnecessary and contrary to the public state and local governments, and is not interest. A delay would place certain List of Subjects in 26 CFR Part 1 required by statute, or preempts state taxpayers in the unusual position of Income taxes, Reporting and law, unless the agency meets the having to determine whether to file tax recordkeeping requirements. consultation and funding requirements returns during the pre-effective date of section 6 of the Executive Order. period based on final regulations that Adoption of Amendments to the These regulations do not have are not yet effective. If taxpayers chose Regulations federalism implications and do not not to follow the final regulations and Accordingly, 26 CFR part 1 is impose substantial direct compliance did not amend their returns after the amended as follows: costs on state and local governments or regulations became effective, it would preempt state law within the meaning of place significant strain on the IRS to PART 1—INCOME TAXES the Executive Order. ensure that taxpayers correctly calculated their tax liabilities. For ■ Paragraph 1. The authority citation VI. Congressional Review Act example, in cases where taxpayers and for part 1 is amended by adding entries The Administrator of the Office of their CFCs have engaged in disqualified for §§ 1.78–1, 1.861–12, 1.951–1, Information and Regulatory Affairs of transfers or other abusive transactions, a 1.951A–2, 1.951A–3, 1.951A–5, 1.1502– the OMB has determined that this delayed effective date may hamper the 51, 1.6038–5 in numerical order to read Treasury decision is a major rule for IRS’ ability to detect such transactions. in part as follows: purposes of the Congressional Review Moreover, a delayed effective date could Authority: 26 U.S.C. 7805 * * * Act (5 U.S.C. 801 et seq.) (‘‘CRA’’). create uncertainty and possible Section 1.78–1 also issued under 26 U.S.C. Under section 801(3) of the CRA, a restatements with respect to financial 245A(g). major rule takes effect 60 days after the statement audits. Therefore, the rules in * * * * * rule is published in the Federal this Treasury decision are effective on Section 1.861–12 also issued under 26 Register. Notwithstanding this the date of publication in the Federal U.S.C. 864(e)(7). requirement, section 808(2) of the CRA Register and apply in certain cases to * * * * * allows agencies to dispense with the taxable years of foreign corporations and Section 1.951–1 also issued under 26 requirements of section 801 of the CRA United States persons beginning before U.S.C. 7701(a). when the agency for good cause finds such date. Section 1.951A–2 also issued under 26 that such procedure would be The foregoing good cause statement U.S.C. 882(c)(1)(A) and 954(b)(5). impracticable, unnecessary, or contrary only applies to the 60-day delayed Section 1.951A–3 also issued under 26 to the public interest and that the rule effective date provision of section 801(3) U.S.C. 951A(d)(4). shall take effect at such time as the of the CRA and is permitted under Section 1.951A–5 also issued under 26 agency promulgating the rule section 808(2) of the CRA. The Treasury U.S.C. 951A(f)(1)(B). determines. Department and the IRS hereby comply * * * * * Pursuant to section 808(2) of the CRA, with all aspects of the CRA and the Section 1.1502–51 also issued under 26 the Treasury Department and the IRS Administrative Procedure Act (5 U.S.C. U.S.C. 1502. find, for good cause, that a 60-day delay 551 et seq.). * * * * *

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Section 1.6038–5 also issued under 26 (1) The corporation includes in gross (B) Computational rules—(1) U.S.C. 6038. income under section 951(a)(1)(A) the Adjustments to basis—(i) Application of * * * * * amounts by reason of which there are section 961 or 1293(d). For purposes of deemed paid under section 960(a) the this section, a taxpayer’s adjusted basis ■ Par. 2. Section 1.78–1 is revised to foreign income taxes that give rise to in the stock of a foreign corporation read as follows: that section 78 dividend, does not include any amount included notwithstanding that the foreign income in basis under section 961 or 1293(d) of § 1.78–1 Gross up for deemed paid foreign the Code. tax credit. taxes may be carried back or carried over to another taxable year and deemed (ii) Application of section 965(b). For (a) Taxes deemed paid by certain to be paid or accrued in such other purposes of this section, if a taxpayer domestic corporations treated as a taxable year under section 904(c); or owned the stock of a specified foreign dividend. If a domestic corporation (2) The corporation includes in gross corporation (as defined in § 1.965– chooses to have the benefits of the income under section 951A(a) the 1(f)(45)) as of the close of the last foreign tax credit under section 901 for amounts by reason of which there are taxable year of the specified foreign any taxable year, an amount that is deemed paid under section 960(d) the corporation that began before January 1, equal to the U.S. dollar amount of foreign income taxes that give rise to 2018, the taxpayer’s adjusted basis in foreign income taxes deemed to be paid that section 78 dividend. the stock of the specified foreign by the corporation for the year under (c) Applicability date. This section corporation for that taxable year and any section 960 (in the case of section applies to taxable years of foreign subsequent taxable year is determined 960(d), determined without regard to corporations that begin after December as if the taxpayer did not make the the phrase ‘‘80 percent of’’ in section 31, 2017, and to taxable years of United election described in § 1.965–2(f)(2)(i) 960(d)(1)) is, to the extent provided by States shareholders in which or with (regardless of whether the election was this section, treated as a dividend (a which such taxable years of foreign actually made) and is further adjusted as section 78 dividend) received by the corporations end. The second sentence described in this paragraph domestic corporation from the foreign of paragraph (a) of this section also (c)(2)(i)(B)(1)(ii). If § 1.965–2(f)(2)(ii)(B) corporation. A section 78 dividend is applies to section 78 dividends that are applied (or would have applied if the treated as a dividend for all purposes of received after December 31, 2017, by election had been made) with respect to the Code, except that it is not treated as reason of taxes deemed paid under the stock of a specified foreign a dividend for purposes of section 245 section 960(a) with respect to a taxable corporation, the taxpayer’s adjusted or 245A, and does not increase the year of a foreign corporation beginning basis in the stock of the specified earnings and profits of the domestic before January 1, 2018. foreign corporation is reduced by the corporation or decrease the earnings and ■ Par. 3. Section 1.861–12 is amended amount described in § 1.965– profits of the foreign corporation. Any by revising paragraph (c)(2) and adding 2(f)(2)(ii)(B)(1) (without regard to the reduction under section 907(a) of the paragraph (k) to read as follows. rule for limited basis adjustments in foreign income taxes deemed paid with § 1.965–2(f)(2)(ii)(B)(2) and the respect to combined foreign oil and gas § 1.861–12 Characterization rules and limitation in § 1.965–2(f)(2)(ii)(C), and adjustments for certain assets. income does not affect the amount without regard to the rules regarding the treated as a section 78 dividend. See * * * * * netting of basis adjustments in § 1.965– § 1.907(a)–1(e)(3). Similarly, any (c) * * * 2(h)(2)). The reduction in the taxpayer’s (2) Basis adjustment for stock in 10 reduction under section 901(e) of the adjusted basis in the stock may reduce percent owned corporations—(i) foreign income taxes deemed paid with the taxpayer’s adjusted basis in the Taxpayers using the tax book value respect to foreign mineral income does stock below zero prior to the application method—(A) General rule. For purposes not affect the amount treated as a of paragraphs (c)(2)(i)(A)(1) and (2) of of apportioning expenses on the basis of section 78 dividend. See § 1.901– this section. No adjustment is made in the tax book value of assets, the adjusted 3(a)(2)(i), (b)(2)(i)(b), and (d) Example 8. the taxpayer’s adjusted basis in the basis of any stock in a 10 percent owned Any reduction under section stock of a specified foreign corporation corporation owned by the taxpayer 6038(c)(1)(B) in the foreign taxes paid or for an amount described in § 1.965– either directly or indirectly through a accrued by a foreign corporation is 2(f)(2)(ii)(A). To the extent that, in an partnership or other pass-through entity exchange described in section 351, 354, taken into account in determining (after taking into account the or 356, a taxpayer receives stock of a foreign taxes deemed paid and the adjustments described in paragraph foreign corporation in exchange for amount treated as a section 78 dividend. (c)(2)(i)(B)(1) of this section) shall be— stock of a specified foreign corporation See, for example, § 1.6038–2(k)(5) (1) Increased by the amount of the described in this paragraph Example 1. To the extent provided in earnings and profits of such corporation (c)(2)(i)(B)(1)(ii), this paragraph the Code, section 78 does not apply to (and of lower-tier 10 percent owned (c)(2)(i)(B)(1)(ii) applies to such stock any tax not allowed as a credit. See, for corporations) attributable to such stock received. example, sections 901(j)(3), 901(k)(7), and accumulated during the period the (2) Amount of earnings and profits. 901(l)(4), 901(m)(6), and 908(b). For taxpayer or other members of its For purposes of this paragraph (c)(2), rules on determining the source of a affiliated group held 10 percent or more earnings and profits (or deficits) are section 78 dividend in computing the of such stock; or computed under the rules of section 312 limitation on the foreign tax credit (2) Reduced by any deficit in earnings and, in the case of a foreign corporation, under section 904, see §§ 1.861–3(a)(3), and profits of such corporation (and of sections 964(a) and 986 for taxable years 1.862–1(a)(1)(ii), and 1.904–5(m)(6). For lower-tier 10 percent owned of the 10 percent owned corporation rules on assigning a section 78 dividend corporations) attributable to such stock ending on or before the close of the to a separate category, see § 1.904–4. for such period; or taxable year of the taxpayer. (b) Date on which section 78 dividend (3) Zero, if after application of Accordingly, the earnings and profits of is received. A section 78 dividend is paragraphs (c)(2)(i)(A)(1) and (2) of this a controlled foreign corporation include considered received by a domestic section, the adjusted basis of the stock all earnings and profits described in corporation on the date on which— is less than zero. section 959(c). The amount of the

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earnings and profits with respect to application of paragraph (c)(2)(i)(B) of this under section 961 or 1293(d), USP’s adjusted stock of a foreign corporation held by section). basis in the stock of CFC2 is $0 (before the the taxpayer is determined according to (ii) Analysis. Under paragraph application of paragraph (c)(2)(i)(B) of this the attribution principles of section (c)(2)(i)(B)(1)(ii) of this section, USP’s section). Additionally, the adjusted basis of adjusted basis in the stock of CFC1 is USP in the stock of CFC1 and CFC2 at the 1248 and the regulations under section determined as if USP did not make the end of the 2019 taxable year is the same as 1248. The attribution principles of election described in § 1.965–2(f)(2)(i). USP’s at the beginning of that year, and as of the section 1248 apply without regard to the adjusted basis in the stock of CFC2 is then end of the 2019 taxable year, CFC1 has requirements of section 1248 that are reduced by $75x, the amount described in earnings and profits of $25x and CFC2 has not relevant to the determination of a § 1.965–2(f)(2)(ii)(B)(1), without regard to the earnings and profits of $50x that are shareholder’s pro rata portion of rule for limited basis adjustments in § 1.965– attributable to the stock owned by USP and earnings and profits, such as whether 2(f)(2)(ii)(B)(2) and without regard to the accumulated during the period that USP held earnings and profits (or deficits) were rules regarding the netting of basis the stock of CFC1 and CFC2. adjustments in § 1.965–2(h)(2). No (ii) Analysis. The analysis is the same as in derived (or incurred) during taxable adjustment is made to USP’s adjusted basis paragraph (c)(2)(i)(C)(1)(ii) of this section (the years beginning before or after in the stock in CFC1. Accordingly, for analysis in Example 1) except that for December 31, 1962. purposes of determining the value of stock of purposes of determining the value of stock of (3) Annual noncumulative CFC1 and CFC2 at the beginning of the 2019 CFC1 and CFC2 at the beginning of the 2019 adjustment. The adjustment required by taxable year, USP’s adjusted basis in the taxable year, USP’s adjusted basis in the paragraph (c)(2)(i)(A) of this section is stock of CFC1 is $100x and USP’s adjusted stock of CFC2 is ¥$75x ($0¥$75x). Because made annually and is noncumulative. basis in the stock of CFC2 is $275x USP’s basis in the stock of CFC1 and CFC2 ¥ Thus, the adjusted basis of the stock ($350x $75x). is the same at the end of the 2019 taxable (determined without regard to prior (2) Example 2: Election described in year, prior to the application of the § 1.965–2(f)(2)(i)—(i) Facts. USP, a domestic years’ adjustments under paragraph adjustments in paragraphs (c)(2)(i)(A)(1) and corporation, owns all of the stock of CFC1, (2) of this section, USP’s adjusted basis in the (c)(2)(i)(A) of this section) is adjusted which owns all of the stock of CFC2, both stock of CFC1 is $100x and USP’s adjusted annually by the amount of accumulated controlled foreign corporations. USP, CFC1, basis in the stock of CFC2 is ¥$75x. Under earnings and profits (or deficits) and CFC2 all use the calendar year as their paragraph (c)(2)(i)(A)(1) of this section, for attributable to the stock as of the end of U.S. taxable year. USP owned CFC1, and purposes of apportioning expenses on the each year. CFC1 owned CFC2 as of December 31, 2017, basis of the tax book value of assets, USP’s (4) Translation of non-dollar and CFC1 and CFC2 were specified foreign adjusted basis in the stock of CFC1 is $125x functional currency earnings and corporations with respect to USP. USP’s basis ($100x + $25x). Under paragraph profits. Earnings and profits (or deficits) in each share of stock of CFC1 is identical. (c)(2)(i)(A)(3) of this section, for purposes of of a qualified business unit that has a USP made the election described in § 1.965– apportioning expenses on the basis of the tax 2(f)(2)(i). As a result of the election, USP was functional currency other than the book value of assets, USP’s adjusted basis in required to increase its basis in the stock of the stock of CFC2 is $0 because after dollar must be computed under this CFC1 by $90x under § 1.965–2(f)(2)(ii)(A)(1), applying paragraph (c)(2)(i)(A)(1) of this paragraph (c)(2) in functional currency and to decrease its basis in the stock of CFC1 section, USP’s adjusted basis in the stock of and translated into dollars using the by $90x under § 1.965–2(f)(2)(ii)(B)(1). CFC2 is less than zero (¥$75x + $50x). exchange rate at the end of the Pursuant to § 1.965–2(h)(2), USP netted the (4) Example 4: Election described in taxpayer’s current taxable year (and not increase of $90x against the decrease of $90x § 1.965–2(f)(2)(i) and adjusted basis below the exchange rates for the years in and made no net adjustment to the basis in zero—(i) Facts. The facts are the same as in which the earnings and profits or the stock of CFC1. For purposes of paragraph (c)(2)(i)(C)(3)(i) of this section (the deficits were derived or incurred). determining the value of the stock of CFC1 facts in Example 3), except that USP made (C) Examples. The following at the beginning of the 2019 taxable year, the election described in § 1.965–2(f)(2)(i) without regard to amounts included in basis examples illustrate the application of and, as result, recognized $75x of gain under under section 961 or 1293(d), USP’s adjusted § 1.965–2(h)(3). paragraph (c)(2)(i) of this section. basis in the stock of CFC1 is $600x (before (ii) Analysis. The analysis is the same as in (1) Example 1: No election described in the application of paragraph (c)(2)(i)(B) of paragraph (c)(2)(i)(C)(3)(ii) of this section (the § 1.965–2(f)(2)(i)—(i) Facts. USP, a domestic this section). analysis in Example 3). (ii) Analysis. Under paragraph corporation, owns all of the stock of CFC1 (c)(2)(ii) through (c)(2)(vi) [Reserved]. and CFC2, both controlled foreign (c)(2)(i)(B)(1)(ii) of this section, USP’s corporations. USP, CFC1, and CFC2 all use adjusted basis in the stock of CFC1 is For further guidance, see § 1.861– the calendar year as their U.S. taxable year. determined as if USP did not make the 12T(c)(2)(ii) through (c)(2)(vi). USP owned CFC1 and CFC2 as of December election described in § 1.965–2(f)(2)(i). While * * * * * 31, 2017, and CFC1 and CFC2 were specified USP made the election, no adjustment was (k) Applicability date. This section foreign corporations with respect to USP. made to the stock of CFC1 as a result of the applies to taxable years that both begin USP’s basis in each share of stock of each of election. However, USP’s adjusted basis in after December 31, 2017, and end on or the stock of CFC1 is then reduced by $90x, CFC1 and CFC2 is identical. USP did not after December 4, 2018. Paragraphs make the election described in § 1.965– the amount described in § 1.965– 2(f)(2)(i), but if USP had made the election, 2(f)(2)(ii)(B)(1), without regard to the rules (c)(2)(i)(A) and (c)(2)(i)(B)(1)(ii) of this § 1.965–2(f)(2)(ii)(B) would have applied to regarding the netting of basis described in section also apply to the last taxable the stock of CFC2 and the amount described § 1.965–2(h)(2). No adjustment is made to year of a foreign corporation that begins in § 1.965–2(f)(2)(ii)(B)(1) (without regard to USP’s basis in the stock of CFC1 for the before January 1, 2018, and with respect the rule for limited basis adjustments in amount described in § 1.965–2(f)(2)(ii)(A)(1). to a United States person, the taxable § 1.965–2(f)(2)(ii)(B)(2) and without regard to Accordingly, for purposes of determining the year in which or with which such the rules regarding the netting of basis value of stock of CFC1 at the beginning of the taxable year of the foreign corporation adjustments in § 1.965–2(h)(2)) with respect 2019 taxable year, USP’s adjusted basis in the ends. to the stock of CFC2, in aggregate, is $75x. stock of CFC1 is $510x ($600x¥$90x). ■ For purposes of determining the value of the (3) Example 3: Adjusted basis below zero— Par. 4. Section 1.861–12T is amended stock of CFC1 and CFC2 at the beginning of (i) Facts. The facts are the same as in by revising paragraph (c)(2)(i) to read as the 2019 taxable year, without regard to paragraph (c)(2)(i)(C)(1)(i) of this section (the follows: amounts included in basis under section 961 facts in Example 1), except that for purposes or 1293(d), USP’s adjusted basis in the stock of determining the value of the stock of CFC2 § 1.861–12T Characterization rules and of CFC1 is $100x and its adjusted basis in the at the beginning of the 2019 taxable year, adjustments for certain assets (temporary). stock of CFC2 is $350x (before the without regard to amounts included in basis * * * * *

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(c) * * * § 1.951A–2(b)(1)) of such corporation for share of the subpart F income of M for Year (c)(2)(i)(A) through (C) [Reserved]. For the taxable year, and 1 is $100x. further guidance, see § 1.861– (B) The dividend which would have (iii) Example 2—(A) Facts. The facts are 12(c)(2)(i)(A) through (c)(2)(i)(C). been received by such other person if the same as in paragraph (b)(2)(ii)(A) of this the distributions by such corporation to section (the facts in Example 1), except that * * * * * instead of holding 100% of the stock of M for ■ Par. 5. Section 1.951–1 is amended all its shareholders had been the amount which bears the same ratio to the the entire year, A sells 60% of such stock to by: B on May 26, Year 1. Thus, M is a controlled subpart F income of such corporation ■ 1. Revising paragraph (a) introductory foreign corporation for the period January 1, text. for the taxable year as the part of such Year 1, through May 26, Year 1. ■ 2. Revising paragraphs (b)(1)(ii), (b)(2), year during which such shareholder did (B) Analysis. Under section 951(a)(2)(A) (c), (e), and (g)(1). not own (within the meaning of section and paragraph (b)(1)(i) of this section, A’s pro ■ 3. Adding paragraphs (h) and (i). 958(a)) such stock bears to the entire rata share of the subpart F income of M is The revisions and addition read as taxable year. limited to the subpart F income of M which follows: (2) Examples. The following examples bears the same ratio to its subpart F income illustrate the application of this for such taxable year ($100x) as the part of § 1.951–1 Amounts included in gross paragraph (b). such year during which M is a controlled income of United States shareholders. (i) Facts. The following facts are foreign corporation bears to the entire taxable (a) In general. If a foreign corporation assumed for purposes of the examples. year (146/365). Accordingly, under section is a controlled foreign corporation (A) A is a United States shareholder. 951(a)(2) and paragraph (b)(1) of this section, (within the meaning of section 957) at (B) M is a foreign corporation that has A’s pro rata share of the subpart F income of only one class of stock outstanding. M for Year 1 is $40x ($100x × 146/365). any time during any taxable year of such (iv) Example 3—(A) Facts. The facts are the corporation, every person— (C) B is a nonresident alien individual, and stock owned by B is not same as in paragraph (b)(2)(ii)(A) of this * * * * * considered owned by a domestic entity section (the facts in Example 1), except that (b) * * * under section 958(b). instead of holding 100% of the stock of M for (1) * * * (D) P and R are foreign corporations. the entire year, A holds 60% of such stock on December 31, Year 1, having acquired (ii) The lesser of— (E) All persons use the calendar year such stock on May 26, Year 1, from B, who (A) The amount of distributions as their taxable year. received by any other person during owned such stock from January 1, Year 1. (F) Year 1 ends on or after October 3, Before A’s acquisition of the stock, M had such taxable year as a dividend with 2018, and has 365 days. respect to such stock multiplied by a distributed a dividend of $15x to B in Year 1 with respect to the stock so acquired by A. fraction, the numerator of which is the (ii) Example 1—(A) Facts. A owns 100% of the stock of M throughout Year 1. For Year M has no tested income for Year 1. subpart F income of such corporation 1, M derives $100x of subpart F income, has (B) Analysis. Under section 951(a)(2) and for the taxable year and the denominator $100x of earnings and profits, and makes no paragraph (b)(1) of this section, A’s pro rata of which is the sum of the subpart F distributions. share of the subpart F income of M for Year income and the tested income (as (B) Analysis. Under section 951(a)(2) and 1 is $21x, such amount being determined as defined in section 951A(c)(2)(A) and paragraph (b)(1) of this section, A’s pro rata follows:

Table 1 to paragraph (b)(2)(iv)(B): M’s subpart F income for Year 1 ...... $100x Less: Reduction under section 951(a)(2)(A) for period (1–1 through 5–26) during which M is not a controlled foreign corporation ($100x × 146/365) ...... 40x Subpart F income for Year 1 as limited by section 951(a)(2)(A) ...... 60x A’s pro rata share of subpart F income as determined under section 951(a)(2)(A) (0.6 × $60x) ...... 36x Less: Reduction under section 951(a)(2)(B) for dividends received by B during Year 1 with respect to the stock of M acquired by A: (i) Dividend received by B ($15x), multiplied by a fraction ($100x/$100x), the numerator of which is the subpart F income of such corporation for the taxable year ($100x) and the denominator of which is the sum of the subpart F income and the tested income of such corporation for the taxable year ($100x) ($15x × ($100x/$100x)) ...... 15x (ii) B’s pro rata share (60%) of the amount which bears the same ratio to the subpart F income of such corporation for the taxable year ($100x) as the part of such year during which A did not own (within the meaning of section 958(a)) such stock bears to the entire taxable year (146/365) (0.6 × $100x × (146/365)) ...... 24x (iii) Amount of reduction under section 951(a)(2)(B) (lesser of (i) or (ii)) ...... 15x A’s pro rata share of subpart F income as determined under section 951(a)(2) ...... 21x

(v) Example 4—(A) Facts. A owns 100% of 951(a)(2)(B) and paragraph (b)(1)(ii) of this the entire year, P holds 60% of such stock the only class of stock of P throughout Year section for the dividend of $20x paid to P on December 31, Year 1, having acquired 1, and P owns 100% of the only class of stock because there was no part of Year 1 during such stock on March 14, Year 1, from B. of R throughout Year 1. For Year 1, R derives which A did not own (within the meaning of Before P’s acquisition of the stock, R had $100x of subpart F income, has $100x of section 958(a)) the stock of R. Under section distributed a dividend of $100x to B in Year earnings and profits, and distributes a 959(b), the $20x distribution from R to P is 1 with respect to the stock so acquired by P. dividend of $20x to P. R has no gross tested not again includible in the gross income of The stock interest so acquired by P was income. P has no income for Year 1 other A under section 951(a). The $20x distribution owned by B from January 1, Year 1, until than the dividend received from R. from R to P is not includible in the gross acquired by P. R also has $300x of tested (B) Analysis. Under section 951(a)(2) and tested income of P. income for Year 1. paragraph (b)(1) of this section, A’s pro rata (vi) Example 5—(A) Facts. The facts are the (B) Analysis—(1) Limitation of pro rata share of the subpart F income of R for Year same as in paragraph (b)(2)(v)(A) of this share of subpart F income. Under section 1 is $100x. A’s pro rata share of the subpart section (the facts in Example 4), except that 951(a)(2) and paragraph (b)(1) of this section, F income of R is not reduced under section instead of holding 100% of the stock of R for A’s pro rata share of the subpart F income of

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M for Year 1 is $28x, such amount being determined as follows:

Table 1 to paragraph (b)(2)(vi)(B)(1): R’s subpart F income for Year 1 ...... $100x Less: Reduction under section 951(a)(2)(A) for period (1–1 through 3–14) during which R is not a controlled foreign corporation ($100x × 73/365) ...... 20x Subpart F income for Year 1 as limited by section 951(a)(2)(A) ...... 80x A’s pro rata share of subpart F income as determined under section 951(a)(2)(A) (0.6 × $80x) ...... 48x Less: Reduction under section 951(a)(2)(B) for dividends received by B during Year 1 with respect to the stock of R indirectly acquired by A: (i) Dividend received by B ($100x) multiplied by a fraction ($100x/$400x), the numerator of which is the subpart F income of such corporation for the taxable year ($100x) and the denominator of which is the sum of the subpart F income and the tested income of such corporation for the taxable year ($400x) ($100x × ($100x/$400x)) ...... 25x (ii) B’s pro rata share (60%) of the amount which bears the same ratio to the subpart F income of such corporation for the taxable year ($100x) as the part of such year during which A did not own (within the meaning of section 958(a)) such stock bears to the entire taxable year (73/365) (0.6 × $100x × (73/365)) ...... 12x (iii) Amount of reduction under section 951(a)(2)(B) (lesser of (i) or (ii)) ...... 12x A’s pro rata share of subpart F income as determined under section 951(a)(2) ...... 36x

(2) Limitation of pro rata share of tested tested income of M for Year 1 is $108x, such income. Under section 951A(e)(1) and amount being determined as follows: § 1.951A–1(d)(2), A’s pro rata share of the

Table 1 to paragraph (b)(2)(vi)(B)(2): R’s tested income for Year 1 ...... $300x Less: Reduction under section 951(a)(2)(A) for period (1–1 through 3–14) during which R is not a controlled foreign corporation ($300x × 73/365) ...... 60x Tested income for Year 1 as limited by under section 951(a)(2)(A) ...... 240x A’s pro rata share of tested income as determined under § 1.951A–1(d)(2) (0.6 × $240x) ...... 144x Less: Reduction under section 951(a)(2)(B for dividends received by B during Year 1 with respect to the stock of R indirectly acquired by A: (i) Dividend received by B ($100x) multiplied by a fraction ($300x/$400x), the numerator of which is the tested income of such corporation for the taxable year ($300x) and the denominator of which is the sum of the subpart F income and the tested income of such corporation for the taxable year ($400x) ($100x × ($300x/$400x)) ...... 75x (ii) B’s pro rata share (60%) of the amount which bears the same ratio to the tested income of such corporation for the tax- able year ($300x) as the part of such year during which A did not own (within the meaning of section 958(a)) such stock bears to the entire taxable year (73/365) (0.6 × $300x × (73/365)) ...... 36x (iii) Amount of reduction under section 951(a)(2)(B) (lesser of (i) or (ii)) ...... 36x A’s pro rata share of tested income under section 951A(e)(1) ...... 108x

(c) [Reserved] for the taxable year (not reduced by 951A(c)(2)(A) and § 1.951A–2(b)(1)) of * * * * * actual distributions during the year) the corporation for the taxable year. (e) Pro rata share of subpart F income were distributed (hypothetical (2) One class of stock. If a controlled defined—(1) In general—(i) distribution) on the last day of the foreign corporation for a taxable year Hypothetical distribution. For purposes corporation’s taxable year on which has only one class of stock outstanding of paragraph (b) of this section, a United such corporation is a controlled foreign on the hypothetical distribution date, States shareholder’s pro rata share of a corporation (hypothetical distribution the amount of the corporation’s controlled foreign corporation’s subpart date). allocable earnings and profits F income for a taxable year is the (ii) Definition of allocable earnings distributed in the hypothetical amount that bears the same ratio to the and profits. For purposes of this distribution with respect to each share corporation’s subpart F income for the paragraph (e), the term allocable in the class of stock is determined as if taxable year as the amount of the earnings and profits means, with respect the hypothetical distribution were made corporation’s allocable earnings and to a controlled foreign corporation for a pro rata with respect to each share in profits that would be distributed with taxable year, the amount that is the the class of stock. respect to the stock of the corporation greater of— (3) More than one class of stock. If a which the United States shareholder (A) The earnings and profits of the controlled foreign corporation for a owns (within the meaning of section corporation for the taxable year taxable year has more than one class of 958(a)) for the taxable year bears to the determined under section 964; and stock outstanding on the hypothetical total amount of the corporation’s (B) The sum of the subpart F income distribution date, the amount of the allocable earnings and profits that (as determined under section 952 after corporation’s allocable earnings and would be distributed with respect to the the application of section profits distributed in the hypothetical stock owned by all the shareholders of 951A(c)(2)(B)(ii) and § 1.951A–6(b)) of distribution with respect to each class of the corporation if all the allocable the corporation for the taxable year and stock is determined based on the earnings and profits of the corporation the tested income (as defined in section distribution rights of each class of stock

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on the hypothetical distribution date, the class of preferred stock does not (whether determined by a percentage of which amount is then further have a mandatory redemption date, the par value, a reference to a floating distributed pro rata with respect to each mandatory redemption date is the date coupon rate, a stated return expressed in share in the class of stock. Subject to that the class of preferred stock is terms of a certain amount of U.S. dollars paragraphs (e)(4) through (6) of this expected to be redeemed based on all or foreign currency, or otherwise) with section, the distribution rights of a class facts and circumstances. respect to a class of stock the of stock are determined taking into (iii) Dividend arrearages. If there is an distribution of which is a condition account all facts and circumstances arrearage in dividends for prior taxable precedent to a further distribution of related to the economic rights and years with respect to a class of preferred earnings and profits that year with interest in the allocable earnings and stock of a controlled foreign respect to any class of stock (not profits of the corporation of each class, corporation, an amount of the including a distribution in partial or including the terms of the class of stock, corporation’s allocable earnings and complete liquidation) is not a restriction any agreement among the shareholders profits is distributed in the hypothetical or other limitation on the distribution of and, if and to the extent appropriate, the distribution to the class of preferred earnings and profits by a controlled relative fair market value of shares of stock by reason of the arrearage only to foreign corporation. stock. For purposes of this paragraph the extent the arrearage exceeds the (iv) Illustrative list of restrictions and (e)(3), facts and circumstances do not accumulated earnings and profits of the limitations. Except as provided in include actual distributions (including controlled foreign corporation paragraph (e)(5)(iii) of this section, distributions by redemption) or any remaining from prior taxable years restrictions or other limitations on amount treated as a dividend under any beginning after December 31, 1962, as of distributions include, but are not other provision of subtitle A of the the beginning of the taxable year, or the limited to— Internal Revenue Code (for example, date on which such stock was issued, (A) An arrangement that restricts the under section 78, 356(a)(2), 367(b), or whichever is later (the applicable date). ability of a controlled foreign 1248) made during the taxable year that If there is an arrearage in dividends for corporation to pay dividends on a class includes the hypothetical distribution prior taxable years with respect to more of stock of the corporation until a date. than one class of preferred stock, the condition or conditions are satisfied (for (4) Special rules—(i) Redemptions, previous sentence is applied to each example, until another class of stock is liquidations, and returns of capital. No class in order of priority, except that the redeemed); amount of allocable earnings and profits accumulated earnings and profits (B) A loan agreement entered into by is distributed in the hypothetical remaining after the applicable date are a controlled foreign corporation that distribution with respect to a particular reduced by the allocable earnings and restricts or otherwise affects the ability class of stock based on the terms of the profits necessary to satisfy arrearages to make distributions on its stock until class of stock of the controlled foreign with respect to classes of stock with a certain requirements are satisfied; or corporation or any agreement or higher priority. For purposes of this (C) An arrangement that conditions arrangement with respect thereto that paragraph (e)(4)(iii), the amount of any would result in a redemption (even if arrearage with respect to stock described the ability of a controlled foreign such redemption would be treated as a in paragraph (e)(4)(ii) of this section is corporation to pay dividends to its distribution of property to which determined in the same manner as the shareholders on the financial condition section 301 applies pursuant to section present value of unpaid current of the corporation. 302(d)), a distribution in liquidation, or dividends on such stock under (6) Transactions and arrangements a return of capital. paragraph (e)(4)(ii) of this section. with a principal purpose of changing (ii) Certain cumulative preferred (5) Restrictions or other limitations on pro rata shares. Appropriate stock. If a controlled foreign corporation distributions—(i) In general. A adjustments must be made to the has outstanding a class of redeemable restriction or other limitation on allocation of allocable earnings and preferred stock with cumulative distributions of an amount of earnings profits that would be distributed dividend rights and dividend arrearages and profits by a controlled foreign (without regard to this paragraph (e)(6)) on such stock do not compound at least corporation is not taken into account in in a hypothetical distribution with annually at a rate that equals or exceeds determining the amount of the respect to any share of stock outstanding the applicable Federal rate (as defined corporation’s allocable earnings and as of the hypothetical distribution date in section 1274(d)(1)) that applies on the profits distributed in a hypothetical to disregard the effect on the date the stock is issued for the term distribution to a class of stock of the hypothetical distribution of any from such issue date to the mandatory controlled foreign corporation. transaction or arrangement that is redemption date based on a comparable (ii) Definition. For purposes of undertaken as part of a plan a principal compounding assumption (the relevant paragraph (e)(5)(i) of this section, a purpose of which is the avoidance of AFR), the amount of the corporation’s restriction or other limitation on Federal income taxation by changing the allocable earnings and profits distributions includes any limitation amount of allocable earnings and profits distributed in the hypothetical that has the effect of limiting the distributed in any hypothetical distribution with respect to the class of distribution of an amount of earnings distribution with respect to such share. stock may not exceed the amount of and profits by a controlled foreign This paragraph (e)(6) also applies for dividends actually paid during the corporation with respect to a class of purposes of the pro rata share rules taxable year with respect to the class of stock of the corporation, other than described in § 1.951A–1(d) that stock plus the present value at the end currency or other restrictions or reference this paragraph (e), including of the controlled foreign corporation’s limitations imposed under the laws of the rules in § 1.951A–1(d)(3) that taxable year of the unpaid current any foreign country as provided in determine the pro rata share of qualified dividends with respect to the class section 964(b). business asset investment based on the determined using the relevant AFR and (iii) Exception for certain preferred pro rata share of tested income. assuming the dividends will be paid at distributions. For purposes of paragraph (7) Examples. The following examples the mandatory redemption date. For (e)(5)(i) of this section, the right to illustrate the application of this purposes of this paragraph (e)(4)(ii), if receive periodically a fixed amount paragraph (e).

