26 CFR 1.963-4 Limitations on minimum distribution from a chain or
group.
(a) Minimum overall tax burden -- (1) In general. Notwithstanding
the fact that distributions of the type described in paragraph (a) of
1.963-3 are made by a chain or group to the United States shareholder in
an amount sufficient to constitute a minimum distribution for the
taxable year of such shareholder to which the chain or group election
relates, no exclusion shall be allowable under section 963 to such
shareholder with respect to such chain or group for such year unless --
(i) Without applying the special rules set forth in paragraphs (b)
and (c) of this section, the overall United States and foreign income
tax (as defined in subparagraph (2)(ii) of this paragraph) for the
taxable year with respect to the distribution which is made equals or
exceeds 90 percent of an amount determined by multiplying the sum of the
consolidated earnings and profits (as determined under paragraph (d)(3)
of 1.963-2) and the consolidated foreign income taxes (as determined
under paragraph (e)(2) of 1.963-2) of such chain or group for the
taxable year with respect to such shareholder by a percentage which
equals the sum of the normal tax rate and the surtax rate (determined
without regard to the surtax exemption) prescribed by section 11 for the
taxable year of the shareholder, or
(ii) With the application of the special rules set forth in
paragraphs (b) and (c) of this section --
(a) Such shareholder receives a pro rata minimum distribution (as
defined in subparagraph (2)(i) of this paragraph) from such chain or
group for such taxable year, or
(b) To the extent necessary, the amount of the foreign income tax
allowable as a credit for such year under section 901 with respect to
the distribution which is made is reduced and credit for the reduction
is deferred, as provided in paragraph (c)(3) of this section, so that
the overall United States and foreign income tax for the taxable year
with respect to such distribution equals or exceeds the lesser of --
(1) The overall United States and foreign income tax which would be
paid or accrued for such year with respect to a pro rata minimum
distribution received by such shareholder from such chain or group for
such year, and
(2) Ninety percent of an amount determined by multiplying the sum of
the consolidated earnings and profits (as determined under paragraph
(b)(1) of this section) and the consolidated foreign income taxes (as
determined under paragraph (b)(1) of this section) of such chain or
group for the taxable year with respect to such shareholder by a
percentage which equals the sum of the normal tax rate and the surtax
rate (determined without regard to the surtax exemption) prescribed by
section 11 for the taxable year of the shareholder.
(2) Definitions. For purposes of 1.963-1 through 1.963.8 --
(i) Pro rata minimum distribution. A pro rata minimum distribution
from a chain or group for the taxable year is a distribution of earnings
and profits to the United States shareholder, with respect to stock to
which the chain or group election relates, which is the statutory
percentage (applicable with respect to such chain or group as determined
under paragraph (b) of 1.963-2) of the United States shareholder's
proportionate share of the taxable year's earnings and profits of each
foreign corporation in such chain or group (determined in accordance
with paragraph (d)(2) of 1.963-2 but without making any deduction under
paragraph (d)(1)(iii) of such section).
(ii) Overall United States and foreign income tax. The overall
United States and foreign income tax for any taxable year of a chain or
group with respect to a minimum distribution is the sum of --
(a) The consolidated foreign income taxes of the chain or group for
such year with respect to the United States shareholder making the chain
or group election,
(b) Any other foreign income tax paid or accrued by a foreign
corporation in the chain or group by reason of the receipt of any
distributions counting toward such minimum distribution from such chain
or group for that year, and
(c) The foreign income tax, if any, and United States income tax paid
or accrued by such shareholder upon amounts counting toward such minimum
distribution from such chain or group for such year.
Such overall United States and foreign income tax shall be determined
with respect to such minimum distribution without taking into account
any foreign income tax which is deemed paid for such year under section
904(d), relating to carryback and carryover of excess tax paid. For
purposes of this subdivision, the consolidated foreign income taxes of
the chain or group shall be determined under paragraph (e)(2) of
1.963-2, applied without regard to the second sentence of paragraph
(d)(1) of that section.
(3) Taxes paid by foreign corporation on distributions received
during its distribution period. For purposes of determining foreign
income tax deemed paid by the United States shareholder for the taxable
year under section 902, if a distribution received by a foreign
corporation in a chain or group from another foreign corporation in such
chain or group after the close of the recipient's taxable year but
during its distribution period for such year is allocated to the
earnings and profits of such recipient corporation for such year under
paragraph (c)(2) of 1.963-3, any foreign income tax paid or accrued by
such recipient corporation on such distribution shall be treated as paid
or accrued for such taxable year.
(4) Illustration. The application of this paragraph may be
illustrated by the following example:
Example. (a) Domestic corporation M directly owns all of the one
class of stock of foreign corporation A, which in turn directly owns all
of the one class of stock of foreign corporation B. Corporation M makes
a chain election with respect to A Corporation and B Corporation. All
such corporations use the calendar year as the taxable year. Assuming
that A Corporation does not incur foreign tax on amounts distributed by
B Corporation, the foreign income tax and earnings and profits of
corporations A and B, the effective foreign tax rate, and the statutory
percentage for 1966, are as follows:
(b) Corporation M is entitled for 1966 to exclude its pro rata share
of the subpart F income of corporations A and B for such year if it
receives from the 1966 consolidated earnings and profits of the chain
distributions totaling at least $96.60 (0.69 $140) and if --
(1) The sum of the consolidated foreign income taxes ($60) of the
chain for 1966 and of the United States income tax for 1966 (determined
by taking into account the foreign tax credit under section 901 without
regard to paragraph (c) of this section) imposed on such distributions
equals at least $86.40 (0.90 0.48 $200);
(2) Under the special rules of paragraphs (b) and (c) of this
section, the distributions received consist of a distribution from each
of corporations A and B which is 69 percent of the earnings and profits
for 1966 of such corporation, that is, a distribution of $55.20 (0.69
$80) from A Corporation and of $41.40 (0.69 $60) from B Corporation; or
(3) Under the special rules of paragraphs (b) and (c) of this
section, the foreign tax credit is reduced and deferred to such an
extent that the sum of the consolidated foreign income taxes ($60) of
the chain for 1966 and of the United States income tax for 1966
(determined by taking into account the foreign tax credit under section
901 as modified by paragraph (c) of this section) imposed on such
distributions equals the lesser of $86.40 (0.90 0.48 $200) and the
amount which the sum of such taxes would be if M Corporation were to
receive a distribution of $55.20 (0.69 $80) from the 1966 earnings and
profits of A Corporation and $41.40 (0.69 $60) from the 1966 earnings
and profits of B Corporation.
(b) Special rules for determining earnings and profits and foreign
income taxes. For purposes of determining the minimum overall tax
burden under paragraph (a)(1)(ii) of this section, 1.963-2 and 1.963-3
shall apply as modified by the following subparagraphs:
(1) Exclusion of tax on intercorporate distributions. The
consolidated earnings and profits and consolidated foreign income taxes
of a chain or group for the taxable year shall be determined in
accordance with 1.963-2, except that foreign income tax referred to in
paragraph (d)(1)(iii) of such section may be taken into account in
determining the effective foreign tax rate only --
(i) To the extent that such tax is not deemed paid by the United
States shareholder under section 902 (as modified by paragraph (c) of
this section) for its taxable year to which the chain or group election
relates, or
(ii) If, by taking the tax into account, the effective foreign tax
rate with respect to such chain or group, as determined under paragraph
(c)(2) of 1.963-2, exceeds the highest effective foreign tax rate
requiring a distribution under section 963(b) for such year of the
shareholder.
(2) Allocation of deficits. For purposes of determining the amount
of each foreign corporation's share of a pro rata minimum distribution
from a chain or group for the taxable year and for purposes of
determining the foreign tax credit under paragraph (c) of this section
of the United States shareholder with respect to any minimum
distribution from a chain or group for the taxable year --
(i) Deficits of foreign corporations. The total of the United States
shareholder's proportionate shares, as determined under paragraph
(d)(2)(ii) of 1.963-2, of the deficit of every foreign corporation in
the chain or group having a deficit for the taxable year shall be
allocated against and shall reduce such shareholder's proportionate
share, as determined under paragraph (d)(2)(i) of 1.963-2, of the
earnings and profits for the taxable year of each other foreign
corporation in the chain or group having earnings and profits for such
year in an amount which bears to such total of shares of deficit the
same ratio which such share of earnings and profits bears to the total
of such shareholder's proportionate shares, as so determined, of the
earnings and profits of all foreign corporations in the chain or group
having earnings and profits for the taxable year.
(ii) Deficits of foreign branches. If for the taxable year a group
includes under paragraph (f)(4) of 1.963-1 foreign branches the
aggregate of whose allowable deductions (other than any net operating
loss deduction) exceeds the aggregate of their gross incomes for the
taxable year, determined as provided in paragraph (f)(4)(ii) of such
section, the amount of such excess shall be allocated as provided by
subdivision (i) of this subparagraph.
(3) Distributions through a chain or group. In determining whether
and to what extent a distribution for any taxable year has been made out
of the earnings and profits of a foreign corporation included in a chain
of ownership described in section 958(a) consisting of two or more
corporations in a chain or group for the taxable year, the following
subdivisions shall apply:
(i) Allocation first to income received as a distribution. If any
foreign corporation included in the chain or group for the taxable year
receives a distribution for such year from another foreign corporation
in the chain or group and in turn makes a distribution for the taxable
year, the distribution so made shall first be allocated to the earnings
and profits, to the extent thereof, attributable to the distribution so
received; if distributions are received from more than one other
corporation in the chain or group, the distribution made by the
recipient corporation shall be apportioned among all such amounts. For
purposes of determining whether a distribution is made or received for
the taxable year, see paragraph (c) of 1.963-3.
(ii) Successive distributions through a chain or group. If any
foreign corporation included in the chain or group for the taxable year
distributes an amount from its earnings and profits of such year, the
amount so distributed shall be considered to be received from such
earnings and profits by the United States shareholder to the extent the
amount is distributed by successive distributions made by each other
foreign corporation in the chain or group for the taxable year through
the chain of ownership described in section 958(a) into the hands of
such shareholder.
(iii) Distribution determined without reduction by taxes of
intervening corporations. If, for the taxable year to which the
election to secure an exclusion under section 963 applies, the United
States shareholder receives a distribution to which subdivision (ii) of
this subparagraph applies, the entire amount distributed by the foreign
corporation from such shareholder's proportionate share of its earnings
and profits for the taxable year shall, except where taxes referred to
in paragraph (d)(1)(iii) of 1.963-2 are taken into account as provided
by subparagraph (1) of this paragraph, count toward a minimum
distribution and shall not be reduced for such purpose by an foreign
income tax paid or accrued on such amount by another foreign corporation
in the chain or group through which such amount is distributed by
successive distributions into the hands of such shareholder. The
application of this subdivision may be illustrated by the following
examples:
Example 1. For 1966, domestic corporation M makes a chain election
with respect to controlled foreign corporation A, all the one class of
stock of which is directly owned by M Corporation, and controlled
foreign corporation B, all the one class of stock of which is directly
owned by A Corporation. All corporations use the the calendar year as
the taxable year. Corporation M complies with the special rules of this
paragraph and paragraph (c) of this section for the taxable year.
Corporation A's only income for 1966 is a dividend of $52.50 distributed
in such year by B Corporation, on which A Corporation is subject to an
income tax of $10.50. The remaining $42 ($52.50 less $10.50) is
distributed by A Corporation for 1966 to M Corporation. The full $52.50
distributed by B Corporation counts toward a minimum distribution by the
chain for 1966.
Example 2. For 1966, domestic corporation M makes a chain election
with respect to controlled foreign corporation A, all the one class of
stock of which it owns directly, and controlled foreign corporation B,
all the one class of stock of which A Corporation own directly. All
corporations use the calendar year as the taxable year. Corporation M
complies with the special rules of this paragraph and paragraph (c) of
this section for the taxable year. The predistribution and pretax
earnings and profits for 1966 of B Corporation are $100, and of A
Corporation, $0. Corporation B pays foreign income tax of $30 and
during the year distributes $70. On such $70, A Corporation pays
foreign income tax of $14. By applying paragraph (d)(1)(iii) of
1.963-2, the consolidated foreign income taxes of the chain for 1966 are
$44 ($30+$14) and the consolidated earnings and profits of the chain are
$56 ($70^$14); in such case, the effective foreign tax rate of the
chain for 1966 is 44 percent ($44/($56+$44)) and thus in excess of the
highest effective foreign tax rate requiring a distribution for such
year under section 963(b). Since M Corporation may thus take A
Corporation's tax of $14 into account, the statutory percentage under
section 963(b) for 1966 is zero percent and the amount of the minimum
distribution required to be made by the chain is $0.
(c) Special foreign tax credit rules -- (1) In general. In
determining the minimum overall tax burden under paragraph (a)(1)(ii) of
this section, the foreign tax credit of the United States shareholder
with respect to a minimum distribution received for the taxable year
from the chain or group shall be determined under the provisions of
sections 901 through 905 as modified by 1.963-3 except that --
(i) Under subparagraph (2) of this paragraph --
(a) Taxes of a second-tier corporation making a distribution through
a first-tier corporation shall not be averaged with taxes of such
first-tier corporation,
(b) Taxes of a first-tier corporation or a second-tier corporation on
a distribution made through such corporation shall not be averaged with
such corporation's taxes on its other income; and
(c) Taxes of a first-tier corporation or a second-tier corporation
shall not be deemed paid with respect to distributions from the earnings
and profits of such corporation which are offset by a deficit allocated
under paragraph (b)(2) of this section to the United States
shareholder's proportionate share of the earnings and profits of such
corporation; and
(ii) The foreign tax credit may be reduced and the reduction deferred
under subparagraph (3) of this paragraph to another taxable year of the
United States shareholder.
(2) Nonaveraging of tax -- (i) Year of minimum distribution -- (a)
Taxes deemed paid by a first-tier corporation and taxes actually paid by
such corporation. If, by successive distributions through a chain or
group, a United States shareholder receives for a taxable year a
distribution of the earnings and profits for such year of any
corporation in such chain or group, and if both section 902(a) and
section 902(b) apply with respect to such distribution, all the taxes
deemed paid under section 902(b) by the first-tier corporation described
in section 902(a) with respect to such distribution of such earnings and
profits shall be deemed paid by the United States shareholder for such
taxable year under section 902(a) with respect to the earnings and
profits so distributed and, notwithstanding the rules otherwise
applicable under section 902, no part of the taxes so deemed paid by
such first-tier corporation shall be attributed to other earnings and
profits of such first-tier corporation for such year and no part of the
taxes paid or accrued with respect to such other earnings and profits
shall be attributed to the earnings and profits so received as a
distribution.
(b) Taxes of a foreign corporation paid on intercorporate
distributions and on other income. If, by successive distributions
through a chain or group, a United States shareholder receives for a
taxable year a distribution of the earnings and profits for such year of
any corporation in such chain or group, then in applying section 902(a)
with respect to such distribution through a first-tier corporation
described in section 902(a), or in applying section 902(b) with respect
to such distribution through a second-tier corporation described in
section 902(b), as the case may be, the taxes of such corporation which
shall be taken into account in determining taxes deemed paid under such
section shall be the foreign income tax actually paid or accrued for the
taxable year by such first-tier or second-tier corporation, as the case
may be, with respect to such distribution; and, notwithstanding the
rules otherwise applicable under section 902, no part of the taxes so
paid by such first-tier or second-tier corporation shall be attributed
to other earnings and profits of such corporation for such year and no
part of the taxes paid or accrued with respect to such other earnings
and profits shall be attributed to the earnings and profits so received
as a distribution.
(c) Corporation with earnings and profits reduced by allocated
deficits. In the application of section 902, a United States
shareholder's proportionate share of the earnings and profits for the
taxable year of a foreign corporation to which the chain or group
election applies shall reflect the reduction of such earnings and
profits by deficits allocated thereto under paragraph (b)(2) of this
section. No taxes paid or accrued by such corporation shall be deemed
paid under section 902 with respect to a distribution to such
shareholder from the earnings and profits of such corporation for such
year to the extent that such distribution exceeds the shareholder's
proportionate share as so reduced.
(ii) Year of distribution of remaining earnings and profits. If for
a taxable year in respect of which a United States shareholder receives
a minimum distribution pursuant to an election under section 963 and in
respect of which the provisions of this subparagraph are applied --
(a) The foreign income tax which is paid or accrued by a foreign
corporation for such year, by reason of the receipt and payment of
earnings and profits counting toward such minimum distribution, is
deemed paid under subdivision (i) (a) or (b) of this subparagraph,
(b) The pretax and predistribution earnings and profits for such year
of a foreign corporation in a chain or group with respect to stock on
which such minimum distribution is received are reduced by reason of the
deduction under paragraph (d)(1)(i) of 1.963-2 of distributions
received from other corporations in such chain or group, or
(c) Such shareholder's proportionate share of the earnings and
profits for such year of a foreign corporation in a chain or group
making a distribution counting toward such minimum distribution is
reduced by the allocation thereto under paragraph (b)(2) of this section
of a portion of the deficits of foreign branches or other foreign
corporations in such chain or group,
the pretax and predistribution earnings and profits of such foreign
corporation for such year to which such minimum distribution is
attributable and the foreign income tax which is taken into account in
determining tax deemed paid under section 902 on such pretax and
predistribution earnings and profits shall not be taken into account in
the application of section 902 when other earnings and profits of such
foreign corporation for such year are distributed in a subsequent
taxable year of such foreign corporation to such shareholder. For the
purpose of applying the preceding sentence to a case in which (c) of
this subdivision applies, the pretax and predistribution earnings and
profits of the foreign corporation for such year to which the minimum
distributed is attributable shall be the amount of such corporation's
earnings and profits which are distributed and count toward the minimum
distribution plus the foreign income tax of such foreign corporation
allocated thereto in determining the taxes deemed paid under section 902
for the taxable year of the minimum distribution.
(iii) Illustrations. The application of this subparagraph may be
illustrated by the following examples:
Example 1. Domestic corporation M makes a chain election for 1966
with respect to controlled foreign corporation A, which is wholly owned
directly by M Corporation, and controlled foreign corporation B, which
is wholly owned directly by A Corporation. Each corporation uses the
calendar year as the taxable year. In 1966, corporations A and B are
subject to foreign income tax at the rates of 20 percent and 30 percent,
respectively, with no deduction being allowed for dividends received or
paid; each such corporation has pretax and predistribution earnings and
profits of $100. Corporation M receives from the chain a pro rata
minimum distribution for such year and applies thereto the special rules
of this paragraph and paragraph (b) of this section. Corporation A is
not a less developed country corporation under section 902(d). The 1966
foreign income tax of corporations A and B which is deemed paid by M
Corporation under section 902(a) for 1966, and the remaining tax which
is allocated to earnings and profits to be distributed to M Corporation
in future years, are determined as follows:
Example 2. The facts are the same as in example 1 except that A
Corporation pays foreign income tax at the rate of 30 percent and B
Corporation, at the rate of 20 percent; and A Corporation is allowed a
deduction, in computing its income subject to tax, for the full amount
of dividends received. The determination of tax deemed paid for 1966 is
as follows:
Example 3. For 1966, domestic corporation M makes a group election
with respect to controlled foreign corporations A and B, both of which
are wholly owned directly by M Corporation, and foreign branch C of M
Corporation. All such corporations use the calendar year as the taxable
year. Corporation M receives a pro rata minimum distribution from the
group for 1966 and applies thereto the special rules of this paragraph
and paragraph (b) of this section. Neither foreign corporation is a
less developed country corporation under section 902(d). Corporations A
and B pay foreign income tax at a flat rate of 20 percent and 30
percent, respectively. The 1966 foreign income tax of corporations A
and B which is deemed paid by M Corporation under section 902(a) for
1966, and the remaining tax which is allocated to earnings and profits
to be distributed to M Corporation in future years, are determined as
follows:
Example 4. The facts are the same as in example 3 except that the
group does not make a pro rata minimum distribution but distributes
$48.30, consisting of $40 distributed by A Corporation and $8.30
distributed by B Corporation. Corporation M complies with the special
rules of this paragraph and paragraph (b) of this section. The 1966
foreign income tax of corporations A and B which is deemed paid by M
Corporation under section 902(a) for 1966, and the remaining tax which
is allocated to earnings and profits to be distributed to M Corporation
in future years, are determined as follows, the minimum overall tax
burden for 1966 being such as to satisfy the requirement of paragraph
(a)(1)(ii)(b) of this section:
(3) Reduction and deferral of the foreign tax credit -- (1) In
general. To the extent specified in paragraph (a)(1)(ii)(b) of this
section a reduction shall be made in the foreign tax credit allowable
under section 901 for the taxable year with respect to distributions
counting toward a minimum distribution for such year from the chain or
group; and such reduction in credit shall be allocated, as provided in
subdivision (ii) of this subparagraph, to foreign corporations in such
chain or group and deferred, as provided in subdivision (iii) of this
subparagraph, to subsequent taxable years of the United States
shareholder.