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(i) Facts. Except as otherwise stated, of this section, the amount of FC1’s allocable the preferred shareholders on the the following facts are assumed for earnings and profits distributed in the hypothetical distribution date as a result of purposes of the examples: hypothetical distribution with respect to FC1’s right to redeem the preferred shares. (A) FC1 is a controlled foreign Individual A’s preferred shares is $12x (0.04 This is the case regardless of the restriction × $10x × 30) and with respect to USP1’s on paying dividends to the common corporation. common shares is $88x ($100x¥$12x). shareholders while the preferred stock is (B) USP1 and USP2 are domestic Accordingly, under paragraph (e)(1) of this outstanding, and regardless of the fact that a corporations. section, USP1’s pro rata share of FC1’s redemption of FC2’s preferred shares would (C) Individual A is a foreign subpart F income is $44x ($50x ¥ $88x/ be treated as a distribution to which section individual, and FC2 is a foreign $100x) for Year 1. 301 applies under section 302(d) (due to corporation that is not a controlled (iv) Example 3: Restriction based on FC2’s constructive ownership of the common foreign corporation. cumulative income—(A) Facts. FC1 has shares). Thus, neither the restriction on (D) All persons use the calendar year outstanding 10 shares of common stock and paying dividends to the common 400 shares of 2% nonparticipating, voting shareholders while the preferred stock is as their taxable year. preferred stock with a par value of $1x per outstanding nor FC1’s redemption rights with (E) Any ownership of FC1 by any share. USP1 owns all of the common shares. respect to the preferred shares affects the shareholder is for all of Year 1. FC2 owns all of the preferred shares. USP1 distribution of allocable earnings and profits (F) The common shareholders of FC1 and FC2 cause the governing documents of in the hypothetical distribution to FC1’s are entitled to dividends when declared FC1 to provide that no dividends may be shareholders. However, the distribution by FC1’s board of directors. paid to the common shareholders until FC1 rights of the preferred shares are not a (G) There are no accrued but unpaid cumulatively earns $100,000x of income. For restriction or other limitation within the dividends with respect to preferred Year 1, FC1 has $50x of earnings and profits meaning of paragraph (e)(5) of this section. and $50x of subpart F income within the As a result, the amount of FC1’s allocable shares, the preferred stock is not meaning of section 952. earnings and profits distributed in the described in paragraph (e)(4)(ii) of this (B) Analysis. The agreement restricting hypothetical distribution with respect to section, and common shares have FC1’s ability to pay dividends to common FC2’s preferred shares is $20x (0.04 × $50x positive liquidation value. shareholders until FC1 cumulatively earns × 10) and with respect to USP1’s common (H) There are no other facts and $100,000x of income is a restriction or other shares is $80x ($100x¥$20x). Accordingly, circumstances related to the economic limitation within the meaning of paragraph under paragraph (e)(1) of this section, USP1’s rights and interest of any class of stock (e)(5) of this section. Therefore, the pro rata share of FC1’s subpart F income is in the allocable earnings and profits of restriction is disregarded for purposes of $80x for Year 1. a foreign corporation, and no determining the amount of FC1’s allocable (vi) Example 5: Shareholder owns common earnings and profits distributed in the and preferred stock—(A) Facts. FC1 has transaction or arrangement was entered hypothetical distribution to a class of stock. outstanding 40 shares of common stock and into as part of a plan a principal The distribution rights of the preferred shares 60 shares of 6% nonparticipating, nonvoting purpose of which is the avoidance of are not a restriction or other limitation within preferred stock with a par value of $100x per Federal income taxation. the meaning of paragraph (e)(5) of this share. USP1 owns 30 shares of the common (I) FC1 has neither tested income section. Under paragraph (e)(3) of this stock and 15 shares of the preferred stock within the meaning of section section, the amount of FC1’s allocable during Year 1. The remaining 10 shares of 951A(c)(2)(A) and § 1.951A–2(b)(1) nor earnings and profits distributed in the common stock and 45 shares of preferred hypothetical distribution with respect to stock of FC1 are owned by Individual A. For tested loss within the meaning of × × section 951A(c)(2)(B)(i) and § 1.951A– FC2’s preferred shares is $8x (0.02 $1x Year 1, FC1 has $1,000x of earnings and 400) and with respect to USP1’s common profits and $500x of subpart F income within 2(b)(2). shares is $42x ($50x ¥ $8x). Accordingly, the meaning of section 952. (ii) Example 1: Single class of stock—(A) under paragraph (e)(1) of this section, USP1’s (B) Analysis. The right of the holder of the Facts. FC1 has outstanding 100 shares of one pro rata share of FC1’s subpart F income is preferred stock to receive 6% of par value is class of stock. USP1 owns 60 shares of FC1. $42x for Year 1. not a restriction or other limitation within USP2 owns 40 shares of FC1. For Year 1, FC1 (v) Example 4: Redemption rights—(A) the meaning of paragraph (e)(5) of this has $1,000x of earnings and profits and Facts. FC1 has outstanding 40 shares of section. The amount of FC1’s allocable $100x of subpart F income within the common stock and 10 shares of 4% earnings and profits distributed in the meaning of section 952. nonparticipating, preferred stock with a par hypothetical distribution with respect to (B) Analysis. FC1 has one class of stock. value of $50x per share. Pursuant to the FC1’s preferred shares is $360x (0.06 × $100x Therefore, under paragraph (e)(2) of this terms of the preferred stock, FC1 has the right × 60) and with respect to its common shares section, FC1’s allocable earnings and profits to redeem at any time, in whole or in part, is $640x ($1,000x¥$360x). As a result, the of $1,000x are distributed in the hypothetical the preferred stock. FC2 owns all of the amount of FC1’s allocable earnings and distribution pro rata to each share of stock. preferred shares. USP1, wholly owned by profits distributed in the hypothetical Accordingly, under paragraph (e)(1) of this FC2, owns all of the common shares. distribution to USP1 is $570x, the sum of section, for Year 1, USP1’s pro rata share of Pursuant to the governing documents of FC1, $90x ($360x × 15/60) with respect to its FC1’s subpart F income is $60x ($100x × no dividends may be paid to the common preferred shares and $480x ($640x × 30/40) $600x/$1,000x) and USP2’s pro rata share of shareholders while the preferred stock is with respect to its common shares. FC1’s subpart F income is $40x ($100x × outstanding. For Year 1, FC1 has $100x of Accordingly, under paragraph (e)(1) of this $400x/$1,000x). earnings and profits and $100x of subpart F section, USP1’s pro rata share of the subpart (iii) Example 2: Common and preferred income within the meaning of section 952. F income of FC1 is $285x ($500x × $570x/ stock—(A) Facts. FC1 has outstanding 70 (B) Analysis. The agreement restricting $1,000x). shares of common stock and 30 shares of 4% FC1’s ability to pay dividends to common (vii) Example 6: Subpart F income and nonparticipating, voting preferred stock with shareholders while the preferred stock is tested income—(A) Facts. FC1 has a par value of $10x per share. USP1 owns all outstanding is a restriction or other limitation outstanding 700 shares of common stock and of the common shares. Individual A owns all within the meaning of paragraph (e)(5) of this 300 shares of 4% nonparticipating, voting of the preferred shares. For Year 1, FC1 has section. Therefore, the restriction is preferred stock with a par value of $100x per $100x of earnings and profits and $50x of disregarded for purposes of determining the share. USP1 owns all of the common shares. subpart F income within the meaning of amount of FC1’s allocable earnings and USP2 owns all of the preferred shares. For section 952. profits distributed in the hypothetical Year 1, FC1 has $10,000x of earnings and (B) Analysis. The distribution rights of the distribution to a class of stock. Under profits, $2,000x of subpart F income within preferred shares are not a restriction or other paragraph (e)(4)(i) of this section, no amount the meaning of section 952, and $9,000x of limitation within the meaning of paragraph of allocable earnings and profits is tested income within the meaning of section (e)(5) of this section. Under paragraph (e)(3) distributed in the hypothetical distribution to 951A(c)(2)(A) and § 1.951A–2(b)(1).

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(B) Analysis—(1) Hypothetical distribution. United States shareholder means, with with respect to a United States The allocable earnings and profits of FC1 respect to a foreign corporation, a shareholder, a person that is related to determined under paragraph (e)(1)(ii) of this United States person (as defined in the United States shareholder within the section are $11,000x, the greater of FC1’s meaning of section 267(b) or 707(b)(1). earnings and profits as determined under section 957(c)) who owns within the section 964 ($10,000x) or the sum of FC1’s meaning of section 958(a), or is (3) Example—(i) Facts. USP, a domestic subpart F income and tested income ($2,000x considered as owning by applying the corporation, owns all of the stock of CFC1 + $9,000x). The amount of FC1’s allocable rules of ownership of section 958(b), 10 and CFC2. CFC1 and CFC2 own 60% and earnings and profits distributed in the percent or more of the total combined 40%, respectively, of the interests in the hypothetical distribution with respect to voting power of all classes of stock capital and profits of DPS, a domestic USP2’s preferred shares is $1,200x (0.04 × partnership. DPS owns all of the stock of × entitled to vote of such foreign $100x 300) and with respect to USP1’s corporation, or 10 percent or more of the CFC3. Each of CFC1, CFC2, and CFC3 is a common shares is $9,800x controlled foreign corporation. USP, DPS, ($11,000x¥$1,200x). total value of shares of all classes of CFC1, CFC2, and CFC3 all use the calendar (2) Pro rata share of subpart F income. stock of such foreign corporation. year as their taxable year. For Year 1, CFC3 Accordingly, under paragraph (e)(1) of this * * * * * has $100x of subpart F income and $100x of section, USP1’s pro rata share of FC1’s (h) Special rule for partnership earnings and profits. × subpart F income is $1,782x ($2,000x blocker structures—(1) In general. For (ii) Analysis. DPS is a controlled domestic $9,800x/$11,000x), and USP2’s pro rata share partnership within the meaning of paragraph of FC1’s subpart F income is $218x ($2,000x purposes of sections 951 through 964, other than for purposes of 951A, a (h)(2) of this section because more than 50% × $1,200x/$11,000x). of the interests in its capital or profits are (3) Pro rata share of tested income. controlled domestic partnership is owned by persons related to USP within the Accordingly, under § 1.951A–1(d)(2), USP1’s treated as a foreign partnership in meaning of section 267(b) (that is, CFC1 and pro rata share of FC1’s tested income is determining the stock of a controlled CFC2), and thus DPS is controlled by USP $8,018x ($9,000x × $9,800x/$11,000x), and foreign corporation owned (within the and related persons. The conditions of USP2’s pro rata share of FC1’s tested income paragraph (h)(1) of this section are satisfied × meaning of section 958(a)) by a United is $982x ($9,000x $1,200x/$11,000x) for States person if the following conditions because, without regard to paragraph (h) of Year 1. this section, DPS is a United States (viii) Example 7: Subpart F income and are satisfied— (i) Without regard to paragraph (h) of shareholder that owns (within the meaning of tested loss—(A) Facts. The facts are the same section 958(a)) stock of CFC3, a controlled as in paragraph (e)(7)(vii)(A) of this section this section, the controlled domestic foreign corporation, and if DPS were treated (the facts in Example 6), except that for Year partnership owns (within the meaning as foreign, CFC3 would continue to be a 1, FC1 has $8,000x of earnings and profits, of section 958(a)) stock of a controlled controlled foreign corporation, and USP $10,000x of subpart F income within the foreign corporation; and would be treated as owning (within the meaning of section 952 (but without regard (ii) If the controlled domestic meaning of section 958(a)) stock of CFC3 to the limitation in section 952(c)(1)(A)), and partnership (and all other controlled through CFC1 and CFC2, which are both $2,000x of tested loss within the meaning of partners in DPS. Thus, under paragraph section 951A(c)(2)(B)(i) and § 1.951A–2(b)(2). domestic partnerships in the chain of ownership of the controlled foreign (h)(1) of this section, DPS is treated as a Under section 951A(c)(2)(B)(ii) and foreign partnership for purposes of § 1.951A–6(b), the earnings and profits of corporation) were treated as foreign— determining the stock of CFC3 owned (within FC1 are increased for purposes of section (A) The controlled foreign corporation the meaning of section 958(a)) by USP. 952(c)(1)(A) by the amount of FC1’s tested would continue to be a controlled Accordingly, USP’s pro rata share of CFC3’s loss. Accordingly, after the application of foreign corporation; and subpart F income for Year 1 is $100x, and section 951A(c)(2)(B)(ii) and § 1.951A–6(b), (B) At least one United States USP includes in its gross income $100x the subpart F income of FC1 is $10,000x. shareholder of the controlled foreign under section 951(a)(1)(A). DPS is not a (B) Analysis—(1) Pro rata share of subpart corporation would be treated as owning United States shareholder of CFC3 for F income. The allocable earnings and profits purposes of sections 951 through 964. determined under paragraph (e)(1)(ii) of this (within the meaning of section 958(a)) section are $10,000x, the greater of the stock of the controlled foreign (i) Applicability dates. Paragraphs (a), earnings and profits of FC1 determined under corporation through another foreign (b)(1)(ii), (b)(2), (e)(1)(ii)(B), and (g)(1) of section 964 ($8,000x) or the sum of FC1’s corporation that is a direct or indirect this section apply to taxable years of subpart F income and tested income partner in the controlled domestic foreign corporations beginning after ($10,000x + $0). The amount of FC1’s partnership. December 31, 2017, and to taxable years allocable earnings and profits distributed in (2) Definition of a controlled domestic of United States shareholders in which the hypothetical distribution with respect to USP2’s preferred shares is $1,200x (.04 × partnership. For purposes of paragraph or with which such taxable years of $100x × 300) and with respect to USP1’s (h)(1) of this section, the term controlled foreign corporations end. Except for common shares is $8,800x domestic partnership means a domestic paragraph (e)(1)(ii)(B) of this section, ($10,000x¥$1,200x). Accordingly, under partnership that is controlled by a paragraph (e) of this section applies to paragraph (e)(1) of this section, for Year 1, United States shareholder described in taxable years of United States USP1’s pro rata share of FC1’s subpart F paragraph (h)(1)(ii)(B) of this section shareholders ending on or after October income is $8,800x and USP2’s pro rata share and persons related to the United States 3, 2018. Paragraph (h) of this section of FC1’s subpart F income is $1,200x. shareholder. For purposes of this applies to taxable years of domestic (2) Pro rata share of tested loss. The allocable earnings and profits determined paragraph (h)(2), control is determined partnerships ending on or after May 14, under § 1.951A–1(d)(4)(i)(B) are $2,000x, the based on all the facts and 2010. amount of FC1’s tested loss. Under § 1.951A– circumstances, except that a partnership ■ Par. 6. Sections 1.951A–0 through 1(d)(4)(i)(C), the entire $2,000x of tested loss will be deemed to be controlled by a 1.951A–7 are added to read as follows: is allocated in the hypothetical distribution United States shareholder and related to USP1’s common shares. Accordingly, persons in any case in which those § 1.951A–0 Outline of section 951A USP1’s pro rata share of the tested loss is persons, in the aggregate, own (directly regulations. $2,000x. or indirectly through one or more This section lists the headings for §§ 1.951A–1 through 1.951A–7. * * * * * partnerships) more than 50 percent of (g) * * * the interests in the partnership capital § 1.951A–1 General provisions. (1) In general. For purposes of or profits. For purposes of this (a) Overview. sections 951 through 964, the term paragraph (h)(2), a related person is, (1) In general.

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(2) Scope. (i) Example 1. (B) Residual CFC gross income. (b) Inclusion of global intangible low-taxed (A) Facts. (iv) Examples. income. (B) Analysis. (A) Example 1: Sale of intangible property (c) Determination of GILTI inclusion (1) CFC and United States shareholder during the disqualified period. amount. determinations. (1) Facts. (1) In general. (2) Application of section 951A. (2) Analysis. (2) Definition of net CFC tested income. (ii) Example 2. (B) Example 2: Related party transfer after (3) Definition of net deemed tangible (A) Facts. the disqualified period; gain recognition. income return. (B) Analysis. (1) Facts. (i) In general. (1) CFC and United States shareholder (2) Analysis. (ii) Definition of deemed tangible income determination. (C) Example 3: Related party transfer after return. (2) Application of section 951A. the disqualified period; loss recognition. (iii) Definition of specified interest (f) Definitions. (1) Facts. expense. (1) CFC inclusion year. (2) Analysis. (4) Determination of GILTI inclusion (2) Controlled foreign corporation. § 1.951A–3 Qualified business asset amount for consolidated groups. (3) Hypothetical distribution date. investment. (d) Determination of pro rata share. (4) Section 958(a) stock. (a) Scope. (1) In general. (5) Tested item. (b) Qualified business asset investment. (2) Tested income. (6) United States shareholder. (c) Specified tangible property. (i) In general. (7) U.S. shareholder inclusion year. (1) In general. (ii) Special rule for prior allocation of § 1.951A–2 Tested income and tested loss. (2) Tangible property. tested loss. (a) Scope. (d) Dual use property. (3) Qualified business asset investment. (b) Definitions related to tested income and (1) In general. (i) In general. tested loss. (2) Definition of dual use property. (ii) Special rule for excess hypothetical (1) Tested income and tested income CFC. (3) Dual use ratio. tangible return. (2) Tested loss and tested loss CFC. (4) Example. (A) In general. (c) Rules relating to the determination of (i) Facts. (B) Determination of pro rata share of tested income and tested loss. (ii) Analysis. hypothetical tangible return. (1) Definition of gross tested income. (A) Dual use property. (C) Definition of hypothetical tangible (2) Determination of gross income and (B) Depreciation not capitalized to return. allowable deductions. inventory. (iii) Examples. (i) In general. (C) Depreciation capitalized to inventory. (A) Example 1. (ii) Deemed payment under section 367(d). (e) Determination of adjusted basis in (1) Facts. (3) Allocation of deductions to gross tested specified tangible property. (2) Analysis. income. (1) In general. (i) Determination of pro rata share of tested (4) Gross income taken into account in (2) Effect of change in law. income. determining subpart F income. (3) Specified tangible property placed in (ii) Determination of pro rata share of (i) In general. service before enactment of section 951A. qualified business asset investment. (ii) Items of gross income included in (i) In general. (B) Example 2. subpart F income. (ii) Election to use income and earnings (1) Facts. (A) Insurance income. and profits depreciation method for property (2) Analysis. (B) Foreign base company income. placed in service before the first taxable year (i) Determination of pro rata share of tested (C) International boycott Income. beginning after December 22, 2017. income. (D) Illegal bribes, kickbacks, or other (A) In general. (ii) Determination of pro rata share of payments. (B) Manner of making the election. qualified business asset investment. (E) Income earned in certain foreign (f) Special rules for short taxable years. (C) Example 3. countries. (1) In general. (1) Facts. (iii) Coordination rules. (2) Determination of quarter closes. (2) Analysis. (A) Coordination with E&P limitation. (3) Reduction of qualified business asset (i) Determination of pro rata share of tested (B) Coordination with E&P recapture. investment. income. (C) Coordination with full inclusion rule (4) Example. (ii) Determination of pro rata share of and high tax exception. (i) Facts. qualified business asset investment. (iv) Examples. (ii) Analysis. (4) Tested loss. (A) Example 1. (A) Determination of short taxable years (i) In general. (1) Facts. and quarters. (ii) Special rule in case of accrued but (2) Analysis. (B) Calculation of qualified business asset unpaid dividends. (i) Year 1. investment for the first short taxable year. (iii) Special rule for stock with no (ii) Year 2. (C) Calculation of qualified business asset liquidation value. (B) Example 2. investment for the second short taxable year. (iv) Examples. (1) Facts. (g) Partnership property. (A) Example 1. (2) Analysis. (1) In general. (1) Facts. (i) FC1. (2) Determination of partnership QBAI. (2) Analysis. (ii) FC2. (3) Determination of partner adjusted basis. (B) Example 2. (C) Example 3. (i) In general. (1) Facts. (1) Facts. (ii) Sole use partnership property. (2) Analysis. (2) Analysis. (A) In general. (i) Year 1. (i) Foreign base company income. (B) Definition of sole use partnership (ii) Year 2. (ii) Recapture of subpart F income. property. (5) Tested interest expense. (iii) Gross tested income. (iii) Dual use partnership property. (6) Tested interest income. (5) Allocation of deduction or loss (A) In general. (e) Treatment of domestic partnerships. attributable to disqualified basis. (B) Definition of dual use partnership (1) In general. (i) In general. property. (2) Non-application for determination of (ii) Determination of deduction or loss (4) Determination of proportionate share of status as United States shareholder and attributable to disqualified basis. the partnership’s adjusted basis in controlled foreign corporation. (iii) Definitions. partnership specified tangible property. (3) Examples. (A) Disqualified basis. (i) In general.

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(ii) Proportionate share ratio. (A) Facts. (a) Scope. (5) Definition of partnership specified (B) Example 1: Qualification for safe (b) Definitions related to specified interest tangible property. harbor. expense. (6) Determination of partnership adjusted (1) Facts. (1) Tested interest expense. basis. (2) Analysis. (i) In general. (7) Determination of partner-specific QBAI (C) Example 2: Transfers between CFCs (ii) Interest expense. basis. with different taxable year ends. (iii) Qualified interest expense. (8) Examples. (1) Facts. (A) In general. (i) Facts. (2) Analysis. (B) Qualified asset. (ii) Example 1: Sole use partnership (D) Example 3: Acquisition from unrelated (1) In general. property. person. (2) Exclusion for related party receivables. (A) Facts. (1) Facts. (3) Look-through rule for subsidiary stock. (B) Analysis. (2) Analysis. (4) Look-through rule for certain (1) Sole use partnership property. (E) Example 4: Acquisitions from tested partnership interests. (2) Proportionate share. loss CFCs. (iv) Tested loss QBAI amount. (3) Partner adjusted basis. (1) Facts. (2) Tested interest income. (4) Partnership QBAI. (2) Analysis. (i) In general. (iii) Example 2: Dual use partnership (2) Disregard of adjusted basis in property (ii) Interest income. property. transferred during the disqualified period. (iii) Qualified interest income. (A) Facts. (i) Operative rules. (A) In general. (1) Asset C. (A) In general. (B) Exclusion for related party interest. (2) Asset D. (B) Application to dual use property. (c) Examples. (3) Asset E. (C) Application to partnership specified (1) Example 1: Wholly-owned CFCs. (B) Analysis. tangible property. (i) Facts. (1) Asset C. (ii) Determination of disqualified basis. (ii) Analysis. (i) Proportionate share. (A) In general. (A) CFC-level determination; tested interest (ii) Dual use ratio. (B) Adjustments to disqualified basis. expense and tested interest income. (iii) Partner adjusted basis. (1) Reduction or elimination of disqualified (1) Tested interest expense and tested (3) Asset D. basis. interest income of FS1. (i) Proportionate share. (i) In general. (2) Tested interest expense and tested (ii) Dual use ratio. (ii) Exception for related party transfers. interest income of FS2. (2) Increase to disqualified basis for (B) United States shareholder-level (iii) Partner adjusted basis. nonrecognition transactions. determination; pro rata share and specified (4) Asset E. (i) Increase corresponding to adjustments interest expense. (i) Proportionate share. in other property. (2) Example 2: Less than wholly-owned (ii) Dual use ratio. (ii) Exchanged basis property. CFCs. (iii) Partner adjusted basis. (iii) Increase by reason of section 732(d). (i) Facts. (5) Partnership QBAI. (3) Election to eliminate disqualified basis. (ii) Analysis. (iv) Example 3: Sole use partnership (i) In general. (A) CFC-level determination; tested interest specified tangible property; section 743(b) (ii) Manner of making the election with expense and tested interest income. adjustments. respect to a controlled foreign corporation. (B) United States shareholder-level (A) Facts. (iii) Manner of making the election with determination; pro rata share and specified (B) Analysis. respect to a partnership. interest expense. (v) Example 4: Tested income CFC with (iv) Conditions of making an election. (3) Example 3: Operating company; distributive share of loss from a partnership. (C) Definitions related to disqualified basis. qualified interest expense. (A) Facts. (1) Disqualified period. (i) Facts. (B) Analysis. (2) Disqualified transfer. (ii) Analysis. (vi) Example 5: Tested income CFC sale of (3) Qualified gain amount. (A) CFC-level determination; tested interest partnership interest before CFC inclusion (4) Related person. expense and tested interest income. date. (5) Transfer. (1) Tested interest expense and tested (A) Facts. (6) Transferor CFC. interest income of FS1. (B) Analysis. (iii) Examples. (2) Tested interest expense and tested (1) FC1. (A) Example 1: Sale of asset; disqualified interest income of FS2. (2) FC2. period. (B) United States shareholder-level (vii) Example 6: Partnership adjusted basis; (1) Facts. determination; pro rata share and specified distribution of property in liquidation of (2) Analysis. interest expense. partnership interest. (B) Example 2: Sale of asset; no (4) Example 4: Holding company; qualified (A) Facts. disqualified period. interest expense. (B) Analysis. (1) Facts. (i) Facts. (h) Anti-avoidance rules related to certain (2) Analysis. (ii) Analysis. transfers of property. (C) Example 3: Sale of partnership interest. (A) CFC-level determination; tested interest (1) Disregard of adjusted basis in specified (1) Facts. expense and tested interest income. tangible property held temporarily. (2) Analysis. (1) Tested interest expense and tested (i) In general. (D) Example 4: Distribution of property in interest income of FS1. (ii) Disregard of first quarter close. liquidation of partnership interest. (2) Tested interest expense and tested (iii) Safe harbor for certain transfers (1) Facts. interest income of FS2. involving CFCs. (2) Analysis. (3) Tested interest expense and tested (iv) Determination of principal purpose (E) Example 5: Distribution of property to interest income of FS3. and transitory holding. a partner in basis reduction transaction. (B) United States shareholder-level (A) Presumption for ownership less than (1) Facts. determination; pro rata share and specified 12 months. (2) Analysis. interest expense. (B) Presumption for ownership greater than (F) Example 6: Dual use property with (5) Example 5: Specified interest expense 36 months. disqualified basis. and tested loss QBAI amount. (v) Determination of holding period. (1) Facts. (i) Facts. (vi) Treatment as single applicable U.S. (2) Analysis. (ii) Analysis. shareholder. § 1.951A–4 Tested interest expense and (A) CFC-level determination; tested interest (vii) Examples. tested interest income. expense and tested interest income.

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(1) Tested interest expense and tested corporation related to a tested loss. tested loss CFC (as defined in § 1.951A– interest income of FS1. Section 1.951A–7 provides dates of 2(b)(2)) for a CFC inclusion year that (2) Tested interest expense and tested applicability. ends with or within the U.S. interest income of FS2. (2) Scope. Paragraph (b) of this section shareholder inclusion year. (B) United States shareholder-level determination; pro rata share and specified provides the general rule requiring a (3) Definition of net deemed tangible interest expense. United States shareholder to include in income return—(i) In general. The term § 1.951A–5 Treatment of GILTI inclusion gross income its global intangible low- net deemed tangible income return amounts. taxed income for a U.S. shareholder means, with respect to a United States (a) Scope. inclusion year. Paragraph (c) of this shareholder and a U.S. shareholder (b) Treatment as subpart F income for section provides rules for determining inclusion year, the excess (if any) of— certain purposes. the amount of a United States (A) The shareholder’s deemed (1) In general. shareholder’s global intangible low- tangible income return (as defined in (2) Allocation of GILTI inclusion amount to taxed income for the U.S. shareholder paragraph (c)(3)(ii) of this section) for tested income CFCs. inclusion year, including a rule for the the U.S. shareholder inclusion year, (i) In general. application of section 951A and the over (ii) Example. section 951A regulations to (B) The shareholder’s specified (A) Facts. interest expense (as defined in (B) Analysis. consolidated groups. Paragraph (d) of (3) Translation of portion of GILTI this section provides rules for paragraph (c)(3)(iii) of this section) for inclusion amount allocated to tested income determining a United States the U.S. shareholder inclusion year. CFC. shareholder’s pro rata share of certain (ii) Definition of deemed tangible (c) Treatment as an amount includible in items for purposes of determining the income return. The term deemed the gross income of a United States person. United States shareholder’s global tangible income return means, with (d) Treatment for purposes of personal intangible low-taxed income. Paragraph respect to a United States shareholder holding company rules. (e) of this section provides rules for the and a U.S. shareholder inclusion year, § 1.951A–6 Adjustments related to tested treatment of a domestic partnership and 10 percent of the aggregate of the losses. its partners for purposes of section 951A shareholder’s pro rata share of the (a) Scope. and the section 951A regulations. qualified business asset investment (as (b) Increase of earnings and profits of defined in § 1.951A–3(b)) of each tested tested loss CFC for purposes of section Paragraph (f) of this section provides 952(c)(1)(A). additional definitions for purposes of income CFC for a CFC inclusion year (c) [Reserved] this section and the section 951A that ends with or within the U.S. § 1.951A–7 Applicability dates. regulations. shareholder inclusion year. (iii) Definition of specified interest § 1.951A–1 General provisions. (b) Inclusion of global intangible low- taxed income. Each person who is a expense. The term specified interest (a) Overview—(1) In general. This United States shareholder of any expense means, with respect to a United section and §§ 1.951A–2 through controlled foreign corporation and owns States shareholder and a U.S. 1.951A–7 (collectively, the section 951A section 958(a) stock of any such shareholder inclusion year, the excess regulations) provide rules to determine controlled foreign corporation includes (if any) of— a United States shareholder’s income in gross income in the U.S. shareholder (A) The aggregate of the shareholder’s inclusion under section 951A, describe inclusion year the shareholder’s GILTI pro rata share of the tested interest certain consequences of an income inclusion amount, if any, for the U.S. expense (as defined in § 1.951A–4(b)(1)) inclusion under section 951A with shareholder inclusion year. of each controlled foreign corporation respect to controlled foreign (c) Determination of GILTI inclusion for a CFC inclusion year that ends with corporations and their United States amount—(1) In general. Except as or within the U.S. shareholder inclusion shareholders, and define certain terms provided in paragraph (c)(4) of this year, over for purposes of section 951A and the section, the term GILTI inclusion (B) The aggregate of the shareholder’s section 951A regulations. This section amount means, with respect to a United pro rata share of the tested interest provides general rules for determining a States shareholder and a U.S. income (as defined in § 1.951A–4(b)(2)) United States shareholder’s inclusion of shareholder inclusion year, the excess of each controlled foreign corporation global intangible low-taxed income, (if any) of— for a CFC inclusion year that ends with including a rule relating to the (i) The shareholder’s net CFC tested or within the U.S. shareholder inclusion application of section 951A and the income (as defined in paragraph (c)(2) of year. section 951A regulations to domestic this section) for the year, over (4) Determination of GILTI inclusion partnerships and their partners. Section (ii) The shareholder’s net deemed amount for consolidated groups. For 1.951A–2 provides rules for determining tangible income return (as defined in purposes of section 951A and the a controlled foreign corporation’s tested paragraph (c)(3) of this section) for the section 951A regulations, a member of income or tested loss. Section 1.951A– year. a consolidated group (as defined in 3 provides rules for determining a (2) Definition of net CFC tested § 1.1502–1(h)) determines its GILTI controlled foreign corporation’s income. The term net CFC tested income inclusion amount taking into account qualified business asset investment. means, with respect to a United States the rules provided in § 1.1502–51. Section 1.951A–4 provides rules for shareholder and a U.S. shareholder (d) Determination of pro rata share— determining a controlled foreign inclusion year, the excess (if any) of— (1) In general. For purposes of corporation’s tested interest expense (i) The aggregate of the shareholder’s paragraph (c) of this section, each and tested interest income. Section pro rata share of the tested income of United States shareholder that owns 1.951A–5 provides rules relating to the each tested income CFC (as defined in section 958(a) stock of a controlled treatment of the inclusion of global § 1.951A–2(b)(1)) for a CFC inclusion foreign corporation as of a hypothetical intangible low-taxed income for certain year that ends with or within the U.S. distribution date determines its pro rata purposes. Section 1.951A–6 provides shareholder inclusion year, over share (if any) of each tested item of the certain adjustments to earnings and (ii) The aggregate of the shareholder’s controlled foreign corporation for the profits and basis of a controlled foreign pro rata share of the tested loss of each CFC inclusion year that includes the

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hypothetical distribution date and ends section, over the sum of the tested (C) Definition of hypothetical tangible with or within the U.S. shareholder income allocated to each such class of return. For purposes of this paragraph inclusion year. Except as otherwise stock for each prior CFC inclusion year (d)(3)(ii), the term hypothetical tangible provided in this paragraph (d), a United under this paragraph (d)(2)(ii). return means, with respect to a tested States shareholder’s pro rata share of Paragraph (d)(2)(i) of this section income CFC for a CFC inclusion year, 10 each tested item is determined applies for purposes of determining a percent of the qualified business asset independently of its pro rata share of United States shareholder’s pro rata investment of the tested income CFC for each other tested item. In no case may share of the remainder of the tested the CFC inclusion year. the sum of the pro rata share of any income, except that, for purposes of the (iii) Examples. The following tested item of a controlled foreign hypothetical distribution of section examples illustrate the application of corporation for a CFC inclusion year 951(a)(2)(A) and § 1.951–1(b)(1)(i) and paragraphs (d)(2) and (3) of this section. allocated to stock under this paragraph (e)(1)(i), the amount of allocable See also § 1.951–1(e)(7)(vii) (Example 6) (d) exceed the amount of such tested earnings and profits of the tested (illustrating a United States item of the controlled foreign income CFC is reduced by the amount shareholder’s pro rata share of tested corporation for the CFC inclusion year. of tested income allocated under the income). Except as modified in this paragraph first sentence of this paragraph (d)(2)(ii). (A) Example 1—(1) Facts. FS, a controlled (d), a United States shareholder’s pro For an example of the application of this foreign corporation, has outstanding 70 rata share of any tested item is paragraph (d)(2), see paragraph shares of common stock and 30 shares of 4% determined under the rules of section (d)(4)(iv)(B) of this section (Example 2). nonparticipating, cumulative preferred stock 951(a)(2) and § 1.951–1(b) and (e) in the (3) Qualified business asset with a par value of $10x per share. P Corp, same manner as those provisions apply investment—(i) In general. Except as a domestic corporation and a United States to subpart F income. Under section shareholder of FS, owns all of the common provided in paragraphs (d)(3)(ii) of this shares. Individual A, a United States citizen 951(a)(2) and § 1.951–1(b) and (e), as section, a United States shareholder’s modified by this paragraph (d), a United and a United States shareholder, owns all of pro rata share of the qualified business the preferred shares. Individual A, FS, and P States shareholder’s pro rata share of asset investment of a tested income CFC Corp use the calendar year as their taxable any tested item for a U.S. shareholder for a U.S. shareholder inclusion year year. Individual A and P Corp are inclusion year is determined with bears the same ratio to the total shareholders of FS for all of Year 4. At the respect to the section 958(a) stock of the qualified business asset investment of beginning of Year 4, FS had no dividend controlled foreign corporation owned by the tested income CFC for the CFC arrearages with respect to its preferred stock. For Year 4, FS has $100x of earnings and the United States shareholder on a inclusion year as the United States hypothetical distribution date with profits, $120x of tested income, and no shareholder’s pro rata share of the tested subpart F income within the meaning of respect to a CFC inclusion year that income of the tested income CFC for the ends with or within the U.S. section 952. FS also has $750x of qualified U.S. shareholder inclusion year bears to business asset investment for Year 4. shareholder inclusion year. A United the total tested income of the tested (2) Analysis—(i) Determination of pro rata States shareholder’s pro rata share of income CFC for the CFC inclusion year. share of tested income. For purposes of any tested item is translated into United (ii) Special rule for excess determining P Corp’s pro rata share of FS’s States dollars using the average hypothetical tangible return—(A) In tested income under paragraph (d)(2) of this exchange rate for the CFC inclusion year section, the amount of FS’s allocable earnings general. If the tested income of a tested of the controlled foreign corporation. and profits for purposes of the hypothetical income CFC for a CFC inclusion year is Paragraphs (d)(2) through (5) of this distribution described in § 1.951–1(e)(1)(i) is less than the hypothetical tangible section provide rules for determining a $120x, the greater of its earnings and profits return of the tested income CFC for the United States shareholder’s pro rata as determined under section 964 ($100x) and CFC inclusion year, a United States the sum of its subpart F income and tested share of each tested item of a controlled income ($0 + $120x). Under paragraph (d)(2) foreign corporation. shareholder’s pro rata share of the qualified business asset investment of of this section and § 1.951–1(e)(3), the (2) Tested income—(i) In general. amount of FS’s allocable earnings and profits Except as provided in paragraph the tested income CFC for a United States shareholder inclusion year bears distributed in the hypothetical distribution (d)(2)(ii) of this section, a United States with respect to Individual A’s preferred shareholder’s pro rata share of the tested the same ratio to the qualified business shares is $12x (0.04 × $10x × 30) and the income of each tested income CFC for asset investment of the tested income amount distributed with respect to P Corp’s a U.S. shareholder inclusion year is CFC as the United States shareholder’s common shares is $108x ($120x ¥ $12x). determined under section 951(a)(2) and pro rata share of the hypothetical Accordingly, under paragraph (d)(2) of this § 1.951–1(b) and (e), substituting ‘‘tested tangible return of the CFC for the U.S. section and § 1.951–1(e)(1), Individual A’s income’’ for ‘‘subpart F income’’ each shareholder inclusion year bears to the pro rata share of FS’s tested income is $12x, and P Corp’s pro rata share of FS’s tested place it appears, other than in § 1.951– total hypothetical tangible return of the CFC for the CFC inclusion year. income is $108x for Year 4. 1(e)(1)(ii)(B) and the denominator of the (ii) Determination of pro rata share of fraction described in § 1.951– (B) Determination of pro rata share of qualified business asset investment. The 1(b)(1)(ii)(A). hypothetical tangible return. For special rule of paragraph (d)(3)(ii)(A) of this (ii) Special rule for prior allocation of purposes of paragraph (d)(3)(ii)(A) of section does not apply because FS’s tested tested loss. In any case in which tested this section, a United States income of $120x is not less than FS’s loss has been allocated to any class of shareholder’s pro rata share of the hypothetical tangible return of $75x, which stock in a prior CFC inclusion year hypothetical tangible return of a CFC for is 10% of FS’s qualified business asset under paragraph (d)(4)(iii) of this a CFC inclusion year is determined in investment of $750x. Accordingly, under the section, tested income is first allocated the same manner as the United States general rule of paragraph (d)(3)(i) of this to each such class of stock in the order shareholder’s pro rata share of the tested section, Individual A’s and P Corp’s respective pro rata shares of FS’s qualified of its liquidation priority to the extent income of the CFC for the CFC inclusion business asset investment bears the same of the excess (if any) of the sum of the year under paragraph (d)(2) of this ratio to FS’s total qualified business asset tested loss allocated to each such class section by treating the amount of the investment as their respective pro rata shares of stock for each prior CFC inclusion hypothetical tangible return as the of FS’s tested income bears to FS’s total year under paragraph (d)(4)(iii) of this amount of tested income. tested income. Thus, Individual A’s pro rata

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share of FS’s qualified business asset and FS all use the calendar year as their Accordingly, R Corp’s pro rata share of the investment is $75x ($750x × $12x/$120x), taxable year. hypothetical tangible return of FS for Year 1 and P Corp’s pro rata share of FS’s qualified (2) Analysis—(i) Determination of pro rata is $130x ($150x ¥ $20x), and R Corp’s pro business asset investment is $675x ($750x × share of tested income. For purposes of rata share of FS’s qualified business asset $108x/$120x). determining R Corp’s pro rata share of FS’s investment is $1,300x ($1,500x × $130x/ (B) Example 2—(1) Facts. The facts are the tested income under paragraph (d)(2) of this $150x). same as in paragraph (d)(3)(iv)(A)(1) of this section, the amount of FS’s allocable earnings (4) Tested loss—(i) In general. A section (the facts in Example 1 of this and profits for purposes of the hypothetical section), except that FS has $1,500x of distribution described in § 1.951–1(e)(1)(i) is United States shareholder’s pro rata qualified business asset investment for Year $50x, the greater of its earnings and profits share of the tested loss of each tested 4. as determined under section 964 ($50x) or loss CFC for a U.S. shareholder (2) Analysis—(i) Determination of pro rata the sum of its subpart F income and tested inclusion year is determined under share of tested income. The analysis and the income ($0 + $50x). Under paragraph (d)(2) section 951(a)(2) and § 1.951–1(b) and result are the same as in paragraph of this section and § 1.951–1(e)(1), FS’s (e) with the following modifications— (d)(3)(iv)(A)(2)(i) of this section (paragraph (i) allocable earnings and profits of $50x are (A) ‘‘Tested loss’’ is substituted for of the analysis in Example 1 of this section). distributed in the hypothetical distribution ‘‘subpart F income’’ each place it (ii) Determination of pro rata share of pro rata to each share of stock. R Corp’s pro qualified business asset investment. The rata share of FS’s tested income for Year 1 appears; special rule of paragraph (d)(3)(ii)(A) of this is its pro rata share under section (B) For purposes of the hypothetical section applies because FS’s tested income of 951(a)(2)(A) and § 1.951–1(b)(1)(i) ($50x), distribution described in section $120x is less than FS’s hypothetical tangible reduced under section 951(a)(2)(B) and 951(a)(2)(A) and § 1.951–1(b)(1)(i) and return of $150x, which is 10% of FS’s § 1.951–1(b)(1)(ii) by $20x, which is the (e)(1)(i), the amount of allocable qualified business asset investment of lesser of $20x, the dividend received by P earnings and profits of a controlled $1,500x. Under paragraph (d)(3)(ii)(A) of this Corp during Year 1 with respect to the FS foreign corporation for a CFC inclusion section, Individual A’s and P Corp’s stock acquired by R Corp ($20x), multiplied year is treated as being equal to the respective pro rata shares of FS’s qualified by a fraction, the numerator of which is the tested loss of the tested loss CFC for the business asset investment bears the same tested income ($50x) of FS for Year 1 and the CFC inclusion year; ratio to FS’s qualified business asset denominator of which is the sum of the (C) Except as provided in paragraphs investment as their respective pro rata shares subpart F income ($0) and the tested income of the hypothetical tangible return of FS ($50x) of FS for Year 1 ($20x × $50x/$50x), (d)(4)(ii) and (iii) of this section, the bears to the total hypothetical tangible return and $20x, which is P Corp’s pro rata share hypothetical distribution described in of FS. Under paragraph (d)(3)(ii)(B) of this (100%) of the amount which bears the same section 951(a)(2)(A) and § 1.951– section, P Corp’s and Individual A’s ratio to FS’s tested income for Year 1 ($50x) 1(b)(1)(i) and (e)(1)(i) is treated as made respective pro rata share of FS’s hypothetical as the period during which R Corp did not solely with respect to the common stock tangible return is determined under own (within the meaning of section 958(a)) of the tested loss CFC; and paragraph (d)(2) of this section in the same the FS stock (146 days) bears to the entire (D) In lieu of applying section manner as their respective pro rata shares of taxable year (1 × $50x × 146/365). 951(a)(2)(B) and § 1.951–1(b)(1)(ii), the the tested income of FS by treating the Accordingly, R Corp’s pro rata share of tested ¥ United States shareholder’s pro rata hypothetical tangible return as the amount of income of FS for Year 1 is $30x ($50x share of the tested loss allocated to tested income. The amount of FS’s allocable $20x). earnings and profits for purposes of the (ii) Determination of pro rata share of section 958(a) stock of the tested loss hypothetical distribution described in qualified business asset investment. The CFC is reduced by an amount that bears § 1.951–1(e)(1)(i) is $150x, the greater of its special rule of paragraph (d)(3)(ii) of this the same ratio to the amount of the earnings and profits as determined under section applies because FS’s tested income of tested loss as the part of such year section 964 ($100x) and the sum of its $50x is less than FS’s hypothetical tangible during which such shareholder did not subpart F income and hypothetical tangible return of $150x, which is 10% of FS’s own (within the meaning of section return ($0 + $150x). The amount of FS’s qualified business asset investment of 958(a)) such stock bears to the entire allocable earnings and profits distributed in $1,500x. Under paragraph (d)(3)(ii) of this × taxable year. the hypothetical distribution is $12x (.04 section, R Corp’s pro rata share of FS’s (ii) Special rule in case of accrued but $10x × 30) with respect to Individual A’s qualified business asset investment is the preferred shares and $138x ($150x ¥ $12x) amount that bears the same ratio to FS’s unpaid dividends. If a tested loss CFC’s with respect to P Corp’s common shares. qualified business asset investment as R earnings and profits that have Accordingly, Individual A’s pro rata share of Corp’s pro rata share of the hypothetical accumulated since the issuance of FS’s qualified business asset investment is tangible return of FS bears to the total preferred shares are reduced below the $120x ($1,500x × $12x/$150x), and P Corp’s hypothetical tangible return of FS. R Corp’s amount necessary to satisfy any accrued pro rata share of FS’s qualified business asset pro rata share of FS’s hypothetical tangible but unpaid dividends with respect to investment is $1,380x ($1,500x × $138x/ return is its pro rata share under section such preferred shares, then the amount $150x). 951(a)(2)(A) and § 1.951–1(b)(1)(i) ($150x), by which the tested loss reduces the (C) Example 3—(1) Facts. P Corp, a reduced under section 951(a)(2)(B) and earnings and profits below the amount domestic corporation and a United States § 1.951–1(b)(1)(ii) by $20x, which is the shareholder, owns 100% of the only class of lesser of $20x, the dividend received by P necessary to satisfy the accrued but stock of FS, a controlled foreign corporation, Corp during Year 1 with respect to the FS unpaid dividends is allocated in the from January 1 of Year 1, until May 26 of stock acquired by R Corp ($20x) multiplied hypothetical distribution described in Year 1. On May 26 of Year 1, P Corp sells by a fraction, the numerator of which is the section 951(a)(2)(A) and § 1.951– all of its FS stock to R Corp, a domestic hypothetical tangible return ($150x) of FS for 1(b)(1)(i) and (e)(1)(i) to the preferred corporation that is not related to P Corp, and Year 1 and the denominator of which is the stock of the tested loss CFC and the recognizes no gain or loss on the sale. R Corp, sum of the subpart F income ($0) and the remainder of the tested loss is allocated a United States shareholder of FS, owns hypothetical tangible return ($150x) of FS for × in the hypothetical distribution to the 100% of the stock of FS from May 26 through Year 1 ($20x $150x/$150x), and $60x, common stock of the tested loss CFC. December 31 of Year 1. For Year 1, FS has which is P Corp’s pro rata share (100%) of (iii) Special rule for stock with no $50x of earnings and profits, $50x of tested the amount which bears the same ratio to income, and no subpart F income within the FS’s hypothetical tangible return for Year 1 liquidation value. If a tested loss CFC’s meaning of section 952. FS also has $1,500x ($150x) as the period during which R Corp common stock has a liquidation value of of qualified business asset investment for did not own (within the meaning of section zero and there is at least one other class Year 1. On May 1 of Year 1, FS distributes 958(a)) the FS stock (146 days) bears to the of equity with a liquidation preference a $20x dividend to P Corp. P Corp, R Corp, entire taxable year (1 × $150x × 146/365). relative to the common stock, then the

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tested loss is allocated in the preferred stock has a liquidation value of income increases the shareholder’s pro hypothetical distribution described in $5,000x and no accrued but unpaid rata share of tested income of the section 951(a)(2)(A) and § 1.951– dividends. In Year 1, FS has a tested loss of controlled foreign corporation for the $1,000x and no other items of income, gain, U.S. shareholder inclusion year, reduces 1(b)(1)(i) and (e)(1)(i) to the most junior deduction, or loss. In Year 2, FS has tested class of equity with a positive income of $3,000x and no other items of the shareholder’s pro rata share of tested liquidation value to the extent of such income, gain, deduction, or loss. FS has loss of the controlled foreign liquidation value. Thereafter, tested loss earnings and profits of $3,000x for Year 2. At corporation for the U.S. shareholder is allocated to the next most junior class the end of Year 2, FS has accrued but unpaid inclusion year, or both. of equity to the extent of its liquidation dividends of $400x with respect to the (e) Treatment of domestic preferred stock, the sum of $200x for Year 1 partnerships—(1) In general. For value and so on. All determinations of × × liquidation value are to be made as of (0.04 $100x 50) and $200x for Year 2 purposes of section 951A and the (0.04 × $100x × 50). the beginning of the CFC inclusion year section 951A regulations, and for (2) Analysis—(i) Year 1. FS is a tested loss purposes of any other provision that of the tested loss CFC. CFC in Year 1. The common stock of FS has (iv) Examples. The following liquidation value of zero, and the preferred applies by reference to section 951A or examples illustrate the application of stock has a liquidation preference relative to the section 951A regulations, a domestic this paragraph (d)(4). See also § 1.951– the common stock. The tested loss ($1,000x) partnership is not treated as owning 1(e)(7)(viii) (Example 7) (illustrating a does not exceed the liquidation value of the stock of a foreign corporation within the United States shareholder’s pro rata preferred stock ($5,000x). Accordingly, under meaning of section 958(a). When the share of subpart F income and tested paragraph (d)(4)(iii) of this section, the tested preceding sentence applies, a domestic loss). loss is allocated to the preferred stock in the partnership is treated in the same hypothetical distribution described in section manner as a foreign partnership under (A) Example 1—(1) Facts. FS, a controlled 951(a)(2)(A) and § 1.951–1(b)(1)(i) and foreign corporation, has outstanding 70 (e)(1)(i). Individual A’s pro rata share of the section 958(a)(2) for purposes of shares of common stock and 30 shares of 4% tested loss is $1,000x, and P Corp’s pro rata determining the persons that own stock nonparticipating, cumulative preferred stock share of the tested loss is $0. of the foreign corporation within the with a par value of $10x per share. P Corp, (ii) Year 2. FS is a tested income CFC in meaning of section 958(a). a domestic corporation and a United States Year 2. Because $1,000x of tested loss was (2) Non-application for determination shareholder of FS, owns all of the common allocated to the preferred stock in Year 1 of status as United States shareholder shares. Individual A, a United States citizen under paragraph (d)(4)(iii) of this section, the and controlled foreign corporation. and a United States shareholder, owns all of first $1,000x of tested income in Year 2 is Paragraph (e)(1) of this section does not the preferred shares. FS, Individual A, and P allocated to the preferred stock under apply for purposes of determining Corp all use the calendar year as their taxable paragraph (d)(2)(ii) of this section. P Corp’s whether any United States person is a year. Individual A and P Corp are and Individual A’s pro rata shares of the shareholders of FS for all of Year 5. At the remaining $2,000x of tested income are United States shareholder (as defined in beginning of Year 5, FS had earnings and determined under the general rule of section 951(b)), whether any United profits of $120x, which accumulated after the paragraph (d)(2)(i) of this section, except that States shareholder is a controlling issuance of the preferred stock. At the end of for purposes of the hypothetical distribution domestic shareholder (as defined in Year 5, the accrued but unpaid dividends the amount of FS’s allocable earnings and § 1.964–1(c)(5)), or whether any foreign with respect to the preferred stock are $36x. profits is reduced by the tested income corporation is a controlled foreign For Year 5, FS has a $100x tested loss, and allocated under paragraph (d)(2)(ii) of this corporation (as defined in section no other items of income, gain, deduction or section to $2,000x ($3,000x ¥ $1,000x). loss. At the end of Year 5, FS has earnings 957(a)). Accordingly, under paragraph (d)(2)(i) of this (3) Examples. The following examples and profits of $20x. section and § 1.951–1(e), the amount of FS’s (2) Analysis. FS is a tested loss CFC for allocable earnings and profits distributed in illustrate the application of this Year 5. Before taking into account the tested the hypothetical distribution with respect to paragraph (e). loss in Year 5, FS had sufficient earnings and Individual A’s preferred stock is $400x (i) Example 1—(A) Facts. USP, a domestic profits to satisfy the accrued but unpaid ($400x of accrued but unpaid dividends) and corporation, and Individual A, a United dividends of $36x. The amount of the with respect to P Corp’s common stock is States citizen unrelated to USP, own 95% reduction in earnings below the amount $1,600x ($2,000x ¥ $400x). Individual A’s and 5%, respectively, of PRS, a domestic necessary to satisfy the accrued but unpaid pro rata share of the tested income is $1,400x partnership. PRS owns 100% of the single dividends attributable to the tested loss is ($1,000x + $400x), and P Corp’s pro rata class of stock of FC, a foreign corporation. ¥ ¥ $16x ($36x ($120x $100x)). share of the tested income is $1,600x. (B) Analysis—(1) CFC and United States Accordingly, under paragraph (d)(4)(ii) of (5) Tested interest expense. A United shareholder determinations. Under this section, $16x of the tested loss is paragraph (e)(2) of this section, the allocated to Individual A’s preferred stock in States shareholder’s pro rata share of determination of whether PRS, USP, and the hypothetical distribution described in tested interest expense of a controlled Individual A (each a United States person) section 951(a)(2)(A) and § 1.951–1(b)(1)(i) foreign corporation for a U.S. are United States shareholders of FC and and (e)(1)(i), and $84x ($100x ¥ $16x) of the shareholder inclusion year is equal to whether FC is a controlled foreign tested loss is allocated to P Corp’s common the amount by which the tested interest corporation is made without regard to shares in the hypothetical distribution. expense reduces the shareholder’s pro paragraph (e)(1) of this section. PRS, a United (B) Example 2—(1) Facts. FS, a controlled rata share of tested income of the States person, owns 100% of the total foreign corporation, has outstanding 100 combined voting power or value of the FC shares of common stock and 50 shares of 4% controlled foreign corporation for the stock within the meaning of section 958(a). nonparticipating, cumulative preferred stock U.S. shareholder inclusion year, Accordingly, PRS is a United States with a par value of $100x per share. P Corp, increases the shareholder’s pro rata shareholder under section 951(b), and FC is a domestic corporation and a United States share of tested loss of the controlled a controlled foreign corporation under shareholder of FS, owns all of the common foreign corporation for the U.S. section 957(a). USP is a United States shares. Individual A, a United States citizen shareholder inclusion year, or both. shareholder of FC because it owns 95% of the and a United States shareholder, owns all of (6) Tested interest income. A United total combined voting power or value of the the preferred shares. FS, Individual A, and P States shareholder’s pro rata share of FC stock under sections 958(b) and Corp all use the calendar year as their taxable 318(a)(2)(A). Individual A, however, is not a year. Individual A and P Corp are tested interest income of a controlled United States shareholder of FC because shareholders of FS for all of Year 1 and Year foreign corporation for a U.S. Individual A owns only 5% of the total 2. At the beginning of Year 1, the common shareholder inclusion year is equal to combined voting power or value of the FC stock has no liquidation value and the the amount by which the tested interest stock under sections 958(b) and 318(a)(2)(A).