(ii) Allocation of reduction in foreign tax credit. The amount of
any reduction in foreign tax credit for the taxable year which is made
under subdivision (i) of this subparagraph with respect to a minimum
distribution for any taxable year from the chain or group shall be
allocated among any first-tier and second-tier corporations described in
section 902 (a) and (b), respectively, which are in such chain or group.
The amount of any such reduction in foreign tax credit shall be
allocated among such first-tier and second-tier corporations in the
ratio which the United States shareholder's proportionate share of
undistributed earnings and profits of each such corporation for the
taxable year bears to the total of such shareholder's proportionate
shares of the undistributed earnings and profits of all such
corporations for such year. None of such reduction shall be allocated
to any other corporations in the chain or group or to any foreign
branches included under paragraph (f)(4) of 1.963-1 in the group as
wholly owned foreign subsidiary corporations.
(iii) Deferral of allocated credit -- (a) Allowance of credit in
subsequent years. The reduction in foreign tax credit allocated to a
first-tier or second-tier corporation in the chain or group for a
taxable year under subdivision (ii) of this subparagraph shall be deemed
paid under the principles of section 902 (applicable to foreign
corporations which are not less developed country corporations) with
respect to distributions, to the extent made by such corporation to the
United States shareholder referred to in subdivision (ii) of this
subparagraph, in a subsequent taxable year from the undistributed
earnings and profits of such corporation for such year of allocation.
Thus, for example, in the case of a distribution in the subsequent year
from such earnings and profits by a first-tier corporation, the tax
deemed paid shall be an amount which bears to the total of such
reduction in foreign tax credit the same ratio that the distribution to
the shareholder in the subsequent year bears to such shareholder's
proportionate share of such undistributed earnings and profits for the
year of allocation.
(b) Limitations on use of deferred credit. The deferred tax so
deemed paid shall be deemed paid for such subsequent taxable year and
shall be allowed under section 901 (without regard to the limitations
under section 904) as a credit against the income tax imposed for such
year by chapter 1 of the Code, but the amount of such credit shall not
exceed the excess of the tax so imposed for such year over the credit
(determined without regard to this subdivision (iii) allowed under
sections 901 through 905 for such year. Any amount by which the deferred
tax so deemed paid in such subsequent taxable year exceeds the
limitation under the preceding sentence shall not be carried back or
carried over under section 904(d) to another taxable year of the United
States shareholder. No credit shall be allowed under this subdivision
for the subsequent taxable year to the extent that the credit would
reduce the tax of the United States shareholder under chapter 1 of the
Code on any minimum distribution for such year to which section 963
applies.
(c) Gross-up not applicable. Any amount allowed as a credit for a
subsequent taxable year under this subdivision shall not be included in
the gross income of the United States shareholder for such year under
section 78.
(d) Illustrations. The application of this section may be
illustrated by the following examples, in which the surtax exemption
provided by section 11(c) is disregarded:
Example 1. (a) For 1966, domestic corporation M makes a chain
election with respect to controlled foreign corporation A, which it
wholly owns directly, and controlled foreign corporation B, which A
Corporation wholly owns directly. Corporation A is not a less developed
country corporation under section 902(d). All corporations use the
calendar year as the taxable year. For 1966, M Corporation complies
with the special rules of paragraphs (b) and (c) of this section.
Corporation A has pretax and predistribution earnings and profits for
1966 of $40 and is subject to foreign income tax at a flat rate of 36
percent, with no deduction being allowed for dividends received or paid.
B Corporation has pretax and predistribution earnings and profits of
$60 for 1966 and is subject to a foreign income tax at a flat rate of 20
percent, with no deduction being allowed for dividends received or paid.
For 1967, B Corporation has no earnings and profits, A Corporation has
no earnings and profits other than a dividend of $21.22 from B
Corporation, and M Corporation has taxable income of $20.98 from United
States sources. Corporation M uses the overall limitation under section
904(a)(2) on the foreign tax credit.
(b) If a pro rata minimum distribution were made for 1966, the
overall United States and foreign income tax for such year with respect
to such distribution would be $41.30, determined as follows:
(c) The chain, however, does not make a pro rata distribution for
1966, but distributes $24 from A Corporation's earnings and profits and
$26.78 from B Corporation's earnings and profits, the total distribution
of $50.78 being equal to the statutory percentage of the consolidated
earnings and profits (0.69 $73.60) of the chain with respect to M
Corporation. Thus, M Corporation must make such a reduction in its
foreign tax credit that the overall United States and foreign income tax
for 1966 with respect to the distribution equals the lesser of $41.30
(the overall United States and foreign income tax which would be paid
with respect to a pro rata minimum distribution) and $43.20 (90 percent
of 48 percent of pretax and predistribution consolidated earnings and
profits of $100). The remaining 1956 earnings and profits of the chain
are distributed late in 1967. Corporation M determines its tax as
follows for such years:
Example 2. (a) For 1963, domestic corporation M makes a group
election with respect to controlled foreign corporations A and B, both
of which M Corporation wholly owns directly. All such corporations use
the calendar year as the taxable year. Corporation A is created under
the laws of foreign country X, and B Corporation is created under the
laws of foreign country Y; neither of such corporations is a less
developed country corporation under section 902(d). Corporation M
complies with the special rules of paragraphs (b) and (c) of this
section. Each foreign corporation has pretax earnings and profits of
$100 for 1963. The income of A Corporation is subject to a foreign
income tax rate of 20 percent, and the income of B Corporation is
subject to a foreign income tax rate of 30 percent. Corporation M uses
the per-country limitation under section 904(a)(1) on the foreign tax
credit.
(b) If a pro rata minimum distribution were made for 1963, the group
would distribute $123 based upon an effective foreign tax rate of 25
percent ($50/($50+$150)) and a statutory percentage of 82 percent under
section 963(b); of this amount $57.40 (0.82 $70) would be distributed
from B Corporation's earnings and profits and $65.60 (0.82 $80) would be
distributed from A Corporation's earnings and profits. In such case,
the overall United States and foreign income tax for 1963 with respect
to the pro rata minimum distribution would be determined as follows,
using the 52 percent United States corporate income tax rate applicable
for such year:
(c) The group, however, does not make a pro rata minimum distribution
for 1963 but distributes $123, consisting of $70 from B Corporation's
earnings and profits and $53 from A Corporation's earnings and profits.
Thus, M Corporation must make such a reduction in its foreign tax credit
that the overall United States and foreign income tax for 1963 with
respect to the distribution equals the lesser of $94.28 (the overall
United States and foreign income tax which would be paid with respect to
a pro rata minimum distribution) and $93.60 (90 percent of 52 percent of
pretax and predistribution consolidated earnings and profits of $200).
The remaining 1963 earnings and profits of the group are distributed
late in 1964. Neither A Corporation nor B Corporation has earnings and
profits for 1964. Corporation M determines its tax as follows for such
years, assuming a 52 percent (instead of 50 percent) United States
corporate income tax rate for 1964:
Example 3. (a) For 1966, domestic corporation M makes a chain
election with respect to controlled foreign corporation A, which it
wholly owns directly, and controlled foreign corporation B, which A
Corporation wholly owns directly. Corporation A is a less developed
country corporation under section 902(d). All corporations use the
calendar year as the taxable year. For 1966, each of the foreign
corporations has pretax and predistribution earnings and profits of
$100. The income of A Corporation is subject to a foreign income tax
rate of 20 percent, with no deduction being allowed for dividends
received or paid; and the income of B Corporation is subject to a
foreign income tax rate of 30 percent on such basis. During 1966, B
Corporation distributes $50 to A Corporation, and A Corporation
distributes $104 to M Corporation. During 1967 the remaining 1966
earnings and profits of such corporations are distributed to M
Corporation.
(b) If M Corporation were not to comply with the special rules of
paragraphs (b) and (c) of this section and were to deduct foreign income
tax on intercorporate distributions under paragraph (d)(1)(iii) of
1.963-2, the chain would not be considered to make a minimum
distribution for 1966 because, although it makes a distribution which is
sufficient in amount to constitute a minimum distribution, the overall
United States and foreign income tax for such year with respect to such
distribution would be insufficient under paragraph (a)(1)(i) of this
section. The determination that M Corporation would not be entitled to
the section 963 exclusion for 1966 by reason of such distribution in
such circumstances is made as follows:
(c) By complying with the special rules of paragraphs (b) and (c) of
this section, however, M Corporation will receive a minimum distribution
for 1966 if it receives the statutory percentage of consolidated
earnings and profits and if the overall United States and foreign income
tax with respect to the distribution which is made is at least the
lesser of $86.40 (0.90 0.48 $200) and of the overall United States and
foreign income tax which would be paid with respect to a pro rata
minimum distribution from the chain. If a pro rata minimum distribution
were made for 1966, the chain would be required to distribute earnings
and profits of $114, based upon an effective foreign tax rate of 25
percent ($50/($50+$150)) and a statutory percentage of 76 percent under
section 963(b); of this amount $53.20 (0.76 $70) would be distributed
from B Corporation's earnings and profits and $60.80 (0.76 $80) would be
distributed from A Corporation's earnings and profits. The overall
United States and foreign income tax with respect to such a pro rata
minimum distribution would be $73.62, determined as follows:
(d) The United States income tax of M Corporation for 1966 and 1967
is determined as follows, assuming that the minimum overall tax burden
is determined under paragraph (a)(1)(ii)(b) of this section:
Example 4. (a) Domestic corporation M directly owns 90 percent of
the one class of stock of controlled foreign corporation A, which
directly owns 80 percent of the one class of stock of controlled foreign
corporation B, which in turn directly owns 60 percent of the one class
of stock of controlled foreign corporation C. None of the foreign
corporations are less developed country corporations under section
902(d); all corporations use the calendar year as the taxable year.
For 1963, M Corporation makes a chain election with respect to
corporations A, B, and C and receives a distribution from the
consolidated earnings and profits of the chain which does not constitute
a pro rata minimum distribution. The remaining 1963 consolidated
earnings and profits of the chain are distributed late in 1964, for
which year it is assumed that the United States corporate income tax
rate is the same (52 percent) as for 1963. No corporation in the chain
has earnings and profits for 1964 other than from distributions received
from remaining 1963 earnings and profits of another corporation in the
chain. The foreign country under the laws of which A Corporation is
created does not tax dividends which are received by such corporation
from B Corporation, but B Corporation is taxed on dividends received
from C Corporation. Corporation M complies with the special rules of
paragraphs (b) and (c) of this section and determines the minimum
overall tax burden under paragraph (a)(1)(ii)(b) of this section with
respect to the distribution which is made. Corporation M uses the
overall limitation under section 904(a)(2) on the foreign tax credit.
The distribution received by M Corporation for 1963 from the
consolidated earnings and profits of the chain is sufficient in amount
to constitute a minimum distribution. The overall United States and
foreign income tax for 1963 with respect to the distribution which is
made must be at least equal to the lesser of $32.21 (the amount payable,
as determined under paragraph (b) of this example, with respect to a pro
rata minimum distribution) and $31.34 (90 percent of 52 percent of
pretax and predistribution consolidated earnings and profits of $66.96).
(b) If the chain were to make a pro rata minimum distribution, the
distributions and the overall United States and foreign income tax for
1963 with respect to the minimum distribution would be determined as
follows, based upon the facts assumed:
(c) Based upon the distributions which are made by corporations A, B,
and C, M. Corporation pays United States tax as follows for 1963 and
1964:
Example 5. (a) Domestic corporation M directly owns all the one
class of stock of each of controlled foreign corporations A, B, C, and
D. All such corporations use the calendar year as the taxable year.
None of the foreign corporations is a less developed country corporation
under section 902(d). For 1963, M Corporation makes a group election
with respect to corporations A, B, C, and D and receives from the 1963
consolidated earnings and profits of the group a distribution which is
not a pro rata minimum distribution. None of the foreign corporations
has earnings and profits for 1964, but the remaining 1963 earnings and
profits of the group are distributed late in 1964, for which year it is
assumed that the United States corporate income tax rate is the same (52
percent) as for 1963. The overall limitation under section 904(a)(2) on
the foreign tax credit applies for both years.
(b) Assume that M Corporation does not comply with the special rules
of paragraphs (b) and (c) of this section and that for 1963 it draws a
distribution of all of B Corporation's earnings and profits and enough
of C Corporation's earnings and profits to receive the amount of a
minimum distribution and to assure that the overall United States and
foreign income tax for such year with respect to the distribution from
the group satisfies the overall minimum tax requirement of paragraph
(a)(1)(i) of this section. In such case, the overall United States and
foreign income tax for 1963 with respect to the distribution which is
made, determined by using the foreign tax credit under section 901
without applying the special credit rules of paragraph (c) of this
section, must at least equal $37.44 (90 percent of 52 percent of pretax
and predistribution consolidated earnings and profits of $80).
Corporation M's United States income tax for 1963 and 1964 with respect
to the distribution of the 1963 earnings and profits of the group is
determined as follows, based upon the facts assumed:
(c) Assume that M Corporation does comply with the special rules of
paragraphs (b) and (c) of this section and for 1963 receives a minimum
distribution consisting of $20 from A Corporation and $14 from C
Corporation. In such case, the overall United States and foreign income
tax for 1963 with respect to the minimum distribution must at least
equal the lesser of $37.44 (0.90 0.52 $80) and the overall United
States and foreign income tax of $37.89 that would be paid with respect
to a pro rata minimum distribution from the group for such year. In
such case, the determinations would be made pursuant to subparagraphs
(1) and (2) of this paragraph.
(1) If a pro rata minimum distribution were made for 1963 by the
group, the overall United States and foreign income tax for such year
with respect to such distribution would be $37.89, determined as
follows:
(2) Corporation M's United States income tax for 1963 and 1964 with
respect to the distribution of the 1963 earnings and profits of the
group is determined as follows:
Example 6. Throughout 1963, domestic corporation M directly owns all
the one class of stock of controlled foreign corporations A, B, and C,
and maintains in a foreign country a branch which qualifies under
paragraph (f)(4) of 1.963-1 for inclusion in a group as a wholly owned
foreign subsidiary corporation. For 1963, a year for which the overall
limitation under section 904(a)(2) on the foreign tax credit applies, M
Corporation makes a group election with respect to A, B, and C
Corporations and the foreign branch. All such corporations use the
calendar year as the taxable year. The foreign branch has pretax and
predistribution earnings and profits of $40 for 1963, as determined
under paragraph (f)(4)(ii) of 1.963-1. None of the foreign corporations
is a less developed country corporation under section 902(d).
Corporation M complies with the special rules of paragraphs (b) and (c)
of this section. The United States income tax of M Corporation for 1963
is as follows, based upon the facts assumed:
Example 7. Domestic group M, an affiliated group of domestic
corporations filing a consolidated return under section 1501, makes a
group election for 1963 with respect to a group consisting of two
controlled foreign corporations C and D, all of whose one class of stock
is directly owned by group M, and foreign branch B, a foreign branch of
a Western Hemisphere trade corporation (as defined in section 921)
included in group M. No distributions are received for the taxable year
from corporations C and D, but the foreign group makes a minimum
distribution by reason of the deemed distribution of all of branch B's
earnings and profits. Group M complies with the special rules of
paragraphs (b) and (c) of this section. For 1963, a year for which the
United States corporate income tax rate is 52 percent, the overall
limitation under section 904(a)(2) on the foreign tax credit applies.
All corporations use the calendar year as the taxable year. None of the
foreign corporations is a less developed country corporation under
section 902(d) for 1963. The income, and the United States and foreign
income tax for 1963, are determined as follows, based upon the facts
assumed:
(T.D. 6759, 29 FR 13335, Sept. 25, 1964; 29 FR 13896, Oct. 8, 1964,
as amended by T.D. 6767, 29 FR 14878, Nov. 3, 1964; T.D. 7100, 36 FR
5336, Mar. 20, 1971)
26 CFR 1.963-5 Foreign corporations with variation in foreign tax rate
because of distributions.
(a) Limited application of section. The rules of this section shall
apply to a foreign corporation only if --
(1) Under the laws of a foreign country or possession of the United
States the foreign income tax of the corporation for the taxable year
depends upon the extent to which distributions are made by such
corporation from its earnings and profits for the taxable year, so that
the rate of such tax for the taxable year on income which is distributed
differs from the rate of such tax for such year on the income which is
not distributed, and
(2) The corporation --
(i) Is a single first-tier corporation, or
(ii) Is for the taxable year in a chain or group from which the
United States shareholder receives a minimum distribution in respect of
which the minimum overall tax burden is determined in accordance with
paragraph (a)(1)(ii) of 1.963-4.
(b) Foreign income tax determined as though no distributions were
made. The foreign income tax on the pretax and predistribution earnings
and profits of the foreign corporation for the taxable year shall
(solely for the purpose of determining the effective foreign tax rate
under paragraph (c) of 1.963-2) be determined as if the foreign
corporation made no distributions for the taxable year. However,
notwithstanding the second sentence of paragraph (d)(1) of 1.963-2,
where the United States shareholder owns the stock (with respect to
which the election under section 963 is made) in such corporation by
reason of stock owned through a chain of ownership described in section
958(a) and the foreign income tax of such corporation for the taxable
year decreases as distributions are made from its earnings and profits,
the rule in the preceding sentence shall not apply if the electing
United States shareholder does not actually receive for the taxable year
its proportionate share of the earnings and profits which are actually
distributed. In such case, the foreign income tax on pretax and
predistribution earnings and profits shall be the actual foreign income
tax of such corporation, computed on the basis of the distributions
which are made. For example, assume that a second-tier foreign
corporation in a chain has pretax and predistribution earnings of $100
for the taxable year and that foreign law imposes on such corporation a
foreign income tax of 50 percent of the pretax earnings and profits
minus dividends for such year and of 20 percent of such dividends. If
the second-tier foreign corporation distributes $20 of earnings and
profits to a first-tier foreign corporation which is part of the same
chain, and if the first-tier corporation retains the dividend so
received, the foreign income tax of the second-tier foreign corporation
shall be considered to be the tax actually paid for the taxable year,
that is, $44 (50 percent of $80 plus 20 percent of $20). If the
first-tier foreign corporation distributes the dividend so received, the
foreign income tax of the second-tier foreign corporation shall be
considered to be $50 (50 percent of $100). For purposes of this
paragraph, the principles of paragraph (b)(3) of 1.963-4 shall apply.
(c) Minimum distribution -- (1) Single first-tier corporation. A
minimum distribution for a taxable year by a single first-tier
corporation described in paragraph (a)(1) of this section shall be a
distribution which is equal to --
(i) The amount resulting from the multiplication of the statutory
percentage specified in paragraph (b) of 1.963-2 for such year by the
United States shareholder's proportionate share of the earnings and
profits of such corporation, as determined under paragraph (d)(2)(i) of
1.963-2 but without the deduction for foreign income tax provided by
paragraph (d)(1)(ii) and (iii) of such section, reduced by
(ii) The foreign income tax on the pretax amount determined under
subdivision (i) of this subparagraph which would be paid or accrued by
such corporation by reason of distributing such amount, less such tax,
for such taxable year.
(2) Corporation in a chain or group making a pro rata minimum
distribution. In case of a corporation described in paragraph
(a)(2)(ii) of this section in a chain or group, such corporation's share
of a pro rata minimum distribution by the chain or group for the taxable
year shall be --
(i) The amount resulting from the multiplication of the statutory
percentage specified in paragraph (b) of 1.963-2 for the taxable year
by the United States shareholder's proportionate share of the earnings
and profits of such corporation, as determined under paragraph (d)(3) of
1.963-2 but without the deduction for foreign income tax provided by
paragraph (d)(1) (ii) and (iii) of such section, reduced by
(ii) The foreign income tax on the pretax amount determined under
subdivision (i) of this subparagraph which would be paid or accrued by
such corporation by reason of distributing such amount, less such tax,
for such taxable year.
(3) A chain or group making a distribution other than a pro rata
minimum distribution. If a chain or group contains one or more foreign
corporations described in paragraph (a)(2)(ii) of this section and such
chain or group makes a minimum distribution other than a pro rata
minimum distribution for the taxable year, the amount of such minimum
distribution to the electing United States shareholder shall be at least
--
(i) The amount resulting from the multiplication of the statutory
percentage specified in paragraph (b) of 1.963-2 for the taxable year
by the consolidated earnings and profits of such chain or group with
respect to such shareholder, as determined under paragraph (d)(3) of
such section but without any deduction for foreign income tax provided
by paragraph (d)(1) (ii) and (iii) of such section, reduced by
(ii) The foreign income tax on the pretax amount determined under
subdivision (i) of this subparagraph which would be paid or accrued by
the foreign corporations in the chain or group by reason of distributing
such amount, less such tax, for such taxable year.
(4) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Domestic corporation M directly owns 80 percent of the
one class of stock of single first-tier corporation B, which for 1964
has $100 of pretax earnings and profits on which is imposed a foreign
income tax of 40 percent of pretax earnings and profits minus dividends
for the taxable year and of 20 percent of the amount of such dividends.
Both corporations use the calendar year as the taxable year. The
effective foreign tax rate applicable to B Corporation, as determined
under paragraph (c) of 1.963-2, is 40 percent, and the statutory
percentage under paragraph (b) of 1.963-2 for 1964 is 38 percent.
Corporation M receives a minimum distribution for 1964 if it receives
from B Corporation's earnings and profits for such year $22.80, that is,
80 percent of $28.50, the distribution which would be made if there were
distributed that amount of earnings and profits which, together with the
foreign income tax at the rate effectively applicable to pretax earnings
and profits to which such distribution is attributable, equals 38
percent of $100. Such distribution may be determined by solving for
''d'' in the following formula:
Example 2. Domestic corporation M directly owns 80 percent of the
one class of stock of each of controlled foreign corporations A and B,
which constitute a group and each of which for 1964 has pretax earnings
and profits of $100. All corporations use the calendar year as the
taxable year. Corporation A is subject to foreign income tax at a flat
rate of 40 percent; and B Corporation is subject to a foreign income
tax of 40 percent of $100 minus dividends for the taxable year and of 20
percent of the amount of such dividends. The effective foreign tax rate
with respect to the group, as determined under paragraph (c) of
1.963-2, is 40 percent, and the statutory percentage under paragraph (b)
of 1.963-2 for 1964 is 38 percent. Corporation B distributes $25 for
1964 toward a minimum distribution from the group which is not a pro
rata minimum distribution. The minimum distribution by the group for
1964 with respect to M Corporation is determined as follows:
Example 3. The facts are the same as in example 2 except that the
$25 distribution of earnings and profits is made by A Corporation. The
amount of the minimum distribution for 1964 is determined as follows:
(d) Distributions through a chain or group. In the application of
paragraph (b)(3)(i) of 1.963-4, relating to the allocation of dividend
payments first to income received as a distribution from other foreign
corporations in the chain or group, if one or more of such other foreign
corporations is a corporation whose foreign income tax rate decreases as
the distributions are made, the allocation under such paragraph shall be
made first to such corporations' distributions.
(e) Foreign tax credit -- (1) Year of minimum distribution. If a
United States shareholder receives for a taxable year a distribution of
the earnings and profits for the taxable year of a foreign corporation
described in paragraph (a) of this section and if for such year such
corporation is a first-tier corporation, or a second-tier corporation
described in section 902 (a) or (b), as the case may be, then, in
applying paragraph (c)(2)(i) of 1.963-4, only the foreign income tax
which is effectively applicable to pretax earnings and profits to which
are attributable the earnings and profits which are distributed shall be
deemed paid for such year under section 902 (a) or (b), as the case may
be, and the foreign income tax so paid or accrued by such corporation
shall not be averaged, for purposes of such section, with its foreign
income tax paid or accrued for such year on its pretax earnings and
profits to which are attributable the earnings and profits which are not
distributed.
(2) Year of distribution of remaining earnings and profits. If for a
taxable year a United States shareholder receives a minimum distribution
from a corporation described in paragraph (a) of this section, the
pretax and predistribution earnings and profits of such corporation for
the taxable year to which such minimum distribution is attributable and
the foreign income tax which is taken into account, in accordance with
paragraph (c)(2)(i) of 1.963-4, in determining tax deemed paid under
section 902 on such pretax and predistribution earnings and profits
shall not be taken into account in the application of section 902 when
other earnings and profits of such foreign corporation for such year are
distributed in a subsequent taxable year of such foreign corporation to
such shareholder.
(3) Illustration. The application of this paragraph may be
illustrated by the following examples:
Example 1. (a) All the income of controlled foreign corporation B,
wholly owned directly by domestic corporation M, is taxed by foreign
country Y, the tax laws of which impose at the local level a corporate
income tax of 10 percent of earnings and profits (before reduction for
income taxes) and, at the national level, an income tax of 30 percent of
such earnings and profits reduced by the local tax and by any profits
which are distributed. Also, at the national level, a tax of 20 percent
is imposed on B Corporation on the dividends which are paid for the
taxable year. Both corporations use the calendar year as the taxable
year. For 1963, B Corporation has earnings and profits (before
reduction by income taxes) of $100. B Corporation is not a less
developed country corporation under section 902(d). For 1963, M
Corporation makes a first-tier election with respect to B Corporation
and receives a minimum distribution. Corporation B has no 1964 earnings
and profits, and its remaining 1963 earnings and profits are distributed
late in 1964. The amount of the minimum distribution required to be
received by M Corporation for 1963 and the United States tax with
respect to the 1963 earnings and profits of B Corporation are determined
as follows, assuming a United States corporate income tax rate of 52
percent (instead of 50 percent) for 1964 and no surtax exemption under
section 11(c) for either year:
(b) If B Corporation were a less developed country corporation under
section 902(d), there would be no gross-up under section 78 and the
foreign tax credit of M Corporation would be $14.28 for 1963
($47.60/(47.60+ $20.40) $20.40), and $7.46 for 1964 ($20.16/
($20.16+$11.84) $11.84).
Example 2. For 1963, domestic corporation M receives a dividend of
$21 from B Corporation which counts toward a minimum distribution from a
group, determined by applying the special rules of paragraphs (b) and
(c) of 1.963-4. Both corporations use the calendar year as the taxable
year. Foreign law imposes on B Corporation an income tax of 40 percent
of the year's pretax earnings and profits, less dividends paid for such
year, and of 20 percent of such dividends. Corporation M directly owns
70 percent of the one class of stock of B Corporation, which for 1963
has pretax and predistribution earnings and profits of $100.
Corporation B is not a less developed country corporation under section
902(d). In late 1964, M Corporation receives a distribution of all of B
Corporation's 1964 earnings and profits and of $25.20 from its 1963
earnings and profits. The foreign income tax of B Corporation deemed
paid for 1963 by M Corporation under section 902(a) is based on the
foreign income tax actually paid by B Corporation on an amount of pretax
earnings and profits which, when reduced by the tax so paid, equals the
total dividend which is paid. The determination of tax deemed paid by M
Corporation with respect to distributions from 1963 earnings and profits
of B Corporation is as follows:
(T.D. 6759, 29 Sept. 25, 1964; 29 FR 13896, Oct. 8, 1964, as amended
by T.D. 6767, 29 FR 14879, Nov. 3, 1964)
26 CFR 1.963-6 Deficiency distribution.
(a) In general. Section 963(e)(2) and this section provide a method
under which, by virtue of a deficiency distribution, a United States
shareholder may be relieved from the payment of a deficiency in tax for
any taxable year arising by reason of failure to include subpart F
income in gross income under section 951(a)(1)(A)(i), when it has been
determined that such shareholder has failed to receive a minimum
distribution for such year in respect of which it elected to secure the
exclusion under section 963. In addition, this section provides rules
with respect to a credit or refund of part or all of any such deficiency
which has been paid. Under the method provided, the benefit of the
exclusion of subpart F income from gross income of the United States
shareholder is allowed retroactively for the taxable year in respect of
which the election under section 963 applied, but only if the subsequent
deficiency distribution meets the requirements of this section. The
benefits of the retroactive exclusion will not, however, prevent the
assessment of interest, additional amounts, and assessable penalties.
(b) Requirements for deficiency distribution -- (1) Distribution made
on or after date of determination. If --
(i) A United States shareholder, in making its return of the tax
imposed by chapter 1 of the Code for any taxable year, elects to secure
an exclusion under section 963 for such year,
(ii) It is subsequently determined (within the meaning of paragraph
(c) of this section) that an exclusion under section 963 of subpart F
income with respect to stock to which such election relates does not
apply for such taxable year because of the failure of such shareholder
to receive a minimum distribution for such year with respect to such
stock, and
(iii) Such failure is due to reasonable cause, a deficiency
distribution which is received by such shareholder with respect to such
stock from a foreign corporation which was the single first-tier
corporation, or a corporation in the chain or group, as the case may be,
with respect to which the election was made, shall count toward a
minimum distribution under section 963 for such year of election if such
deficiency distribution is received (except as provided by subparagraph
(2) of this paragraph) on, or within 90 days after, the date of such
determination and prior to the filing of a claim under paragraph (d)(1)
of this section. Such claim must be filed within 120 days after the
date of such determination, and the deficiency distribution must be a
dividend of such a nature (except as otherwise provided in this section)
as would have permitted it to count toward a minimum distribution for
the taxable year of the election if it had been received by the United
States shareholder during such year. No distribution shall count as a
deficiency distribution under this subparagraph unless a claim therefor
is filed under paragraph (d)(1) of this section.
(2) Distribution made before date of determination. A deficiency
distribution may also be received by a United States shareholder at any
time prior to the date on which the determination required by
subparagraph (1) of this paragraph is made. A distribution will count
as a deficiency distribution under this subparagraph --
(i) To the extent that such distribution otherwise satisfies the
requirements of this section;
(ii) If the United States shareholder files within 90 days after such
distribution but before the determination date an advance claim
described in paragraph (d)(2) of this section for treatment of such
distribution as a deficiency distribution;
(iii) If such shareholder consents in such claim to include such
deficiency distribution in gross income for the taxable year of the
election to the extent necessary to complete a minimum distribution for
such year and under section 6501 to extend the period for the making of
assessments, and the bringing of distraint or a proceeding in court for
collection, in respect of a deficiency and all interest, additional
amounts, and assessable penalties for such taxable year;
(iv) If, when requested by the district director, such shareholder
consents under section 6501 in such claim to extend the period for the
making of assessments, and the bringing of distraint or a proceeding in
court for collection, in respect of a deficiency and all interest,
additional amounts and assessable penalties for the year of receipt of
such distribution; and
(v) To the extent that such shareholder makes advance payment of tax
which would result from the inclusion of such distribution in gross
income as a minimum distribution for the year of such deficiency.
To the extent that such distribution is not necesasry under the
determination (when made under paragraph (c) of this section) for a
deficiency distribution, it shall be included in the United States
shareholder's gross income for the taxable year of receipt of such
distribution and paragraph (g) of this section shall not apply.
(3) Earnings and profits of year of election to be first distributed.
If --
(i) In the case of a first-tier election, the United States
shareholder's proportionate share of the earnings and profits of the
foreign corporation which was the single first-tier corporation, or
(ii) In the case of a chain or group election, any portion of the
share of any corporation or corporations (which were in the chain or
group) of the consolidated earnings and profits with respect to the
United States shareholder,
for the taxable year of the election has not been distributed on the
stock with respect to which the election was made, then a distribution,
in order to be counted toward a deficiency distribution, must be made by
such corporation or corporations and from such earnings and profits to
the extent thereof. Once all such earnings and profits of such
corporation or corporations have been completely distributed, a
deficiency distribution may be made from other earnings and profits of
such foreign corporation which was a single first-tier corporation, or
of such corporation or corporations which were in such chain or group,
as the case may be.
(4) Proof of reasonable cause. Reasonable cause for failure to
receive a minimum distribution shall be deemed to exist, in the absence
of circumstances demonstrating bad faith, if the electing United States
shareholder receives, within the period prescribed by paragraph
(a)(1)(i) of 1.963-3 with respect to the year of election, at least 80
percent of the amount of a minimum distribution (from the earnings and
profits to which the election for such year relates) which if received
during such period would have satisfied the conditions for the section
963 exclusion to apply to such year. If less than 80 percent of the
amount of a minimum distribution is received during such period, the
existence of a reasonable cause for failure to receive a minimum
distribution must be established by clear and convincing evidence;
however, the preceding sentence shall not be taken as a limitation on
the establishment of reasonable cause by any other proof of reasonable
cause. For example, reasonable cause will exist if a single first-tier
corporation for its taxable year makes a distribution which would be a
minimum distribution but for a refund of foreign income tax which it has
paid in good faith under foreign law but which is found not to be due
after the United States income tax return of the United States
shareholder has been filed.
(c) Nature and details of determination. (1) A determination that
the section 963 exclusion does not apply to a United States shareholder
for a taxable year due to its failure to receive a minimum distribution
for such year shall, for the purposes of this section, be established by
--
(i) A decision by the Tax Court or a judgment, decree, or other order
by any court of competent jurisdiction, which has become final;
(ii) A closing agreement made under section 7121; or,
(iii) An agreement which is signed by the district director, or such
other official to whom authority to sign the agreement is delegated, and
by, or on behalf of, such shareholder and which relates to the liability
of such shareholder for the tax under chapter 1 of the Code for such
year.
(2) The date of determination by a decision of the Tax Court shall be
the date upon which such decision becomes final, as prescribed in
section 7481.
(3) The date upon which a judgment of a court becomes final shall be
determined upon the basis of the facts in the particular case.
Ordinarily, a judgment of a United States district court shall become
final upon the expiration of the time allowed for taking an appeal, if
no such appeal is duly taken within such time; and a judgment of the
United States Court of Claims shall become final upon the expiration of
the time allowed for filing a petition for certiorari, if no such
petition is duly filed within such time.
(4) The date of determination by a closing agreement made under
section 7121 shall be the date such agreement is approved by the
Commissioner.
(5) The date of a determination made by an agreement which is signed
by the district director, or such other official to whom authority to
sign the agreement is delegated, shall be the date prescribed by this
subparagraph. The agreement shall be sent to the United States
shareholder at his last known address by either registered or certified
mail. If registered mail is used for such purpose, the date of
registration shall be treated as the date of determination; if
certified mail is used for such purpose, the date of the postmark on the
sender's receipt for such mail shall be treated as the date of
determination. However, if the deficiency distribution is received by
such shareholder before such registration or postmark date but on or
after the date the agreement is signed by the district director or such
other official to whom authority to sign the agreement is delegated, the
date of determination shall be the date on which the agreement is so
signed.
(6) The determination under this paragraph shall find that, due to
the United States shareholder's failure to receive a minimum
distribution, the section 963 exclusion does not apply for the taxable
year with respect to stock to which the election under such section
relates. A determination described in subdivision (ii) or (iii) of
subparagraph (1) of this paragraph shall set forth the amount of the
deficiency distribution and the amount of additional income tax for
which the United States shareholder is liable under Chapter 1 of the
Code by reason of not including in gross income for such year the amount
of the deficiency distribution. If a determination described in
subdivision (i) of subparagraph (1) of this paragraph does not establish
the amount of the deficiency distribution and such amount of additional
tax, such amounts may be established by an agreement which is signed by
the district director, or such other official to whom authority to sign
the agreement is delegated.
(d) Claim for treatment of distribution as a deficiency distribution
-- (1) Claim filed after date of determination. A claim (including any
amendments thereof) for treatment of a deficiency distribution as
counting toward a minimum distribution for the taxable year of election
shall be filed in duplicate, within 120 days after the date of the
determination described in paragraph (c) of this section, with the
requisite declaration prescribed by the Commissioner on the appropriate
claim form and shall be accompanied by --
(i) A copy of such determination and a description of how it became
final;
(ii) If requested by the district director, or by such other official
to whom authority to sign the agreement referred to in paragraph (c) (1)
or (6) of this section is delegated, a consent by the United States
shareholder under section 6501 to extend the period for the making of
assessments, and the bringing of distraint or a proceeding in court for
collection, in respect of a deficiency and all interest, additional
amounts, and assessable penalties for the taxable year of election; and
(iii) Such other information as may be required by the claim form or
the district director, or other official, in support of the claim.
(2) Advance claim. An advance claim for treatment of a deficiency
distribution as counting toward a minimum distribution for the taxable
year of election shall be filed in duplicate, within 90 days after such
distribution but before the date of determination described in paragraph
(c) of this section, and shall satisfy all requirements of subparagraph
(1) of this paragraph other than subdivision (i) of such subparagraph.
However, within 120 days after the date of the determination described
in paragraph (c) of this section, the advance claim shall be completed
so that it satisfies all requirements of subparagraph (1) of this
paragraph.
(e) Computation of interest on deficiencies in tax. If a United
States shareholder, for the taxable year of the election under section
963, completes a minimum distribution for such year by receiving a
deficiency distribution to which this section applies, the interest on
the deficiency in tax due by reason of the failure to include the amount
of such deficiency distribution in such shareholder's gross income for
such year shall be computed for the period from the last date prescribed
for payment of the tax for such year to the date such deficiency in tax
is paid. No interest shall be due by reason of the failure to include
Subpart F income in gross income for a taxable year in respect of which
a minimum distribution under section 963 is completed by a deficiency
distribution to which this section applies.
(f) Claim for credit or refund. If a deficiency in tax is asserted
for any taxable year by reason of failure to include Subpart F income in
gross income under section 951(a)(1)(A)(i) and the United States
shareholder has paid any portion of such asserted deficiency, such
shareholder is entitled to a credit or refund of such payment to the
extent that such payment constitutes an overpayment of tax as the result
of the receipt of a deficiency distribution to which this section
applies. To secure credit or refund of such overpayment of tax, the
United States shareholder must file a claim for refund in accordance
with 301.6402-3, in addition to the claim form required under paragraph
(d) of this section. No interest shall be allowed on such credit or
refund. For other rules applicable to the filing of claims for credit
or refund of an overpayment of tax, see section 6402 and the regulations
thereunder. For the limitations applicable to the credit or refund for
an overpayment of tax, see section 6511 and the regulations thereunder.
(g) Effect of deficiency distribution -- (1) Allocation of
distributions. The deficiency distribution shall be allocated, by
applying the rules of 1.963-3 (and paragraph (b) of 1.963-4, if
applicable for the year of election), as a distribution first from the
earnings and profits (to the extent thereof) of the foreign corporation
which was the single first-tier corporation, or of the distributing
corporation or corporations which were in the chain or group, as the
case may be, for the taxable year in respect of which the election was
made, and then from earnings and profits (to the extent thereof)
described in section 959(c)(3) and determined as provided in section 959
for the most recent taxable year and the first, second, etc., taxable
years preceding such recent taxable years, in that order, of the
distributing corporation or corporations. In applying the preceding
sentence to taxable years other than the taxable year in respect of
which the election was made, the deficiency distribution shall first be
allocated, in the order of allocation prescribed by such sentence, first
to taxable years in respect of which no election under section 963 was
made with respect to the stock on which such distribution is received
and then to taxable years in respect of which an election under such
section was made.
(2) Year of receipt. Any deficiency distribution made with respect
to a taxable year of the United States shareholder shall be treated,
except as provided in paragraph (b)(2) of this section, as having been
received by the shareholder in that year for which such shareholder
elected to secure an exclusion under section 963; and, for purposes of
the foreign tax credit under section 901, the foreign income taxes paid
or accrued, or deemed paid, by the United States shareholder by reason
of a distribution of any amount treated as a deficiency distribution for
such year shall be treated as paid or accrued, or deemed paid, for such
year.
(3) Year of payment. A distribution counting toward a deficiency
distribution for a taxable year of election shall, except as provided in
paragraph (b)(2) of this section, be treated for purposes of applying
paragraph (a) of 1.963-3, relating to conditions under which earnings
and profits are counted toward a minimum distribution, and paragraph
(b)(3) of 1.963-4, relating to rules for distributing through a chain
or group, as if it were distributed during the distribution period (as
defined in paragraph (g) of 1.963-3) with respect to the distributing
corporation and each foreign corporation through which such distribution
is made to the United States shareholder, for the taxable year to which
the election under section 963 applies; and the foreign income taxes
paid by any foreign corporation by reason of such distribution shall, in
the application of section 902 and of the special rules of paragraph (c)
of 1.963-4, be treated as paid or accrued by such foreign corporation
for its taxable year to which such election applies. The distribution
shall not count toward a minimum distribution for any other taxable
year.
(4) Allocation of reduction in tax credit. If any portion of a
deficiency distribution from a corporation which was in a chain or group
is paid from earnings and profits of a taxable year other than that in
respect of which the election was made, then the minimum distribution
toward which such deficiency distribution counts may not be treated as a
pro rata minimum distribution for purposes of 1.963-4. Moreover, the
amount of the overall United States and foreign income tax with respect
to such minimum distribution must satisfy the minimum tax requirements
of paragraph (a)(1)(i), or paragraph (ii), of 1.963-4, but, if the
latter applies, without any reduction and deferral under paragraph
(c)(3) of such section of the foreign tax credit allowable under section
901 with respect to the deficiency distribution.