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(2) Application of section 951A. Under purposes of determining the GILTI inclusion (b) Definitions related to tested paragraph (e)(1) of this section, for purposes of USP and Individual A, USP is treated as income and tested loss—(1) Tested × × of determining a GILTI inclusion amount owning 81% (100% 90% 90%) of the FC income and tested income CFC. The under section 951A and paragraph (b) of this stock under section 958(a), and Individual A term tested income means the excess (if section, PRS is not treated as owning (within × × is treated as owning 9% (100% 90% any) of a controlled foreign the meaning of section 958(a)) the FC stock; 10%) of the FC stock under section 958(a). instead, PRS is treated in the same manner Because USP and Individual A are both corporation’s gross tested income for a as a foreign partnership for purposes of United States shareholders of FC, USP and CFC inclusion year, over the allowable determining the FC stock owned by USP and Individual A determine their respective pro deductions (including taxes) properly Individual A under section 958(a)(2). rata shares of any tested item of FC based on allocable to the gross tested income for Therefore, for purposes of determining the their ownership of section 958(a) stock of FC. the CFC inclusion year (a controlled GILTI inclusion amount of USP and (f) Definitions. This paragraph (f) foreign corporation with tested income Individual A, USP is treated as owning 95% for a CFC inclusion year, a tested of the FC stock under section 958(a), and provides additional definitions that apply for purposes of this section and income CFC). Individual A is treated as owning 5% of the (2) Tested loss and tested loss CFC. FC stock under section 958(a). USP is a the section 951A regulations. Other The term tested loss means the excess (if United States shareholder of FC, and definitions relevant to the section 951A therefore USP determines its pro rata share any) of a controlled foreign regulations are included in §§ 1.951A–2 corporation’s allowable deductions of any tested item of FC based on its through 1.951A–4. ownership of section 958(a) stock of FC. (including taxes) properly allocable to However, because Individual A is not a (1) CFC inclusion year. The term CFC gross tested income (or that would be United States shareholder of FC, Individual inclusion year means any taxable year of allocable to gross tested income if there A does not have a pro rata share of any tested a foreign corporation beginning after were gross tested income) for a CFC item of FC. December 31, 2017, at any time during inclusion year, over the gross tested (ii) Example 2—(A) Facts. USP, a domestic which the corporation is a controlled income of the controlled foreign corporation, and Individual A, a United foreign corporation. corporation for the CFC inclusion year States citizen, own 90% and 10%, (2) Controlled foreign corporation. respectively, of PRS1, a domestic (a controlled foreign corporation The term controlled foreign corporation without tested income for a CFC partnership. PRS1 and Individual B, a has the meaning set forth in section nonresident alien individual, own 90% and inclusion year, a tested loss CFC). 10%, respectively, of PRS2, a domestic 957(a). (c) Rules relating to the determination partnership. PRS2 owns 100% of the single (3) Hypothetical distribution date. of tested income and tested loss—(1) class of stock of FC, a foreign corporation. The term hypothetical distribution date Definition of gross tested income. The USP, Individual A, and Individual B are has the meaning set forth in § 1.951– term gross tested income means the unrelated to each other. 1(e)(1)(i). gross income of a controlled foreign (B) Analysis—(1) CFC and United States (4) Section 958(a) stock. The term corporation for a CFC inclusion year shareholder determination. Under paragraph section 958(a) stock means stock of a (e)(2) of this section, the determination of determined without regard to— controlled foreign corporation owned (i) Items of income described in whether PRS1, PRS2, USP, and Individual A (directly or indirectly) by a United (each a United States person) are United section 952(b), States shareholders of FC and whether FC is States shareholder within the meaning (ii) Gross income taken into account a controlled foreign corporation is made of section 958(a), as modified by in determining the subpart F income of without regard to paragraph (e)(1) of this paragraph (e)(1) of this section. the corporation, section. PRS2 owns 100% of the total (5) Tested item. The term tested item (iii) Gross income excluded from the combined voting power or value of the FC means tested income, tested loss, foreign base company income (as stock within the meaning of section 958(a). qualified business asset investment, defined in section 954) or the insurance Accordingly, PRS2 is a United States tested interest expense, or tested interest income (as defined in section 953) of the shareholder under section 951(b), and FC is income. corporation solely by reason of an a controlled foreign corporation under section 957(a). Under sections 958(b) and (6) United States shareholder. The election made under section 954(b)(4) 318(a)(2)(A), PRS1 is treated as owning 90% term United States shareholder has the and § 1.954–1(d)(5), of the FC stock owned by PRS2. Accordingly, meaning set forth in section 951(b). (iv) Dividends received by the PRS1 is a United States shareholder under (7) U.S. shareholder inclusion year. corporation from related persons (as section 951(b). Further, under section The term U.S. shareholder inclusion defined in section 954(d)(3)), and 958(b)(2), PRS1 is treated as owning 100% of year means any taxable year of a United (v) Foreign oil and gas extraction the FC stock for purposes of determining the States shareholder in which or with income (as defined in section 907(c)(1)) FC stock treated as owned by USP and which a CFC inclusion year of a of the corporation. Individual A under section 318(a)(2)(A). controlled foreign corporation ends. (2) Determination of gross income and Therefore, USP is treated as owning 90% of × allowable deductions—(i) In general. the FC stock under section 958(b) (100% § 1.951A–2 Tested income and tested loss. For purposes of determining tested 100% × 90%), and Individual A is treated as owning 10% of the FC stock under section (a) Scope. This section provides rules income and tested loss, the gross 958(b) (100% × 100% × 10%). Accordingly, for determining the tested income or income and allowable deductions of a both USP and Individual A are United States tested loss of a controlled foreign controlled foreign corporation for a CFC shareholders of FC under section 951(b). corporation for purposes of determining inclusion year are determined under the (2) Application of section 951A. Under a United States shareholder’s net CFC rules of § 1.952–2 for determining the paragraph (e)(1) of this section, for purposes tested income under § 1.951A–1(c)(2). subpart F income of the controlled of determining a GILTI inclusion amount Paragraph (b) of this section provides foreign corporation, except, for a under section 951A and paragraph (b) of this definitions related to tested income and controlled foreign corporation which is section, PRS1 and PRS2 are not treated as tested loss. Paragraph (c) of this section engaged in the business of reinsuring or owning (within the meaning of section 958(a)) the FC stock; instead, PRS1 and PRS2 provides rules for determining the gross issuing insurance or annuity contracts are treated in the same manner as foreign tested income of a controlled foreign and which, if it were a domestic partnerships for purposes of determining the corporation and the deductions that are corporation engaged only in such FC stock owned by USP and Individual A properly allocable to gross tested business, would be taxable as an under section 958(a)(2). Therefore, for income. insurance company to which subchapter

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L of chapter 1 of the Code applies, paragraph (c)(4)(ii)(C) is the product of (iv) Examples. The following substituting ‘‘the rules of sections 953 the gross income of the controlled examples illustrate the application of and 954(i)’’ for ‘‘the principles of foreign corporation for the CFC this paragraph (c)(4). §§ 1.953–4 and 1.953–5’’ in § 1.952– inclusion year that gives rise to the (A) Example 1—(1) Facts. A Corp, a 2(b)(2). income described in section 952(a)(3)(A) domestic corporation, owns 100% of the (ii) Deemed payment under section multiplied by the international boycott single class of stock of FS, a controlled 367(d). The allowable deductions of a factor described in section 952(a)(3)(B). foreign corporation. Both A Corp and FS use controlled foreign corporation include a (D) Illegal bribes, kickbacks, or other the calendar year as their taxable year. In deemed payment of the controlled payments. Gross income described in Year 1, FS has passive category foreign foreign corporation under section personal holding company income of $100x, this paragraph (c)(4)(ii)(D) is the sum of a general category loss in foreign oil and gas 367(d)(2)(A). the amounts of the controlled foreign (3) Allocation of deductions to gross extraction income of $100x, and earnings and corporation for the CFC inclusion year tested income. Except as provided in profits of $0. FS has no other income. In Year described in section 952(a)(4). paragraph (c)(5) of this section, any 2, FS has general category gross income of (E) Income earned in certain foreign $100x and earnings and profits of $100x. deductions of a controlled foreign Without regard to section 952(c)(2), in Year corporation allowable under paragraph countries. Gross income described in this paragraph (c)(4)(ii)(E) is income of 2 FS has no income described in any of the (c)(2) of this section are allocated and categories of income excluded from gross apportioned to gross tested income the controlled foreign corporation for tested income in paragraphs (c)(1)(i) through under the principles of section 954(b)(5) the CFC inclusion year described in (v) of this section. FS has no allowable and § 1.954–1(c), by treating gross tested section 952(a)(5). deductions properly allocable to gross tested income that falls within a single (iii) Coordination rules—(A) income for Year 2. separate category (as defined in § 1.904– Coordination with E&P limitation. Gross (2) Analysis—(i) Year 1. As a result of the 5(a)) as a single item of gross income, income of a controlled foreign earnings and profits limitation of section separate and in addition to the items set 952(c)(1)(A), FS has no subpart F income in corporation for a CFC inclusion year Year 1, and A Corp has no inclusion with forth in § 1.954–1(c)(1)(iii). Losses in described in section 951A(c)(2)(A)(i)(II) respect to FS under section 951(a)(1)(A). other separate categories of income and paragraph (c)(1)(ii) of this section Under paragraph (c)(4)(ii)(A) of this section, resulting from the application of includes any item of gross income that gross income described in section § 1.954–1(c)(1)(i) cannot reduce any is excluded from subpart F income of 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of separate category of gross tested income, the controlled foreign corporation for this section includes any item of gross and losses in a separate category of gross the CFC inclusion year, or that is income excluded from the subpart F income tested income cannot reduce income in otherwise excluded from the amount of FS for Year 1 under section 952(c)(1)(A) a category of subpart F income. In included under section 951(a)(1)(A) in and § 1.952–1(c). Therefore, the $100x foreign personal holding company income of addition, deductions of a controlled the gross income of a United States foreign corporation that are allocated FS in Year 1 is excluded from gross tested shareholder of the controlled foreign income by reason of section and apportioned to gross tested income corporation for the U.S. shareholder 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of under this paragraph (c)(3) are not taken inclusion year in which or with which this section, and FS has no gross tested into account for purposes of the CFC inclusion year ends, under income in Year 1. determining a qualified deficit as section 952(c)(1) and § 1.952–1(c), (d), (ii) Year 2. In Year 2, under section defined in section 952(c)(1)(B)(ii). or (e). 952(c)(2) and § 1.952–1(f)(2), FS’s general (4) Gross income taken into account category earnings and profits ($100x) in (B) Coordination with E&P recapture. in determining subpart F income—(i) In excess of its subpart F income ($0) give rise Gross income of a controlled foreign general. Except as provided in to the recharacterization of its passive corporation for a CFC inclusion year paragraph (c)(4)(iii) of this section, gross category recapture account as subpart F described in section 951A(c)(2)(A)(i)(II) income of a controlled foreign income. Therefore, FS has passive category and paragraph (c)(1)(ii) of this section subpart F income of $100x in Year 2, and A corporation for a CFC inclusion year does not include any item of gross Corp has an inclusion of $100x with respect described in section 951A(c)(2)(A)(i)(II) income that results in the to FS under section 951(a)(1)(A). Under and paragraph (c)(1)(ii) of this section is recharacterization of earnings and paragraph (c)(4)(ii)(B) of this section, gross gross income described in paragraphs profits as subpart F income of the income described in section (c)(4)(ii)(A) through (E) of this section. 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of (ii) Items of gross income included in controlled foreign corporation for the this section does not include any item of subpart F income—(A) Insurance CFC inclusion year under section gross income that results in the income. Gross income described in this 952(c)(2) and § 1.952–1(f)(2). recharacterization of earnings and profits as paragraph (c)(4)(ii)(A) is any item of (C) Coordination with full inclusion subpart F income in FS’s taxable year under gross income included in the insurance rule and high tax exception. Gross section 952(c)(2) and § 1.952–1(f)(2). income of a controlled foreign Accordingly, the $100x of general category income (adjusted net insurance income gross income of FS in Year 2 is not excluded as defined in § 1.954–1(a)(6)) of the corporation for a CFC inclusion year from gross tested income by reason of section controlled foreign corporation for the described in section 951A(c)(2)(A)(i)(II) 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of CFC inclusion year. and paragraph (c)(1)(ii) of this section this section, and FS has $100x of general (B) Foreign base company income. does not include full inclusion foreign category gross tested income in Year 2. Gross income described in this base company income that is excluded (B) Example 2—(1) Facts. A Corp, a paragraph (c)(4)(ii)(B) is any item of from subpart F income under § 1.954– domestic corporation, owns 100% of the gross income included in the foreign 1(d)(6). Full inclusion foreign base single class of stock of FC1 and FC2, base company income (adjusted net company income that is excluded from controlled foreign corporations. A Corp, FC1, subpart F income under § 1.954–1(d)(6) and FC2 use the calendar year as their foreign base company income as defined taxable year. In Year 1, FC1 has gross income in § 1.954–1(a)(5)) of the controlled is also not included in gross income of of $290x from product sales to unrelated foreign corporation for the CFC a controlled foreign corporation for a persons within its country of incorporation, inclusion year. CFC inclusion year described in section gross interest income of $10x (an amount that (C) International boycott income. 951A(c)(2)(A)(i)(III) and paragraph is less than $1,000,000) that does not qualify Gross income described in this (c)(1)(iii) of this section. for an exception to foreign personal holding

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company income, and earnings and profits of calendar year as their taxable year. In Year within FS’s country of incorporation is not $300x. In Year 1, FC2 has gross income of 1, FS has gross income of $1,000x, of which excluded from gross tested income under $45x for performing consulting services $720x is general category foreign base either section 951A(c)(2)(A)(i)(II) and within its country of incorporation for company sales income and $280x is general paragraph (c)(1)(ii) of this section or section unrelated persons, gross interest income of category income from sales within its country 951A(c)(2)(A)(i)(III) and paragraph (c)(1)(iii) $150x (an amount that is not less than of incorporation; FS has expenses of $650x of this section. Under paragraph (c)(4)(ii)(B) $1,000,000) that does not qualify for an (including creditable foreign income taxes), of this section, the $280x of gross sales exception to foreign personal holding of which $500x are allocated and income earned from sales within FS’s company income, and earnings and profits of apportioned to foreign base company sales country of incorporation is not excluded $195x. income and $150x are allocated and from gross tested income under section (2) Analysis—(i) FC1. In Year 1, by apportioned to sales income from sales 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of application of the de minimis rule of section within FS’s country of incorporation; and FS this section, because gross income described 954(b)(3)(A) and § 1.954–1(b)(1)(i), the $10x has earnings and profits of $350x for Year 1. in paragraph (c)(1)(ii) of this section does not of gross interest income earned by FC1 is not Foreign income tax of $55x is considered include any item of gross income that results treated as foreign base company income imposed on the $220x ($720x¥$500x) of net in the recharacterization of earnings and ($10x of gross foreign base company income foreign base company sales income, and $26x profits as subpart F income under section is less than $15x, the lesser of 5% of $300x, is considered imposed on the $130x 952(c)(2) and § 1.952–1(f)(2). Further, under FC’s total gross income for Year 1, or ($280x¥$150x) of net income from sales paragraph (c)(4)(iii) of this section, the $280x $1,000,000). Accordingly, FC1 has no subpart within FS’s country of operation. The of gross sales income earned from sales F income in Year 1, and A Corp has no maximum rate of tax in section 11 for the within FS’s country of incorporation is not inclusion with respect to FC1 under section taxable year is 21%, and FS elects the high excluded from gross tested income under 951(a)(1)(A). Under paragraph (c)(4)(i) of this tax exception of section 954(b)(4) under either section 951A(c)(2)(A)(i)(II) and section, gross income described in section § 1.954–1(d)(1) for Year 1 for its foreign base paragraph (c)(1)(ii) of this section or section 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of company sales income. In a prior taxable 951A(c)(2)(A)(i)(III) and paragraph (c)(1)(iii) this section is any item of gross income year, FS had losses with respect to income of this section, because gross income included in foreign base company income, other than foreign base company or insurance described in section 951A(c)(2)(A)(i)(II) and and thus gross income described in section income that, by reason of the limitation in paragraph (c)(1)(ii) of this section or section 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of section 952(c)(1)(A), reduced the subpart F 951A(c)(2)(A)(i)(III) and paragraph (c)(1)(iii) this section does not include any item of income of FS (consisting entirely of foreign of this section does not include full inclusion gross income excluded from foreign base source general category income) by $600x; as foreign base company income that is company income under the de minimis rule of the beginning of Year 1, such amount has excluded from subpart F income under in section 954(b)(3)(A) and § 1.954–1(b)(1)(i). not been recharacterized as subpart F income § 1.954–1(d)(6). Accordingly, FS has $280x of Accordingly, FS’s $10x of gross interest in a subsequent taxable year under section gross tested income for Year 1. income in Year 1 is not excluded from gross 952(c)(2). (5) Allocation of deduction or loss tested income by reason of section (2) Analysis—(i) Foreign base company attributable to disqualified basis—(i) In 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of income. In Year 1, by application of the full general. A deduction or loss attributable this section, and FC1 has $300x ($290x of inclusion rule in section 954(b)(3)(B) and to disqualified basis is allocated and gross sales income and $10x of gross interest § 1.954–1(b)(1)(ii), the $280x of gross income income) of gross tested income in Year 1. earned by FS for sales within its country of apportioned solely to residual CFC gross (ii) FC2. In Year 1, by application of the incorporation is treated as foreign base income, and any depreciation, full inclusion rule in section 954(b)(3)(B) and company income ($720x of gross foreign base amortization, or cost recovery § 1.954–1(b)(1)(ii), the $45x of gross income company income exceeds $700x, which is allowances attributable to disqualified earned by FC2 for performing consulting 70% of $1,000x, FS’s total gross income for basis is not properly allocable to services within its country of incorporation the taxable year). However, the $220x of property produced or acquired for resale for unrelated persons is treated as foreign foreign base company sales income qualifies under section 263, 263A, or 471. base company income ($150x of gross foreign for the high tax exception of section 954(b)(4) (ii) Determination of deduction or loss base company income exceeds $136.5x, and § 1.954–1(d)(1), because the effective rate attributable to disqualified basis. Except which is 70% of $195x, FC2’s total gross of tax with respect to the net foreign base as otherwise provided in this paragraph income for Year 1). Therefore, FC2 has $195x company sales income ($220x) is 20% ($55x/ of foreign base company income in Year 1, ($220x + $55x)) which is greater than 18.9% (c)(5)(ii), in the case of a depreciation or including $45x of full inclusion foreign base (90% of 21%, the maximum rate of tax in amortization deduction with respect to company income as defined in § 1.954– section 11 for the taxable year). Because the property with disqualified basis and 1(b)(2), and A Corp has an inclusion of $195x $220x of net foreign base company sales adjusted basis other than disqualified with respect to FC2 under section income qualifies for the high tax exception of basis, the deduction or loss is treated as 951(a)(1)(A). Under paragraph (c)(4)(i) of this section 954(b)(4) and § 1.954–1(d)(1), the attributable to the disqualified basis in section, gross income described in section $130x of full inclusion foreign base company the same proportion that the 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of income is also excluded from subpart F disqualified basis bears to the total this section is any item of gross income income under § 1.954–1(d)(6). adjusted basis in the property. In the included in foreign base company income, (ii) Recapture of subpart F income. Under and thus gross income described in section section 952(c)(2) and § 1.952–1(f)(2), FS’s case of a loss from a taxable sale or 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of general category earnings and profits ($350x) exchange of property with disqualified this section includes any item of gross in excess of its subpart F income ($0) give basis and adjusted basis other than income included as foreign base company rise to the recharacterization of its general disqualified basis, the loss is treated as income under the full inclusion rule in category recapture account ($600x) as subpart attributable to disqualified basis to the section 954(b)(3)(B) and § 1.954–1(b)(1)(ii). F income to the extent of current year extent thereof. Accordingly, FC2’s $45x of gross services earnings and profits. Therefore, FS has (iii) Definitions. The following income and its $150x of gross interest income general category subpart F income of $350x definitions apply for purposes of this in Year 1 are excluded from gross tested in Year 1, and A Corp has an inclusion of paragraph (c)(5). income by reason of section $350x with respect to FS under section (A) Disqualified basis. The term 951A(c)(2)(A)(i)(II) and paragraph (c)(1)(ii) of 951(a)(1)(A). this section, and FC2 has no gross tested (iii) Gross tested income. The $720x of disqualified basis has the meaning set income in Year 1. gross foreign base company income is forth in § 1.951A–3(h)(2)(ii). (C) Example 3—(1) Facts. A Corp, a excluded from gross tested income under (B) Residual CFC gross income. The domestic corporation, owns 100% of the section 951A(c)(2)(A)(i)(III) and paragraph term residual CFC gross income means single class of stock of FS, a controlled (c)(1)(iii) of this section. However, the $280x gross income other than gross tested foreign corporation. A Corp and FS use the of gross sales income earned from sales income, gross income taken into

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account in determining subpart F A to CFC3, a related person, and CFC2 did determining the qualified business asset income, or gross income that is not recognize a deduction or loss on the sale, investment of a tested income CFC. effectively connected, or treated as the disqualified basis in Asset A is not (b) Qualified business asset effectively connected, with the conduct reduced or eliminated by reason of the sale. investment. The term qualified business of a trade or business in the United Accordingly, under paragraph (c)(5)(i) of this asset investment means the average of a section, any deduction or loss of CFC3 tested income CFC’s aggregate adjusted States (as described in § 1.882–4(a)(1)). attributable to the $72x of disqualified basis (iv) Examples. The following in Asset A is allocated and apportioned bases as of the close of each quarter of examples illustrate the application of solely to residual CFC gross income of CFC3. a CFC inclusion year in specified this paragraph (c)(5). (C) Example 3: Related party transfer after tangible property that is used in a trade (A) Example 1: Sale of intangible property the disqualified period; loss recognition—(1) or business of the tested income CFC during the disqualified period—(1) Facts. Facts. The facts are the same as in paragraph and is of a type with respect to which USP, a domestic corporation, owns all of the (c)(5)(iv)(B)(1) of this section (the facts in a deduction is allowable under section stock in CFC1 and CFC2, each a controlled Example 2), except that CFC2 sells Asset A 167. In the case of partially depreciable foreign corporation. Both USP and CFC2 use to CFC3 in exchange for $70x of cash. property, only the depreciable portion the calendar year as their taxable year. CFC1 (2) Analysis. Under paragraph (c)(5)(ii) of of the property is of a type with respect uses a taxable year ending November 30. On this section, the $20x loss recognized by to which a deduction is allowable under November 1, 2018, before the start of its first CFC2 on the sale is attributable to section 167. A tested loss CFC has no disqualified basis, to the extent thereof, CFC inclusion year, CFC1 sells Asset A to qualified business asset investment. notwithstanding that the loss may be CFC2 in exchange for $100x of cash. Asset A (c) Specified tangible property—(1) In is intangible property that is amortizable deferred under section 267(f). Thus, under under section 197. Immediately before the paragraph (c)(5)(i) of this section, the loss is general. The term specified tangible sale, the adjusted basis in Asset A is $20x, allocated and apportioned solely to residual property means, with respect to a tested and CFC1 recognizes $80x of gain as a result CFC gross income of CFC2 in the CFC income CFC and a CFC inclusion year, of the sale ($100x¥$20x). CFC1’s gain is not inclusion year in which the loss is taken into tangible property of the tested income subject to U.S. tax or taken into account in account pursuant to section 267(f). Under CFC used in the production of gross determining an inclusion to USP under § 1.951A–3(h)(2)(ii)(B)(1)(ii), the disqualified tested income for the CFC inclusion section 951(a)(1)(A). basis in Asset A is reduced by $20x, the loss year. For purposes of the preceding (2) Analysis. The sale by CFC1 is a of CFC2 that is attributable to disqualified sentence, tangible property of a tested disqualified transfer (within the meaning of basis under paragraph (c)(5)(ii) of this income CFC is used in the production § 1.951A–3(h)(2)(ii)(C)(2)) because it is a section. Accordingly, under paragraph transfer of property in which gain was of gross tested income for a CFC (c)(5)(i) of this section, any deduction or loss inclusion year if some or all of the recognized by CFC1, CFC1 and CFC2 are of CFC3 attributable to the remaining $52x of related persons, and the transfer occurs disqualified basis in Asset A is allocated and depreciation or cost recovery allowance during the disqualified period (within the apportioned solely to residual CFC gross with respect to the tangible property is meaning of § 1.951A–3(h)(2)(ii)(C)(1)). The income of CFC3. either allocated and apportioned to the disqualified basis in Asset A is $80x, the gross tested income of the tested income excess of CFC2’s adjusted basis in Asset A § 1.951A–3 Qualified business asset CFC for the CFC inclusion year under immediately after the disqualified transfer § 1.951A–2(c)(3) or capitalized to ($100x), over the sum of CFC1’s basis in investment. Asset A immediately before the transfer inventory or other property held for (a) Scope. This section provides rules sale, some or all of the gross income or ($20x) and the qualified gain amount (as for determining the qualified business defined in § 1.951A–3(h)(2)(ii)(C)(3)) ($0). loss from the sale of which is taken into Accordingly, under paragraph (c)(5)(i) of this asset investment of a controlled foreign account in determining tested income of section, any deduction or loss of CFC2 corporation for purposes of determining the tested income CFC for the CFC attributable to the disqualified basis is a United States shareholder’s deemed inclusion year. None of the tangible allocated and apportioned solely to residual tangible income return under § 1.951A– property of a tested loss CFC is specified CFC gross income of CFC2 and, therefore, is 1(c)(3)(ii). Paragraph (b) of this section tangible property. not taken into account in determining the defines qualified business asset (2) Tangible property. The term tested income, tested loss, subpart F income, investment. Paragraph (c) of this section tangible property means property for or effectively connected income of CFC2 for defines tangible property and specified any CFC inclusion year. which the depreciation deduction (B) Example 2: Related party transfer after tangible property. Paragraph (d) of this provided by section 167(a) is eligible to the disqualified period; gain recognition—(1) section provides rules for determining be determined under section 168 Facts. The facts are the same as in paragraph the portion of tangible property that is without regard to section 168(f)(1), (2), (c)(5)(iv)(A)(1) of this section (the facts in specified tangible property when the or (5), section 168(k)(2)(A)(i)(II), (IV), or Example 1), except that, on November 30, property is used in the production of (V), and the date placed in service. 2020, CFC2 sells Asset A to CFC3, a both gross tested income and gross (d) Dual use property—(1) In general. controlled foreign corporation wholly-owned income that is not gross tested income. The amount of the adjusted basis in by CFC2, in exchange for $120x of cash. Paragraph (e) of this section provides Immediately before the sale, the adjusted dual use property of a tested income basis in Asset A is $90x, $72x of which is rules for determining the adjusted basis CFC for a CFC inclusion year that is disqualified basis. The gain recognized by in specified tangible property. treated as adjusted basis in specified CFC2 on the sale of Asset A is not described Paragraph (f) of this section provides tangible property for the CFC inclusion in paragraphs (c)(1)(i) through (v) of this rules for determining qualified business year is the average of the tested income section. asset investment of a tested income CFC CFC’s adjusted basis in the property (2) Analysis. Paragraph (c)(5)(i) of this with a short taxable year. Paragraph (g) multiplied by the dual use ratio with section does not apply to the sale of Asset A of this section provides rules for respect to the property for the CFC from CFC2 to CFC3 because the sale does not increasing the qualified business asset inclusion year. give rise to a deduction or loss attributable investment of a tested income CFC by (2) Definition of dual use property. to disqualified basis, but instead gives rise to gain. Therefore, CFC2 recognizes $30x reason of property owned by a The term dual use property means, with ($120x¥$90x) of gain that is included in partnership. Paragraph (h) of this respect to a tested income CFC and a gross tested income for its CFC inclusion year section provides anti-avoidance rules CFC inclusion year, specified tangible ending November 30, 2019. Under § 1.951A– that disregard the basis in property property of the tested income CFC that 3(h)(2)(ii)(B)(1)(ii), because CFC2 sold Asset transferred in certain transactions when is used in both the production of gross

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tested income and the production of inventory of Product A, $500x is capitalized the warehouse that is capitalized to inventory gross income that is not gross tested to FS’s ending inventory of Product A, and included in cost of goods sold. income for the CFC inclusion year. For $1,200x is capitalized to inventory of Product Therefore, under paragraph (d)(3) of this purposes of the preceding sentence, A, the gross income or loss from the sale of section, FS’s dual use ratio with respect to which is taken into account in determining the warehouse for Year 1 is 80%, which is specified tangible property of a tested FS’s tested income for Year 1, and $300x is FS’s depreciation with respect to the income CFC is used in the production capitalized to inventory of Product A, the warehouse that is capitalized to inventory of of gross tested income and the gross income or loss from the sale of which Product A, the gross income or loss from the production of gross income that is not is taken into account in determining FS’s sale of which is taken into account in gross tested income for a CFC inclusion foreign base company sales income for Year determining in FS’s tested income for Year 1 year if less than all of the depreciation 1. The trucks have an average adjusted basis ($1,200x), divided by FS’s depreciation with or cost recovery allowance with respect for Year 1 of $4,000x. FS does not capitalize respect to the warehouse that is capitalized to the property is either allocated and depreciation with respect to the trucks to to inventory of Product A, the gross income inventory or other property held for sale. FS’s apportioned to the gross tested income or loss from the sale of which is taken into depreciation deduction with respect to the account in determining FS’s income for Year of the tested income CFC for the CFC trucks is $20x for Year 1, $15x of which is 1 ($1,500x). Accordingly, under paragraph inclusion year under § 1.951A–2(c)(3) or allocated and apportioned to FS’s gross (d)(1) of this section, $16,000x ($20,000x × capitalized to inventory or other tested income under § 1.951A–2(c)(3). 0.8) of FS’s average adjusted basis in the property held for sale, the gross income (ii) Analysis—(A) Dual use property. The warehouse is taken into account under or loss from the sale of which is taken warehouse and trucks are property for which paragraph (b) of this section in determining into account in determining the tested the depreciation deduction provided by FS’s qualified business asset investment for income of the tested income CFC for the section 167(a) is eligible to be determined Year 1. under section 168 (without regard to section CFC inclusion year. 168(f)(1), (2), or (5), section 168(k)(2)(A)(i)(II), (e) Determination of adjusted basis in (3) Dual use ratio. The term dual use (IV), or (V), and the date placed in service). specified tangible property—(1) In ratio means, with respect to dual use Therefore, under paragraph (c)(2) of this general. Except as provided in property, a tested income CFC, and a section, the warehouse and trucks are paragraph (e)(3)(ii) of this section, the CFC inclusion year, a ratio (expressed as tangible property. Furthermore, because the adjusted basis in specified tangible a percentage) calculated as— warehouse and trucks are used in the property for purposes of this section is (i) The sum of— production of gross tested income in Year 1 determined by using the cost within the meaning of paragraph (c)(1) of this (A) The depreciation deduction or capitalization methods of accounting cost recovery allowance with respect to section, the warehouse and trucks are specified tangible property. Finally, because used by the controlled foreign the property that is allocated and the warehouse and trucks are used in both corporation for purposes of determining apportioned to the gross tested income the production of gross tested income and the the gross income and allowable of the tested income CFC for the CFC production of gross income that is not gross deductions of the controlled foreign inclusion year under § 1.951A–2(c)(3), tested income in Year 1 within the meaning corporation under § 1.951A–2(c)(2) and and of paragraph (d)(2) of this section, the the alternative depreciation system (B) The depreciation or cost recovery warehouse and trucks are dual use property. under section 168(g), and by allocating allowance with respect to the property Therefore, under paragraph (d)(1) of this the depreciation deduction with respect section, the amount of FS’s adjusted basis in that is capitalized to inventory or other to such property for a CFC inclusion property held for sale, the gross income the warehouse and trucks that is treated as adjusted basis in specified tangible property year ratably to each day during the or loss from the sale of which is taken for Year 1 is determined by multiplying FS’s period in the CFC inclusion year to into account in determining the tested adjusted basis in the warehouse and trucks which such depreciation relates. For income of the tested income CFC for the by FS’s dual use ratio with respect to the purposes of the preceding sentence, the CFC inclusion year, divided by warehouse and trucks determined under period in the CFC inclusion year to (ii) The sum of— paragraph (d)(3) of this section. which such depreciation relates is (A) The total amount of the tested (B) Depreciation not capitalized to determined without regard to the income CFC’s depreciation deduction or inventory. Because none of the depreciation applicable convention under section with respect to the trucks is capitalized to cost recovery allowance with respect to 168(d). the property for the CFC inclusion year, inventory or other property held for sale, FS’s dual use ratio with respect to the trucks is (2) Effect of change in law. The and determined entirely by reference the adjusted basis in specified tangible (B) The total amount of the tested depreciation deduction with respect to the property is determined without regard income CFC’s depreciation or cost trucks. Therefore, under paragraph (d)(3) of to any provision of law enacted after recovery allowance with respect to the this section, FS’s dual use ratio with respect December 22, 2017, unless such later property capitalized to inventory or to the trucks for Year 1 is 75%, which is FS’s enacted law specifically and directly other property held for sale, the gross depreciation deduction with respect to the amends the definition of qualified income or loss from the sale of which trucks that is allocated and apportioned to business asset investment under section gross tested income under § 1.951A–2(c)(3) is taken into account in determining the 951A. income or loss of the tested income CFC for Year 1 ($15x), divided by the total amount of FS’s depreciation deduction with respect (3) Specified tangible property placed for the CFC inclusion year. to the trucks for Year 1 ($20x). Accordingly, in service before enactment of section (4) Example. The following example under paragraph (d)(1) of this section, 951A—(i) In general. Except as provided illustrates the application of this paragraph $3,000x ($4,000x × 0.75) of FS’s average in paragraph (e)(3)(ii) of this section, the (d). adjusted bases in the trucks is taken into adjusted basis in specified tangible (i) Facts. FS is a tested income CFC and a account under paragraph (b) of this section property placed in service before wholesale distributor of Product A. FS owns in determining FS’s qualified business asset December 22, 2017, is determined using a warehouse and trucks that store and deliver investment for Year 1. the alternative depreciation system Product A, respectively. The warehouse has (C) Depreciation capitalized to inventory. an average adjusted basis for Year 1 of Because all of the depreciation with respect under section 168(g), as if this system $20,000x. The depreciation with respect to to the warehouse is capitalized to inventory, had applied from the date that the the warehouse for Year 1 is $2,000x, which FS’s dual use ratio with respect to the property was placed in service. is capitalized to inventory of Product A. Of warehouse is determined entirely by (ii) Election to use income and the $2,000x depreciation capitalized to reference to the depreciation with respect to earnings and profits depreciation