(T.D. 6759, 29 FR 13346, Sept. 25, 1964, as amended by T.D. 6767, 29
FR 14879, Nov. 3, 1964; T.D. 7410, 41 FR 11020, Mar. 16, 1976)
26 CFR 1.963-7 Transitional rules for certain taxable years.
(a) Extension of time for making, revoking, or changing election --
(1) In general. Subparagraphs (2) and (3) of this paragraph provide
additional rules which apply only to a taxable year of a United States
shareholder for which the last day prescribed by law for filing its
return (including any extensions of time under section 6081) occurs on
or before the 90th day after September 30, 1964.
(2) Manner of making the election. The election of the United State
shareholder to secure the exclusion under section 963 and the consent to
the regulations under such section may be made for the taxable year --
(i) By filing with the return (or with an amended return filed on or
before such 90th day) for such taxable year --
(a) A written statement stating that such election is made for such
taxable year, and
(b) The names of the foreign corporations to which such election
applies, the taxable year, country of incorporation, pretax earnings and
profits, foreign income taxes, earnings and profits, and outstanding
capital stock, of each such corporation, and such other information
relating to the election made as the Commissioner may prescribe, on or
before the date of filing, by instructions or schedules to support such
return; or
(ii) In case of any extension of time under section 6081 with respect
to such taxable year where the last day prescribed by law for filing the
return by the electing United States shareholder (not including any
extensions thereof) occurs on or before September 30, 1964, by filing
with the request for the first such extension of time a written
statement stating that such election is made for such taxable year and
setting forth the names of the foreign corporations to which each
election applies.
(3) Revocation or change of election. An election made in the manner
provided by subparagraph (2) of this paragraph may be revoked or changed
--
(i) By filing with the return on or before the 90th day after
September 30, 1964, a written statement that such election is revoked or
changed, as the case may be, and by setting forth with respect to any
such modified election the information prescribed by subparagraph
(2)(i)(b) of this paragraph, or
(ii) Where the return has been filed on or before such 90th day, by
filing on or before such 90th day an amended return and an accompanying
statement that such election is revoked or changed, as the case may be,
and by setting forth with respect to any such modified election the
information prescribed by subparagraph (2)(i)(b) of this paragraph.
(b) Extension of time for making a minimum distribution -- (1) In
general. This paragraph applies only with respect to a taxable year of
a United States shareholder ending on or before September 30, 1964, for
which an election to secure an exclusion under section 963 is made
where, in case of a first-tier election, the distribution period of such
first-tier corporation with respect to its taxable year to which such
election applies ends on or before the 90th day after such date, and
where, in the case of a chain or group election, the distribution period
ends on or before such 90th day with respect to the taxable year to
which the election applies of any of the foreign corporations in such
chain or group.
(2) Conditions for obtaining extension of time. A distribution on
stock with respect to which the election under section 963 was made
which is received by the United States shareholder from a foreign
corporation which was the single first-tier corporation, or a
corporation in the chain or group, as the case may be, with respect to
which the election was made, shall count toward a minimum distribution
under section 963 for such year of election if --
(i) The distribution is made on or before such 90th day,
(ii) The shareholder, in a statement attached to its return or
amended return for such year (which is filed on or before such 90th day)
indicates the foreign corporation or corporations from which the
distribution is made and states that, and the extent to which, the
distribution is to count toward such minimum distribution,
(iii) The distribution is of such a nature as would have permitted it
to count toward a minimum distribution for such taxable year of the
United States shareholder if it had been made on the last day of such
year, and
(iv) The United States shareholder includes the distribution in gross
income as if it were received on the last day of such taxable year of
election.
The distribution shall be applied against the earnings and profits of
the single first-tier corporation or the foreign corporations in the
chain or group for the taxable year of such corporation or corporations
to which the election applies.
(3) Year of receipt. To the extent that a distribution counts toward
a minimum distribution under this paragraph with respect to a taxable
year of the United States shareholder, it shall be treated as having
been received by the shareholder in that year for the purpose of
determining gross income and the assessment of interest, additional
amounts, and assessable penalties; and, for purposes of the foreign tax
credit under section 901, the foreign income taxes paid or accrued, or
deemed paid, by the United States shareholder by reason of a
distribution of any amount treated as a distribution for such year under
this paragraph shall be treated as paid or accrued, or deemed paid, for
such year.
(4) Year of payment. The distribution shall be treated for purposes
of applying paragraph (a) of 1.963-3, relating to conditions under
which earnings and profits are counted toward a minimum distribution,
and paragraph (b)(3) of 1.963-4, relating to rules for distributing
through a chain or group, as if it were distributed during the
distribution period (as defined in paragraph (g) of 1.963-3) with
respect to the distributing corporation and each foreign corporation
through which such distribution is made to the United States
shareholder, for the taxable year to which the election under section
963 applies; and the foreign income taxes paid by any foreign
corporation by reason of such distribution shall, in the application of
section 902 and of the special rules of paragraph (c) of 1.963-4, be
treated as paid or accrued by such foreign corporation for its taxable
year to which such election applies. The distribution shall not count
toward a minimum distribution for any other taxable year.
(T.D. 6759, 29 FR 13348, Sept. 25, 1964, as amended by T.D. 6767, 29
FR 14879, Nov. 3, 1964)
26 CFR 1.963-8 Determination of minimum distribution during the
surcharge period.
(a) Taxable years not wholly within the surcharge period. In the
case of a taxable year beginning before the surcharge period and ending
within the surcharge period, or beginning within the surcharge period
and ending after the surcharge period, or beginning before January 1,
1970, and ending after December 31, 1969, section 963(b) provides the
method for determining the required minimum distribution. Under the
method prescribed in section 963(b) for such years, the required minimum
distribution is an amount equal to the sums of:
(1) That portion of the minimum distribution which would be required
if the provisions of section 963(b)(1) were applicable to the taxable
year, which the number of days in such taxable year which are within the
surcharge period and before January 1, 1970, bears to the total number
of days in such taxable year.
(2) That portion of the minimum distribution which would be required
if the provisions of section 963(b)(2) were applicable to such taxable
year, which the number of days in such taxable year which are within the
surcharge period and after December 31, 1969, bears to the total number
of days in such taxable year, and
(3) That portion of the minimum distribution which would be required
if the provisions of section 963(b)(3) were applicable to such taxable
year, which the number of days in such taxable year which are not within
the surcharge period bears to the total number of days in such taxable
year.
(b) Calendar year 1970. For calendar year 1970, the required minimum
distribution shall be an amount determined in accordance with the
following table:
(c) Surcharge period. For purposes of this section the term
''surcharge period'' means the period beginning January 1, 1968, and
ending June 30, 1970.
(d) Illustration of principles. The application of the rules set
forth in paragraphs (a), (b), and (c) of this section may be illustrated
by the following example. It is assumed that all computations are
carried to sufficient accuracy:
Example. (a) M, a domestic corporation, and A, its controlled
corporation (the one class of stock of which is wholly owned by M), both
have a taxable year beginning December 1, 1969, and ending November 30,
1970. For such taxable year M makes a first-tier election with respect
to A corporation. The effective foreign tax rate for such year is 30
percent.
(b) Under section 963(b) and paragraph (b) of this section the
surcharge period ends June 30, 1970. Therefore, of the 365 days in the
taxable year, 153 days are not within the surcharge period. Of the
remaining 212 days, 31 are within the surcharge period and before
January 1, 1970 and 181 days are within the surcharge period and after
December 31, 1969. If section 963(b)(1) were applicable to the entire
taxable year, the required minimum distribution of earnings and profits
would be 75 percent. If section 963(b)(2) were applicable to the entire
taxable year, the required minimum distribution would be 72 percent. If
section 963(b)(3) were applicable to the entire taxable year, the
required minimum distribution would be 69 percent.
(c) Under section 963(b) and this section the required minimum
distribution of earnings and profits is 71 percent, computed as follows:
(T.D. 7100, 36 FR 5336, Mar. 20, 1971)
26 CFR 1.964-1 Determination of the earnings and profits of a foreign
corporation.
(a) In general. For purposes of sections 951 through 964, the
earnings and profits (or deficit in earnings and profits) of a foreign
corporation for its taxable year shall, except as provided in paragraph
(f) of this section, be computed substantially as if such corporation
were a domestic corporation by --
(1) Preparing a profit and loss statement with respect to such year
from the books of account regularly maintained by the corporation for
the purpose of accounting to its shareholders;
(2) Making the adjustments necessary to conform such statement to the
accounting principles described in paragraph (b) of this section;
(3) Making the further adjustments necessary to conform such
statement to the tax accounting standards described in paragraph (c) of
this section;
(4) Translating the amounts shown on such adjusted statement into
United States dollars in accordance with paragraph (d) of this section,
and
(5) Adjusting the amount of profit or loss shown on such translated
and adjusted statement in accordance with paragraph (e) of this section
to reflect any exchange gain or loss determined thereunder.
The computation described in the preceding sentence may be made by
following the procedures described in paragraphs (a) (1) through (5) of
this section in an order other than the one listed, as long as the
result so obtained would be the same. In determining earnings and
profits, or the deficit in earnings and profits, of a foreign
corporation under section 964, the amount of any illegal bribe,
kickback, or other payment (within the meaning of section 162(c), as
amended by section 288 of the Tax Equity and Fiscal Responsibility Act
of 1982 in the case of payments made after September 3, 1982, and the
regulations thereunder) paid after November 3, 1976, by or on behalf of
the corporation during the taxable year of the corporation directly or
indirectly to an official, employee, or agent in fact of a government
shall not be taken into account to decrease such earnings and profits or
to increase such deficit. No adjustment shall be required under
subparagraph (2) or (3) of this paragraph unless it is material.
Whether an adjustment is material depends on the facts and circumstances
of the particular case, including the amount of the adjustment, its size
relative to the general level of the corporation's total assets and
annual profit or loss, the consistency with which the practice has been
applied, and whether the item to which the adjustment relates is of a
recurring or merely a nonrecurring nature. For the treatment of
earnings and profits whose distribution is prevented by restrictions and
limitations imposed by a foreign government, see section 964(b) and the
regulations thereunder.
(b) Accounting adjustments -- (1) In general. The accounting
principles to be applied in making the adjustments required by paragraph
(a)(2) of this section shall be those accounting principles generally
accepted in the United States for purposes of reflecting in the
financial statements of a domestic corporation the operations of its
foreign affiliates, including the following:
(i) Clear reflection of income. Any accounting practice designed for
purposes other than the clear reflection on a current basis of income
and expense for the taxable year shall not be given effect. For
example, an adjustment will be required where an allocation is made to
an arbitrary reserve out of current income.
(ii) Physical assets, depreciation, etc. All physical assets (as
defined in paragraph (e)(5)(ii) of this section), including inventory
when reflected at cost, shall be taken into account at historical cost
computed either for individual assets or groups of similar assets. The
historical cost of such an asset shall not reflect any appreciation or
depreciation in its value or in the relative value of the currency in
which its cost was incurred. Depreciation, depletion, and amortization
allowances shall be based on the historical cost of the underlying asset
and no effect shall be given to any such allowance determined on the
basis of a factor other than historical cost. For special rules for
determining historical cost where assets are acquired during a taxable
year beginning before January 1, 1950, or a majority interest in the
foreign corporation is acquired after December 31, 1949, but before
October 27, 1964, see subparagraph (2) of this paragraph.
(iii) Valuation of assets and liabilities. Any accounting practice
which results in the systematic undervaluation of assets or
overvaluation of liabilities shall not be given effect, even though
expressly permitted or required under foreign law, except to the extent
allowable under paragraph (c) of this section. For example, an
adjustment will be required where inventory is written down below market
value. For the definition of market value, see paragraph (a) of
1.471-4.
(iv) Income equalization. Income and expense shall be taken into
account without regard to equalization over more than one accounting
period; and any equalization reserve or similar provision affecting
income or expense shall not be given effect, even though expressly
permitted or required under foreign law, except to the extent allowable
under paragraph (c) of this section.
(v) Foreign currency. If transactions effected in a foreign currency
other than that in which the books of the corporation are kept are
translated into the foreign currency reflected in the books, such
translation shall be made in a manner substantially similar to that
prescribed by paragraph (d) of this section for the translation of
foreign currency amounts into United States dollars.
(2) Historical cost. For purposes of this section, the historical
cost of an asset acquired by the foreign corporation during a taxable
year beginning before January 1, 1963, shall be determined, if it is so
elected by or on behalf of such corporation --
(i) In the event that the foreign corporation became a majority owned
subsidiary of a United States person (within the meaning of section
7701(a)(30)) after December 31, 1949, but before October 27, 1964, and
the asset was held by such foreign corporation at that time, as though
the asset was purchased on the date during such period the foreign
corporation first became a majority owned subsidiary at a price equal to
its then fair market value, or
(ii) In the event that subdivision (i) of this subparagraph is
inapplicable but the asset was acquired by the foreign corporation
during a taxable year beginning before January 1, 1950, as though the
asset were purchased on the first day of the first taxable year of the
foreign corporation beginning after December 31, 1949, at a price equal
to the undepreciated cost (cost or other basis minus book depreciation)
of that asset as of that date as shown on the books of account of such
corporation regularly maintained for the purpose of accounting to its
shareholders.
For purposes of this subparagraph, a foreign corporation shall be
considered a majority owned subsidiary of a United States person if,
taking into account only stock acquired by purchase (as defined in
section 334(b)(3)), the United States person owns (within the meaning of
section 958(a)) more than 50 percent of the total combined voting power
of all classes of stock of the foreign corporation entitled to vote.
The election under this subparagraph shall be made for the first taxable
year beginning after December 31, 1962, in which the foreign corporation
is a controlled foreign corporation (within the meaning of section 957),
or for which it is included in a chain or group under section 963(c)
(2)(B) or (3)(B) (applied as if section 963 had not been repealed by the
Tax Reduction Act of 1975), or has a deficit in earnings and profits
sought to be taken into account under section 952(d) or pays a dividend
that is included in the foreign base company shipping income of a
controlled foreign corporation under 1.954-6(f). Once made, such an
election shall be irrevocable. For the time and manner in which an
election may be made on behalf of a foreign corporation, see paragraph
(c)(3) of this section.
(3) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Corporation M is a controlled foreign corporation which
regularly maintains books of account for the purpose of accounting to
its shareholders in accordance with the accounting practices prevalent
in country X, the country in which it operates. As a consequence of
those practices, the profit and loss statement prepared from these books
of account reflects an allocation to an arbitrary reserve out of current
income and depreciation allowances based on replacement values which are
greater than historical cost. Adjustments are necessary to conform such
statement to accounting principles generally accepted in the United
States. Assuming these adjustments to be material, the unacceptable
practices, will have to be eliminated from the statement, an increase in
the amount of profit (or a decrease in the amount of loss) thereby
resulting.
Example 2. In 1973, Corporation N is a foreign corporation which is
not a controlled foreign corporation but which is included in a chain,
for minimum distribution purposes, under section 963(c)(2)(B).
Corporation N regularly maintains books of account for the purpose of
accounting to its shareholders in accordance with the accounting
practices of country Y, the country in which it operates. As a
consequence of those practices, the profit and loss statement prepared
from these books of account reflects the inclusion in income of stock
dividends and of corporate distributions representing a return of
capital. Adjustments are necessary to conform such statement to
accounting principles generally accepted in the United States. Assuming
these adjustments to be material, the unacceptable practices will have
to be eliminated from the statement, a decrease in the amount of profit
(or increase in the amount of loss) thereby resulting.
(c) Tax adjustments -- (1) In general. The tax accounting standards
to be applied in making the adjustments required by paragraph (a)(3) of
this section shall be the following:
(i) Accounting methods. The method of accounting shall reflect the
provisions of section 446 and the regulations thereunder.
(ii) Inventories. Inventories shall be taken into account in
accordance with the provisions of sections 471 and 472 and the
regulations thereunder.
(iii) Depreciation. Depreciation shall be computed as follows:
(a) For any taxable year beginning before July 1, 1972; depreciation
shall be computed in accordance with section 167 and the regulations
thereunder.
(b) If, for any taxable year beginning after June 30, 1972, 20
percent or more of the gross income from all sources of the corporation
is derived from sources within the United States, then depreciation
shall be computed in accordance with the provisions of 1.312-15.
(c) If, for any taxable year beginning after June 30, 1972, less than
20 percent of the gross income from all sources of the corporation is
derived from sources within the United States, then depreciation shall
be computed in accordance with section 167 and the regulations
thereunder.
(iv) Elections. Effect shall be given to any election made in
accordance with an applicable provision of the Code and the regulations
thereunder and these regulations.
Except as provided in subparagraphs (2) and (3) of this paragraph,
any requirements imposed by the Code or applicable regulations with
respect to making an election or adopting or changing a method of
accounting must be satisfied by or on behalf of the foreign corporation
just as though it were a domestic corporation if such election or such
adoption or change of method is to be taken into account in the
computation of its earnings and profits.
(2) Adoption of method. For the first taxable year beginning after
December 31, 1962, in which the foreign corporation is a controlled
foreign corporation (within the meaning of section 957), or for which it
is included in a chain or group under section 963(c) (2)(B) or (3)(B)
(applied as if section 963 had not been repealed by the Tax Reduction
Act of 1975), or has a deficit in earnings and profits sought to be
taken into account under section 952(d), or pays a dividend that is
included in the foreign base company shipping income of a controlled
foreign corporation under 1.954-6(f), there may be adopted or made by
such corporation or on its behalf any method of accounting or election
allowable under this section notwithstanding that, in previous years,
its earnings and profits were computed, or its books or financial
statements prepared, on a different basis and notwithstanding that such
election is required by the Code or regulations to be made in a prior
taxable year. For purposes of determining the amount of a deficit in
earnings and profits taken into account pursuant to section
952(c)(1)(B), if a different basis is used in previous years, ratable
adjustments shall be made in the earnings and profits attributable to
such previous years to prevent any duplication or omission of amounts
that would otherwise result from the adoption of such method or the
making of such election. See subparagraph (3) of this paragraph for the
manner in which a method of accounting or an election may be adopted or
made on behalf of the foreign corporation.
(3) Action on behalf of corporation -- (i) In general. An election
shall be deemed made, or an adoption or change in method of accounting
deemed effectuated, on behalf of the foreign corporation only if its
controlling United States shareholders (as defined in subparagraph (5)
of this paragraph) --
(a) Satisfy for such corporation any requirements imposed by the Code
or applicable regulations with respect to such election or such adoption
or change in method, such as the filing of forms, the execution of
consents, securing the permission of the Commissioner, or maintaining
books and records in a particular manner,
(b) File the written statement described in subdivision (ii) of this
subparagraph at the time and in the manner prescribed therein, and
(c) Provide the written notice required by subdivision (iii) of this
subparagraph at the time and in the manner prescribed therein.
For purposes of the preceding sentence, the books of the foreign
corporation shall be considered to be maintained in a particular manner
if the controlling United States shareholders or the foreign corporation
regularly keep the records and accounts required by section 964(c) and
the regulations thereunder in that manner. Any election required to be
made or information required to be filed with a tax return shall be
deemed made or furnished on behalf of the foreign corporation if its
controlling United States shareholders file the written statement
described in subdivision (ii) of this subparagraph with respect to such
election within the period specified therein. For a special rule
postponing the time for taking action by or on behalf of a foreign
corporation until the amount of its earnings and profits becomes
significant, see subparagraph (6) of this paragraph.
(ii) Written statement. The written statement required by
subdivision (i) of this subparagraph shall be jointly executed by the
controlling United States shareholders, shall be filed with the Director
of the Internal Revenue Service Center, 11601 Roosevelt Blvd.,
Philadelphia, Pennsylvania 19155, within 180 days after the close of the
taxable year of the foreign corporation with respect to which the
election is made or the adoption or change of method effected, or before
May 1, 1965, whichever is later, and shall set forth the name and
country or organization of the foreign corporation, the names,
addresses, taxpayer identification numbers (in the case of statements
required to be filed after June 20, 1983), and stock interests of the
controlling United States shareholders, the nature of the action taken,
the names, addresses, and (in the case of statements required to be
filed after June 20, 1983) taxpayer identification numbers of all other
United States shareholders notified of the election or adoption or
change of method, and such other information as the Commissioner may by
forms require.
(iii) Notice. Prior to the filing of the written statement described
in subdivision (ii) of this subparagraph, the controlling United States
shareholders shall provide written notice of the election made or the
adoption or change of method effected to all other persons known by them
to be United States shareholders who own (within the meaning of section
958(a)) stock of the foreign corporation. Such notice shall set forth
the name and country of organization of the foreign corporation, the
names, addresses, and stock interests of the controlling United States
shareholders, the nature of the action taken, and such other information
as the Commissioner may by forms require. However, the failure of the
controlling United States shareholders to provide such notice to a
person required to be notified thereunder shall not invalidate the
election made or the adoption or change of method effected, if it is
established to the satisfaction of the Commissioner that reasonable
cause existed for such failure.
(4) Effect of action by controlling United States shareholders. Any
action taken by the controlling United States shareholders on behalf of
the foreign corporation pursuant to subparagraph (3) of this paragraph
shall be reflected in the computation of the earnings and profits of
such corporation under this section to the extent that it bears upon the
tax liability of a United States shareholder who either --
(i) Was a controlling United States shareholder with respect to the
action taken;
(ii) Received the written notice provided by subparagraph (3)(iii) of
this paragraph;
(iii) Failed to file any of the returns required by section 6046 and
the regulations thereunder within the period prescribed by section
6046(d); or
(iv) Was notified by the Director of the Philadelphia Service Center
of the action taken --
(a) Within 61 days after the last day (including extensions of time)
prescribed with respect to the taxable year of the foreign corporation
by subparagraph (3)(ii) of this paragraph for filing the written
statement described in such subparagraph, or
(b) Within 180 days after the close of the first taxable year in
which such shareholder becomes a United States shareholder, whichever is
later.
To the extent that the computation of the earnings and profits of the
foreign corporation bears upon the tax liability of any United States
shareholder other than those enumerated in the preceding sentence, the
computation shall reflect the action taken only if such shareholder
assents to such treatment. Such assent may be given at any time, but
not later than 90 days after the shareholder is first apprised of such
action by the Director of the Philadelphia Service Center. The
shareholder shall signify his assent by filing a written statement with
the Director of the Internal Revenue Service Center, 11601 Roosevelt
Blvd., Philadelphia, Pennsylvania, 19155, setting forth the name and
country of organization of the foreign corporation, his own name,
address, and stock interest in the corporation, the nature of the action
being assented to, and such other information as the Commissioner may by
forms require.
(5) Controlling United States shareholders. For purposes of this
paragraph the controlling United States shareholders of a foreign
corporation shall be those United States shareholders (as defined in
section 951(b)), who, in the aggregate, own (within the meaning of
section 958(a)) more than 50 percent of the total combined voting power
of all classes of the stock of such corporation entitled to vote and who
undertake to act on its behalf. In the event that the foreign
corporation is not a controlled foreign corporation but is included in a
chain or group under section 963(c) (2)(B) or (3)(B), the controlling
United States shareholder with respect to such foreign corporation shall
be deemed to be the domestic corporation which elects to receive the
minimum distribution from such chain or group. In the event that the
foreign corporation is neither a controlled foreign corporation nor
included in a chain or group under section 963(c) (2)(B) or (3)(B) but
has a deficit in earnings and profits sought to be taken into account
under section 952(d), the controlling United States shareholder with
respect to such foreign corporation shall be the shareholder seeking to
take such deficit into account. In the event that the foreign
corporation is a controlled foreign corporation but the United States
shareholders (as defined in section 951(b)) do not, in the aggregate,
own (within the meaning of section 958(a)) more than 50 percent of the
total combined voting power of all classes of the stock of such
corporation entitled to vote, the controlling United States shareholders
of the foreign corporation shall be all those United States shareholders
who own (within the meaning of section 958(a)) stock of such
corporation. In the event that a foreign corporation is not a
controlled foreign corporation but pays a dividend to a controlled
foreign corporation that is attributable to foreign base company
shipping income under 1.954-6(f), the controlling United States
shareholders (as defined in this subparagraph) of the controlled foreign
corporation shall be considered the controlling United States
shareholders of the foreign corporation.
(6) Action not required until significant. Notwithstanding any other
provision of this paragraph, action by or on behalf of a foreign
corporation (other than a foreign corporation subject to tax under
section 882) to make an election or to adopt a method of accounting
shall not be required until 180 days after the close of the first
taxable year for which --
(i) An amount is includible in gross income with respect to such
corporation under section 951(a);
(ii) It is sought to be established that such corporation is a less
developed country corporation (within the meaning of section 955(c), as
in effect before the enactment of the Tax Reduction Act of 1975);
(iii) An amount is excluded from Subpart F income (within the meaning
of section 952) by section 952(c), section 952(d), or section 970(a);
(iv) Such corporation is the subject of an election to secure an
exclusion under section 963 (applied as if section 963 had not been
repealed by the Tax Reduction Act of 1975); or
(v) It is sought to be established that the corporation has foreign
base company shipping income (within the meaning of section 954(f)).
In the event that action by or on behalf of the foreign corporation
is not undertaken by the time specified in the preceding sentence and
such failure is shown to the satisfaction of the Commissioner to be due
to inadvertence or a reasonable cause, such action may be undertaken
during any period of at least 30 days occurring after such showing is
made which the Commissioner may specify as appropriate for this purpose.
Where the action necessary to make an election or to adopt a method of
accounting is undertaken by or on behalf of the foreign corporation in
accordance with this subparagraph, such election shall be deemed to have
been made, or such adoption of accounting method effected, for the first
taxable year of the foreign corporation beginning after December 31,
1962, in which such corporation is a controlled foreign corporation
(within the meaning of section 957) or for which it is included in a
chain or group under section 963(c) (2)(B) or (3)(B) (applied as if
section 963 had not been repealed by the Tax Reduction Act of 1975) or
has a deficit in earnings and profits sought to be taken into account
under section 952(d) or pays a dividend that is included in the foreign
base company shipping income of a controlled foreign corporation under
1.954-6(f). For special rules for computing earnings and profits for
purposes of section 1248 or income for purposes of applying an exclusion
set forth in section 954(b) where the taxable year of the foreign
corporation occurs prior to the making of elections or the adoption of
methods of accounting under this subparagraph, see the regulations under
section 952 and section 1248.
(7) Revocation of election. Notwithstanding any other provision of
this section, any election made by or on behalf of a foreign corporation
(other than a foreign corporation subject to tax under section 882) may
be modified or revoked by or on behalf of such corporation for the
taxable year for which made whenever the consent of the Commissioner is
secured for such modification or revocation, even though such election
would be irrevocable but for this subparagraph.
(8) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. X Corporation is a controlled foreign corporation which
maintains its books, in accordance with the laws of the country in which
it operates, by taking inventoriable items into account under the
''first-in, first-out'' method. A, B, and C, the United States
shareholders of X Corporation, own 45 percent, 30 percent, and 25
percent of its voting stock, respectively. For the first taxable year
of X Corporation beginning after December 31, 1962, B and C adopt on its
behalf the ''last-in, first-out'' inventory method, notifying A of the
action taken. Even though A may object to such action, adjustments must
be made to reflect the use of the LIFO method of inventorying in the
computation of the earnings and profits of X Corporation with respect to
him as well as with respect to B and C.
Example 2. Y Corporation is a controlled foreign corporation which
maintains its books, in accordance with the laws of the country in which
it operates, by employing the straight-line method of depreciation. D
and E, the United States shareholders of Y Corporation, own 51 percent
and 10 percent of its voting stock, respectively. For the first taxable
year of Y Corporation beginning after December 31, 1962, D adopts on its
behalf the declining balance method of depreciation. However, not
knowing that E is a United States shareholder of the company, D fails to
provide him with notice of the action taken. Assuming that E has filed
the return required by section 6046 and the regulations thereunder
within the period prescribed by section 6046(d), adjustments in the
computation of earnings and profits will not be required with respect to
him unless the Director of International Operations notifies him of the
action taken within 240 days after the close of Y's taxable year. If
notice is not provided to E within this period, he will not be compelled
to make the adjustments. At his option, however, he may accept the
action taken by assenting thereto not later than 90 days after he is
first apprised of such action by the Director of International
Operations.
(d) Translation into United States dollars -- (1) In general -- (i)
General rule. Except as provided in subdivisions (ii), (iii), and (iv)
of this subparagraph, the amounts to be shown on the profit and loss
statement, adjusted pursuant to paragraphs (b) and (c) of this section,
shall be translated into United States dollars (as required by paragraph
(a)(4) of this section) at the appropriate exchange rate for the
translation period (as defined in subparagraph (6) of this paragraph) to
which they relate.
(ii) Cost of goods sold. Amounts representing items of inventory
reflected in the cost of goods sold shall be translated --
(a) To the extent that such amounts represent items included in the
opening inventory balance, so as to obtain the same amount of United
States dollars which represented (after translation and adjustment) such
items in the closing inventory balance for the preceding taxable year,
(b) To the extent that such amounts represent items purchased or
otherwise first included in inventory during the taxable year, at the
appropriate exchange rate for the translation period in which the
historical cost of such items was incurred, and
(c) To the extent that such amounts represent items included in the
closing inventory balance, at the appropriate exchange rate for the
translation period in which the historical cost of such items was
incurred, except that, if such amounts are written down to market value,
such market value shall be determined at the year-end rate.
Notwithstanding the preceding sentence, amounts representing items of
inventory included in the closing inventory balance may be translated at
the year-end rate even though not written down to market value;
however, once such a rate is employed under those circumstances,
translation may not be made for subsequent taxable years at the
appropriate exchange rate for the translation period in which the
historical cost of the items of inventory was incurred unless the
permission of the Commissioner is secured.
(iii) Depreciation, depletion, and amortization. Amounts
representing allowances for depreciation, depletion, or amortization
shall be translated at the appropriate exchange rate for the translation
period in which the historical cost of the underlying asset was incurred
or is deemed to have been incurred. For purposes of this subdivision,
if the historical cost of an asset is determined under paragraph (b)(2)
of this section, such cost shall be deemed to have been incurred on the
date the asset is considered to have been purchased under that
paragraph.
(iv) Prepaid expenses or income. Amounts representing expenses or
income paid or received in a prior taxable year shall be translated at
the appropriate exchange rate for the translation period during which
they were paid or received. Notwithstanding the preceding sentence,
amounts representing such prepaid income or expenses may be translated
at the year-end rate; however, once such a rate is employed,
translation may not be made for subsequent taxable years at the
appropriate exchange rate for the translation period during which such
income or expenses were paid or received unless the permission of the
Commissioner is secured.
(2) Appropriate exchange rate -- (i) In general. Where the value of
the foreign currency relative to the United States dollar does not
fluctuate substantially during a translation period, a single exchange
rate shall be appropriate for all amounts representing classes of items
which relate to such period, such rate to be a simple average determined
by dividing the sum of the closing rates for each of the calendar months
ending with or within such period by the number of such months. On the
other hand, where the value of the foreign currency relative to the
United States dollar does fluctuate substantially during a translation
period, the exchange rate appropriate to an amount representing a class
of items which relates to such period shall be either (a) a simple
average determined in accordance with the preceding sentence, or (b) a
weighted average taking into account the volume of transactions
(reflected by the amount being translated) for the calendar months
ending with or within such period, depending upon which average would
produce a result more representative of that which would have been
obtained by translating the individual transactions reflected by that
amount at the closing rate for the month to which each such transaction
relates. Whether the value of the foreign currency relative to the
United States dollar fluctuates substantially during the translation
period is a question of fact, depending upon, among other things, the
extent to which the volume of transactions varies from month to month.
In general, however, the degree of fluctuation will be considered
substantial if the closing rate for any calendar month ending with or
within the translation period varies by more than 10 percent from the
closing rate for any preceding calendar month ending within that period.
(ii) Monthly rate. Notwithstanding subdivision (i) of this
subparagraph, if it is so elected by or on behalf of the foreign
corporation, and if the closing rate for any calendar month ending with
or within a translation period does not vary by more than 3 percent from
the closing rate for any preceding calendar month ending within that
period, the appropriate exchange rate for amounts representing all
classes of items relating to such period shall be any exchange rate
which is designated in the election and which does not vary by more than
3 percent from the closing rate for any calendar month ending with or
within such period. An election under this subdivision may be made with
respect to any translation period of any taxable year of the foreign
corporation beginning after December 31, 1962. Such election shall be
effective only with respect to the translation period for which it is
made, and once made shall be irrevocable with respect to that period.
See paragraph (c)(3) of this section for the time and manner in which an
election may be made on behalf of the foreign corporation.
(iii) Class of items. For purposes of this subparagraph, the term
''class of items'' means any category which is reflected separately on
books of account or financial statements. For example, sales is a class
of items which is reflected separately on the profit and loss statement,
and accounts receivable is a class of items which is reflected
separately on the balance sheet.
(3) Closing rate. The closing rate for any calendar month shall be
the exchange rate on the last day of that month determined by reference
to a qualified source of exchange rates within the meaning of
subparagraph (5) of this paragraph.
(4) Year-end rate. The year-end rate shall be the closing rate for
the last calendar month of the taxable year.
(5) Qualified source of exchange rates. A qualified source of
exchange rates shall be any source which is demonstrated to the
satisfaction of the district director to reflect actual transactions
conducted in a free market and involving representative amounts. In the
absence of such a demonstration, the exchange rates taken into account
in the computation of the earnings and profits of the foreign
corporation shall be determined by reference to the free market rate set
forth in the pertinent monthly issue of ''International Financial
Statistics'' or a successor publication of the International Monetary
Fund, or such other source of exchange rates reflecting actual
transactions conducted in a free market and involving representative
amounts as the Commissioner may designate as appropriate for this
purpose.
(6) Translation period -- (i) In general. Except as provided in
subdivision (ii) of this subparagraph, the translation period shall be a
taxable year.
(ii) Currency fluctuations. If it is so elected by or on behalf of
the foreign corporation, the taxable year shall be divided into groups
consisting of a calendar month or consecutive calendar months as
specified in the election, each such group constituting a separate
translation period. Where the value of the foreign currency relative to
the United States dollar fluctuates substantially during the taxable
year, the use of the weighted average referred to in subparagraph (2)(i)
of this paragraph ordinarily may be avoided by dividing the taxable year
into translation periods so that the first translation period begins
with the first day of such year and each subsequent translation period
begins with the first day of the first calendar month thereafter ending
with or within such year for which the closing rate varies by more than
10 percent from the closing rate for any month in the preceding
translation period. An election under this subdivision may be made with
respect to any taxable year of the foreign corporation beginning after
December 31, 1962. Such election shall be effective only with respect
to the taxable year for which it is made, and once made shall be
irrevocable with respect to such year. For the time and manner in which
an election may be made on behalf of the foreign corporation, see
paragraph (c)(3) of this section.
(7) Actual transactions. Notwithstanding any other provisions of
this paragraph --
(i) Dollar transactions. Any transaction involving the payment or
receipt of United States dollars shall be reflected in the profit and
loss statement by the amount of United States dollars involved in such
transaction.
(ii) Conversion transactions. Any transaction involving the
conversion of a foreign currency into United States dollars, or the
conversion of United States dollars into a foreign currency, shall be
reflected in the profit and loss statement by an amount expressed in
United States dollars and determined by translation at the exchange rate
at which conversion was effected if the foreign corporation knows, or
reasonably should know, that exchange rate.
(iii) Daily rate. Any transaction other than one described in
subdivision (i) or (ii) may be translated into United States dollars at
the exchange rate for the day on which that transaction occurred, such
rate to be determined by reference to a qualified source of exchange
rates within the meaning of subparagraph (5) of this paragraph.
No transaction shall be required to be taken into account under
subdivision (i) or (ii) unless the United States dollars involved are
material in amount.
(8) Other methods. Notwithstanding the other provisions of this
paragraph, translation into United States dollars may be made in
accordance with a system or method not otherwise described in this
paragraph, provided that such system or method (i) was employed by the
corporation for purposes of accounting to its shareholders prior to
January 1, 1963, and (ii) is shown to the satisfaction of the
Commissioner to clearly reflect the earnings and profits of the
corporation.
(9) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. M Corporation, a controlled foreign corporation organized
on January 1, 1963, employs the calendar year as its taxable year and
maintains its books of account in abbas, the currency of the country in
which it operates. During 1963 M Corporation's monthly sales amounted
to 100,000 abbas per month, its total payroll and other expenses for the
year amounted to 180,000 abbas, and its total inventory purchases
amounted to 1,050,000 abbas. Also during 1963, M Corporation purchased
depreciable assets for 1,000,000 abbas. The value of the abba relative
to the United States dollar fluctuated only slightly in 1963; the
monthly closing rate moved between 19.8 abbas and 20.2 abbas per United
States dollar and stood at 19.9 abbas per United States dollar for most
of the year and at yearend. An election under subparagraph (2)(ii) of
this paragraph is made on behalf of M Corporation to use the par rate of
20 abbas per United States dollar as the exchange rate appropriate for
1963. Assuming that none of the amounts shown therein reflects a
transaction described in subparagraph (7) of this paragraph, M
Corporation's adjusted profit and loss statement for 1963 would be
translated into United States dollars as follows:
Example 2. The facts are the same as in example 1 and in addition
during 1964 M Corporation had annual sales of 1,470,000 abbas, annual
wages and other expenses of 252,000 abbas, and inventory purchases of
910,000 abbas. Also during 1964, M Corporation purchased additional
depreciable as sets for 430,000 abbas, the bulk of such purchases being
made in the last half of the year. The value of the abba relative to
the United States dollar gradually declined in 1964, the monthly closing
rate moving from 19.9 abbas per United States dollar down to 22 abbas
per United States dollar. For most classes of items, the appropriate
exchange rate is a simple average of monthly closing rates or 21 abbas
per United States dollar. However, since the bulk of the depreciable
asset purchases were made in the last half of the year, the rate
representative of those transactions is a weighted average of 21.5 abbas
per United States dollar. Assuming that none of the amounts shown
therein reflects a transaction described in subparagraph (7) of this
paragraph and that closing inventory is translated at historical rates,
M Corporation's adjusted profit and loss statement for 1964 would be
translated into United States dollars as follows:
Example 3. The facts are the same as in examples 1 and 2 except that
the 1964 sales of M Corporation amounted to 1,260,000 abbas plus $10,500
in United States dollars. Assuming that closing inventory is translated
at historical rates, M Corporation's adjusted profit and loss statement
for 1964 would be translated as follows:
Example 4. The facts are the same as in examples 1 and 2. M
Corporation continues to operate during 1965 and the value of the abba
relative to the United States dollar declines materially during that
year; the monthly closing rate drops from 22 abbas per United States
dollar to 26 abbas per United States dollar, a decrease of more than 10
percent. An election under subparagraph (6)(ii) of this paragraph is
made on behalf of M Corporation to divide the year into translation
periods, the applicable periods being January 1 through July 31 and
August 1 through December 31. For most classes of items, the
appropriate exchange rate for each of these translation periods is a
simple average of monthly closing rates, or 23 abbas and 25 abbas per
United States dollar, respectively. However, all of the depreciable
asset purchases were made at the end of the first translation period --
January 1 through July 31 -- and, therefore, the rate representative of
those transactions is a weighted average of 24 abbas per United States
dollar. The classes of items reflecting M Corporation's 1965 financial
transactions and the representative rates of exchange for such classes
of items are as follows:
Assuming that M Corporation uses the first-in, first-out method of
inventory valuation, the closing inventory is assumed in normal
circumstances to consist of purchases made during the most recent
translation period as follows:
Assuming that none of the amounts shown therein reflects a
transaction described in subparagraph (7) of this paragraph, and that
closing inventory is translated at historical rates, M Corporation's
adjusted profit and loss statement for 1965 would be translated into
United States dollars as follows:
(e) Exchange gain or loss -- (1) In general. The exchange gain or
loss determined in accordance with subparagraph (2) of this paragraph
shall be applied against and reduce, or applied to and increase, as the
case may be, the amount of profit or loss shown on the profit and loss
statement prepared pursuant to paragraph (a)(1) of this section, as
adjusted and translated pursuant to paragraph (a) (2), (3), and (4) of
this section. For the manner in which the exchange gain or loss is to
be allocated to or applied against Subpart F income, see section 952 and
the regulations thereunder.
(2) Determination of exchange gain or loss. The exchange gain (or
loss) for the taxable year shall be the amount which equals --
(i) The retained earnings for the taxable year as determined under
subparagraph (3) of this paragraph, plus
(ii) The amount of any distributions made during the taxable year
translated at the exchange rate appropriate to the translation period
during which such distributions were made (or taken into account) in
accordance with paragraph (d)(7) of this section, if applicable, minus
(iii) The amount representing retained earnings for the preceding
taxable year as determined under subparagraph (3) of this paragraph,
minus
(iv) The amount of profit (or plus the amount of any loss) shown on
the profit and loss statement for the taxable year prepared pursuant to
paragraph (a)(1) of this section and adjusted and translated pursuant to
paragraph (a) (2), (3), and (4) of this section.