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method for property placed in service (e)(3) only if the shareholder determined $275x as of July 15, $500x as of September before the first taxable year beginning the adjusted basis in specified tangible 30, and $450x as of December 31. after December 22, 2017—(A) In property placed in service before the (ii) Analysis—(A) Determination of short general. If a controlled foreign first taxable year beginning after taxable years and quarters. FS has two short taxable years in Year 1. The first short taxable corporation is not required to use, and December 22, 2017, by applying the year is from January 1 to July 15, with two does not in fact use, the alternative method described in paragraph full quarters (January 1 through March 31 depreciation system under section (e)(3)(ii)(A) of this section with respect and April 1 through June 30) and one short 168(g) for purposes of determining to the first taxable year of the controlled quarter (July 1 through July 15). The second income under § 1.952–2 and earnings foreign corporation beginning after taxable year is from July 16 to December 31, and profits under § 1.964–1 with respect December 22, 2017, and each with one short quarter (July 16 through to property placed in service before the subsequent taxable year. The election September 30) and one full quarter (October first taxable year beginning after statement must be filed in accordance 1 through December 31). (B) Calculation of qualified business asset December 22, 2017, and the controlling with the rules provided in forms or investment for the first short taxable year. domestic shareholders (as defined in instructions. Under paragraph (f)(2) of this section, for the § 1.964–1(c)(5)) of the controlled foreign (f) Special rules for short taxable first short taxable year in Year 1, FS has three corporation make an election described years—(1) In general. In the case of a quarter closes (March 31, June 30, and July in this paragraph (e)(3)(ii), the adjusted tested income CFC that has a CFC 15). Under paragraph (f)(3) of this section, the basis in specified tangible property of inclusion year that is less than twelve qualified business asset investment of FS for the controlled foreign corporation that months (a short taxable year), the rules the first short taxable year is $148.80x, the was placed in service before the first for determining the qualified business sum of $137.50x (($250x + $300x)/4) asset investment of the tested income attributable to the two full quarters and taxable year of the controlled foreign $11.30x ($275x × 15/365) attributable to the corporation beginning after December CFC under this section are modified as short quarter. 22, 2017, and the partner adjusted basis provided in paragraphs (f)(2) and (3) of (C) Calculation of qualified business asset in partnership specified tangible this section with respect to the CFC investment for the second short taxable year. property of any partnership of which inclusion year. Under paragraph (f)(2) of this section, for the the controlled foreign corporation is a (2) Determination of quarter closes. second short taxable year in Year 1, FS has partner that was placed in service before For purposes of determining quarter two quarter closes (September 30 and the first taxable year of the partnership closes, in determining the qualified December 31). Under paragraph (f)(3) of this beginning after December 22, 2017, is business asset investment of a tested section, the qualified business asset income CFC for a short taxable year, the investment of FS for the second short taxable determined for purposes of this section year is $217.98x, the sum of $112.50x based on the method of accounting for quarters of the tested income CFC for ($450x/4) attributable to the one full quarter depreciation used by the controlled purposes of this section are the full and $105.48x ($500x × 77/365) attributable to foreign corporation for purposes of quarters beginning and ending within the short quarter. the short taxable year (if any), determining income under § 1.952–2, (g) Partnership property—(1) In determining quarter length as if the subject to the modification described in general. If a tested income CFC holds an tested income CFC did not have a short this paragraph (e)(3)(ii)(A). If the interest in one or more partnerships taxable year, plus one or more short controlled foreign corporation’s method during a CFC inclusion year (including of accounting for depreciation takes into quarters (if any). (3) Reduction of qualified business indirectly through one or more account salvage value of the property, partnerships that are partners in a the salvage value is reduced to zero by asset investment. The qualified business asset investment of a tested income CFC lower-tier partnership), the qualified allocating the salvage value ratably to business asset investment of the tested each day of the taxable year for a short taxable year is the sum of— (i) The sum of the tested income income CFC for the CFC inclusion year immediately after the last taxable year (determined without regard to this in which the method of accounting CFC’s aggregate adjusted bases in specified tangible property as of the paragraph (g)(1)) is increased by the sum determined an amount of depreciation of the tested income CFC’s partnership deduction for the property. close of each full quarter (if any) in the CFC inclusion year divided by four, QBAI with respect to each partnership (B) Manner of making the election. plus for the CFC inclusion year. A tested loss The controlling domestic shareholders (ii) The tested income CFC’s aggregate CFC has no partnership QBAI for a CFC making the election described in this adjusted bases in specified tangible inclusion year. paragraph (e)(3) must file a statement property as of the close of each short (2) Determination of partnership that meets the requirements of § 1.964– quarter (if any) in the CFC inclusion QBAI. For purposes of paragraph (g)(1) 1(c)(3)(ii) with their income tax returns year multiplied by the sum of the of this section, the term partnership for the taxable year that includes the last number of days in each short quarter QBAI means, with respect to a day of the controlled foreign divided by 365. partnership, a tested income CFC, and a corporation’s applicable taxable year CFC inclusion year, the sum of the and follow the notice requirements of (4) Example. The following example tested income CFC’s partner adjusted § 1.964–1(c)(3)(iii). The controlled illustrates the application of this paragraph (f). basis in each partnership specified foreign corporation’s applicable taxable (i) Facts. USP1, a domestic corporation, tangible property of the partnership for year is the first CFC inclusion year that owns all of the stock of FS, a controlled each partnership taxable year that ends begins after December 31, 2017, and foreign corporation. USP1 owns FS from the with or within the CFC inclusion year. ends within the controlling domestic beginning of Year 1. On July 15, Year 1, USP1 If a partnership taxable year is less than shareholder’s taxable year. For purposes sells FS to USP2, an unrelated person. USP2 twelve months, the principles of of § 301.9100–3 of this chapter makes a section 338(g) election with respect paragraph (f) of this section apply in (addressing requests for extensions of to the purchase of FS, as a result of which FS’s taxable year is treated as ending on July determining a tested income CFC’s time for filing certain regulatory 15. USP1, USP2, and FS all use the calendar partnership QBAI with respect to the elections), a controlling domestic year as their taxable year. FS’s aggregate partnership. shareholder is qualified to make the adjusted bases in specified tangible property (3) Determination of partner adjusted election described in this paragraph is $250x as of March 31, $300x as of June 30, basis—(i) In general. For purposes of

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paragraph (g)(2) of this section, the term partnership adjusted basis in the the property for the partnership taxable partner adjusted basis means the property for the partnership taxable year year, and amount described in paragraph (g)(3)(ii) and the tested income CFC’s partner- (2) The total amount of the of this section with respect to sole use specific QBAI basis in the property for partnership’s depreciation or cost partnership property or paragraph the partnership taxable year, multiplied recovery allowance with respect to the (g)(3)(iii) of this section with respect to by the tested income CFC’s dual use property capitalized to inventory or dual use partnership property. The ratio with respect to the property for the other property held for sale, the gross principles of section 706(d) apply to this partnership taxable year determined income or loss from the sale of which determination. under the principles of paragraph (d)(3) is taken into account in determining the (ii) Sole use partnership property— of this section, except that the ratio partnership’s income or loss for the (A) In general. The amount described in described in paragraph (d)(3) of this partnership taxable year. this paragraph (g)(3)(ii), with respect to section is determined by reference to the (5) Definition of partnership specified sole use partnership property, a tested income CFC’s distributive share tangible property. The term partnership partnership taxable year, and a tested of the amounts described in paragraph specified tangible property means, with income CFC, is the sum of the tested (d)(3) of this section. respect to a tested income CFC, tangible income CFC’s proportionate share of the (B) Definition of dual use partnership property (as defined in paragraph (c)(2) partnership adjusted basis in the sole property. The term dual use partnership of this section) of a partnership that is— use partnership property for the property means partnership specified (i) Used in the trade or business of the partnership taxable year and the tested tangible property other than sole use partnership, (ii) Of a type with respect to which a income CFC’s partner-specific QBAI partnership property. basis in the sole use partnership deduction is allowable under section (4) Determination of proportionate 167, and property for the partnership taxable share of the partnership’s adjusted basis year. (iii) Used in the production of gross in partnership specified tangible income included in the tested income (B) Definition of sole use partnership property—(i) In general. For purposes of property. The term sole use partnership CFC’s gross tested income. paragraph (g)(3) of this section, the (6) Determination of partnership property means, with respect to a tested income CFC’s proportionate share partnership, a partnership taxable year, adjusted basis. For purposes of this of the partnership adjusted basis in and a tested income CFC, partnership paragraph (g), the term partnership partnership specified tangible property specified tangible property of the adjusted basis means, with respect to a for a partnership taxable year is the partnership that is used in the partnership, partnership specified partnership adjusted basis in the production of only gross tested income tangible property, and a partnership property multiplied by the tested of the tested income CFC for the CFC taxable year, the amount equal to the income CFC’s proportionate share ratio inclusion year in which or with which average of the partnership’s adjusted with respect to the property for the the partnership taxable year ends. For basis in the partnership specified partnership taxable year. Solely for purposes of the preceding sentence, tangible property as of the close of each purposes of determining the partnership specified tangible property quarter in the partnership taxable year of a partnership is used in the proportionate share ratio under determined without regard to any production of only gross tested income paragraph (g)(4)(ii) of this section, the adjustments under section 734(b) except for a CFC inclusion year if all the tested partnership’s calculation of, and a for adjustments under section income CFC’s distributive share of the partner’s distributive share of, any 734(b)(1)(B) or section 734(b)(2)(B) that partnership’s depreciation deduction or income, loss, depreciation, or cost are attributable to distributions of cost recovery allowance with respect to recovery allowance is determined under tangible property (as defined in the property (if any) for the partnership section 704(b). paragraph (c)(2) of this section) and for taxable year that ends with or within the (ii) Proportionate share ratio. The adjustments under section 734(b)(1)(A) CFC inclusion year is allocated and term proportionate share ratio means, or 734(b)(2)(A). The principles of apportioned to the tested income CFC’s with respect to a partnership, a paragraphs (e) and (h) of this section gross tested income for the CFC partnership taxable year, and a tested apply for purposes of determining a inclusion year under § 1.951A–2(c)(3) income CFC, the ratio (expressed as a partnership’s adjusted basis in and, if any of the partnership’s percentage) calculated as— partnership specified tangible property depreciation or cost recovery allowance (A) The sum of— and the proportionate share of the with respect to the property is (1) The tested income CFC’s partnership’s adjusted basis in capitalized to inventory or other distributive share of the partnership’s partnership specified tangible property. property held for sale, all the tested depreciation deduction or cost recovery (7) Determination of partner-specific income CFC’s distributive share of the allowance with respect to the property QBAI basis. For purposes of this partnership’s gross income or loss from for the partnership taxable year, and paragraph (g), the term partner-specific the sale of such inventory or other (2) The amount of the partnership’s QBAI basis means, with respect to a property for the partnership taxable year depreciation or cost recovery allowance tested income CFC, a partnership, and that ends with or within the CFC with respect to the property that is partnership specified tangible property, inclusion year is taken into account in capitalized to inventory or other the amount that is equal to the average determining the tested income of the property held for sale, the gross income of the basis adjustment under section tested income CFC for the CFC or loss from the sale of which is taken 743(b) that is allocated to the inclusion year. into account in determining the tested partnership specified tangible property (iii) Dual use partnership property— income CFC’s distributive share of the of the partnership with respect to the (A) In general. The amount described in partnership’s income or loss for the tested income CFC as of the close of this paragraph (g)(3)(iii), with respect to partnership taxable year, divided by each quarter in the partnership taxable dual use partnership property, a (B) The sum of— year. For this purpose, a negative basis partnership taxable year, and a tested (1) The total amount of the adjustment under section 743(b) is income CFC, is the sum of the tested partnership’s depreciation deduction or expressed as a negative number. The income CFC’s proportionate share of the cost recovery allowance with respect to principles of paragraphs (e) and (h) of

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this section apply for purposes of 1 is 80%, which is the ratio of FC’s section Asset D capitalized to inventory of Product determining the partner-specific QBAI 704(b) distributive share of PRS’s section A is capitalized to ending inventory. basis with respect to partnership 704(b) depreciation deduction with respect to However, of the $40x capitalized to inventory specified tangible property. Asset A for Year 1 ($8x), divided by the total of Product B, $10x is capitalized to ending amount of PRS’s section 704(b) depreciation inventory. Therefore, the amount of (8) Examples. The following examples deduction with respect to Asset A for Year depreciation with respect to Asset D illustrate the rules of this paragraph (g). 1 ($10x). FC’s proportionate share ratio with capitalized to inventory of Product A that is (i) Facts. Except as otherwise stated, respect to Asset B for Year 1 is 20%, which taken into account in determining FC’s the following facts are assumed for is the ratio of FC’s section 704(b) distributive distributive share of the income or loss of purposes of the examples: share of PRS’s section 704(b) depreciation PRS for Year 1 is $5x ($10x × 0.5), and the (A) FC, FC1, FC2, and FC3 are tested deduction with respect to Asset B for Year 1 amount of depreciation with respect to Asset income CFCs. ($1x), divided by the total amount of PRS’s D capitalized to inventory of Product B that (B) PRS is a partnership and its section 704(b) depreciation deduction with is taken into account in determining FC’s respect to Asset B for Year 1 ($5x). distributive share of the income or loss of allocations satisfy the requirements of Accordingly, under paragraph (g)(4)(i) of this PRS for Year 1 is $15x ($30x × 0.5). section 704. section, FC’s proportionate share of PRS’s (3) Asset E. The average of PRS’s adjusted (C) All properties are partnership partnership adjusted basis in Asset A is $80x basis as of the close of each quarter of PRS’s specified tangible property. ($100x × 0.8), and FC’s proportionate share taxable year in Asset E is $600x. In Year 1, (D) All persons use the calendar year of PRS’s partnership adjusted basis in Asset PRS’s depreciation is $60x with respect to as their taxable year. B is $100x ($500x × 0.2). Asset E. Of the $60x depreciation with (E) There is neither disqualified basis (3) Partner adjusted basis. Because FC has respect to Asset E, $20x is allowed as a nor partner-specific QBAI basis with no partner-specific QBAI basis with respect deduction, $24x is capitalized to inventory of to Asset A and Asset B, FC’s partner adjusted Product A, and $16x is capitalized to respect to any property. basis in Asset A and Asset B is determined inventory of Product B. FC’s distributive (ii) Example 1: Sole use partnership entirely by reference to its proportionate share of the depreciation deduction with property—(A) Facts. FC is a partner in PRS. share of PRS’s partnership adjusted basis in respect to Asset E is $10x ($20x × 0.5), $8x PRS owns two properties, Asset A and Asset Asset A and Asset B. Therefore, under of which is allocated and apportioned to FC’s B. The average of PRS’s adjusted basis as of paragraph (g)(3)(ii)(A) of this section, FC’s gross tested income under § 1.951A–2(c)(3). the close of each quarter of PRS’s taxable year partner adjusted basis in Asset A is $80x, None of the $24x depreciation with respect in Asset A is $100x and in Asset B is $500x. FC’s proportionate share of PRS’s partnership to Asset E capitalized to inventory of Product In Year 1, PRS’s section 704(b) depreciation adjusted basis in Asset A, and FC’s partner A is capitalized to ending inventory. deduction is $10x with respect to Asset A adjusted basis in Asset B is $100x, FC’s However, of the $16x depreciation with and $5x with respect to Asset B, and FC’s proportionate share of PRS’s partnership respect to Asset E capitalized to inventory of section 704(b) distributive share of the adjusted basis in Asset A. Product B, $10x is capitalized to ending depreciation deduction is $8x with respect to (4) Partnership QBAI. Under paragraph inventory. Therefore, the amount of Asset A and $1x with respect to Asset B. (g)(2) of this section, FC’s partnership QBAI depreciation with respect to Asset E None of the depreciation with respect to with respect to PRS is $180x, the sum of FC’s capitalized to inventory of Product A that is Asset A or Asset B is capitalized to inventory partner adjusted basis in Asset A ($80x) and taken into account in determining FC’s or other property held for sale. FC’s entire FC’s partner adjusted basis in Asset B distributive share of the income or loss of distributive share of the depreciation ($100x). Accordingly, under paragraph (g)(1) PRS for Year 1 is $12x ($24x × 0.5), and the deduction with respect to Asset A and Asset of this section, FC increases its qualified amount of depreciation with respect to Asset B is allocated and apportioned to FC’s gross business asset investment for Year 1 by E capitalized to inventory of Product B that tested income for Year 1 under § 1.951A– $180x. is taken into account in determining FC’s 2(c)(3). (iii) Example 2: Dual use partnership distributive share of the income or loss of (B) Analysis—(1) Sole use partnership property—(A) Facts. FC owns a 50% interest PRS for Year 1 is $3x ($6x × 0.5). property. Because all of FC’s distributive in PRS. All section 704(b) and tax items are (B) Analysis. Because Asset C, Asset D, and share of the depreciation deduction with identical and are allocated equally between Asset E are not used in the production of respect to Asset A and B is allocated and FC and its other partner. PRS owns three only gross tested income in Year 1 within the apportioned to gross tested income for Year properties, Asset C, Asset D, and Asset E. meaning of paragraph (g)(3)(ii)(B) of this 1, Asset A and Asset B are sole use PRS sells two products, Product A and section, Asset C, Asset D, and Asset E are partnership property within the meaning of Product B. All of FC’s distributive share of partnership dual use property within the paragraph (g)(3)(ii)(B) of this section. the gross income or loss from the sale of meaning of paragraph (g)(3)(iii)(B) of this Therefore, under paragraph (g)(3)(ii)(A) of Product A is taken into account in section. Therefore, under paragraph this section, FC’s partner adjusted basis in determining FC’s tested income, and none of (g)(3)(iii)(A) of this section, FC’s partner Asset A and Asset B is equal to the sum of FC’s distributive share of the gross income or adjusted basis in Asset C, Asset D, and Asset FC’s proportionate share of PRS’s partnership loss from the sale of Product B is taken into E is the sum of FC’s proportionate share of adjusted basis in Asset A and Asset B for account in determining FC’s tested income. PRS’s partnership adjusted basis in Asset C, Year 1 and FC’s partner-specific QBAI basis (1) Asset C. The average of PRS’s adjusted Asset D, and Asset E, respectively, for Year in Asset A and Asset B for Year 1, basis as of the close of each quarter of PRS’s 1, and FC’s partner-specific QBAI basis in respectively. taxable year in Asset C is $100x. In Year 1, Asset C, Asset D, and Asset E, respectively, (2) Proportionate share. Under paragraph PRS’s depreciation is $10x with respect to for Year 1, multiplied by FC’s dual use ratio (g)(4)(i) of this section, FC’s proportionate Asset C, none of which is capitalized to with respect to Asset C, Asset D, and Asset share of PRS’s partnership adjusted basis in inventory or other property held for sale. E, respectively, for Year 1, determined under Asset A and Asset B is PRS’s partnership FC’s distributive share of the depreciation the principles of paragraph (d)(3) of this adjusted basis in Asset A and Asset B for deduction with respect to Asset C is $5x section, except that the ratio described in Year 1, multiplied by FC’s proportionate ($10x × 0.5), $3x of which is allocated and paragraph (d)(3) of this section is determined share ratio with respect to Asset A and Asset apportioned to FC’s gross tested income by reference to FC’s distributive share of the B for Year 1, respectively. Because none of under § 1.951A–2(c)(3). amounts described in paragraph (d)(3) of this the depreciation with respect to Asset A or (2) Asset D. The average of PRS’s adjusted section. Asset B is capitalized to inventory or other basis as of the close of each quarter of PRS’s (1) Asset C—(i) Proportionate share. Under property held for sale, FC’s proportionate taxable year in Asset D is $500x. In Year 1, paragraph (g)(4)(i) of this section, FC’s share ratio with respect to Asset A and Asset PRS’s depreciation is $50x with respect to proportionate share of PRS’s partnership B is determined entirely by reference to the Asset D, $10x of which is capitalized to adjusted basis in Asset C is PRS’s partnership depreciation deduction with respect to Asset inventory of Product A and $40x is adjusted basis in Asset C for Year 1, A and Asset B. Therefore, FC’s proportionate capitalized to inventory of Product B. None multiplied by FC’s proportionate share ratio share ratio with respect to Asset A for Year of the $10x depreciation with respect to with respect to Asset C for Year 1. Because

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none of the depreciation with respect to ($40x). Accordingly, under paragraph (g)(4)(i) (ii) Dual use ratio. Because the Asset C is capitalized to inventory or other of this section, FC’s proportionate share of depreciation with respect to Asset E is partly property held for sale, FC’s proportionate PRS’s partnership adjusted basis in Asset D deducted and partly capitalized to inventory, share ratio with respect to Asset C is is $250x ($500x × 0.5). FC’s dual use ratio with respect to Asset E determined entirely by reference to the (ii) Dual use ratio. Because all of the is determined by reference to the depreciation deduction with respect to Asset depreciation with respect to Asset D is depreciation that is deducted and the C. Therefore, FC’s proportionate share ratio capitalized to inventory, FC’s dual use ratio depreciation that is capitalized to inventory with respect to Asset C is 50%, which is the with respect to Asset D is determined and included in cost of goods sold. ratio calculated as the amount of FC’s section entirely by reference to the depreciation with Therefore, FC’s dual use ratio with respect to 704(b) distributive share of PRS’s section respect to Asset D that is capitalized to Asset E is 80%, which is the ratio calculated 704(b) depreciation deduction with respect to inventory and included in cost of goods sold. as the sum ($20x) of the amount of FC’s Asset C for Year 1 ($5x), divided by the total Therefore, FC’s dual use ratio with respect to distributive share of PRS’s depreciation amount of PRS’s section 704(b) depreciation Asset D is 25%, which is the ratio calculated deduction with respect to Asset E that is deduction with respect to Asset C for Year 1 as the amount of depreciation with respect to allocated and apportioned to FC’s gross ($10x). Accordingly, under paragraph (g)(4)(i) Asset D capitalized to inventory of Product tested income under § 1.951A–2(c)(3) for of this section, FC’s proportionate share of A and Product B that is taken into account Year 1 ($8x) and the amount of depreciation PRS’s partnership adjusted basis in Asset C in determining FC’s tested income for Year with respect to Asset E capitalized to is $50x ($100x × 0.5). 1 ($5x), divided by the total amount of inventory of Product A and Product B that is (ii) Dual use ratio. Because none of the depreciation with respect to Asset D taken into account in determining FC’s tested depreciation with respect to Asset C is capitalized to inventory of Product A and income for Year 1 ($12x), divided by the sum capitalized to inventory or other property Product B that is taken into account in ($25x) of the total amount of FC’s distributive held for sale, FC’s dual use ratio with respect determining FC’s income or loss for Year 1 share of PRS’s depreciation deduction with to Asset C is determined entirely by reference ($20x). respect to Asset E for Year 1 ($10x) and the to the depreciation deduction with respect to (iii) Partner adjusted basis. Because FC has total amount of depreciation with respect to Asset C. Therefore, FC’s dual use ratio with no partner-specific QBAI basis with respect Asset E capitalized to inventory of Product A respect to Asset C is 60%, which is the ratio to Asset D, FC’s partner adjusted basis in and Product B that is taken into account in calculated as the amount of FC’s distributive Asset D is determined entirely by reference determining FC’s income or loss for Year 1 share of PRS’s depreciation deduction with to FC’s proportionate share of PRS’s ($15x). respect to Asset C that is allocated and partnership adjusted basis in Asset D, (iii) Partner adjusted basis. Because FC has apportioned to FC’s gross tested income multiplied by FC’s dual use ratio with no partner-specific QBAI basis with respect under § 1.951A–2(c)(3) for Year 1 ($3x), respect to Asset D. Under paragraph to Asset E, FC’s partner adjusted basis in divided by the total amount of FC’s (g)(3)(iii)(A) of this section, FC’s partner Asset E is determined entirely by reference distributive share of PRS’s depreciation adjusted basis in Asset D is $62.50x, FC’s to FC’s proportionate share of PRS’s deduction with respect to Asset C for Year 1 proportionate share of PRS’s partnership partnership adjusted basis in Asset E, ($5x). adjusted basis in Asset D for Year 1 ($250x), multiplied by FC’s dual use ratio with (iii) Partner adjusted basis. Because FC has multiplied by FC’s dual use ratio with respect to Asset E. Under paragraph no partner-specific QBAI basis with respect respect to Asset D for Year 1 (25%). (g)(3)(iii)(A) of this section, FC’s partner to Asset C, FC’s partner adjusted basis in (4) Asset E—(i) Proportionate share. Under adjusted basis in Asset E is $240x, FC’s Asset C is determined entirely by reference paragraph (g)(4)(i) of this section, FC’s proportionate share of PRS’s partnership to FC’s proportionate share of PRS’s proportionate share of PRS’s partnership adjusted basis in Asset E for Year 1 ($300x), partnership adjusted basis in Asset C, adjusted basis in Asset E is PRS’s partnership multiplied by FC’s dual use ratio with multiplied by FC’s dual use ratio with adjusted basis in Asset E for Year 1, respect to Asset E for Year 1 (80%). respect to Asset C. Under paragraph multiplied by FC’s proportionate share ratio (5) Partnership QBAI. Under paragraph (g)(3)(iii)(A) of this section, FC’s partner with respect to Asset E for Year 1. Because (g)(2) of this section, FC’s partnership QBAI adjusted basis in Asset C is $30x, FC’s the depreciation with respect to Asset E is with respect to PRS is $332.50x, the sum of proportionate share of PRS’s partnership partly deducted and partly capitalized to FC’s partner adjusted basis in Asset C ($30x), adjusted basis in Asset C for Year 1 ($50x), inventory, FC’s proportionate share ratio FC’s partner adjusted basis in Asset D multiplied by FC’s dual use ratio with with respect to Asset E is determined by ($62.50x), and FC’s partner adjusted basis in respect to Asset C for Year 1 (60%). reference to both the depreciation that is Asset E ($240x). Accordingly, under (3) Asset D—(i) Proportionate share. Under deducted and the depreciation that is paragraph (g)(1) of this section, FC increases paragraph (g)(4)(i) of this section, FC’s capitalized to inventory and included in cost its qualified business asset investment for proportionate share of PRS’s partnership of goods sold. Therefore, FC’s proportionate Year 1 by $332.50x. adjusted basis in Asset D is PRS’s partnership share ratio with respect to Asset E is 50%, (iv) Example 3: Sole use partnership adjusted basis in Asset D for Year 1, which is the ratio calculated as the sum specified tangible property; section 743(b) multiplied by FC’s proportionate share ratio ($25x) of the amount of FC’s section 704(b) adjustments—(A) Facts. The facts are the with respect to Asset D for Year 1. Because distributive share of PRS’s section 704(b) same as in paragraph (g)(8)(ii)(A) of this all of the depreciation with respect to Asset depreciation deduction with respect to Asset section (the facts in Example 1), except that D is capitalized to inventory, FC’s E for Year 1 ($10x) and the amount of PRS’s there is an average of $40x positive proportionate share ratio with respect to section 704(b) depreciation with respect to adjustment to the adjusted basis in Asset A Asset D is determined entirely by reference Asset E capitalized to inventory of Product A as of the close of each quarter of PRS’s to the depreciation with respect to Asset D and Product B that is taken into account in taxable year with respect to FC under section that is capitalized to inventory and included determining FC’s section 704(b) distributive 743(b) and an average of $20x negative in cost of goods sold. Therefore, FC’s share of PRS’s income or loss for Year 1 adjustment to the adjusted basis in Asset B proportionate share ratio with respect to ($15x), divided by the sum ($50x) of the total as of the close of each quarter of PRS’s Asset D is 50%, which is the ratio calculated amount of PRS’s section 704(b) depreciation taxable year with respect to FC under section as the amount of PRS’s section 704(b) deduction with respect to Asset E for Year 1 743(b). depreciation with respect to Asset D ($20x) and the total amount of PRS’s section (B) Analysis. Under paragraph (g)(3)(ii)(A) capitalized to Product A and Product B that 704(b) depreciation with respect to Asset E of this section, FC’s partner adjusted basis in is taken into account in determining FC’s capitalized to inventory of Product A and Asset A is $120x, which is the sum of $80x section 704(b) distributive share of PRS’s Product B that is taken into account in (FC’s proportionate share of PRS’s income or loss for Year 1 ($20x), divided by determining PRS’s section 704(b) income or partnership adjusted basis in Asset A as the total amount of PRS’s section 704(b) loss for Year 1 ($30x). Accordingly, under illustrated in paragraph (g)(8)(ii)(B)(2) of this depreciation with respect to Asset D paragraph (g)(4)(i) of this section, FC’s section (paragraph (B)(2) of the analysis in capitalized to Product A and Product B that proportionate share of PRS’s partnership Example 1)) and $40x (FC’s partner-specific is taken into account in determining PRS’s adjusted basis in Asset E is $300x ($600x × QBAI basis in Asset A). Under paragraph section 704(b) income or loss for Year 1 0.5). (g)(3)(ii)(A) of this section, FC’s partner