(3) Retained earnings. The retained earnings for any taxable year
shall be determined by first --
(i) Preparing a balance sheet as of the end of such year from the
books of account regularly maintained by the foreign corporation for the
purpose of accounting to its shareholders;
(ii) Making the adjustments necessary to conform such balance sheet
to the accounting principles described in paragraph (b) of this section;
(iii) Making the further adjustments necessary to conform such
balance sheet to the tax accounting standards described in paragraph (c)
of this section; and
(iv) Translating the amounts shown on the balance sheet (other than
amounts representing retained earnings) into United States dollars in
accordance with subparagraph (4) of this paragraph.
The retained earnings shall be an amount equal to the excess of the
aggregate amount representing assets on the balance sheet (as adjusted
and translated under this subparagraph) over the aggregate amount
representing liabilities, reserves (other than reserves out of current
or accumulated earnings), and paid- in capital on the balance sheet (as
adjusted and translated under this subparagraph).
(4) Translation of balance sheet. Amounts shown on the balance sheet
as adjusted pursuant to subparagraph (3) (ii) and (iii) of this
paragraph (other than amounts representing retained earnings) shall be
translated into United States dollars as follows:
(i) Financial assets. Amounts representing financial assets shall be
translated at the year-end rate.
(ii) Physical assets. Amounts representing physical assets (other
than inventory) shall be translated at the appropriate exchange rate for
the translation period in which the historical cost of the asset was
incurred or is deemed to have been incurred. For special rules for
determining date on which the historical cost of certain assets acquired
during taxable years beginning before January 1, 1950, or owned at the
time a majority interest in the corporation was acquired after December
31, 1949, but before October 27, 1964, is deemed to have been incurred,
see paragraph (b)(2) of this section.
(iii) Depreciation and similar reserves. Amounts representing
depreciation, depletion, and amortization reserves shall be translated
at the appropriate exchange rate for the translation period in which the
historical cost of the underlying asset was incurred or is deemed to
have been incurred.
(iv) Inventory. Amounts representing items of inventory included in
the closing inventory balance shall be translated in accordance with
paragraph (d)(1)(ii) of this section.
(v) Bad debt reserves. Amounts representing bad debts reserves shall
be translated at the year-end rate.
(vi) Prepaid income or expense. Amounts representing expenses or
income paid or received in a prior taxable year shall be translated in
accordance with paragraph (d)(1)(iv) of this section.
(vii) Short-term liabilities. Amounts representing short-term
liabilities shall be translated at the year-end rate.
(viii) Long-term liabilities. Amounts representing long-term
liabilities shall be translated at the appropriate exchange rate for the
translation period in which such liabilities were incurred.
(ix) Paid-in capital. Amounts representing paid-in capital shall be
translated at the appropriate exchange rate for the translation period
in which such capital was paid in.
Notwithstanding any other provisions of this subparagraph, where the
amount representing an item shown on the balance sheet reflects a
transaction described in paragraph (d)(7) of this section, such
transaction shall be taken into account in accordance with that
paragraph.
(5) Definitions. For purposes of this paragraph --
(i) Financial assets. A financial asset shall be any asset
reflecting a fixed amount of foreign currency, such as cash on hand,
bank deposits, and loans and accounts receivable. Securities (within
the meaning of section 1236(c)) shall be considered physical assets if
they have been or are reasonably expected to be held for at least six
months; if not they shall be considered financial assets whether or not
they reflect a fixed amount of foreign currency. Moreover, advances on
open account to any corporation in which the foreign corporation and any
related persons (within the meaning of section 954(d)(3) and the
regulations thereunder) with respect thereto own at least 10 percent of
the combined voting power of all classes of stock entitled to vote shall
not be considered financial assets if such advances have remained open
for more than one year.
(ii) Physical assets. A physical asset shall be any asset other than
a financial asset and shall include goodwill, patents, and other
intangibles.
(iii) Short-term liabilities. A short-term liability shall be any
indebtedness of the foreign corporation which is due or overdue as of
the date of the balance sheet or which will become due within 1 year
thereafter.
(iv) Long-term liabilities. A long- term liability is any
indebtedness of the foreign corporation other than a short- term
liability.
For the definition of ''appropriate exchange rate'', ''year-end
rate'', and ''translation period'', see paragraph (d) (2), (4), and (6),
respectively, of this section.
(6) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. N Corporation is a controlled foreign corporation which
uses the calendar year as its taxable year and which maintains its books
in yuccas, the currency of the country in which it operates. For 1963,
its operating profit is 140,000 yuccas or $55,720. At the end of the
year, its balance sheet, as translated and adjusted pursuant to
subparagraph (3) of this paragraph, is as follows:
N Corporation's retained earnings for 1962 are determined on the
basis of its balance sheet as of the end of that year, translated as
follows:
The exchange gain or loss of N Corporation for 1963 may be computed
as follows:
Example 2. Assume the same facts as in example 1. For 1964, N
Corporation's operating profit is 104,300 yuccas or $15,740. It pays a
dividend of 26,000 yuccas during a translation period when the
appropriate exchange rate is 2.60 yuccas per United States dollar. At
yearend, its balance sheet, as translated and adjusted pursuant to
subparagraph (3) of this paragraph, is as follows:
The exchange gain or loss of N Corporation for 1964 would be computed
as follows:
(f) Determination of earnings and profits as if a domestic
corporation -- (1) In general. If the books of account regularly
maintained by a foreign corporation for the purpose of accounting to its
shareholders are kept in U.S. dollars and in accordance with accounting
principles generally accepted in the United States, and if it is so
elected by or on behalf of such corporation, the earnings and profits of
the foreign corporation for a taxable year shall, except as otherwise
provided in paragraph (f)(2) of this section, be determined in every
respect as if it were a domestic corporation. Such election shall be
effective only for the taxable year with respect to which the election
is made. Once made, such election shall be irrevocable. See paragraph
(c)(3) of this section for the time and manner in which an election may
be made on behalf of a foreign corporation.
(2) Illegal payments. The amount of any illegal bribe, kickback, or
other payment (within the meaning of section 162(c), as amended by
section 288 of the Tax Equity and Fiscal Responsibility Act of 1982 in
the case of payments made after September 3, 1982, and the regulations
thereunder) paid after November 3, 1976, by or on behalf of the
corporation during the taxable year of the corporation directly or
indirectly to an official, employee, or agent in fact of a government
shall not be taken into account to decrease earnings and profits or
increase the deficit in earnings and profits otherwise determined under
paragraph (f)(1) of this section.
(T.D. 6764, 29 FR 14628, Oct. 27, 1964; 29 FR 15204, Nov. 11, 1964,
as amended by T.D. 6787, 29 FR 18502, Dec. 29, 1964; T.D. 6995, 34 FR
832, Jan. 18, 1969; T.D. 7221, 37 FR 24747, Nov. 21, 1972; T.D. 7322,
39 FR 30931, Aug. 27, 1974; T.D. 7545, 43 FR 19652, May 8, 1978; T.D.
7862, 47 FR 56491, Dec. 17, 1982; T.D. 7893, 48 FR 22510, May 19, 1983)
26 CFR 1.964-1T Special rules for computing earnings and profits of
controlled foreign corporations in taxable years beginning after
December 31, 1986 (temporary).
(a)-(f) (Reserved)
(g)(1) Earnings and profits computed in functional currency -- (i)
Rule. For taxable years of a controlled foreign corporation (within the
meaning of section 957) beginning after December 31, 1986, earnings and
profits shall be computed in the controlled foreign corporation's
functional currency (determined under section 985 and the regulations
thereunder) in accordance with 1.964-1 as modified by this paragraph
(g). Accordingly, 1.964-1 (d), (e), and (f) and (to the extent
inconsistent with this paragraph (g)) 1.964-1(c) do not apply for
taxable years of a controlled foreign corporation beginning after
December 31, 1986. For purposes of this section, the term ''earnings
and profits'' includes a deficit in earnings and profits.
(ii) Cross reference. In the case of a controlled foreign
corporation with a functional currency other than the United States
dollar (dollar), see sections 986(b) and 989(b) for rules regarding the
time and manner of translating distributions or inclusions of the
controlled foreign corporation's earnings and profits into dollars.
(2) Election required when first significant. Tax accounting methods
or elections may be adopted or made by, or on behalf of, a controlled
foreign corporation in the manner prescribed by the Code and regulations
no later than 180 days after the close of the first taxable year of the
controlled foreign corporation in which the computation of its earnings
and profits is significant for United States income tax purposes with
respect to its controlling United States shareholders (as defined in
1.964-1(c)(5)). For taxable years of a controlled foreign corporation
beginning before January 1, 1989, only the events listed in
1.964-1(c)(6) are considered to cause a controlled foreign corporation's
earnings and profits to have United States tax significance. For
taxable years of a controlled foreign corporation beginning after
December 31, 1988, events that cause a controlled foreign corporation's
earnings and profits to have United States tax significance include,
without limitation --
(i) The events listed in 1.964-1(c)(6),
(ii) A distribution from the controlled foreign corporation to its
shareholders with respect to their stock,
(iii) Any event making the controlled foreign corporation subject to
tax under section 882,
(iv) An election by the controlled foreign corporation's controlling
United States shareholders to use the tax book value method of
allocating interest expense under section 864(e)(4), and
(v) A sale or exchange of the controlled foreign corporation's stock
by the controlling United States shareholders.
The filing of the information return required by section 6038 shall
not itself constitute a significant event.
(3) Effect of failure to make required election. If an accounting
method or election is not timely adopted or made by, or on behalf of, a
controlled foreign corporation, and such failure is not shown to the
satisfaction of the Commissioner to be due to reasonable cause under
1.964-1(c)(6), earnings and profits shall be computed in accordance with
this section. Such computation shall be made as if no elections had
been made and any permissible accounting methods not requiring an
election and reflected in the books of account regularly maintained by
the controlled foreign corporation for the purpose of accounting to its
shareholders had been adopted. Thereafter, any change in a particular
accounting method or methods may be made by, or on behalf of, the
controlled foreign corporation only with the Commission's consent.
(4) Computation of earnings and profits by a minority shareholder
prior to majority election or significant event. A minority United
States shareholder (as defined in section 951(b)) of a controlled
foreign corporation may be required to compute a controlled foreign
corporation's earnings and profits before the controlled foreign
corporation or its controlling United States shareholders make, or are
required under this section to make, an election or adopt a method of
accounting for United States tax purposes. In such a case, the minority
United States shareholder must compute earnings and profits in
accordance with this section. Such computation shall be made as if no
elections had been made and any permissible accounting methods not
requiring an election and reflected in the books of account regularly
maintained by the controlled foreign corporation for the purpose of
accounting to its shareholders had been adopted. However, a later,
properly filed, and timely election or adoption of method by, or on
behalf of, the controlled foreign corporation shall not be treated as a
change in accounting method.
(5) Binding effect. For taxable years beginning after December 31,
1986, except as otherwise provided in the Code or regulations, earnings
and profits of a controlled foreign corporation shall be computed
consistently under the rules of sections 964(a) and 986(b) for all
federal income tax purposes. An election or adoption of a method of
accounting for United States tax purposes by a controlled foreign
corporation, or on its behalf pursuant to 1.964-1(c) or any other
provision of the regulations (e.g., 1.985-2(c)(3)), shall bind both the
controlled foreign corporation and its United States shareholders as to
the computation of the controlled foreign corporation's earnings and
profits under section 964(a) for the year of the election or adoption
and in subsequent taxable years unless the Commissioner consents to a
change. The preceding sentence shall apply regardless of --
(i) Whether the election or adoption of a method of accounting was
made in a pre-1987 or a post-1986 taxable year;
(ii) Whether the controlled foreign corporation was a controlled
foreign corporation at the time of the election or adoption of method;
(iii) When ownership was acquired; or
(iv) Whether the United States shareholder received the written
notice required by 1.964-1(c)(3).
Adjustments to the appropriate separate category (as defined in
1.904-5(a)(1)) of earnings and profits and income of the controlled
foreign corporation shall be required using the principles of section
481 to prevent any duplication or omission of amounts attributable to
previous years that would otherwise result from any such election or
adoption.
(6) Examples. The following examples illustrate the rules of this
section.
Example 1 -- (i) P, a calendar year domestic corporation, owns all of
the outstanding stock of FX, a calendar year controlled foreign
corporation. None of the significant events specified in 1.964-1(c)(6)
or this section has occurred. In addition, neither P nor FX has ever
made or adopted, or been required to make or adopt, an election or
method of accounting for United States tax purposes with respect to FX.
On June 1, 1990, FX makes a distribution to P. FX does not act to make
any election or adopt a method of accounting for United States tax
purposes.
(ii) P must compute FX's earnings and profits in order to determine
if any portion of the distribution is taxable as a dividend and to
determine P's foreign tax credit on such portion under section 902. P
must satisfy the requirements of 1.964-1(c)(3) and file the written
statement and notice described therein within 180 days after the close
of FX's 1990 taxable year in order to make an election or to adopt a
method of accounting on behalf of FX. Any such election or adoption
will govern the computation of earnings and profits of FX for all
federal income tax purposes (including, e.g., the determination of
foreign tax credits on subpart F inclusions) in 1990 and subsequent
taxable years unless the Commissioner consents to a change.
(iii) If P fails to satisfy the regulatory requirements in a timely
manner and such failure is not shown to the satisfaction of the
Commissioner to be due to reasonable cause, the earnings and profits of
FX shall be computed as if no elections were made and any permissible
methods of accounting not requiring an election and reflected in its
books were adopted. Any subsequent attempt by FX or P to change an
accounting method shall be effective only if the Commissioner consents
to the change.
Example 2 -- (i) The facts are the same as in Example 1, except that
P elects to allocate its interest expense under section 864(e)(4) for
its 1989 taxable year under the tax book value method of 1.861-12T(c)
of the Temporary Income Tax Regulations.
(ii) P must compute the earnings and profits of FX in order to
determine the adjustment to P's basis in the stock of FX for P's 1989
taxable year. P must satisfy the requirements of 1.964-1(c)(3) and
file the written statement and notice described therein within 180 days
after the close of FX's 1989 taxable year in order to make an election
or to adopt a method of accounting on behalf of FX. Any such election
or adoption will govern the computation of FX's earnings and profits in
1989 and subsequent taxable years for all federal income tax purposes
(including, e.g., the characterization of the June 1, 1990 distribution
and the determination of P's foreign tax credit, if any, with respect
thereto) unless the Commissioner consents to a change.
(iii) If P fails to satisfy the regulatory requirements in a timely
manner and such failure is not shown to the satisfaction of the
Commissioner to be due to reasonable cause, the earnings and profits of
FX shall be computed as if no elections were made and any permissible
methods of accounting not requiring an election and reflected in its
books were adopted. Any subsequent attempt by FX or P to change an
accounting method shall be effective only if the Commissioner consents
to the change.
Example 3 -- (i) The facts are the same as in Example 2, except that
P elects to allocate its interest expense under section 864(e)(4) for
its 1988 taxable year under the tax book value method of 1.861-12T (c)
of the Temporary Income Tax Regulations.
(ii) P must compute the earnings and profits of FX in order to
determine the adjustment to P's basis in the stock of FX for P's 1988
taxable year. P must satisfy the requirements of 1.964-1(c)(3) and
file the written statement and notice described therein within 180 days
after the close of FX's 1988 taxable year in order to make an election
or to adopt a method of accounting on behalf of FX. Any such election
or adoption will govern the computation of FX's earnings and profits in
1988 and subsequent taxable years for all federal income tax purposes
(including, e.g., P's basis adjustment for purposes of section 864(e)(4)
in 1989 and the characterization of the June 1, 1990 distribution and
the determination of P's foreign tax credit, if any, with respect
thereto) unless the Commissioner consents to a change.
(iii) If P fails to satisfy the regulatory requirements in a timely
manner and such failure is not shown to the satisfaction of the
Commissioner to be due to reasonable cause, the earnings and profits of
FX for 1988 shall be computed as if no elections were made and any
permissible methods of accounting not requiring an election and
reflected in its books were adopted. However, a properly filed, timely
election or adoption of method by, or on behalf of, FX with respect to
its 1989 taxable year, when P's basis adjustment for purposes of section
864(e)(4) first constitutes a significant event, shall not be treated as
a change in accounting method. No recomputation of P's basis adjustment
for 1988 shall be required by reason of any such election or adoption of
method with respect to FX's 1989 taxable year, but prospective
adjustments to FX's earnings and profits and income shall be made to the
extent required by 1.964-1T(g)(5).
Example 4 -- (i) The facts are the same as in Example 3, except that
FX had subpart F income taxable to P in 1986, and P computed FX's
earnings and profits for purposes of determining the amount of the
inclusion and the foreign taxes deemed paid by P in 1986 under section
960 pursuant to 1.964-1 (a) through (e).
(ii) Any election made or method of accounting adopted on behalf of
FX by P pursuant to 1.964-1(c) in 1986 is binding on P and FX for
purposes of computing FX's earnings and profits in 1986 and subsequent
taxable years. Thus, in determining P's basis adjustment for purposes
of section 864(e)(4) in 1988 and 1989 and its deemed-paid credit with
respect to the 1990 dividend, FX's earnings and profits must be computed
consistently with the method used by P with regard to the 1986 subpart F
inclusion. (However, 1.964-1 (d), (e), and (f) do not apply in
computing FX's earnings and profits in post-1986 taxable years.)
Example 5 -- (i) The facts are the same as in Example 4, except that
FX made a dividend distribution to P on June 1, 1985, and P computed
FX's earnings and profits for purposes of computing the foreign taxes
deemed paid by P in 1985 under section 902 with respect to the
distribution under 1.964-1 exclusive of paragraphs (d), (e), and (f)
pursuant to a timely election under 1.902-1(g)(1).
(ii) Any election made or method of accounting adopted on behalf of
FX by P pursuant to 1.964-1(c) in 1985 is binding on P and FX for
purposes of computing FX's earnings and profits in 1985 and subsequent
taxable years. Thus, in determining P's basis adjustment for purposes
of section 864(e)(4) in 1988 and 1989 and its deemed-paid credit with
respect to the 1986 subpart F inclusion and the 1990 dividend, FX's
earnings and profits must be computed consistently with the method used
by P with regard to the 1985 dividend. If, rather than choosing under
1.902-1(g)(1) to use the section 964 rules, P computed FX's earnings and
profits for purposes of section 902 in 1985 in all respects as if FX
were a domestic corporation, then P would have been free to make
elections or adopt a method of accounting on behalf of FX under
1.964-1(c) with respect to the subpart F inclusion in 1986. Any such
election or adoption would be binding on P and FX as to the computation
of FX's earnings and profits in 1986 and subsequent taxable years.
(T.D. 8283, 55 FR 2516, Jan. 25, 1990; 55 FR 7711, Mar. 5, 1990)
26 CFR 1.964-2 Treatment of blocked earnings and profits.
(a) General rule. If, in accordance with paragraph (d) of this
section, it is established to the satisfaction of the district director
that any amount of the earnings and profits of a controlled foreign
corporation for the taxable year (determined under 1.964-1) was subject
to a currency or other restriction or limitation imposed under the laws
of any foreign country (within the meaning of paragraph (b) of this
section) on its distribution to United States shareholders who own
(within the meaning of section 958(a)) stock of such corporation, such
amount shall not be included in earnings and profits for purposes of
sections 952, 955 (as in effect both before and after the enactment of
the Tax Reduction Act of 1975), and 956 for such taxable year. For
rules governing the treatment of amounts with respect to which such
restriction or limitation is removed, see paragraph (c) of this section.
(b) Rules of application. For purposes of paragraph (a) of this
section --
(1) Period of restriction or limitation. An amount of earnings and
profits of a controlled foreign corporation for any taxable year shall
not be included in earnings and profits for purposes of sections 952,
955 (as in effect both before and after the enactment of the Tax
Reduction Act of 1975), and 956 only if such amount of earnings and
profits is subject to a currency or other restriction or limitation
(within the meaning of subparagraph (2) of this paragraph) throughout
the 150-day period beginning 90 days before the close of the taxable
year and ending 60 days after the close of such taxable year.
(2) Restriction or limitation defined. Whether earnings and profits
of a controlled foreign corporation are subject to a currency or other
restriction or limitation imposed under the laws of a foreign country
must be determined on the basis of all the facts and circumstances in
each case. Generally, such a restriction or limitation must prevent --
(i) The ready conversion (directly or indirectly) of such currency
into United States dollars, or into property of a type normally owned by
such corporation in the operation of its business or other money which
is readily convertible into United States dollars; or
(ii) The distribution of dividends by such corporation to its United
States shareholders.
For purposes of this subparagraph, if a United States shareholder
owns (within the meaning of section 958(a)), or is considered as owning
by applying the rules of ownership of section 958(b), 80 percent or more
of the total combined voting power of all classes of stock of a foreign
corporation in a chain of ownership described in section 958(a), the
distribution of dividends by such corporation to such shareholder will
not be considered prevented solely by reason of the existence of a
currency or other restriction or limitation at an intermediate tier in
such chain if dividends may be distributed directly to such
shareholders.
(3) Foreign laws. A currency or other restriction or limitation on
the distribution of earnings and profits may be imposed in a foreign
country by express statutory provisions, executive orders or decrees,
rules or regulations of a governmental agency, court decisions, the
actions of appropriate officials who are acting within the scope of
their authority, or by any similar official action. A currency
restriction will not be considered to exist unless export restrictions
are also imposed which prevent the exportation of property of a type
normally owned by the controlled foreign corporation in the operation of
its business which could be readily converted into United States
dollars.
(4) Voluntary restriction or limitation. A currency or other
restriction or limitation arising from the voluntary act of the
controlled foreign corporation or its United States shareholders during
a taxable year beginning after December 31, 1962, will not be taken into
account. For example, if a controlled foreign corporation --
(i) Issues a stock dividend which has the effect of capitalizing
earnings and profits;
(ii) Elects to restrict its earnings and profits or to make certain
investments as a means of avoiding current tax or securing a reduced
rate of tax; or
(iii) Allocates earnings and profits to an optional or arbitrary
reserve; such restriction is voluntary and will not be taken into
account.
(5) Treatment of earnings and profits in cases of certain mandatory
reserves -- (i) In general. If a controlled foreign corporation is
required under the laws of a foreign country to establish a reserve out
of earnings and profits for the taxable year, such earnings and profits
shall be considered subject to a restriction or limitation by reason of
such requirement only to the extent that the amount required to be
included in such reserve at the close of the taxable year exceeds the
accumulated earnings and profits (determined in accordance with
subdivision (ii) of this subparagraph) of such corporation at the close
of the preceding taxable year.
(ii) Determination of earnings and profits. For purposes of
determining the accumulated earnings and profits of a controlled foreign
corporation under subdivision (i) of this subparagraph, such earnings
and profits shall not include any amounts which are attributable to --
(a) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder under section 951(a) and
have not been distributed;
(b) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder of such foreign
corporation under section 551(b) and have not been distributed; or
(c) Amounts which become subject to a voluntary restriction or
limitation (within the meaning of subparagraph (4) of this paragraph)
during a taxable year beginning before January 1, 1963.
The rules of this subdivision apply only in determining the
accumulated earnings and profits of a controlled foreign corporation for
purposes of this subparagraph. See section 959 and the regulations
thereunder for limitations on the exclusion from gross income of
previously taxed earnings and profits.
(6) Exhaustion of procedures for distributing earnings and profits.
Earnings and profits of a controlled foreign corporation for a taxable
year will not be considered subject to a currency or other restriction
or limitation on their distribution unless the United States
shareholders of such corporation demonstrate either that the available
procedures for distributing such earnings and profits have been
exhausted or that the use of such procedures will be futile. As a
general rule, such procedures will be considered to have been exhausted
if the foreign corporation applies for dollars (or foreign currency
readily convertible into dollars) at the appropriate rate of exchange
and complies with the applicable laws and regulations governing the
acquisition and transfer of such currency including submission of the
necessary documentation to the exchange authority. The fact that
available procedures for distributing earnings and profits were
exhausted without success with respect to a prior year is not, of
itself, sufficient evidence that such procedures would not be successful
with respect to the current taxable year.
(c) Removal of restriction or limitation -- (1) In general. If,
during any taxable year, a currency or other restriction or limitation
(within the meaning of paragraph (b) of this section) imposed under the
laws of a foreign country on the distribution of earnings and profits of
a controlled foreign corporation to its United States shareholders is
removed --
(i) Treatment of deferred income. Each United States shareholder of
such corporation on the last day in such year that such corporation is a
controlled foreign corporation shall include in his gross income for
such taxable year the amounts attributable to such earnings and profits
which would have been includible in his gross income under section
951(a) for prior taxable years but for the existence of the currency or
other restriction or limitation except that the amounts included under
this subdivision (i) shall not exceed his pro rata share of --
(a) The earnings and profits upon which the restriction was removed
determined on the basis of his stock ownership on the last day of the
immediately preceding taxable year, and
(b ) The applicable limitations under paragraph (c) of 1.952-1,
paragraph (b)(2) of 1.955-1, paragraph (b)(2) of 1.955A-1, or
paragraph (b) of 1.956-1, determined as of the last day of the
immediately preceding taxable year, taking into account the provisions
of subdivision (ii) of this subparagraph.
(ii) Treatment of earnings and profits. For purposes of sections
952, 955 (as in effect both before and after the enactment of the Tax
Reduction Act of 1975), and 956, the earnings and profits which are no
longer subject to a currency or other restriction or limitation shall be
treated as included in the corporation's earnings and profits for the
year in which such earnings and profits were derived.
Amounts with respect to which a currency or other restriction or
limitation is removed shall be translated into United States dollars at
the appropriate exchange rate for the translation period during which
such currency or other restriction or limitation is removed. See
paragraph (d) of 1.964-1. Amounts with respect to which a currency or
other restriction or limitation is removed shall not be taken into
account in determining whether a deficiency distribution (within the
meaning of 1.963-6 (applied as if section 963 had not been repealed by
the Tax Reduction Act of 1975)) is required to be made for the year in
which such earnings and profits were derived.
(2) Removal of restriction or limitation defined. An amount of
earnings and profits shall be considered no longer subject to a
limitation or restriction if and to the extent that --
(i) Money or property in such foreign country is readily convertible
into United States dollars, or into other money or property of a type
normally owned by such corporation in the operation of its business
which is readily convertible into United States dollars;
(ii) Notwithstanding the existence of any laws or regulations
forbidding the exchange of money or property into United States dollars,
conversion is actually made into United States dollars, or other money
or property of a type normally owned by such corporation in the
operation of its business which is readily convertible into United
States dollars; or
(iii) A mandatory reserve requirement (described in paragraph (b)(5)
of this section) is removed either by a change in law of the foreign
country imposing such requirement or by an accumulation of earnings and
profits not subject to such requirement.
(3) Distribution in foreign country. If, during any taxable year,
earnings and profits previously subject to a currency or other
restriction or limitation are distributed in a foreign country to one or
more United States shareholders of a controlled foreign corporation
directly, or indirectly through a chain of ownership described in
section 958(a), such earnings and profits shall be considered no longer
subject to a restriction or limitation. However, distributed amounts
may be excluded from such shareholder's gross income for the taxable
year of receipt if such shareholder elects a method of accounting under
which the reporting of blocked foreign income is deferred until the
income ceases to be blocked.
(4) Source of distribution. If, during any taxable year, earnings
and profits previously subject to a currency or other restriction or
limitation is distributed to one or more United States shareholders of a
controlled foreign corporation directly, or indirectly through a chain
of ownership described in section 958(a), the source of such
distribution shall be determined in accordance with the rules of
1.959-3.
(5) Illustration. The provisions of this paragraph may be
illustrated by the following example:
Example. (a) M, a United States person, owns all of the only class of
stock of A Corporation, a foreign corporation incorporated under the
laws of foreign country X on January 1, 1963. Both M and A Corporations
use the calendar year as a taxable year and A Corporation is a
controlled foreign corporation throughout the period here involved.
(b) During 1963, A Corporation derives income of $100,000 all of
which is subpart F income and has earnings and profits of $100,000.
Under the laws of X Country, currency cannot be exported without a
license. During the last 90 days of 1963 and the first 60 days of 1964,
A Corporation can obtain a license to distribute only an amount
equivalent to $10,000. M must include $10,000 in his gross income for
1963 under section 951(a)(1)(A)(i) and $90,000 of A Corporation's
earnings and profits for 1963 are not taken into account for purposes of
sections 952, 955, and 956.
(c) During 1964, A Corporation has no income and no earnings and
profits. On June 1, 1964, A Corporation converts an amount equivalent
to $20,000 into property of a type normally owned by such corporation in
the operation of its business which is readily convertible into United
States dollars but does not distribute such amount. Corporation A must
include $20,000 in its earnings and profits for 1963 for purposes of
sections 952, 955, and 956. M must include $20,000 in his gross income
for 1964.
(d) During 1965, A Corporation has no income and no earnings and
profits. On December 15, 1965, A Corporation distributes an amount
equivalent to $15,000 to M in X Country. Neither M nor A Corporation
can obtain a license to export currency from X Country. In his return
for the taxable year 1965, M elects a method of accounting under which
the reporting of blocked foreign income is deferred until the income
ceases to be blocked. Accordingly, M does not include the $15,000 in
his gross income for 1965.
(e) During 1966, A Corporation has no income and no earnings and
profits. On February 1, 1966, notwithstanding the laws and regulations
of X Country which forbid the exchange of X Country's currency into
United States dollars, M converts an amount equivalent to $15,000 into a
currency which is readily convertible into United States dollars. Since
the income has ceased to be blocked, M must include $15,000 in his gross
income for 1966.
(d) Manner of claiming existence of restriction or limitation on
distribution of earnings and profits. A United States shareholder
claiming that an amount of the earnings and profits of a controlled
foreign corporation for the taxable year was subject to a currency or
other restriction or limitation imposed under the laws of a foreign
country on its distribution shall file a statement with his return for
the taxable year with or within which the taxable year of the foreign
corporation ends which shall include --
(1) The name and address of the foreign corporation,
(2) A description of the classes of stock of the foreign corporation
and a statement of the number of shares of each class owned (within the
meaning of section 958(a)) or considered as owned (by applying the rules
of ownership of section 958(b)) by the United States shareholder,
(3) A description of the currency or other restriction or limitation
on the distribution of earnings and profits,
(4) The total earnings and profits of the foreign corporation for the
taxable year (before any amount is excluded from earnings and profits
under this section) and the United States shareholder's pro rata share
of such total earnings and profits,
(5) The United States shareholder's pro rata share of the amount of
earnings and profits subject to a restriction or limitation on
distribution,
(6) The amounts which would be includible in the United States
shareholder's gross income under section 951(a) but for the existence of
the currency or other restriction or limitation,
(7) A description of the available procedures for distributing
earnings and profits and a statement setting forth the steps taken to
exhaust such procedures or a statement setting forth the reasons that
the use of such procedures would be futile, and
(8) The amount of distributions made in a foreign country and a
statement as to whether a method of accounting has been elected under
which the reporting of blocked income is deferred until such income
ceases to be blocked, including an identification of the taxable year
and place of filing of such election.
In addition, such United States shareholder shall furnish to the
district director such other information as he may require to verify the
status of a currency or other restriction or limitation.
(T.D. 6892, 31 FR 11142, Aug. 23, 1966, as amended by T.D. 7545, 43
FR 19652, May 8, 1978; T.D. 7893, 48 FR 22510, May 19, 1983)
26 CFR 1.964-3 Records to be provided by United States shareholders.
(a) Shareholder's responsibility for providing records. For purposes
of verifying his income tax liability in respect of amounts includible
in income under section 951 for the taxable year of a controlled foreign
corporation each United State shareholder (as defined in section 951(b))
who owns (within the meaning of section 958(a)) stock of such
corporation shall, within a reasonable time after demand by the district
director, provide the district director --
(1) Such permanent books of account or records as are sufficient to
satisfy the requirements of section 6001 and section 964(c), or true
copies thereof, as are reasonably demanded, and
(2) If such books or records are not maintained in the English
language, either (i) an accurate English translation of such books or
records or (ii) the services of a qualified interpreter satisfactory to
the district director.
If such books or records are being used by another district director,
the United States shareholder upon whom the district director has made a
demand to provide such books or records shall file a statement of such
fact with his district director, indicating the location of such books
or records. For the length of time the United States shareholder of a
controlled foreign corporation must cause such books or records as are
under his control to be retained, see paragraph (e) of 1.6001-1.
(b) Records to be provided. Except as otherwise provided in
paragraph (c) of this section, the requirements of section 6001 and
section 964(c) for record keeping shall be considered satisfied if the
books or records produced are sufficient to verify for the taxable year
--
(1) The subpart F income of the controlled foreign corporation and,
if any part of such income is excluded from the income of the United
States shareholder under section 963 or section 970(a), the application
of such exclusion,
(2) The previously excluded subpart F income of such corporation
withdrawn from investment in less developed countries,
(3) The previously excluded subpart F income of such corporation
withdrawn from investment in foreign base company shipping operations,
(4) The previously excluded export trade income of such corporation
withdrawn from investment, and
(5) The increase in earnings invested by such corporation in United
States property.
(c) Special rules. Verification of the subpart F income of the
controlled foreign corporation for the taxable year shall not be
required if --
(1) It can be demonstrated to the satisfaction of the district
director that --
(i) The locus and nature of such corporation's activities were such
as to make it unlikely that the foreign base company income of such
corporation (determined in accordance with paragraph (c)(3) of 1.952-3)
exceeded 5 percent of its gross income (determined in accordance with
paragraph (b)(1) of 1.952-3) for the taxable year. (For taxable years
to which 1.952-3 does not apply, such amounts shall be determined under
26 CFR 1.954-1(d)(3) (i) and (ii) (Revised as of April 1, 1975))), and
(ii) If such corporation reinsures or issues insurance or annuity
contracts in connection with United States risks, the 5-percent minimum
premium requirement prescribed in paragraph (b) of 1.953-1 has not been
exceeded for the taxable year, or
(2) The United States shareholder's pro rata share of such subpart F
income is excluded in full from his income under section 963 and the
books or records verify the application of such exclusion.
(T.D. 6824, 30 FR 6480, May 11, 1965, as amended by T.D. 7893, 48 FR
22510, May 19, 1983)
26 CFR 1.964-4 Verification of certain classes of income.
(a) In general. The provisions of this section shall apply for
purposes of determining when books or records are sufficient for
purposes of 1.964-3 to verify the classes of income described in such
section.
(b) Subpart F income. Books or records sufficient to verify the
subpart F income of a controlled foreign corporation must establish for
the taxable year --
(1) Its gross income and deductions,
(2) The income derived from the insurance of United States risks (as
provided in paragraph (c) of this section),
(3) The foreign base company income (as provided in paragraph (d) of
this section), and
(4) In the case of a United States shareholder claiming the benefit
of the exclusion provided in section 952(b) or the limitation provided
in section 952(c) --
(i) The items of income excluded from subpart F income by paragraph
(b) of 1.952-1 as income derived from sources within the United States,
the United States income tax incurred with respect thereto, and the
deductions properly allocable thereto and connected therewith, and
(ii) The earnings and profits, or deficit in earnings and profits, of
any foreign corporation necessary for the determinations provided in
paragraphs (c) and (d) of 1.952-1.
(c) Income from insurance of United States risks. Books or records
sufficient to verify the income of a controlled foreign corporation from
the insurance of United States risks must establish for the taxable year
--
(1) That the 5-percent minimum premium requirement prescribed in
paragraph (b) of 1.953-1 has not been exceeded, or
(2) The taxable income, as determined under 1.953-4 or 1.953-5,
which is attributable to the reinsuring or the issuing of any insurance
or annuity contracts in connection with United States risks, as defined
in 1.953-2 or 1.953-3.
(d) Foreign base company income and exclusions therefrom. Books or
records sufficient to verify the income of a controlled foreign
corporation which is foreign base company income must establish for the
taxable year the following items:
(1) Foreign personal holding company income. The foreign personal
holding company income to which section 954(c) and 1.954-2 apply, for
which purpose there must be established the gross income from --
(i) All rents and royalties,
(ii) Rents and royalties received in the active conduct of a trade or
business from an unrelated person, as determined under section
954(c)(3)(A) and paragraph (d)(1) of 1.954-2,
(iii) Rents and royalties received from a related person for the use
of property in the country of incorporation of the controlled foreign
corporation, as determined under section 954(c)(4)(C) and paragraph
(e)(3) of 1.954-2,
(iv) All dividends, interest, and except where the controlled foreign
corporation is a regular dealer in stock or securities, all gains and
losses from the sale or exchange of stock or securities,
(v) Dividends, interest, and gains from the sale or exchange of stock
or securities, received in the conduct of a banking, financing, or
insurance business from an unrelated person, as determined under section
954(c)(3)(B) and paragraph (d) (2) and (3) of 1.954-2,
(vi) Dividends and interest received from a related corporation
organized in the country of incorporation of the controlled foreign
corporation, as determined under section 954(c)(4)(A) and paragraph
(e)(1) of 1.954-2,
(vii) Interest received in the conduct of a banking or other
financing business from a related person, as determined under section
954(c)(4)(B) and paragraph (e)(2) of 1.954-2,
(viii) All annuities,
(ix) All gains from commodities transactions described in section
553(a)(3),
(x) All income from estates and trusts described in section
553(a)(4),
(xi) All income from personal service contracts described in section
553(a)(5), and
(xii) All compensation for the use of corporate property by
shareholders described in section 553(a)(6).
(2) Foreign base company sales income. The foreign base company
sales income to which section 954(d) and 1.954-3 apply, for which
purpose there must be established the gross income from --
(i) All sales by the controlled foreign corporation of its personal
property and all purchases or sales of personal property by such
corporation on behalf of another person,
(ii) Purchases and/or sales of personal property in connection with
transactions not involving related persons (as defined in paragraph
(e)(2) of 1.954-1),
(iii) Purchases and/or sales of personal property manufactured,
produced, etc., in the country of incorporation of the controlled
foreign corporation, as determined under paragraph (a)(2) of 1.954-3,
(iv) Purchases and/or sales of personal property for use, etc., in
the country of incorporation of the controlled foreign corporation, as
determined under paragraph (a)(3) of 1.954-3, and
(v) Sales of personal property manufactured or produced by the
controlled foreign corporation, as determined under paragraph (a)(4) of
1.954-3.
Where an item of income falls within more than one of subdivisions
(ii) through (v) of this subparagraph, it shall be sufficient to
establish that it falls within any one of them. If a branch or similar
establishment is treated as a wholly owned subsidiary corporation
through the application of section 954(d)(2) and paragraph (b) of
1.954-3, the requirements of this subparagraph shall be satisfied
separately for each branch or similar establishment so treated and for
the remainder of the controlled foreign corporation.
(3) Foreign base company services income. The foreign base company
services income to which section 954(e) and 1.954-4 apply, for which
purpose there must be established the gross income from --
(i) All services performed by the controlled foreign corporation,
(ii) Services other than those (as determined under paragraph (b) of
1.954-4) performed for, or on behalf of, a related person,
(iii) Services performed in the country of incorporation of the
controlled foreign corporation, as determined under paragraph (c) of
1.954-4, and
(iv) Services performed in connection with the sale or exchange of,
or with an offer or effort to sell or exchange, personal property
manufactured, produced, etc., by the controlled foreign corporation, as
determined under paragraph (d) of 1.954-4.
Where an item of income falls within more than one of subdivisions
(ii) through (iv) of this subparagraph, it shall be sufficient to
establish that it falls within any one of them.
(4) Foreign base company oil related income. (i) The foreign base
company oil related income described in section 954(g) and 1.954-8, for
which purpose there must be established, with respect to each foreign
country, the gross income derived from --
(A) The processing of minerals extracted (by the taxpayer or by any
other person) from oil or gas wells into their primary products, as
determined under section 907(c)(2)(A),
(B) The transportation of such minerals or primary products, as
determined under section 907(c)(2)(B),
(C) The distribution or sale of such minerals or primary products, as
determined under section 907(c)(2)(C),
(D) The disposition of assets used by the taxpayer in a trade or
business described in subdivision (A), (B) or (C), as determined under
section 907(c)(2)(D),
(E) Dividends, interests, partnership distributions, and other
amounts, as determined under section 907(c)(3).
Where an item of income falls within more than one of the listings in
paragraphs (d)(4)(i) (A) through (E) of this section, it shall be
sufficient to establish that it falls within any one of them.
(ii) If any of the items of income listed in paragraph (d)(4)(i) of
this section arising from sources within a foreign country relates to
oil, gas, or a primary product thereof and is described in section
954(g)(1) (A) or (B) and 1.954-8(a)(1) (i) or (ii) (and, hence, is not
foreign base company oil related income), then there must be established
facts sufficient to verify the amount of such item of income which is
not foreign base company oil related income. In this regard, the total
quantities of oil, gas and primary products thereof which gave rise to
such item of income and the portions of such quantities which were
extracted or sold within the foreign country must be established.