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adjusted basis in Asset B is $80x, the sum of share of partnership items of the partnership adjusted basis in specified tangible $100x (FC’s proportionate share of the under section 706(d), FC1 has partnership property is disregarded as of the tested partnership adjusted basis in the property as QBAI with respect to PRS in the amount quarter close if the controlled foreign illustrated in paragraph (g)(8)(ii)(B)(2) of this determined under paragraph (g)(2) of this corporation (acquiring CFC) acquires the section (paragraph (B)(2) of the analysis in section. Under paragraph (g)(3)(i) of this Example 1)) and (¥$20x) (FC’s partner- section, FC1’s partner adjusted basis in Asset property temporarily before the tested specific QBAI basis in Asset B). Therefore, G is $25x, the product of $100x (the quarter close with a principal purpose under paragraph (g)(2) of this section, FC’s partnership’s adjusted basis in the property) of increasing the deemed tangible partnership QBAI with respect to PRS is and 25% (FC1’s section 704(b) distributive income return of a U.S. shareholder $200x ($120x + $80x). Accordingly, under share of depreciation deduction with respect (applicable U.S. shareholder) for a U.S. paragraph (g)(1) of this section, FC increases to Asset G). Therefore, FC1’s partnership shareholder year, and the holding of the its qualified business asset investment for QBAI with respect to PRS is $25x. property by the acquiring CFC as of the Year 1 by $200x. Accordingly, under paragraph (g)(1) of this tested quarter close would, without (v) Example 4: Tested income CFC with section, FC1 increases its qualified business regard to this paragraph (h)(1)(i), distributive share of loss from a asset investment by $25x for Year 1. partnership—(A) Facts. FC owns a 50% (2) FC2. FC2’s partner adjusted basis in increase the deemed tangible income interest in PRS. All section 704(b) and tax Asset G is also $25x, the product of $100x return of the applicable U.S. items are identical and are allocated equally (the partnership’s adjusted basis in the shareholder for the U.S. shareholder between FC and its other partner. PRS owns property) and 25% (FC2’s section 704(b) inclusion year. Asset F. None of the depreciation with distributive share of depreciation deduction (ii) Disregard of first quarter close. respect to Asset F is capitalized to inventory with respect to Asset G). Therefore, FC2’s The adjusted basis in specified tangible or other property held for sale. The average partnership QBAI with respect to PRS is property may be disregarded under of PRS’s adjusted basis as of the close of each $25x. Accordingly, under paragraph (g)(1) of paragraph (h)(1)(i) of this section for quarter of PRS’s taxable year in Asset F is this section, FC2 increases its qualified purposes of multiple tested quarter $220x. PRS has $20x of gross income, a $22x business asset investment by $25x for Year 1. closes that follow an acquisition and on depreciation deduction with respect to Asset (vii) Example 6: Partnership adjusted F, and no other income or expense in Year basis; distribution of property in liquidation which the acquiring CFC holds the 1. FC’s distributive share of the gross income of partnership interest—(A) Facts. FC1, FC2, property. However, if the holding of is $10x, all of which is includible in FC’s and FC3 are equal partners in PRS, a specified tangible property would, gross tested income in Year 1, and FC’s partnership. FC1 and FC2 each has an without regard to paragraph (h)(1)(i) of distributive share of PRS’s depreciation adjusted basis of $100x in its partnership this section, increase the deemed deduction with respect to Asset F is $11x in interest. FC3 has an adjusted basis of $50x in tangible income return of an applicable Year 1, all of which is allocated and its partnership interest. PRS has a section 754 U.S. shareholder because the adjusted apportioned to FC’s gross tested income election in effect. PRS owns Asset H with a basis in such property is taken into under § 1.951A–2(c)(3). FC’s distributive fair market value of $50x and an adjusted basis of $0, Asset I with a fair market value account for only one additional quarter share of loss from PRS is $1x. FC also has $8x close of a tested income CFC of the of gross tested income from other sources in of $100x and an adjusted basis of $100x, and Year 1 and no other deductions. Therefore, Asset J with a fair market value of $150x and applicable U.S. shareholder in FC has tested income of $7x for Year 1. an adjusted basis of $150x. Asset H and Asset determining the deemed tangible (B) Analysis. FC’s partner adjusted basis in J are tangible property, but Asset I is not income return of the applicable U.S. Asset F is $110x, which is the sum of FC’s tangible property. PRS distributes Asset I to shareholder of the U.S. shareholder proportionate share of the partnership FC3 in liquidation of FC3’s interest in PRS. inclusion year, the adjusted basis in the adjusted basis in the property ($220x × 0.5) None of FC1, FC2, FC3, or PRS recognizes property is disregarded for purposes of and FC’s partnership-specific QBAI basis in gain on the distribution. Under section determining the acquiring CFC’s 732(b), FC3’s adjusted basis in Asset I is Asset F ($0). Therefore, FC’s partnership aggregate adjusted bases in specified QBAI with respect to PRS is $110x. $50x. PRS’s adjusted basis in Asset H is increased by $50x to $50x under section tangible property only as of the first Accordingly, under paragraph (g)(1) of this tested quarter close that follows the section, FC increases its qualified business 734(b)(1)(B), which is the amount by which asset investment by $110x, notwithstanding PRS’s adjusted basis in Asset I immediately acquisition. that FC would not be a tested income CFC before the distribution exceeds FC3’s (iii) Safe harbor for certain transfers but for its $8x of gross tested income from adjusted basis in Asset I. involving CFCs. The holding of specified other sources. (B) Analysis. Under paragraph (g)(6) of this tangible property as of a tested quarter (vi) Example 5: Tested income CFC sale of section, PRS’s adjusted basis in Asset H is close does not increase the deemed partnership interest before CFC inclusion determined without regard to any tangible income return of an applicable date—(A) Facts. FC1 owns a 50% interest in adjustments under section 734(b) except for U.S. shareholder within the meaning of PRS on January 1 of Year 1. On July 1 of Year adjustments under section 734(b)(1)(B) or section 734(b)(2)(B) that are attributable to paragraph (h)(1)(i) of this section if each 1, FC1 sells its entire interest in PRS to FC2. of the following conditions is satisfied PRS owns Asset G. The average of PRS’s distributions of tangible property and for adjustments under section 734(b)(1)(A) or with respect to the acquisition and adjusted basis as of the close of each quarter subsequent transfer of property by the of PRS’s taxable year in Asset G is $100x. 734(b)(2)(A). The adjustment to the adjusted FC1’s section 704(b) distributive share of the basis in Asset H is under section 734(b)(1)(B) acquiring CFC— depreciation deduction with respect to Asset and is attributable to the distribution of Asset (A) A controlled foreign corporation G is 25% with respect to PRS’s entire year. I, which is not tangible property. (predecessor CFC) holds the property on FC2’s section 704(b) distributive share of the Accordingly, for purposes of applying a quarter close of the predecessor CFC depreciation deduction with respect to Asset paragraph (g)(1) of this section, PRS’s (preceding quarter close) that occurs on G is also 25% with respect to PRS’s entire adjusted basis in Asset H is $0. the same date as the last quarter close year. Both FC1’s and FC2’s entire distributive (h) Anti-avoidance rules related to of the acquiring CFC preceding the shares of the depreciation deduction with certain transfers of property—(1) acquisition. respect to Asset G are allocated and Disregard of adjusted basis in specified (B) A controlled foreign corporation apportioned under § 1.951A–2(c)(3) to FC1’s tangible property held temporarily—(i) (successor CFC) holds the property on a and FC2’s gross tested income, respectively, for Year 1. PRS’s allocations satisfy section In general. For purposes of determining quarter close of the successor CFC 706(d). a controlled foreign corporation’s (succeeding quarter close) that occurs (B) Analysis—(1) FC1. Because FC1 owns aggregate adjusted bases in specified on the same date as the first quarter an interest in PRS during FC1’s CFC tangible property as of the close of a close of the acquiring CFC following the inclusion year and receives a distributive quarter (tested quarter close), the subsequent transfer.

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(C) The proportion of the stock that presumption described in the preceding satisfied because CFC1, a predecessor CFC, the applicable U.S. shareholder owns sentence may be rebutted only if the held Asset A on September 30, Year 1, a (within the meaning of section 958(a)) of facts and circumstances clearly establish quarter close of CFC1 that occurs on the same the acquiring CFC on the tested quarter that the subsequent transfer of the date as the last quarter close of CFC2, the acquiring CFC, preceding the December 30, close does not exceed the proportion of property by the acquiring CFC was Year 1 acquisition of Asset A. The the stock that the applicable U.S. contemplated when the property was requirement in paragraph (h)(1)(iii)(B) of this shareholder owns of either the acquired by the acquiring CFC and that section is satisfied because CFC3, a successor predecessor CFC on the preceding a principal purpose of the acquisition of CFC, holds Asset A on June 30, Year 2, a quarter close or the successor CFC on the property was to increase the deemed quarter close of CFC3 that occurs on the same the succeeding quarter close; and tangible income return of the applicable date as the first quarter close of CFC2 (D) Each of the predecessor CFC and U.S. shareholder for a U.S. shareholder following April 10, Year 2, the date of the the successor CFC is a tested income inclusion year. subsequent transfer of Asset A. The requirement in paragraph (h)(1)(iii)(C) of this CFC for its CFC inclusion year that (v) Determination of holding period. includes the date of the tested quarter section is satisfied because the proportion of For purposes of this paragraph (h)(1), stock that USP, the applicable U.S. close. the period during which an acquiring shareholder, owns (within the meaning of (iv) Determination of principal CFC holds specified tangible property is section 958(a)) of CFC2, the acquiring CFC, purpose and transitory holding—(A) determined without regard to section on each of the December 31, Year 1 tested Presumption for ownership less than 12 1223. quarter close and the March 31, Year 2 tested months. For purposes of paragraph (vi) Treatment as single applicable quarter close (100%), does not exceed the (h)(1)(i) of this section, specified U.S. shareholder. For purposes of this proportion of the stock that USP owns of either CFC1 (100%) on the preceding quarter tangible property is presumed to be paragraph (h)(1), all U.S. persons that acquired temporarily with a principal close (September 30, Year 1) or of CFC3 are related persons are treated as a (100%) on the succeeding quarter close (June purpose of increasing the deemed single applicable U.S. shareholder. For tangible income return of an applicable 30, Year 2). Finally, the requirement in purposes of the preceding sentence, U.S. paragraph (h)(1)(iii)(D) of this section is U.S. shareholder for a U.S. shareholder persons are related if they bear a satisfied because each of CFC1 and CFC3 is inclusion year if the property is held by relationship described in section 267(b) a tested income CFC for Year 1 and Year 2, the acquiring CFC for less than 12 or 707(b) immediately before or the CFC inclusion years that include the months and the holding of the property immediately after a transaction. December 31, Year 1 tested quarter close and by the acquiring CFC as of the tested (vii) Examples. The following the March 31, Year 2 tested quarter close. Accordingly, paragraph (h)(1)(i) of this quarter close would have the effect of examples illustrate the application of increasing the deemed tangible income section does not apply to disregard the this paragraph (h)(1). adjusted basis in Asset A in determining return of the applicable U.S. (A) Facts. Except as otherwise stated, shareholder for a U.S. shareholder CFC2’s aggregate adjusted basis in specified the following facts are assumed for inclusion year. The presumption tangible property as of December 31, Year 1, purposes of the examples: or March 30, Year 2. described in the preceding sentence (1) USP is a domestic corporation. (C) Example 2: Transfers between CFCs may be rebutted only if the facts and (2) CFC1, CFC2 and CFC3 are tested with different taxable year ends—(1) Facts. circumstances clearly establish that the income CFCs. The facts are the same as in paragraph subsequent transfer of the property by (3) R is unrelated to USP. (h)(1)(vii)(B)(1) of this section (the facts in the acquiring CFC was not contemplated Example 1), except that CFC1 has a taxable (4) All persons use the calendar year when the property was acquired by the year ending November 30, and the facts and as their taxable year. acquiring CFC and that a principal circumstances do not clearly establish that (5) Asset A is specified tangible purpose of the acquisition of the the April 10, Year 2 transfer of Asset A by property was not to increase the deemed property. CFC2 was not contemplated when Asset A tangible income return of the applicable (6) Both Year 1 and Year 2 begin on was acquired by CFC2 and that a principal purpose of the acquisition of the property U.S. shareholder for a U.S. shareholder or after January 1, 2018, and have 365 days. was not to increase the deemed tangible inclusion year. In order to rebut the income return of USP, the applicable U.S. presumption, a statement must be (7) USP has no specified interest expense (as defined in § 1.951A– shareholder. attached to the Form 5471 filed by the (2) Analysis. CFC2’s holding of Asset A as taxpayer for the taxable year of the CFC 1(c)(3)(iii)). of each of the December 31, Year 1 tested in which the subsequent transfer occurs (B) Example 1: Qualification for safe quarter close and the March 31, Year 2 tested and include any information required harbor—(1) Facts. USP owns all of the stock quarter close does not satisfy the safe harbor by applicable administrative of CFC1, which owns all of the stock of under paragraph (h)(1)(iii) of this section announcements, forms or instructions. CFC2, which owns all the stock of CFC3. As because CFC1, the predecessor CFC, does not The statement must explain the facts of January 1, Year 1, CFC1 owns Asset A, hold Asset A on a quarter close of CFC1 that which is specified tangible property. On occurs on the same date as the September 30, and circumstances supporting the December 30, Year 1, CFC1 transfers Asset A Year 1, quarter close of CFC2, the acquiring rebuttal and be in accordance with any to CFC2. On April 10, Year 2, CFC2 transfers CFC, which is the last quarter close of CFC2 rules provided in forms and Asset A to CFC3. CFC3 holds Asset A for the preceding the December 30, Year 1 instructions. rest of Year 2. acquisition of Asset A. In addition, because (B) Presumption for ownership greater (2) Analysis. Under the safe harbor of CFC2 held Asset A for less than 12 months than 36 months. For purposes of paragraph (h)(1)(iii) of this section, CFC2’s (from December 31, Year 1, until April 10, paragraph (h)(1)(i) of this section, holding of Asset A as of each of the Year 2), the presumption in paragraph specified tangible property is presumed December 31, Year 1 tested quarter close and (h)(1)(iv)(A) of this section applies such that not to be acquired temporarily with a the March 31, Year 2 tested quarter close CFC2 is presumed to have acquired Asset A principal purpose of increasing the does not increase the deemed tangible temporarily with a principal purpose of income return of USP, the applicable United increasing the deemed tangible income deemed tangible income return of an States shareholder, for Year 1 or Year 2 return of USP for the shareholder inclusion applicable U.S. shareholder for a U.S. because each of the requirements in year, and the facts and circumstances do not shareholder inclusion year if the paragraphs (h)(1)(iii)(A) through (D) of this clearly establish that CFC2 did not acquire property is held by the acquiring CFC section is satisfied. The requirement in Asset A with such a principal purpose. for more than 36 months. The paragraph (h)(1)(iii)(A) of this section is Because CFC2 holds Asset A as of December

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31, Year 1, the tested quarter close, the close on November 30, Year 1, and CFC2’s of paragraph (d)(2) of this section and adjusted basis in Asset A would be, without quarter close on December 31, Year 1). If for purposes of determining the dual use regard to paragraph (h)(1)(i) of this section, instead CFC2 had acquired Asset B directly ratio with respect to dual use property taken into account for purposes of from R, the adjusted basis in Asset B would under paragraph (d)(3) of this section, determining USP’s deemed tangible income have been taken into account for purposes of return for its Year 1 taxable year as of five determining USP’s deemed tangible income the rules of § 1.951A–2(c)(5) are not quarter closes (CFC1’s quarter closes on return for its Year 1 taxable year as of only taken into account. February 28, May 31, August 31, and one quarter close (CFC2’s quarter close on (C) Application to partnership November 30, and CFC2’s quarter close on December 31, Year 1). Accordingly, under specified tangible property. In the case December 31). If instead CFC1 had retained paragraph (h)(1)(i) of this section, the of partnership specified tangible Asset A during the period CFC2 temporarily adjusted basis in Asset B is disregarded in property (as defined in paragraph (g)(5) held the asset and had transferred Asset A determining CFC1’s aggregate adjusted basis of this section), paragraph (h)(2)(i)(A) of directly to CFC3 on January 10, Year 2, the in specified tangible property as of November this section applies by reducing a tested adjusted basis in Asset A would have been 30, Year 1. income CFC’s partner adjusted basis taken into account for purposes of (E) Example 4: Acquisitions from tested with respect to partnership specified determining USP’s deemed tangible income loss CFCs—(1) Facts. USP owns all of the return for its Year 1 taxable year as of only stock of CFC1 and CFC2. As of January 1, tangible property under paragraph four quarter closes (CFC1’s quarter closes on Year 1, CFC1 owns Asset C. On March 30, (g)(3)(i) of this section by the tested February 28, May 30, August 30, and Year 1, CFC1 transfers Asset C to CFC2. For income CFC’s share of the disqualified November 30). Under paragraph (h)(1)(ii) of Year 1, CFC1 is a tested loss CFC and CFC2 basis in the partnership specified this section, because the adjusted basis in is a tested income CFC. On March 30, Year tangible property. A tested income Asset A would (without regard to paragraph 2, CFC2 transfers Asset C back to CFC1. For CFC’s share of disqualified basis in (h)(1)(i) of this section) be taken into account Year 2, both CFC1 and CFC2 are tested partnership specified tangible property for only one additional quarter close of a income CFCs. A principal purpose of CFC2 is the sum of the tested income CFC’s tested income CFC of USP in determining holding Asset C as of March 31, Year 1, June proportionate share of the disqualified USP’s deemed tangible income return for 30, Year 1, September 30, Year 1, and basis in the partnership specified Year 1 and Year 2, the adjusted basis in Asset December 31, Year 1, was to increase USP’s A is disregarded for purposes of determining deemed tangible income return. tangible property determined under the CFC’s aggregate adjusted bases in specified (2) Analysis. CFC2’s holding of Asset C as principles of paragraph (g)(4) of this tangible property only as of December 31, of March 31, Year 1, June 30, Year 1, section and the tested income CFC’s Year 1, the first tested quarter close that September 30, Year 1, and December 31, Year partner-specific QBAI basis in the follows the acquisition. Accordingly, under 1 does not satisfy the safe harbor under property determined under the paragraph (h)(1)(i) of this section, the paragraph (h)(1)(iii) of this section because principles of paragraph (g)(7) of this adjusted basis in Asset A is disregarded in CFC1 is not a tested income CFC for Year 1 section that is disqualified basis. For determining CFC2’s aggregate adjusted basis and thus the requirement in paragraph purposes of determining the amount in specified tangible property as of December (h)(1)(iii)(D) of this section is not satisfied. described in paragraph (g)(3)(i) of this 31, Year 1. Because CFC2 acquired Asset C before, and section, including for purposes of (D) Example 3: Acquisition from unrelated temporarily held as of, March 31, Year 1, person—(1) Facts. USP owns all of the stock June 30, Year 1, September 30, Year 1, determining whether partnership of CFC1 and CFC2. CFC1 has a taxable year December 31, Year 1 and the holding of the specified tangible property is sole use ending November 30. On October 30, Year 1, property by CFC2 as of each such tested partnership property within the CFC1 acquires Asset B from R. On December quarter close would increase the deemed meaning of paragraph (g)(3)(ii)(B) of this 30, Year 1, CFC1 transfers Asset B to CFC2. tangible income return of USP, under section or dual use partnership property The facts and circumstances do not clearly paragraph (h)(1)(i) of this section, the within the meaning of paragraph establish that the December 31, Year 1, adjusted basis in Asset C is disregarded in (g)(3)(iii)(B) of this section and for transfer of Asset B by CFC1 was not determining CFC2’s aggregate adjusted basis purposes of determining the dual use contemplated when Asset B was acquired by in specified tangible property as of each of ratio with respect to dual use CFC1 and that a principal purpose of the March 31, Year 1, June 30, Year 1, September partnership property under the acquisition of the property was not to 30, Year 1, and December 31, Year 1. increase the deemed tangible income return principles of paragraph (d)(3) of this of USP, the applicable U.S. shareholder. (2) Disregard of adjusted basis in section, the rules of § 1.951A–2(c)(5) are (2) Analysis. CFC1’s holding of Asset B as property transferred during the not taken into account. of the November 30, Year 1 tested quarter disqualified period—(i) Operative (ii) Determination of disqualified close does not satisfy the safe harbor under rules—(A) In general. For purposes of basis—(A) In general. Subject to the paragraph (h)(1)(iii) of this section because determining the qualified business asset adjustments described in paragraph the requirements in paragraphs (h)(1)(iii)(A) investment of a tested income CFC for (h)(2)(ii)(B) of this section, the term through (D) of this section are not satisfied. any CFC inclusion year, disqualified disqualified basis means, with respect to Because CFC1 held Asset B for less than 12 basis in property is disregarded. property (other than property described months (from October 30, Year 1, until (B) Application to dual use property. in section 1221(a)(1)), the excess (if any) December 30, Year 1), the presumption in In the case of dual use property (as paragraph (h)(1)(iv)(A) of this section applies of the property’s adjusted basis such that CFC1 is presumed to have held defined in paragraph (d)(2) of this immediately after a disqualified Asset B temporarily with a principal purpose section), paragraph (h)(2)(i)(A) of this transfer, over the sum of the property’s of increasing the deemed tangible income section applies by reducing the amount adjusted basis immediately before the return of USP for the taxable year, and the of the adjusted basis in the property disqualified transfer and the qualified facts and circumstances do not clearly treated as adjusted basis in specified gain amount with respect to the establish that CFC1 did not acquire Asset B tangible property for the CFC inclusion disqualified transfer. For this purpose, with a principal purpose of increasing the year under paragraph (d)(1) of this the adjusted basis in property deemed tangible income return of USP. section by the amount of the immediately after a disqualified transfer Because CFC1 holds Asset B as of November disqualified basis in the property. For 30, Year 1, the adjusted basis in Asset B includes a positive adjustment to the would be, without regard to paragraph purposes of determining the amount adjusted basis in partnership property (h)(1)(i) of this section, taken into account for described in paragraph (d)(1) of this with respect to a partner under section purposes of determining USP’s deemed section, including for purposes of 734(b)(1)(A) or 743(b). tangible income return for its Year 1 taxable determining whether tangible property (B) Adjustments to disqualified year as of two quarter closes (CFC1’s quarter is dual use property within the meaning basis—(1) Reduction or elimination of

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disqualified basis—(i) In general. Except (iii) Increase by reason of section (iv) Conditions of making an election. to the extent provided in this paragraph 732(d). Disqualified basis in property is An election under this paragraph (h)(2)(ii)(B)(1), disqualified basis in increased by the amount of a positive (h)(2)(ii)(B)(3) with respect to a property is reduced or eliminated to the adjustment to the adjusted basis in controlled foreign corporation or a extent that such basis reduces taxable property under section 732(d) to the partnership is not effective unless the income through, for example, extent that, if an election provided in election is made with respect to each depreciation, amortization, and taxable section 754 were in effect at the time of controlled foreign corporation or sales or exchanges, or is otherwise the acquisition described in section partnership that holds property with reduced or eliminated, for example, 732(d), the adjusted basis in the disqualified basis and that is related through the application of section 362(e) property immediately after the (within the meaning of section 267(b) or 732(a) or (b). In such circumstances, acquisition would have been and 707(b)) to the controlled foreign in the case of property with disqualified disqualified basis under paragraph corporation or partnership and unless basis and adjusted basis other than (h)(2)(ii)(A) of this section. any return that has been filed that is disqualified basis, disqualified basis in (3) Election to eliminate disqualified inconsistent with the elimination of the the property is reduced or eliminated in basis—(i) In general. If an election made adjusted basis and disqualified basis the same proportion that the under this paragraph (h)(2)(ii)(B)(3) with immediately after the disqualified disqualified basis bears to the total respect to a controlled foreign transfer by reason of this paragraph adjusted basis in the property. However, corporation or a partnership is effective, (h)(2)(ii)(B)(3) is amended to take into in the case of a loss from a taxable sale the adjusted basis in each property with account the elimination of the adjusted or exchange, disqualified basis in the disqualified basis held by the controlled basis and disqualified basis immediately property is reduced or eliminated to the foreign corporation or the partnership is after the disqualified transfer by reason extent the loss is treated as attributable reduced by the amount of the of this paragraph (h)(2)(ii)(B)(3). to disqualified basis under § 1.951A– disqualified basis and the disqualified (C) Definitions related to disqualified 2(c)(5)(ii). basis in each property is eliminated. basis. The following definitions apply (ii) Exception for related party The reduction of the adjusted basis and for purposes of this paragraph (h)(2). (1) Disqualified period. The term transfers. Disqualified basis in property the elimination of the disqualified basis disqualified period means, with respect is not reduced or eliminated by reason described in the preceding sentence is to a transferor CFC, the period of any transfer of the property to a treated as occurring immediately after beginning on January 1, 2018, and related person, except to the extent any the disqualified transfer of each ending as of the close of the transferor loss recognized on the transfer of such property. CFC’s last taxable year that is not a CFC property is treated as attributable to the (ii) Manner of making the election inclusion year. A transferor CFC that disqualified basis under § 1.951A– with respect to a controlled foreign has a CFC inclusion year beginning 2(c)(5)(ii), or the basis is reduced or corporation. The election described in January 1, 2018, has no disqualified eliminated in a nonrecognition this paragraph (h)(2)(ii)(B)(3) with period. transaction within the meaning of respect to a controlled foreign (2) Disqualified transfer. The term section 7701(a)(45), for example, corporation is made by each controlling disqualified transfer means a transfer of through the application of section 362(e) domestic shareholder (as defined in property during a transferor CFC’s or 732(a) or (b). § 1.964–1(c)(5)) of the controlled foreign disqualified period by the transferor (2) Increase to disqualified basis for corporation by filing a statement as CFC to a related person in which gain nonrecognition transactions—(i) described in § 1.964–1(c)(3)(ii) with its was recognized, in whole or in part, by Increase corresponding to adjustments income tax return for its taxable year the transferor CFC. in other property. If the adjusted basis that includes the last day of the taxable (3) Qualified gain amount. The term in property is increased by reason of a year of the controlled foreign qualified gain amount means, with nonrecognition transaction (as defined corporation that includes the respect to a disqualified transfer by a in section 7701(a)(45)), for example, disqualified transfer and follow the transferor CFC, the sum of the following through the application of section notice requirements of § 1.964– amounts: 732(b) or section 734(b)(1)(B), the 1(c)(3)(iii). If the return for the taxable (i) The amount of gain recognized by disqualified basis in the property is year has been filed before July 22, 2019, the transferor CFC on the disqualified increased by a proportionate share of the statement must be included with an transfer of property that is subject to the aggregate reduction to the amended return filed within 180 days Federal income tax under section 882 disqualified basis (if any) in one or more June 21, 2019. The election statement (except to the extent the gain is exempt other properties by reason of such must be filed in accordance with the from tax pursuant to an applicable nonrecognition transaction under rules provided in forms or instructions. treaty obligation of the United States); paragraph (h)(2)(ii)(B)(1) of this section. (iii) Manner of making the election and (ii) Exchanged basis property. with respect to a partnership. The (ii) Any United States shareholder’s Disqualified basis in exchanged basis election described in this paragraph pro rata share of the gain recognized by property (as defined in section (h)(2)(ii)(B)(3) with respect to a the transferor CFC on the disqualified 7701(a)(44)) includes the amount of the partnership is made by the partnership transfer of property (determined without disqualified basis in any property by by filing a statement as described in regard to properly allocable deductions) reference to which the adjusted basis in § 1.754–1(b)(1) for the taxable year that taken into account in determining the the exchanged basis property was includes the date of the disqualified United States shareholder’s inclusion determined, in whole or in part, transfer. If a return for the taxable year under section 951(a)(1)(A), excluding provided that the nonrecognition has been filed before July 22, 2019, the any amount that is described in transaction giving rise to such statement must be included with an paragraph (h)(2)(ii)(C)(3)(i) of this exchanged basis did not also increase amended return filed within 180 days of section. the disqualified basis in the exchanged June 21, 2019. The election statement (4) Related person. The term related basis property under paragraph must be filed in accordance with the person means, with respect to a person (h)(2)(ii)(B)(2)(i) of this section. rules provided in forms or instructions. that transfers property, any person that

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bears a relationship to such person this section (the facts in Example 1), except Asset C exceeds PRS’s adjusted basis in Asset described in section 267(b) or 707(b) that CFC1 uses the calendar year as its C immediately before the distribution. immediately before or immediately after taxable year. (2) Analysis. The distribution of Asset C is the transfer. (2) Analysis. Because CFC1 has a taxable a nonrecognition transaction under section year beginning January 1, 2018, CFC1 has no 7701(a)(45). Under paragraph (5) Transfer. The term transfer disqualified period. Accordingly, the (h)(2)(ii)(B)(1)(i) of this section, the includes any disposition of property, property was not transferred during a disqualified bases in Asset D and Asset E are including any sale, exchange, disqualified period of CFC1, and there is no reduced, in the aggregate, by $50x. Further, contribution, or distribution of property, disqualified basis with respect to the under paragraph (h)(2)(ii)(B)(2)(i) of this and includes an indirect transfer. For property. section, the disqualified basis in Asset C is example, a transfer of an interest in a (C) Example 3: Sale of partnership increased by $50x, the aggregate reduction to partnership is treated as an indirect interest—(1) Facts. USP, a domestic the disqualified basis in Asset D and Asset transfer of the property of the corporation, owns all of the stock of CFC1, E. CFC2, and CFC3, each a controlled foreign (E) Example 5: Distribution of property to partnership and a transfer by or to a corporation. CFC1 and CFC2 are equal a partner in basis reduction transaction—(1) partnership is treated as an indirect partners in PRS, a partnership. PRS owns Facts. The facts are the same as in paragraph transfer by or to its partners. In addition, Asset B with an adjusted basis of $20x and (h)(2)(iii)(D)(1) of this section (the facts in a distribution of property to a partner a fair market value of $100x. PRS has a Example 4), except PRS distributes Asset D with respect to which gain is recognized section 754 election in effect. USP, CFC2, to FC1. Under section 732(a), FC1’s adjusted to the distributee partner under section and CFC3 all use the calendar year as their basis in Asset D is $0. PRS’s adjusted basis 731(a)(1) is treated as an indirect taxable year. CFC1 uses a taxable year ending in Asset C is increased by $50x under section transfer of the property of the November 30. On November 1, 2018, before 734(b)(1)(B), which is the amount by which partnership. the start of its first CFC inclusion year, CFC1 PRS’s adjusted basis in Asset D immediately (6) Transferor CFC. The term sells its interest in the partnership to CFC3 before the distribution exceeds FC1’s for $50x of cash. CFC1 has an adjusted basis adjusted basis in Asset D under section transferor CFC means any controlled of $10x in its partnership interest, and thus 732(a). foreign corporation that transfers CFC1 recognizes $40x of gain as a result of (2) Analysis. The distribution of Asset D is property during the disqualified period the sale ($50x ¥ $10x), none of which is a nonrecognition transaction under section of the controlled foreign corporation. foreign base company income or otherwise 7701(a)(45). Under paragraph (iii) Examples. The following subject to U.S. tax. As a result of the sale, (h)(2)(ii)(B)(1)(i) of this section, the examples illustrate the application of there is a $40x adjustment to the adjusted disqualified basis in Asset D is reduced by this paragraph (h)(2). basis in Asset B with respect to CFC3 under $50x. Further, under paragraph section 743(b). (h)(2)(ii)(B)(2)(i) of this section, the (A) Example 1: Sale of asset; disqualified (2) Analysis. The transfer of the PRS disqualified basis in Asset C is increased by period—(1) Facts. USP, a domestic partnership interest is a disqualified transfer $50x, the reduction to the disqualified basis corporation, owns all of the stock of CFC1 of Asset B because it is an indirect transfer in Asset D. and CFC2, each a controlled foreign of property (other than property described in (F) Example 6: Dual use property with corporation. Both USP and CFC2 use the section 1221(a)(1)) by CFC1; CFC1 and CFC3 disqualified basis—(1) Facts. FS is a tested calendar year as their taxable year. CFC1 uses are related persons; and the transfer occurs income CFC and a wholesale distributor of a taxable year ending November 30. On during the disqualified period, the period Product A. FS owns trucks that deliver November 1, 2018, before the start of its first that begins on January 1, 2018, and ends the Product A. The trucks are specified tangible CFC inclusion year, CFC1 sells Asset A, which has an adjusted basis of $10x in the last day before the first CFC inclusion year property. In Year 1, FS earns $250x in total hands of CFC1, to CFC2 in exchange for of CFC1 (November 30, 2018). Accordingly, gross income from inventory sales of Product $100x of cash. CFC1 recognizes $90x of gain under paragraph (h)(2)(ii)(A) of this section, A, $200x of which is included in gross tested as a result of the sale ($100x ¥ $10x), $30x the disqualified basis in Asset B immediately income. The trucks have an average adjusted of which is foreign base company income. after the disqualified transfer is $40x, the basis for Year 1 of $4,000x, of which $2,500x USP includes in gross income under section excess of CFC3’s share of adjusted basis in is disqualified basis. FS does not capitalize 951(a)(1)(A) its pro rata share of the subpart Asset B immediately after the disqualified depreciation with respect to the trucks to F income of $30x. CFC1’s gain is not transfer ($50x), taking into account the basis inventory or other property held for sale. The otherwise subject to U.S. tax or taken into adjustment with respect to CFC3 under depreciation deduction with respect to the account in determining USP’s inclusion section 743(b), over CFC1’s share of adjusted trucks is $20x, $15x of which would be under section 951(a)(1)(A). basis in the property immediately before the allocated and apportioned to gross tested (2) Analysis. The transfer of Asset A is a transfer ($10x). income under § 1.951A–2(c)(3) without disqualified transfer of Asset A because it is (D) Example 4: Distribution of property in regard to § 1.951A–2(c)(5). a transfer of property (other than property liquidation of partnership interest—(1) Facts. (2) Analysis. Because the trucks are used in described in section 1221(a)(1)) by CFC1; FC1, FC2, and FC3 are controlled foreign both the production of gross tested income CFC1 and CFC2 are related persons; and the corporations that are equal partners in PRS, and the production of gross income that is transfer occurs during the disqualified a partnership. FC1’s adjusted basis in its not gross tested income in Year 1, the trucks period, the period that begins on January 1, partnership interest in PRS is $0, FC2’s basis are dual use property within the meaning of 2018, and ends the last day before the first is $50x, and FC3’s basis is $50x. PRS has a paragraph (d)(2) of this section. Under CFC inclusion year of CFC1 (November 30, section 754 election in effect. PRS owns paragraph (h)(2)(i)(A) of this section, the 2018). Accordingly, under paragraph Asset C with a fair market value of $50x and disqualified basis in the trucks is disregarded (h)(2)(ii)(A) of this section, the disqualified an adjusted basis of $0, Asset D with a fair for purposes of determining FS’s qualified basis in Asset A immediately after the market value of $50x and an adjusted basis business asset investment for Year 1. Under disqualified transfer is $60x, the excess of of $50x, and Asset E with a fair market value paragraph (h)(2)(i)(B) of this section, CFC2’s adjusted basis in Asset A of $50x and an adjusted basis of $50x, and paragraph (h)(2)(i)(A) of this section applies immediately after the disqualified transfer all the adjusted basis in Asset D and Asset by reducing the amount of FS’s adjusted ($100x), over the sum of CFC1’s adjusted E is disqualified basis. PRS distributes Asset basis in the trucks treated as adjusted basis basis in Asset A immediately before the C to FC3 in liquidation of FC3’s interest in in specified tangible property for Year 1 transfer ($10x) and USP’s pro rata share of PRS. None of FC1, FC2, FC3, or PRS under paragraph (d)(1) of this section the gain recognized by CFC1 on the transfer recognizes gain on the distribution. Under (determined without regard to § 1.951A– of the property taken into account by USP section 732(b), FC3’s adjusted basis in Asset 2(c)(5)) by the amount of the disqualified under section 951(a)(1)(A) ($30x). C is $50x. PRS’s adjusted bases in Asset D basis in the trucks. Without regard to (B) Example 2: Sale of asset; no and Asset E are decreased, in the aggregate, § 1.951A–2(c)(5), FS’s adjusted basis in the disqualified period—(1) Facts. The facts are by $50x under section 734(b)(2)(B), which is trucks treated as adjusted basis in specified the same as in paragraph (h)(2)(iii)(A)(1) of the amount by which FC3’s adjusted basis in tangible property for Year 1 under paragraph

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(d)(1) of this section is FS’s adjusted basis in (ii) Interest expense. The term interest property held by the partnership, as the trucks multiplied by FS’s dual use ratio expense means any expense or loss that determined under the principles of with respect to the trucks for Year 1. Because is treated as interest expense under § 1.956–4(b), and the controlled foreign none of the depreciation with respect to the section 163(j). corporation’s basis in the partnership trucks is capitalized into inventory or other property held for sale, FS’s dual use ratio (iii) Qualified interest expense—(A) In interest is not taken into account. with respect to the trucks is determined general. The term qualified interest (iv) Tested loss QBAI amount. The entirely by reference to the depreciation expense means, with respect to a term tested loss QBAI amount means, deduction with respect to the trucks. controlled foreign corporation for a CFC with respect to a tested loss CFC for a Therefore, under paragraph (d)(3) of this inclusion year, to the extent established CFC inclusion year, 10 percent of the section, without regard to § 1.951A–2(c)(5), by the controlled foreign corporation, amount that would be the qualified FS’s dual use ratio with respect to the trucks the interest expense paid or accrued by business asset investment of the tested for Year 1 is 75%, which is FS’s depreciation the controlled foreign corporation that is deduction with respect to the trucks that is loss CFC for the CFC inclusion year allocated and apportioned to gross tested allocated and apportioned to gross under section 951A(d) and § 1.951A–3 if income under § 1.951A–2(c)(3) for Year 1 tested income of the controlled foreign the tested loss CFC were a tested income ($15x), divided by FS’s depreciation corporation for the CFC inclusion year CFC for the CFC inclusion year. deduction with respect to the trucks for Year under § 1.951A–2(c)(3), multiplied by a (2) Tested interest income—(i) In 1 ($20x). Accordingly, paragraph (d)(1) of fraction, the numerator of which is the general. The term tested interest income this section, without regard to paragraph average of the aggregate adjusted bases means, with respect to a controlled (h)(2)(i)(A) of this section, FS’s adjusted basis as of the close of each quarter of the CFC foreign corporation for a CFC inclusion in the trucks treated as adjusted basis in inclusion year of qualified assets held specified tangible property is $3,000x year, interest income included in gross ($4,000x × 0.75). Under paragraph (h)(2)(i)(A) by the controlled foreign corporation, tested income of the controlled foreign and (B) of this section, the amount of the and the denominator of which is the corporation for the CFC inclusion year, adjusted basis in the trucks treated as average of the aggregate adjusted bases reduced by qualified interest income of adjusted basis in specified tangible property as of the close of each quarter of the CFC the controlled foreign corporation for is reduced by the $2,500x of disqualified inclusion year of all assets held by the the CFC inclusion year. basis in the trucks. Accordingly, $500x controlled foreign corporation. (ii) Interest income. The term interest ¥ ($3,000x $2,500x) of FS’s average adjusted (B) Qualified asset—(1) In general. income means any income or gain that basis in the trucks is taken into account Except as provided in paragraph is treated as interest income under under paragraph (b) of this section in (b)(1)(iii)(B)(2) of this section, the term determining FS’s qualified business asset section 163(j). investment for Year 1. qualified asset means, with respect to a (iii) Qualified interest income—(A) In controlled foreign corporation for a CFC general. Except as provided in § 1.951A–4 Tested interest expense and inclusion year, any obligation or paragraph (b)(2)(iii)(B) of this section, tested interest income. financial instrument held by the the term qualified interest income (a) Scope. This section provides rules controlled foreign corporation that gives means, with respect to a controlled for determining the tested interest rise to income included in the gross foreign corporation for a CFC inclusion expense and tested interest income of a tested income of the controlled foreign year, interest income of the controlled controlled foreign corporation for corporation for the CFC inclusion year foreign corporation for the CFC purposes of determining a United States that is excluded from foreign personal inclusion year included in the gross shareholder’s specified interest expense holding company income (as defined in tested income of the controlled foreign under § 1.951A–1(c)(3)(iii). Paragraph section 954(c)(1)) by reason of section corporation for the CFC inclusion year (b) of this section provides definitions 954(c)(2)(C)(ii) or section 954(h) or (i). that is excluded from foreign personal related to tested interest expense and (2) Exclusion for related party holding company income (as defined in tested interest income. Paragraph (c) of receivables. A qualified asset does not section 954(c)(1)) by reason of section this section provides examples include an asset that gives rise to 954(c)(2)(C)(ii) or section 954(h) or (i). illustrating these definitions and the interest income that is also excludible (B) Exclusion for related party application of § 1.951A–1(c)(3)(iii). The from foreign personal holding company interest. Qualified interest income does amount of specified interest expense income by reason of section 954(c)(3) or not include interest income that is also determined under § 1.951A–1(c)(3)(iii) (6). excludable from foreign personal and this section is the amount of (3) Look-through rule for subsidiary holding company income by reason of interest expense described in section stock. For purposes of paragraph section 954(c)(3) or (6). 951A(b)(2)(B). (b)(1)(iii)(A) of this section, the adjusted (c) Examples. The following examples (b) Definitions related to specified basis in the stock of another controlled illustrate the application of this section. interest expense—(1) Tested interest foreign corporation held by a controlled expense—(i) In general. The term tested foreign corporation is treated as (1) Example 1: Wholly-owned CFCs—(i) interest expense means, with respect to Facts. A Corp, a domestic corporation, owns adjusted basis in a qualified asset in an 100% of the single class of stock of each of a controlled foreign corporation for a amount equal to the adjusted basis in FS1 and FS2, each a controlled foreign CFC inclusion year, interest expense the stock multiplied by the fraction corporation. A Corp, FS1, and FS2 all use the paid or accrued by the controlled described in paragraph (b)(1)(iii)(A) of calendar year as their taxable year. For Year foreign corporation that is allocated and this section determined with respect to 1, FS1 and FS2 are both tested income CFCs. apportioned to gross tested income of the assets of such other controlled In Year 1, FS1 pays $100x of interest to FS2. the controlled foreign corporation for foreign corporation. The interest expense of FS1 is allocated and the CFC inclusion year under § 1.951A– (4) Look-through rule for certain apportioned to its gross tested income under 2(c)(3), reduced (but not below zero) by partnership interests. For purposes of § 1.951A–2(c)(3). The interest income of FS2 the sum of the qualified interest expense paragraph (b)(1)(iii)(A) of this section, if is excluded from its foreign personal holding company income under section 954(c)(6). of the controlled foreign corporation for a controlled foreign corporation owns Also, in Year 1, FS2 pays $100x of interest the CFC inclusion year and the tested 25 percent or more of the capital or to a bank that is not related to FS2, which loss QBAI amount of the controlled profits interest in a partnership the interest expense is allocated and apportioned foreign corporation for the CFC controlled foreign corporation is treated to FS2’s gross tested income under § 1.951A– inclusion year. as holding its attributable share of any 2(c)(3). Neither FS1 nor FS2 holds qualified

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assets or owns stock of another controlled is excluded from its foreign personal holding single class of stock of each of FS1 and FS2, foreign corporation. company income by reason of section each a controlled foreign corporation. FS2 (ii) Analysis—(A) CFC-level determination; 954(c)(6). In addition, in Year 1, FS2 receives owns 100% of the single class of stock of tested interest expense and tested interest $300x of interest from customers that are not FS3, a qualifying insurance company within income—(1) Tested interest expense and related to FS2, which interest income is the meaning of section 953(e)(3). For Year 1, tested interest income of FS1. FS1 has $100x excluded from FS2’s foreign personal holding FS1, FS2, and FS3 are all tested income of interest expense that is allocated and company income by reason of section 954(h), CFCs. C Corp, FS1, FS2, and FS3 all use the apportioned to its gross tested income under and FS2 pays $300x of interest to a bank, calendar year as their taxable year. In Year § 1.951A–2(c)(3). FS1 has no interest income. which interest expense is allocated and 1, FS1 pays $100x of interest to FS3. The Accordingly, FS1 has $100x of tested interest apportioned to FS2’s gross tested income interest expense of FS1 is allocated and expense and no tested interest income for under § 1.951A–2(c)(3). Neither FS1 nor FS2 apportioned to its gross tested income under Year 1. owns stock of another controlled foreign § 1.951A–2(c)(3). The interest income of FS3 (2) Tested interest expense and tested corporation. FS1 does not hold qualified is excluded from its foreign personal holding interest income of FS2. FS2 has $100x of assets. FS2’s average adjusted bases in company income by reason of section interest expense that is allocated and qualified assets is $8,000x, and FS2’s average 954(c)(6). In addition, FS3 receives $300x of apportioned to its gross tested income under adjusted bases in all its assets is $12,000x. interest from persons that are not related to § 1.951A–2(c)(3) and $100x of interest (ii) Analysis—(A) CFC-level determination; FS3, which interest income is excluded from income that is included in its gross tested tested interest expense and tested interest FS’s foreign personal holding company income. Accordingly, FS2 has $100x of tested income—(1) Tested interest expense and income by reason of section 954(i). Also in interest expense and $100x of tested interest tested interest income of FS1. FS1 has $100x Year 1, FS2 pays $300x of interest to a bank, income for Year 1. of interest expense that is allocated and which interest expense is allocated and (B) United States shareholder-level apportioned to its gross tested income under apportioned to FS2’s gross tested income determination; pro rata share and specified § 1.951A–2(c)(3). FS1 has no interest income. under § 1.951A–2(c)(3). None of FS1, FS2, or interest expense. Under § 1.951A–1(d)(5) and Accordingly, FS1 has $100x of tested interest FS3 owns stock of another controlled foreign (6), A Corp’s pro rata share of FS1’s tested expense and no tested interest income for corporation, except for the stock of FS3 interest expense is $100x, its pro rata share Year 1. owned by FS2. FS2 has no assets other than of FS2’s tested interest expense is $100x, and (2) Tested interest expense and tested the stock of FS3. Neither FS1 nor FS2 hold its pro rata share of FS2’s tested interest interest income of FS2. FS2 has $300x of qualified assets directly. FS2’s average income is $100x. For Year 1, A Corp’s interest expense that is allocated and adjusted bases in the FS3 stock is $6,000x. aggregate pro rata share of tested interest apportioned to its gross tested income under FS3’s average adjusted bases in qualified expense is $200x and its aggregate pro rata § 1.951A–2(c)(3) and $400x of interest assets is $8,000x, and FS3’s average adjusted share of tested interest income is $100x. income that is included in gross tested bases in all its assets is $12,000x. Accordingly, under § 1.951A–1(c)(3)(iii), A income. However, a portion of FS2’s interest (ii) Analysis—(A) CFC-level determination; Corp’s specified interest expense is $100x income is excluded from foreign personal tested interest expense and tested interest ($200x¥$100x) for Year 1. holding company income by reason of income—(1) Tested interest expense and (2) Example 2: Less than wholly-owned section 954(h), and a portion of FS2’s assets tested interest income of FS1. In Year 1, FS1 CFCs—(i) Facts. The facts are the same as in are qualified assets. As a result, in has $100x of interest expense allocated and paragraph (c)(1)(i) of this section (the facts in determining the tested interest income and apportioned to its gross tested income under Example 1), except that A Corp owns 50% of tested interest expense of FS2, the qualified § 1.951A–2(c)(3). FS1 has no interest income. the single class of stock of FS1 and 80% of interest income and qualified interest Accordingly, FS1 has $100x of tested interest the single class of stock of FS2. expense of FS2 are excluded. FS2 has expense and no tested interest income for (ii) Analysis—(A) CFC-level determination; qualified interest income of $300x, the Year 1. tested interest expense and tested interest amount of FS2’s interest income that is (2) Tested interest expense and tested income. The analysis is the same as in excluded from foreign personal holding interest income of FS2. FS2 has $300x of paragraph (c)(1)(ii)(A) of this section company income by reason of section 954(h). interest expense that is allocated and (paragraph (A) of the analysis in Example 1). In addition, FS2 has qualified interest apportioned to its gross tested income under (B) United States shareholder-level expense of $200x, the amount of FS2’s § 1.951A–2(c)(3). FS2 has no interest income. determination; pro rata share and specified interest expense that is allocated and While FS2 holds no qualified assets directly, interest expense. Under § 1.951A–1(d)(5) and apportioned to its gross tested income under $4,000x of FS3’s average adjusted basis in (6), A Corp’s pro rata share of FS1’s tested § 1.951A–2(c)(3) ($300x), multiplied by a FS3 stock is treated as adjusted basis in a interest expense is $50x ($100x × 0.50), its fraction, the numerator of which is FS2’s qualified asset, which is equal to FS3’s pro rata share of FS2’s tested interest expense average adjusted bases in qualified assets average adjusted basis in FS3 stock ($6,000x) is $80x ($100x × 0.80), and its pro rata share ($8,000x), and the denominator of which is multiplied by a fraction, the numerator of of FS2’s tested interest income is $80x ($100x FS2’s average adjusted bases in all its assets which is FS3’s average adjusted bases in × 0.80). For Year 1, A Corp’s aggregate pro ($12,000x). Accordingly, FS2 has tested qualified assets ($8,000x), and the rata share of the tested interest expense is interest income of $100x ($400x¥$300x) and denominator of which is FS3’s average $130x ($50x + $80x) and its aggregate pro tested interest expense of $100x adjusted bases in all its assets ($12,000x). rata share of the tested interest income is ($300x¥$200x) for Year 1. Accordingly, FS2 has qualified interest $80x ($0 + $80x). Accordingly, under (B) United States shareholder-level expense of $200x, the amount of FS2’s § 1.951A–1(c)(3)(iii), A Corp’s specified determination; pro rata share and specified interest expense allocated and apportioned to interest expense is $50x ($130x¥$80x) for interest expense. Under § 1.951A–1(d)(5) and FS2’s gross tested income under § 1.951A– Year 1. (6), B Corp’s pro rata share of FS1’s tested 2(c)(3) ($300x), multiplied by a fraction, the (3) Example 3: Operating company; interest expense is $100x, its pro rata share numerator of which is FS2’s average adjusted qualified interest expense—(i) Facts. B Corp, of FS2’s tested interest expense is $100x, and bases in qualified assets ($4,000x), and the a domestic corporation, owns 100% of the its pro rata share of FS2’s tested interest denominator of which is FS2’s average single class of stock of each of FS1 and FS2, income is $100x. For Year 1, B Corp’s adjusted bases in all its assets ($6,000x). each a controlled foreign corporation. For aggregate pro rata share of tested interest Therefore, FS2 has tested interest expense of Year 1, FS1 and FS2 are both tested income expense is $200x ($100x + $100x) and its $100x ($300x¥$200x) and no tested interest CFCs. B Corp, FS1, and FS2 all use the aggregate pro rata share of tested interest income for Year 1. calendar year as their taxable year. FS2 is an income is $100x ($0 + $100x). Accordingly, (3) Tested interest expense and tested eligible controlled foreign corporation within under § 1.951A–1(c)(3)(iii), B Corp’s interest income of FS3. In Year 1, FS3 has no the meaning of section 954(h)(2). In Year 1, specified interest expense is $100x interest expense, but FS3 has $400x of FS1 pays $100x of interest to FS2. The ($200x¥$100x) for Year 1. interest income that is included in gross interest expense of FS1 is allocated and (4) Example 4: Holding company; qualified tested income. However, a portion of FS3’s apportioned to its gross tested income under interest expense—(i) Facts. C Corp, a interest income is excluded from foreign § 1.951A–2(c)(3). The interest income of FS2 domestic corporation, owns 100% of the personal holding company income by reason

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of section 954(i). As a result, in determining (B) United States shareholder-level U.S. shareholder inclusion year bears to the tested interest income of FS3, the determination; pro rata share and specified the aggregate amount of the United qualified interest income of FS3 is excluded. interest expense. Under § 1.951A–1(d)(5) and States shareholder’s pro rata share of the FS3 has qualified interest income of $300x, (6), D Corp’s pro rata share of FS1’s tested tested income of each tested income the amount of FS3’s interest income that is interest expense is $100x, its pro rata share excluded from foreign personal holding of FS2’s tested interest expense is $0, and its CFC for the U.S. shareholder inclusion company income by reason of section 954(i). pro rata share of FS2’s tested interest income year. Therefore, FS2 has tested interest income of is $100x. For Year 1, D Corp’s aggregate pro (ii) Example. The following example $100x ($400x¥$300x) and no tested interest rata share of tested interest expense is $100x, illustrates the application of paragraph expense for Year 1. and its aggregate pro rata share of tested (b)(2)(i) of this section. (B) United States shareholder-level interest income is $100x. Accordingly, under (A) Facts. USP, a domestic corporation, determination; pro rata share and specified § 1.951A–1(c)(3)(iii), D Corp’s specified owns all of the stock of three controlled interest expense. Under § 1.951A–1(d)(5) and interest expense is $0 ($100x¥$100x) for foreign corporations, CFC1, CFC2, and CFC3. (6), C Corp’s pro rata share of FS1’s tested Year 1. USP, CFC1, CFC2, and CFC3 all use the interest expense is $100x, its pro rata share calendar year as their taxable year. In Year of FS2’s tested interest expense is $100x, and § 1.951A–5 Treatment of GILTI inclusion 1, CFC1 has tested income of $100x, CFC2 its pro rata share of FS3’s tested interest amounts. has tested income of $300x, and CFC3 has income is $100x. For Year 1, C Corp’s tested loss of $50x. USP has no net deemed aggregate pro rata share of tested interest (a) Scope. This section provides rules relating to the treatment of GILTI tangible income return for Year 1. expense is $200x ($100x + $100x + $0) and (B) Analysis. In Year 1, USP has net CFC its aggregate pro rata share of tested interest inclusion amounts and adjustments to tested income (as defined in § 1.951A– income is $100x ($0 + $0 + $100x). earnings and profits to account for 1(c)(2)) of $350x ($100x + $300x¥$50x) and, Accordingly, under § 1.951A–1(c)(3)(iii), C tested losses. Paragraph (b) of this because USP has no net deemed tangible Corp’s specified interest expense is $100x section provides that a GILTI inclusion income return, a GILTI inclusion amount (as ($200x¥$100x) for Year 1. amount is treated in the same manner as defined in § 1.951A–1(c)(1)) of $350x (5) Example 5: Specified interest expense an amount included under section ($350x¥$0). The aggregate amount of USP’s and tested loss QBAI amount—(i) Facts. D 951(a)(1)(A) for purposes of applying pro rata share of tested income is $400x Corp, a domestic corporation, owns 100% of certain Code sections. Paragraph (c) of ($100x from CFC1 + $300x from CFC2). a single class of stock of each of FS1 and FS2, Therefore, under paragraph (b)(2)(i) of this each a controlled foreign corporation. For this section provides rules for the section, the portion of USP’s GILTI inclusion Year 1, FS1 is a tested income CFC and FS2 treatment of amounts taken into account amount treated as being with respect to CFC1 is a tested loss CFC. D Corp, FS1, and FS2 in determining the net CFC tested is $87.50x ($350x × $100x/$400x). The all use the calendar year as their taxable year. income of a United States shareholder portion of USP’s GILTI inclusion amount In Year 1, FS1 pays $100x of interest to FS2. when applying sections 163(e)(3)(B)(i) treated as being with respect to CFC2 is The interest expense of FS1 is allocated and and 267(a)(3)(B). Paragraph (d) of this $262.50x ($350x × $300x/$400x). The portion apportioned to its gross tested income under section provides a rule for the treatment of USP’s GILTI inclusion amount treated as § 1.951A–2(c)(3). The interest income of FS2 of a GILTI inclusion amount for being with respect to CFC3 is $0 because is excluded from its foreign personal holding CFC3 is a tested loss CFC. purposes of determining the personal company income by reason of section (3) Translation of portion of GILTI 954(c)(6). Also, in Year 1, FS2 pays $100x of holding company income of a United interest to a bank that is not related to FS2, States shareholder that is a domestic inclusion amount allocated to tested which interest expense is allocated and corporation under section 543. income CFC. The portion of the GILTI apportioned to FS2’s gross tested income (b) Treatment as subpart F income for inclusion amount of a United States under § 1.951A–2(c)(3). Neither FS1 nor FS2 certain purposes—(1) In general. A shareholder allocated to a tested income holds qualified assets or owns stock of GILTI inclusion amount is treated in the CFC under section 951A(f)(2) and another controlled foreign corporation. same manner as an amount included paragraph (b)(2)(i) of this section is Because FS2 is a tested loss CFC, FS2 has no under section 951(a)(1)(A) for purposes translated into the functional currency QBAI. See § 1.951A–3(b). However, if FS2 of applying sections 168(h)(2)(B), of the tested income CFC using the were a tested income CFC, FS2 would have average exchange rate for the CFC QBAI of $1,000x. 535(b)(10), 851(b), 904(h)(1), 959, 961, (ii) Analysis—(A) CFC-level determination; 962, 993(a)(1)(E), 996(f)(1), 1248(b)(1), inclusion year of the tested income CFC. tested interest expense and tested interest 1248(d)(1), 1411, 6501(e)(1)(C), (c) Treatment as an amount income—(1) Tested interest expense and 6654(d)(2)(D), and 6655(e)(4). includible in the gross income of a tested interest income of FS1. In Year 1, FS1 (2) Allocation of GILTI inclusion United States person. For purposes of has $100x of interest expense that is amount to tested income CFCs—(i) In sections 163(e)(3)(B)(i) and 267(a)(3)(B), allocated and apportioned to its gross tested general. For purposes of the sections an item (including original issue income under § 1.951A–2(c)(3). FS1 has no referred to in paragraph (b)(1) of this discount) is treated as includible in the interest income. Accordingly, FS1 has $100x section, the portion of the GILTI gross income of a United States person of tested interest expense and no tested inclusion amount of a United States to the extent that the item increases a interest income for Year 1. (2) Tested interest expense and tested shareholder for a U.S. shareholder United States shareholder’s pro rata interest income of FS2. FS2 has $100x of inclusion year treated as being with share of tested income of a controlled interest income that is included in gross respect to each controlled foreign foreign corporation for a U.S. tested income. Accordingly, FS2 has $100x of corporation of the United States shareholder inclusion year, reduces the tested interest income. FS2 also has 100x of shareholder for the U.S. shareholder shareholder’s pro rata share of tested interest expense that is allocated and inclusion year is— loss of a controlled foreign corporation apportioned to its gross tested income. (A) In the case of a tested loss CFC, for the U.S. shareholder inclusion year, However, because FS2 is a tested loss CFC, zero, and or both. FS2’s tested interest expense is reduced by (B) In the case of a tested income CFC, (d) Treatment for purposes of its tested loss QBAI amount. FS2’s tested loss the portion of the GILTI inclusion personal holding company rules. For QBAI amount is $100x (10% of $1,000x, the amount that would be QBAI if FS2 were a amount of the United States shareholder purposes of determining whether a tested income CFC). Accordingly, FS2’s which bears the same ratio to such United States shareholder that is a tested interest expense is $0 ($100x interest amount as the United States domestic corporation is a personal expense¥$100x tested loss QBAI amount) shareholder’s pro rata share of the tested holding company under section 542, no for Year 1. income of the tested income CFC for the portion of the adjusted ordinary gross

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income of such domestic corporation year. The source and separate category allowed as a deduction for the taxable that consists of its GILTI inclusion (as defined in § 1.904–5(a)) components year. See paragraph (e)(1)(i) of this amount for the U.S. shareholder of the deferred amount are determined section. The deferred amount (which is inclusion year is personal holding in accordance with paragraph (e)(1)(iv) the corresponding addition to the net company income (as defined in section of this section. operating loss for the taxable year) 543(a)). * * * * * comprises a ratable portion of the (iv) Effect of section 965(n) election— deductions (including the deduction § 1.951A–6 Adjustments related to tested allowed under section 965(c)) allocated losses. (A) In general. The section 965(n) election for a taxable year applies solely and apportioned to each statutory and (a) Scope. This section provides rules for purposes of determining the amount residual grouping under paragraph relating to adjustments related to tested of net operating loss under section 172 (e)(1)(iv)(B)(1) of this section. Such losses. Paragraph (b) of this section for the taxable year and determining the ratable portion equals the deferred provides rules that increase the earnings amount of taxable income for the amount multiplied by a fraction, the and profits of a tested loss CFC for taxable year (computed without regard numerator of which is the deductions purposes of section 952(c)(1)(A). to the deduction allowable under allocated and apportioned to the Paragraph (c) of this section is reserved section 172) that may be reduced by net statutory or residual grouping under for a rule for tested loss adjustments. operating loss carryovers or carrybacks paragraph (e)(1)(iv)(B)(1) of this section (b) Increase of earnings and profits of to such taxable year under section 172. and the denominator of which is the tested loss CFC for purposes of section Paragraph (e)(1)(iv)(B) of this section total deductions described in paragraph 952(c)(1)(A). For purposes of section provides a rule for coordinating the (e)(1)(iv)(B)(1) of this section. 952(c)(1)(A) with respect to a CFC section 965(n) election’s effect on Accordingly, the fraction described in inclusion year, the earnings and profits section 172 with the computation of the the previous sentence takes into account of a tested loss CFC are increased by an separate foreign tax credit limitations the deferred amount. amount equal to the tested loss of the (3) Taxable income and the separate under section 904. tested loss CFC for the CFC inclusion foreign tax credit limitations under (B) Ordering rule for allocation and year. section 904 for the taxable year are apportionment of deductions for (c) [Reserved] computed without taking into account purposes of the section 904 limitation. any deferred amount. Deductions § 1.951A–7 Applicability dates. The effect of a section 965(n) election allocated and apportioned to the Sections 1.951A–1 through 1.951A–6 with respect to a taxable year on the statutory and residual groupings under apply to taxable years of foreign computation of the separate foreign tax paragraph (e)(1)(iv)(B)(1) of this section, corporations beginning after December credit limitations under section 904 is to the extent deducted in the taxable 31, 2017, and to taxable years of United computed as follows and in the year rather than deferred to create or States shareholders in which or with following order. increase a net operating loss, are which such taxable years of foreign (1) Deductions, including those that combined with income in the statutory corporations end. create or increase a net operating loss and residual groupings to which those ■ Par. 7. Section 1.965–7 is amended by: for the taxable year by reason of the deductions are assigned in order to ■ 1. Revising the last sentence of section 965(n) election, are allocated compute the amount of separate paragraph (e)(1)(i). and apportioned under §§ 1.861–8 limitation income or loss in each ■ 2. Adding three sentences at the end through 1.861–17 to the relevant separate category and U.S. source of paragraph (e)(1)(i). statutory and residual groupings, taking income or loss for the taxable year. ■ 3. Adding paragraph (e)(1)(iv). into account the amount described in Section 904(b), (f), and (g) are then ■ 4. Revising paragraph (e)(2)(ii). paragraph (e)(1)(ii) of this section. The applied to determine the applicable ■ 5. Adding paragraph (e)(3). source and separate category of the net foreign tax credit limitations for the The revisions and additions read as operating loss carryover or carryback to taxable year. follows: the taxable year, if any, is determined (2) * * * under the rules of § 1.904(g)–3(b), taking (ii) Timing—(A) In general. A section § 1.965–7 Elections, payment, and other into account the amount described in 965(n) election must be made no later special rules. paragraph (e)(1)(ii) of this section. than the due date (taking into account * * * * * Therefore, if the amount of the net extensions, if any) for the person’s (e) * * * operating loss carryover or carryback to return for the taxable year to which the (1) . . . (i) . . . Except as provided in the taxable year (as reduced by reason election applies. Relief is not available paragraph (e)(2)(ii)(B) of this section, the of the section 965(n) election) exceeds under § 301.9100–2 or § 301.9100–3 of election for each taxable year is the U.S. source loss component of the this chapter to make a late election. irrevocable. If the section 965(n) net operating loss that is carried over (B) Transition rule. In the case of a election creates or increases a net under § 1.904(g)–3(b)(3)(i), but such section 965(n) election made before June operating loss under section 172 for the excess is less than the potential 21, 2019, the election may be revoked taxable year, then the taxable income of carryovers (or carrybacks) of the by attaching a statement, signed under the person for the taxable year cannot be separate limitation losses that are part of penalties of perjury, to an amended less than the amount described in the net operating loss, the potential return for the taxable year to which the paragraph (e)(1)(ii) of this section. The carryovers (or carrybacks) are election applies (the election year). The amount of deductions equal to the proportionately reduced as provided in statement must include the person’s amount by which a net operating loss is § 1.904(g)–3(b)(3)(ii) or (iii), as name, taxpayer identification number, created or increased for the taxable year applicable. and a statement that the person revokes by reason of the section 965(n) election (2) If a net operating loss is created or the section 965(n) election. The (the deferred amount) is not taken into increased for the taxable year by reason amended return to which the statement account in computing taxable income or of the section 965(n) election, the is attached must be filed by— the separate foreign tax credit deferred amount (as defined in (1) In the case of a revocation with limitations under section 904 for that paragraph (e)(1)(i) of this section) is not respect to an election due before

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February 5, 2019, the due date (taking (B) Analysis—(1) The amount described in foreign source general category income for into account extensions, if any, or any paragraph (e)(1)(ii) of this section is $80x the taxable year is computed without taking ¥ additional time that would have been ($100x section 965(a) inclusion $70x into account the $37.5x of the deferred granted if the person had made an section 965(c) deduction + $50x section 78 amount that is attributable to the deductions dividends). Not taking into account the $80x extension request) for the return for the allocated and apportioned to the foreign creates a net operating loss under section 172 source general category. Therefore, for the taxable year following the election year; of $60x ($20x taxable income without regard 2017 taxable year, foreign source general ¥ or to the section 965(n) election $80x) for the category income is $12.5x ($100x section (2) In the case of a revocation with taxable year (the ‘‘deferred amount’’). Under 965(a) inclusion + $50x section 78 respect to an election due on or after paragraph (e)(1)(i) of this section, the dividends¥($175x deductions¥$37.5x February 5, 2019, the due date (taking deferred amount of $60x constitutes a net deferred amount). The remaining taxable into account extensions, if any, or any operating loss and is not allowed as a income of $67.5x is U.S. source income. additional time that would have been deduction for the taxable year. USP’s taxable (ii) Example 2: Net operating loss carryover granted if the person had made an income for the year is $80x ($100x + $50x + to the inclusion year—(A) Facts. USP, a $150x¥($280x¥$60x)). domestic corporation, has a section 965(a) extension request) for the return for the (2) Under paragraph (e)(1)(iv)(B)(1) of this inclusion of $100x and has a section 965(c) election year. section, deductions are allocated and deduction of $60x for its taxable year ending * * * * * apportioned under §§ 1.861–8 through 1.861– December 31, 2017. USP also includes in (3) Examples. The following examples 17 to the relevant statutory and residual gross income the amount treated as groupings, taking into account the amount illustrate the application of paragraph dividends under section 78 of $40x (the (e)(1)(iv) of this section. described in paragraph (e)(1)(ii) of this section. Under § 1.861–8(b), USP’s section foreign taxes deemed paid under section (i) Example 1: Net operating loss in 965(c) deduction is definitely related to the 960(a) for the taxable year with respect to inclusion year—(A) Facts. USP, a domestic section 965(a) inclusion, and, therefore, is USP’s section 965(a) inclusion). The section corporation, has a section 965(a) inclusion of 965(a) inclusion and the section 78 dividends $100x and has a section 965(c) deduction of allocated solely to foreign source general category income. Under § 1.861–9T, based on are foreign source general category income. $70x for its taxable year ending December 31, USP also has U.S. source gross income of 2017. USP also includes in gross income the USP’s asset values, the interest expense of $60x is ratably apportioned $30x to foreign $200x, foreign source passive category gross amount treated as dividends under section 78 income of $100x, and other deductions of of $50x (the foreign taxes deemed paid under source general category income and $30x to U.S. source income. Under § 1.861–8(c)(3), $140x. Under § 1.861–8(b), USP’s $60x section 960(a) for the taxable year with section 965(c) deduction is definitely related respect to USP’s section 965(a) inclusion). based on $150x of gross U.S. source income to the section 965(a) inclusion, and, The section 965(a) inclusion and the section and $150x of gross foreign source general therefore, is allocated solely to foreign source 78 dividends are foreign source general category income, the other expenses of $150x general category income. Under §§ 1.861–8 category income. During the 2017 taxable are ratably apportioned $75x to foreign year, USP also has U.S. source gross income source general category income and $75x to through 1.861–17, USP allocates and of $150x and other deductions of $210x, U.S. source income. Therefore, USP’s apportions the other $140x of deductions as comprising $60x of interest expense and deductions allocated and apportioned to follows: $40x to foreign source general $150x of other deductible expenses that are foreign source general category income are category income, $40x to foreign source not definitely related to any gross income. $175x ($70x + $30x + $75x) and its passive category income, and $60x to U.S. USP’s total tax book value of its assets, as deductions allocated and apportioned to U.S. source income. USP has a net operating loss determined under §§ 1.861–9(g)(2) and source income are $105x ($30x + $75x). of $260x for the 2016 taxable year consisting 1.861–9T(g)(3), is divided equally between (3) Under paragraph (e)(1)(iv)(B)(2) of this of a $120x U.S. source loss, a $75x general assets that generate foreign source general section, the deferred amount of $60x category separate limitation loss, and a $65x category income and assets that generate U.S. comprises a ratable portion of the allocated passive category separate limitation loss. source income. USP elects under paragraph and apportioned deductions. Therefore, Under paragraph (e)(1)(i) of this section, USP (e)(1)(i) of this section to not take into $37.5x ($60x × $175x/$280x) of the deferred elects to not take into account the amount account the amount described in paragraph amount comprises deductions allocated and described in paragraph (e)(1)(ii) of this (e)(1)(ii) of this section in determining its net apportioned to foreign source general section in determining the amount of taxable operating loss under section 172 for the category income, and $22.5x ($60x × $105x/ income that may be reduced by net operating taxable year. Before taking into account the $280x) comprises deductions allocated and loss carryovers and carrybacks to the taxable section 965(n) election, USP’s total apportioned to U.S. source income. year under section 172. USP’s taxable income deductions are $280x ($210x + $70x) and (4) Under paragraph (e)(1)(iv)(B)(3) of this before taking into account the section 965(n) USP’s taxable income is $20x ($100x + $50x section, for purposes of the separate foreign election and any net operating loss carryover + $150x¥$70x¥$210x). tax credit limitation under section 904, deduction is $240x:

TABLE 1 TO PARAGRAPH (e)(3)(ii)(A)

General Passive U.S. Total

Section 965(a) inclusion ...... $100x ...... $100x Section 78 dividend ...... 40x ...... 40x Other gross income ...... 100x 200x 300x Section 965(c) deduction ...... (60x) ...... (60x) Other deductions ...... (40x) (40x) (60x) (140x)

Net Income ...... 40x 60x 140x 240x

(B) Analysis—(1) The amount described in from $240x to $160x (the amount of USP’s the 2017 taxable year is determined under paragraph (e)(1)(ii) of this section is $80x taxable income reduced by the amount the rules of § 1.904(g)–3(b), taking into ($100x section 965(a) inclusion¥$60x described in paragraph (e)(1)(ii) of this account the amount described in paragraph section 965(c) deduction + $40x section 78 section). (e)(1)(ii) of this section. Under § 1.904(g)– dividends). As a result of the section 965(n) (2) Under paragraph (e)(1)(iv)(B)(1) of this 3(b)(3)(i), first the $120x U.S. source election, the net operating loss deduction section, the source and separate category of component of the net operating loss is allowed in the 2017 taxable year is reduced the net operating loss deduction allowed in allocated to U.S. source income for the 2017

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taxable year. Because the total tentative reduced proportionately, to $16x ($40x × is carried forward and combined with carryover under § 1.904(g)–3(b)(3)(ii) of $40x/$100x) for the general category and income in the same respective categories for $100x ($40x in the general category and $60x $24x ($40x × $60x/$100x) for the passive the 2017 taxable year. After allocation of the in the passive category) exceeds the category. Accordingly, $16x of the general net operating loss carryover from 2016, USP’s remaining net operating loss deduction of category component of the net operating loss taxable income for the 2017 taxable year is $40x ($160x¥$120x), the tentative carryover is carried forward, and $24x of the passive as follows: amount from each separate category is category component of the net operating loss

TABLE 1 TO PARAGRAPH (e)(3)(ii)(B)(2)

General Passive U.S. Total

Net income before NOL deduction ...... $40x $60x $140x $240x NOL deduction ...... (16x) (24x) (120x) (160x) Net income after NOL deduction ...... 24x 36x 20x 80x

* * * * * 951A(a) and § 1.951A–1(b). The GILTI consolidated tested loss of the member’s ■ Par. 8. Section 1.1502–12 is amended inclusion amount of a member for a U.S. consolidated group and the member’s by adding paragraph (s) to read as shareholder inclusion year is the excess GILTI allocation ratio. follows: (if any) of the member’s net CFC tested (4) Consolidated QBAI. With respect income for the U.S. shareholder to a consolidated group, the term § 1.1502–12 Separate taxable income. inclusion year, over the member’s net consolidated QBAI means the sum of * * * * * deemed tangible income return for the each member’s pro rata share (s) See § 1.1502–51 for rules relating U.S. shareholder inclusion year, (determined under § 1.951A–1(d)(3)) of to the computation of a member’s GILTI determined using the definitions the qualified business asset investment inclusion amount under section 951A provided in paragraph (e) of this of each tested income CFC for a CFC and related basis adjustments. section. In addition, see § 1.951A–1(e). inclusion year that ends with or within ■ Par. 9. Section 1.1502–32 is amended (c) [Reserved] the U.S. shareholder inclusion year. by adding and reserving paragraphs (d) [Reserved] (5) Consolidated specified interest (b)(3)(ii)(E) and (b)(3)(iii)(C). (e) Definitions. Any term used but not expense. With respect to a consolidated defined in this section has the meaning group, the term consolidated specified § 1.1502–32 Investment adjustments. set forth in §§ 1.951A–1 through interest expense means the excess (if * * * * * 1.951A–6. In addition, the following any) of— (b) * * * definitions apply for purposes of this (i) The sum of each member’s pro rata (3) * * * section. (ii) * * * share (determined under § 1.951A– (1) Aggregate tested income. With 1(d)(5)) of the tested interest expense of (E) [Reserved] respect to a member, the term aggregate (iii) * * * each controlled foreign corporation for a tested income means the aggregate of the CFC inclusion year that ends with or (C) [Reserved] member’s pro rata share (determined * * * * * within the U.S. shareholder inclusion under § 1.951A–1(d)(2)) of the tested year, over ■ Par. 10. Section 1.1502–51 is added to income of each tested income CFC for (ii) The sum of each member’s pro read as follows: a CFC inclusion year that ends with or rata share (determined under § 1.951A– within the U.S. shareholder inclusion 1(d)(6)) of the tested interest income of § 1.1502–51 Consolidated section 951A. year. (a) In general. This section provides (2) Aggregate tested loss. With respect each controlled foreign corporation for a rules for applying section 951A to each to a member, the term aggregate tested CFC inclusion year that ends with or member of a consolidated group (each, loss means the aggregate of the within the U.S. shareholder inclusion a member) that is a United States member’s pro rata share (determined year. shareholder of any controlled foreign under § 1.951A–1(d)(4)) of the tested (6) Consolidated tested income. With corporation. Paragraph (b) of this loss of each tested loss CFC for a CFC respect to a consolidated group, the section describes the inclusion of the inclusion year that ends with or within term consolidated tested income means GILTI inclusion amount by a member of the U.S. shareholder inclusion year. the sum of each member’s aggregate a consolidated group. Paragraphs (c) and (3) Allocable share. The term tested income for the U.S. shareholder (d) of this section are reserved. allocable share means, with respect to a inclusion year. Paragraph (e) of this section provides member that is a United States (7) Consolidated tested loss. With definitions for purposes of this section. shareholder and a U.S. shareholder respect to a consolidated group, the Paragraph (f) of this section provides inclusion year— term consolidated tested loss means the examples illustrating the rules of this (i) With respect to consolidated QBAI, sum of each member’s aggregate tested section. Paragraph (g) of this section the product of the consolidated QBAI of loss for the U.S. shareholder inclusion provides an applicability date. the member’s consolidated group and year. (b) Calculation of the GILTI inclusion the member’s GILTI allocation ratio. (8) Controlled foreign corporation. amount for a member of a consolidated (ii) With respect to consolidated The term controlled foreign corporation group. Each member who is a United specified interest expense, the product has the meaning provided in § 1.951A– States shareholder of any controlled of the consolidated specified interest 1(f)(2). foreign corporation includes in gross expense of the member’s consolidated (9) Deemed tangible income return. income in the U.S. shareholder group and the member’s GILTI With respect to a member, the term inclusion year the member’s GILTI allocation ratio. deemed tangible income return means inclusion amount, if any, for the U.S. (iii) With respect to consolidated 10 percent of the member’s allocable shareholder inclusion year. See section tested loss, the product of the share of the consolidated QBAI.

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(10) GILTI allocation ratio. With P consolidated group; CFC1, CFC2, income and a GILTI allocation ratio of 0, respect to a member, the term GILTI CFC3, and CFC4 are all controlled USS2 has $200x of aggregate tested income allocation ratio means the ratio of— foreign corporations (within the and a GILTI allocation ratio of 0.25, and (i) The aggregate tested income of the USS3 has $600x of aggregate tested income meaning of paragraph (e)(8) of this and a GILTI allocation ratio of 0.75. member for the U.S. shareholder section); and the taxable year of all Additionally, the P consolidated group’s inclusion year, to persons is the calendar year. consolidated tested loss is $300x (the (ii) The consolidated tested income of (1) Example 1: Calculation of net CFC aggregate of USS1’s aggregate tested loss, the consolidated group of which the tested income within a consolidated group which is equal to its pro rata share member is a member for the U.S. when all CFCs are wholly owned by a (determined under § 1.951A–1(d)(4)) of shareholder inclusion year. member—(i) Facts. USS1 owns all of the CFC1’s tested loss ($100x); USS2’s aggregate (11) GILTI inclusion amount. With single class of stock of CFC1. USS2 owns all tested loss, which is equal to its pro rata respect to a member, the term GILTI of the single class of stock of each of CFC2 share (determined under § 1.951A–1(d)(4)) of CFC3’s tested loss ($100x); and USS3’s inclusion amount has the meaning and CFC3. USS3 owns all of the single class of stock of CFC4. In Year 1, CFC1 has tested aggregate tested loss, which is equal to its pro provided in paragraph (b) of this rata share (determined under § 1.951A– section. loss of $100x, CFC2 has tested income of $200x, CFC3 has tested loss of $200x, and 1(d)(4)) of CFC3’s tested loss ($100x)). As a (12) Net CFC tested income. With CFC4 has tested income of $600x. None of result, under paragraph (e)(12) of this section, respect to a member, the term net CFC CFC1, CFC2, CFC3, or CFC4 has qualified as in paragraph (f)(1)(ii)(C) of this section tested income means the excess (if any) business asset investment in Year 1. (paragraph (C) of the analysis in Example 1), the net CFC tested income of USS1, USS2, of— (ii) Analysis—(A) Consolidated tested ¥ (i) The member’s aggregate tested income and GILTI allocation ratio. USS1 has and USS3 are $0 ($0 $0), $125x ($200x¥$75x), and $375x ($600x¥$225x), income, over no aggregate tested income; USS2’s aggregate tested income is $200x, its pro rata share respectively. (ii) The member’s allocable share of (3) Example 3: Calculation of GILTI (determined under § 1.951A–1(d)(2)) of the consolidated tested loss. inclusion amount—(i) Facts. The facts are the CFC2’s tested income; and USS3’s aggregate (13) Net deemed tangible income same as in paragraph (f)(1)(i) of this section tested income is $600x, its pro rata share return. With respect to a member, the (the facts in Example 1), except that CFC2 (determined under § 1.951A–1(d)(2)) of and CFC4 have qualified business asset term net deemed tangible income return CFC4’s tested income. Therefore, under investment of $500x and $2,000x, means the excess (if any) of the paragraph (e)(6) of this section, the P respectively, for Year 1. In Year 1, CFC1 and member’s deemed tangible income consolidated group’s consolidated tested CFC4 each have tested interest expense income is $800x ($200x + $600x). As a result, return over the member’s allocable share (within the meaning of § 1.951A–4(b)(1)) of of the consolidated specified interest the GILTI allocation ratios of USS1, USS2, $25x, and none of CFC1, CFC2, CFC3, and expense. and USS3 are 0 ($0/$800x), 0.25 ($200x/ CFC4 have tested interest income (within the (14) through (16) [Reserved] $800x), and 0.75 ($600x/$800x), respectively. meaning of § 1.951A–4(b)(2)). CFC1’s tested (17) Qualified business asset (B) Consolidated tested loss. Under loss of $100x and CFC4’s tested income of investment. The term qualified business paragraph (e)(7) of this section, the P $600x take into account the tested interest consolidated group’s consolidated tested loss asset investment has the meaning expense. is $300x ($100x + $200x), the sum of USS1’s (ii) Analysis—(A) GILTI allocation ratio. As provided in § 1.951A–3(b). aggregate tested loss, which is equal to its pro (18) Tested income. The term tested in paragraph (f)(1)(ii)(A) of this section rata share (determined under § 1.951A– (paragraph (A) of the analysis in Example 1), income has the meaning provided in 1(d)(4)) of CFC1’s tested loss ($100x), and the GILTI allocation ratios of USS1, USS2, § 1.951A–2(b)(1). USS2’s aggregate tested loss, which is equal and USS3 are 0 ($0/$800x), 0.25 ($200x/ (19) Tested income CFC. The term to its pro rata share (determined under $800x), and 0.75 ($600x/$800x), respectively. tested income CFC has the meaning § 1.951A–1(d)(4)) of CFC3’s tested loss (B) Consolidated QBAI. Under paragraph provided in § 1.951A–2(b)(1). ($200x). Under paragraph (e)(3)(iii) of this (e)(4) of this section, the P consolidated (20) Tested interest expense. The term section, a member’s allocable share of the group’s consolidated QBAI is $2,500x ($500x tested interest expense has the meaning consolidated tested loss is the product of the + $2,000x), the aggregate of USS2’s pro rata consolidated tested loss of the member’s share (determined under § 1.951A–1(d)(3)) of provided in § 1.951A–4(b)(1). consolidated group and the member’s GILTI (21) Tested interest income. The term the qualified business asset investment of allocation ratio. Therefore, the allocable CFC2 and USS3’s pro rata share (determined tested interest income has the meaning shares of the consolidated tested loss of under § 1.951A–1(d)(3)) of the qualified × provided in § 1.951A–4(b)(2). USS1, USS2, and USS3 are $0 (0 $300x), business asset investment of CFC4. Under × × (22) Tested loss. The term tested loss $75x (0.25 $300x), and $225x (0.75 paragraph (e)(3)(i) of this section, a member’s has the meaning provided in § 1.951A– $300x), respectively. allocable share of consolidated QBAI is the 2(b)(2). (C) Calculation of net CFC tested income. product of the consolidated QBAI of the (23) Tested loss CFC. The term tested Under paragraph (e)(12) of this section, a member’s consolidated group and the loss CFC has the meaning provided in member’s net CFC tested income is the member’s GILTI allocation ratio. Therefore, § 1.951A–2(b)(2). excess (if any) of the member’s aggregate the allocable shares of the consolidated QBAI tested income over the member’s allocable of each of USS1, USS2, and USS3 are $0 (0 (24) United States shareholder. The share of the consolidated tested loss. As a × × term United States shareholder has the $2,500x), $625x (0.25 $2,500x), and result, the net CFC tested income of USS1, $1,875x (0.75 × $2,500x), respectively. meaning provided in § 1.951A–1(f)(6). USS2, and USS3 are $0 ($0¥$0), $125x (C) Consolidated specified interest (25) U.S. shareholder inclusion year. ($200x¥$75x), and $375x ($600x¥$225x), expense—(1) Pro rata share of tested interest The term U.S. shareholder inclusion respectively. expense. USS1’s pro rata share (determined year has the meaning provided in (2) Example 2: Calculation of net CFC under § 1.951A–1(d)(5)) of the tested interest § 1.951A–1(f)(7). tested income within a consolidated group expense of CFC1 is $25x, the amount by (f) Examples. The following examples when ownership of a tested loss CFC is split which the tested interest expense increases illustrate the rules of this section. For between members—(i) Facts. The facts are the USS1’s pro rata share of CFC1’s tested loss purposes of the examples in this same as in paragraph (f)(1)(i) of this section (from $75x to $100x) for Year 1. USS3’s pro (the facts in Example 1), except that USS2 section, unless otherwise stated: P is the rata share (determined under § 1.951A– and USS3 each own 50% of the single class 1(d)(5)) of the tested interest expense of CFC4 common parent of the P consolidated of stock of CFC3. is also $25x, the amount by which the tested group; P owns all of the single class of (ii) Analysis. As in paragraph (f)(1)(ii)(A) of interest expense decreases USS3’s pro rata stock of subsidiaries USS1, USS2, and this section (paragraph (A) of the analysis in share of CFC4’s tested income (from $625x to USS3, all of whom are members of the Example 1), USS1 has no aggregate tested $600x).

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(2) Consolidated specified interest expense. rules of this section to all taxable years furnish the information prescribed on Under paragraph (e)(5) of this section, the P described in § 1.951A–7 and with Form 8992 within the time prescribed consolidated group’s consolidated specified respect to all members. by paragraph (b) of this section, the interest expense is $50x, the excess of the (2) [Reserved] penalties imposed by section 6038(b) sum of each member’s pro rata share of the ■ and (c) apply. tested interest expense of each controlled Par. 11. Section 1.6038–2 is amended foreign corporation ($50x, $25x from USS1 + by revising the section heading, the (2) Increase in penalty. If a failure $25x from USS3), over the sum of each introductory text of paragraph (a), and described in paragraph (c)(1) of this member’s pro rata share of tested interest paragraph (m) to read as follows: section continues for more than 90 days income ($0). Under paragraph (e)(3)(ii) of this after the date on which the Director of section, a member’s allocable share of § 1.6038–2 Information returns required of Field Operations, Area Director, or consolidated specified interest expense is the United States persons with respect to Director of Compliance Campus product of the consolidated specified interest annual accounting periods of certain Operations mails notice of such failure expense of the member’s consolidated group foreign corporations. to the person required to file Form 8992, and the member’s GILTI allocation ratio. (a) Requirement of return. Every U.S. such person shall pay a penalty of Therefore, the allocable shares of person shall make a separate annual $10,000, in addition to the penalty consolidated specified interest expense of × information return with respect to each imposed by section 6038(b)(1), for each USS1, USS2, and USS3 are $0 (0 $50x), annual accounting period (described in $12.50x (0.25 × $50x), and $37.50x (0.75 × 30-day period (or a fraction of) during $50x), respectively. paragraph (e) of this section) of each which such failure continues after such (D) Calculation of deemed tangible income foreign corporation which that person 90-day period has expired. The return. Under paragraph (e)(9) of this section, controls (as defined in paragraph (b) of additional penalty imposed by section a member’s deemed tangible income return this section) at any time during such 6038(b)(2) and this paragraph (c)(2) means 10 percent of the member’s allocable annual accounting period. shall be limited to a maximum of share of the consolidated QBAI. As a result, * * * * * $50,000 for each failure. the deemed tangible income returns of USS1, (m) Applicability dates—(1) In (3) Reasonable cause—(i) For USS2, and USS3 are $0 (0.1 × $0), $62.50x × × general. This section applies to taxable purposes of section 6038(b) and (c) and (0.1 $625x), and $187.50x (0.1 $1,875x), this section, the time prescribed for respectively. years of foreign corporations beginning (E) Calculation of net deemed tangible on or after October 3, 2018. See 26 CFR furnishing information under paragraph income return. Under paragraph (e)(13) of 1.6038–2 (revised as of April 1, 2018) (b) of this section, and the beginning of this section, a member’s net deemed tangible for rules applicable to taxable years of the 90-day period after mailing of notice income return means the excess (if any) of a foreign corporations beginning before by the director under paragraph (c)(2) of member’s deemed tangible income return such date. this section, shall be treated as being not over the member’s allocable share of the (2) [Reserved] earlier than the last day on which consolidated specified interest expense. As a ■ reasonable cause existed for failure to result, the net deemed tangible income Par. 12. Section 1.6038–5 is added to read as follows: furnish the information. returns of USS1, USS2, and USS3 are $0 (ii) To show that reasonable cause ($0¥$0), $50x ($62.50x¥$12.50x), and ¥ § 1.6038–5 Information returns required of existed for failure to furnish information $150x ($187.50x $37.50x), respectively. certain United States persons to report as required by section 6038 and this (F) Calculation of GILTI inclusion amount. amounts determined with respect to certain Under paragraph (b) of this section, a section, the person required to report foreign corporations for global intangible such information must make an member’s GILTI inclusion amount for a U.S. low-taxed income (GILTI) purposes. shareholder inclusion year is the excess (if affirmative showing of all facts alleged any) of the member’s net CFC tested income (a) Requirement of return. Except as as reasonable cause for such failure in for the U.S. shareholder inclusion year, over provided in paragraph (d) of this a written statement containing a the shareholder’s net deemed tangible section, each United States person who declaration that it is made under the income return for the U.S. shareholder is a United States shareholder (as penalties of perjury. The statement must inclusion year. As described in paragraph defined in section 951(b)) of any be filed with the director where the (f)(1)(ii)(C) of this section (paragraph (C) of controlled foreign corporation (as return is required to be filed. The the analysis in Example 1), the net CFC defined in section 957) must make an director shall determine whether the tested income of USS1, USS2, and USS3 are annual return on Form 8992, ‘‘U.S. $0, $125x, and $375x, respectively. As failure to furnish information was due described in paragraph (f)(3)(ii)(E) of this Shareholder Calculation of Global to reasonable cause, and if so, the period section (paragraph (E) of the analysis in this Intangible Low-Taxed Income (GILTI),’’ of time for which such reasonable cause example), the net deemed tangible income (or successor form) for each U.S. existed. In the case of a return that has returns of USS1, USS2, and USS3 are $0, shareholder inclusion year (as defined been filed as required by this section $50x, and $150x, respectively. As a result, in § 1.951A–1(f)(7)) setting forth the except for an omission of, or error with under paragraph (b) of this section, the GILTI information with respect to each such respect to, some of the information inclusion amounts of USS1, USS2, and USS3 controlled foreign corporation, in such ¥ ¥ required, if the person who filed the are $0 ($0 $0), $75x ($125x $50x), and form and manner, as Form 8992 (or return establishes to the satisfaction of $225x ($375x¥$150x), respectively. successor form) prescribes. the director that the person has (g) Applicability date—(1) In general. (b) Time and manner for filing. substantially complied with this Except as otherwise provided in this Returns on Form 8992 (or successor section, then the omission or error shall paragraph (g), this section applies to form) required under paragraph (a) of not constitute a failure under this taxable years of United States this section for a taxable year must be section. shareholders for which the due date filed with the United States person’s (d) Exception from filing requirement. (without extensions) of the consolidated income tax return on or before the due Any United States person that does not return is after June 21, 2019. However, date (taking into account extensions) for own, within the meaning of section a consolidated group may apply the filing that person’s income tax return. 958(a), stock of a controlled foreign rules of this section in their entirety to (c) Failure to furnish information—(1) corporation in which the United States all taxable years of its members that are Penalties. If any person required to file person is a United States shareholder for described in § 1.951A–7. In such a case, Form 8992 (or successor form) under a taxable year is not required to file the consolidated group must apply the section 6038 and this section fails to Form 8992. For this purpose, whether a

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U.S. person owns, within the meaning foreign corporations beginning on or of section 958(a), stock of a controlled after October 3, 2018. foreign corporation is determined under Kirsten Wielobob, § 1.951A–1(e). Deputy Commissioner for Services and (e) Applicability date. This section Enforcement. applies to taxable years of controlled Approved: June 6, 2019. David J. Kautter, Assistant Secretary of the Treasury (Tax Policy). [FR Doc. 2019–12437 Filed 6–14–19; 4:15 pm] BILLING CODE 4830–01–P

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