(5) Qualified investments in less developed countries. For rules in
effect for taxable years of foreign corporations beginning before
January 1, 1976, see 26 CFR 1.964-4(d)(4) (Revised as of April 1, 1975).
(6) Income derived from aircraft or ships. For rules in effect for
taxable years of foreign corporations beginning before January 1, 1976,
see CFR 1.964-4(d)(5) (Revised as of April 1, 1975).
(7) Foreign base company shipping income. The foreign base company
shipping income to which section 954(f) and 1.954-6 apply, for which
purpose there must be established --
(i) Gross income derived from, or in connection with, the use (or
hiring or leasing for use) of any aircraft or vessel in foreign
commerce, as determined under 1.954-6(c),
(ii) Gross income derived from, or in connection with, the
performance of services directly related to the use of any aircraft or
vessel in foreign commerce, as determined under 1.954-6(d),
(iii) Gross income incidental to income described in subdivisions (i)
and (ii) of this subparagraph, as determined under 1.954-6(e),
(iv) Gross income derived from the sale, exchange, or other
disposition of any aircraft or vessel used (by the seller or by a person
related to the seller) in foreign commerce,
(v) Dividends, interest, and gains described in 1.954-6(f) and
1.954(b) (1)(viii),
(vi) Income described in 1.954-6(g) (relating to partnerships,
trusts, etc.), and
(vii) Exchange gain, to the extent allocable to foreign base company
shipping income, as determined under 1.952-2(c)(2)(v)(b).
If the controlled foreign corporation has income derived from or in
connection with, the use (or hiring or leasing for use) of any aircraft
or vessel in foreign commerce, or derived from, or in connection with,
the performance of services directly related to the use of any aircraft
or vessel in foreign commerce, it shall be necessary to establish, from
the books and records of the controlled foreign corporation, that such
aircraft or vessel was used in foreign commerce within the meaning of
subparagraphs (3) and (4) of 1.954-6(b).
(8) Income on which taxes are not substantially reduced. The gross
income excluded from foreign base company income under section 954(b)(4)
and paragraph (b) (3) or (4) of 1.954-1 in the case of a controlled
foreign corporation not availed of to substantially reduce income taxes,
the income or similar taxes incurred with respect thereto, and all other
factors necessary to verify the application of such exclusion.
(9) Qualified investments in foreign base company shipping
operations. The foreign base company shipping income that is excluded
from foreign base company income under section 954(b)(2) and
1.954-1(b)(1).
(10) Special rule for shipping income. The distributions received
through a chain of ownership described in section 958(a) which are
excluded from foreign base company income under section 954(b)(6)(B) and
1.954-1(b)(2).
(11) Deductions. The deductions allocable, under paragraph (c) of
1.954-1, to each of the classes and subclasses of gross income described
in subparagraphs (1) through (9) of this paragraph.
(e) Exclusion under section 963. Books or records sufficient to
verify the application of the exclusion provided by section 963 with
respect to the subpart F income for the taxable year of a controlled
foreign corporation must establish that the conditions set forth in
paragraph (a)(2) of 1.963-1 have been met.
(f) Exclusion under section 970(a). Books or records sufficient to
verify the application for the taxable year of the exclusion provided by
section 970(a) in respect of export trade income which is foreign base
company income must establish for such year --
(1) That the controlled foreign corporation is an export trade
corporation, as defined in section 971(a) and paragraph (a) of 1.971-1,
(2) The export trade income, as determined under section 971(b) and
paragraph (b) of 1.971-1, which constitutes foreign base company
income,
(3) The export promotion expenses, as determined under section 971(d)
and paragraph (d) of 1.971-1, which are allocable to the excludable
export trade income,
(4) The gross receipts, and the gross amount on which is computed
compensation included in gross receipts, from property in respect of
which the excludable export trade income is derived, as described in
section 970(a)(1)(B) and paragraph (b)(2)(ii) of 1.970-1, and
(5) The increase in investments in export trade assets, as determined
under section 970(c)(2) and paragraph (d)(2) of 1.970-1.
(g-1) Withdrawal of previously excluded subpart F income from
qualified investment in less developed countries. Books or records
sufficient to verify the previously excluded subpart F income of the
controlled foreign corporation withdrawn from investment in less
developed countries for the taxable year must establish --
(1) The sum of the amounts of income excluded from foreign base
company income under section 954(b)(1) and paragraph (b)(1) of 1.954-1
(as in effect for taxable years beginning before January 1, 1976; see
26 CFR 1.954-1(b)(1) (Revised as of April 1, 1975)) for all prior
taxable years,
(2) The sum of the amounts of previously excluded subpart F income
withdrawn from investment in less developed countries for all prior
taxable years, as determined under section 955(a) (as in effect before
the enactment of the Tax Reduction Act of 1975) and paragraph (b) of
1.955-1, and
(3) The amount withdrawn from investment in less developed countries
for the taxable year as determined under section 955(a) (as in effect
before the enactment of the Tax Reduction Act of 1975) and paragraph (b)
of 1.955-1.
(g-2) Withdrawal of previously excluded subpart F income from
investment in foreign base company shipping operations. Books or
records sufficient to verify the previously excluded subpart F income of
the controlled foreign corporation withdrawn from investment in foreign
base company shipping operations for the taxable year must establish --
(1) The sum of the amounts of income excluded from foreign base
company income under section 954(b)(2) and paragraph (b)(1) of 1.954-1
for all prior taxable years,
(2) The sum of the amounts of previously excluded subpart F income
withdrawn from investment in foreign base company shipping operations
for all prior taxable years, as determined under section 955(a) and
paragraph (b) of 1.955A-1,
(3) The amount withdrawn from investment in foreign base company
shipping operations for the taxable year as determined under section
955(a) and paragraph (b) of 1.955A-1, and
(4) If the carryover (as described in 1.955A-1(b)(3)) of amounts
relating to investments in less developed country shipping companies (as
described in 1.995-5(b)) is applicable, (i) the amount of the
corporation's qualified investments (determined under 1.955-2 other
than paragraph (b)(5) thereof) in less developed country shipping
companies at the close of the last taxable year of the corporation
beginning before January 1, 1976, and (ii) the amount of the limitation
with respect to previously excluded subpart F income (determined under
1.955-1(b)(1)(i)(b)) for the first taxable year of the corporation
beginning after December 31, 1975.
(h) Withdrawal of previously excluded export trade income from
investment. Books or records sufficient to verify the previously
excluded export trade income of the controlled foreign corporation
withdrawn from investment for the taxable year must establish the United
States shareholder's proportionate share of --
(1) The sum of the amounts by which the subpart F income of such
corporation was reduced for all prior taxable years under section 970(a)
and paragraph (b) of 1.970-1,
(2) The sum of the amounts described in section 970(b)(1)(B),
(3) The sum of the amounts of previously excluded export trade income
of such corporation withdrawn from investment under section 970(b) and
paragraph (c) of 1.970-1 for all prior taxable years, and
(4) The amount withdrawn from investment under section 970(b) and
paragraph (c) of 1.970-1 for the taxable year.
(i) Increase in earnings invested in United States property. Books
or records sufficient to verify the increase for the taxable year in
earnings invested by the controlled foreign corporations in United
States property must establish --
(1) The amount of such corporation's earnings invested in United
States property (as defined in section 956(b)(1) and paragraph (a) of
1.956-2) at the close of the current and preceding taxable years, as
determined under paragraph (b) of 1.956-1,
(2) The amount of excluded property described in section 956(b)(2)
and paragraph (b) of 1.956-2 held by such corporation at the close of
such years,
(3) The earnings and profits, to which section 959(c)(1) and
paragraph (b)(1) of 1.959-3 apply, distributed by such corporation
during the preceding taxable year, and
(4) The amount of increase in earnings invested by such corporation
in United States property which is excluded from the United States
shareholder's gross income for the taxable year under section 959(a)(2)
and paragraph (c) of 1.959-1.
(T.D. 6824, 30 FR 6481, May 11, 1965, as amended by T.D. 7211, 37 FR
21436, Oct. 11, 1972; T.D. 7893, 48 FR 22511, May 19, 1983; T.D.
8331, 56 FR 2849, Jan. 25, 1991)
26 CFR 1.964-5 Effective date of subpart F.
Sections 951 through 964 and 1.951 through 1.964-4 shall apply with
respect to taxable years of foreign corporations beginning after
December 31, 1962, and to taxable years of United States shareholders
within which or with which such taxable years of such corporations end.
(T.D. 7120, 36 FR 10862, June 4, 1971)
26 CFR 1.964-5 export trade corporations
26 CFR 1.970-1 Export trade corporations.
(a) In general. Sections 970 through 972 provide in general that if
a controlled foreign corporation is an export trade corporation for any
taxable year, the subpart F income of such corporation shall, subject to
limitations provided by section 970(a) and paragraph (b) of this
section, be reduced by so much of such corporation's export trade income
as constitutes foreign base company income. To the extent subpart F
income of an export trade corporation is reduced under section 970 and
this section, an amount is required by section 970(b) and paragraph (c)
of this section to be included in gross income of United States
shareholders of the corporation if there is a subsequent decrease in
such corporation's investments in export trade assets. See section
971(a) and paragraph (a) of 1.971-1 for definition of the term ''export
trade corporation'', section 971(b) and paragraph (b) of 1.971-1 for
definition of the term ''export trade income'', and section 971(c) and
paragraph (c) of 1.971-1 for definition of the term ''export trade
assets''.
(b) Amount by which export trade income shall reduce subpart F income
-- (1) Deductible amount. The subpart F income, determined as provided
in section 952 and the regulations thereunder but without regard to
section 970 and this paragraph, of a controlled foreign corporation
which is an export trade corporation for its taxable year shall be
reduced by an amount equal to so much of its export trade income as
constitutes foreign base company income for such taxable year, but only
to the extent that such amount of export trade income does not exceed
the limitation determined under subparagraph (2) of this paragraph for
such taxable year. See section 972 and 1.972-1 for rules relating to
the consolidation of export trade corporations for purposes of
determining the limitations described in subparagraph (2) of this
paragraph.
(2) Limitation on the amount of export trade income deductible from
subpart F income. The amount by which subpart F income of an export
trade corporation may be reduced for any taxable year under subparagraph
(1) of this paragraph may not exceed whichever of the following
limitations is the smallest:
(i) The amount which is equal to 150 percent of the export promotion
expenses, as defined in section 971(d) and paragraph (d) of 1.971-1, of
the export trade corporation paid or incurred during the taxable year
which are properly allocable to the receipt or the production of so much
of its export trade income as constitutes foreign base company income
for such taxable year;
(ii) The amount which is equal to 10 percent of the gross receipts
(other than from commissions, fees, or other compensation for services),
plus 10 percent of the gross amount upon the basis of which are computed
commissions, fees, or other compensation for services included in gross
receipts, of the export trade corporation received or accrued during the
taxable year from, or in connection with, the sale, installation,
operation, maintenance, or use of property in respect of which such
corporation derives export trade income which constitutes foreign base
company income for such taxable year; or
(iii) The amount which bears the same ratio to the increase in
investments in export trade assets, as defined in section 970(c)(2) and
paragraph (d)(2) of this section, of the export trade corporation for
its taxable year as the export trade income which constitutes foreign
base company income of such corporation for such taxable year bears to
the entire export trade income of the corporation for such year.
Under subdivision (ii) of this subparagraph, in the case of minimum
or maximum fee arrangements, the determination shall be made on the
basis of the actual gross amounts with respect to which such fees are
paid, rather than on the basis of the amounts upon which such minimum or
maximum fees are computed. All determinations of limitations under this
subparagraph shall be made on an aggregate basis and not with respect to
separate items or categories of income described in paragraph (b)(1) of
1.971-1.
(3) Determination of export promotion expense limitation. For
purposes of determining the limitation contained in subparagraph (2)(i)
of this paragraph for any taxable year of the export trade corporation,
there shall be taken into account with respect to those items or
categories of export trade income which constitute foreign base company
income the entire amount of those export promotion expenses which are
directly related to such items or categories of income and a ratable
part of any other export promotion expenses which are indirectly related
to such items or categories of income, except that no export promotion
expense shall be allocated to an item or category of income to which it
clearly does not apply and no deduction allowable to such corporation
under section 882(c) and the regulations thereunder shall be taken into
account.
(4) Application of section 482. The limitations provided in section
970(a) and subparagraph (2) of this paragraph shall not affect the
authority of the district director to apply the provisions of section
482 and the regulations thereunder, relating to allocation of income and
deductions among taxpayers.
(5) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Foreign corporation A is a wholly owned subsidiary of
domestic corporation M. Both corporations use the calendar year as the
taxable year. For 1963, A Corporation's subpart F income determined
under section 952 and the regulations thereunder is $35, the total of
its gross receipts and gross amounts referred to in subparagraph (2)(ii)
of this paragraph is $310, its export promotion expenses properly
allocable to its export trade income which constitutes foreign base
company income are $18, its increase in investments in export trade
assets is $32, and its export trade income is $40, of which $30
constitutes foreign base company income and $10 does not constitute
foreign base company income. The subpart F income of A Corporation for
1963 as reduced under section 970(a) is $11, determined as follows:
Example 2. The facts are the same as in example 1, except that A
Corporation's export promotion expenses properly allocable to export
trade income which constitutes foreign base company income are $14
instead of $18. The applicable limitation on the amount deductible from
A Corporation's subpart F income for 1963 is $21 (150% of $14) instead
of $24. The subpart F income as reduced under section 970(a) is $14
($35 less $21).
Example 3. The facts are the same as in example 1, except that the
total amount of A Corporation's gross receipts and gross amounts
referred to in subparagraph (2)(ii) of this paragraph is $200 instead of
$310. The applicable limitation on the amount deductible from A
Corporation's subpart F income for 1963 is $20 (10 percent of $200)
instead of $24. The subpart F income as reduced under section 970(a) is
$15 ($35 less $20).
Example 4. The facts are the same as in example 1, except that A
Corporation derives its export trade income which constitutes foreign
base company income of $30 in a service arrangement with M Corporation
under which it receives as a fee 5 percent of the gross receipts from M
Corporation's sales or a minimum fee of $30. Such gross receipts are
$220. The gross amounts taken into account in determining the
limitation under subparagraph (2)(ii) of this paragraph are $220. The
applicable limitation on the amount deductible from A Corporation's
subpart F income for 1963 is $22 (10 percent of $220) instead of $24.
The subpart F income as reduced under section 970(a) is $13 ($35 minus
$22).
Example 5. The facts are the same as in example 1, except that A
Corporation derives its export trade income which constitutes foreign
base company income of $30 in a service arrangement with M Corporation
under which it receives as a fee 9 percent of the gross receipts from M
Corporation's sales or a maximum fee of $30. Such gross receipts are
$400. In such instance, the limitation under (ii)(b) of example 1 is
$40 (10 percent of $400) instead of $31. The applicable limitation on
the amount deductible from A Corporation's subpart F income for 1963 is
$24, the smallest of the three limitations. The subpart F income as
reduced under section 970(a) is $11 ($35 less $24).
(c) Withdrawal of previously excluded export trade income -- (1)
Inclusion of withdrawal in income of United States shareholders. If --
(i) A controlled foreign corporation was an export trade corporation
for any taxable year,
(ii) Such corporation in any such taxable year derived subpart F
income which, under the provisions of section 970(a) and paragraph (b)
of this section, was reduced, and
(iii) Such corporation has in a subsequent taxable year a decrease in
investments in export trade assets,
every person who is a United States shareholder, as defined in
section 951(b), of such corporation on the last day of such subsequent
taxable year on which such corporation is a controlled foreign
corporation shall include in his gross income, under section
951(a)(1)(A)(ii) and the regulations thereunder as an amount to which
section 955 (as in effect before the enactment of the Tax Reduction Act
of 1975) applies, his pro rata share of the amount of such decrease in
investments but only to the extent that such pro rata share does not
exceed the limitations determined under subparagraph (2) of this
paragraph. A United States shareholder's pro rata share of a controlled
foreign corporation's decrease for any taxable year in investments in
export trade assets shall be his pro rata share of such corporation's
decrease for such year determined under section 970(c)(3) and paragraph
(d)(3) of this section.
(2) Limitations applicable in determining amount includible in income
-- (i) General. A United States shareholder's pro rata share of a
controlled foreign corporation's decrease in investments in export trade
assets for any taxable year of such corporation shall, for purposes of
determining an amount to be included in the gross income for any taxable
year of such shareholder, not exceed the lesser of the limitations
determined under (a) and (b) of this subdivision:
(a) Such shareholder's pro rata share of the sum of the controlled
foreign corporation's earnings and profits (or deficit in earnings and
profits) for the taxable year, computed as of the close of the taxable
year without diminution by reason of any distributions made during the
taxable year, plus his pro rata share of the sum of its earnings and
profits (or deficits in earnings and profits) accumulated for prior
taxable years beginning after December 31, 1962, or
(b)(1) Such shareholder's pro rata share of the sum of the amounts by
which the subpart F income of such controlled foreign corporation for
prior taxable years was reduced under section 970(a) and paragraph (b)
of this section, plus
(2) Such shareholder's pro rata share of the sum of the amounts which
were not included in the subpart F income of such controlled foreign
corporation for such prior taxable years by reason of the application of
section 972 and 1.972-1, minus
(3) Such shareholder's pro rata share of the sum of the amounts which
were previously included in his gross income for prior taxable years
under section 951(a)(1)(A)(ii) by reason of the application of section
970(b) and this paragraph with respect to such controlled foreign
corporation.
The net amount determined under (b) of this subdivision with respect
to any stock owned by the United States shareholder shall be determined
without taking into account any amount attributable to a period prior to
the date on which such shareholder acquired such stock. See section
1248 and the regulations thereunder for rules governing the treatment of
gain from sales or exchanges of stock in certain foreign corporations.
(ii) Treatment of earnings and profits. For purposes of determining
earnings and profits of a controlled foreign corporation under
subdivision (i) (a) of this subparagraph, such earnings and profits
shall be considered not to include any amounts which are attributable to
--
(a) Amounts which are, or have been, included in the gross income of
a United States shareholder of such controlled foreign corporation under
section 951(a) (other than an amount included in the gross income of a
United States shareholder under section 951(a)(1)(A)(ii) or section
951(a)(1)(B) for the taxable year) and have not been distributed, or
(b) (1) Amounts which for the current taxable year, are included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 551(b) or would be so included under
such section but for the fact that such amounts were distributed to such
shareholder during the taxable year, or
(2) Amounts which, for any prior taxable year, have been included in
the gross income of a United States shareholder of such controlled
foreign corporation under section 551(b) and have not been distributed.
The rules of this subdivision apply only in determining the
limitation on a United States shareholder's pro rata share of a
controlled foreign corporation's decrease in investments in export trade
assets. See section 959 and the regulations thereunder for limitations
on the exclusion of previously taxed earnings and profits.
(iii) Rules of application. The determinations made under
subdivision (i) of this subparagraph for purposes of determining the
United States shareholder's pro rata share of a controlled foreign
corporation's decrease in investments in export trade assets for any
taxable year shall be made on the basis of the stock such shareholder
owns, within the meaning of section 958(a) and the regulations
thereunder, in the controlled foreign corporation on the last day in the
taxable year on which such corporation is a controlled foreign
corporation even though such shareholder owned more or less stock in
such corporation prior to that date. See section 972 and paragraph
(b)(3) of 1.972-1 for rules relating to the allocation of a decrease in
investments in export trade assets of export trade corporations in a
consolidated chain of such corporations. See section 951(a)(3) and the
regulations thereunder for an additional limitation upon the amount of a
United States shareholder's pro rata share determined under this
paragraph.
(3) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. Foreign corporation A, which has one class of stock
outstanding, is a wholly owned subsidiary of domestic corporation M
throughout 1963 and 1964. Both corporations use the calendar year as
the taxable year. For 1963, A Corporation qualifies as an export trade
corporation and its subpart F income, determined in accordance with the
provisions of section 952 and the regulations thereunder, is reduced by
$20 under the provisions of section 970(a) and paragraph (b) of this
section. Section 972 is assumed not to apply to A Corporation. For
1964, A Corporation has a decrease of $8 in investments in export trade
assets. For 1963 and 1964, A Corporation has earnings and profits of
$30 (determined under the provisions of subparagraph (2) of this
paragraph). Corporation M's pro rata share of A Corporation's decrease
in investments in export trade assets for 1964 which is includible in M
Corporation's gross income for 1964 under section 951(a)(1)(A)(ii) by
reason of the application of section 970(b) is $8, determined as
follows:
Example 2. Assume the same facts as in example 1, except that on
February 14, 1965, M Corporation sells 25 percent of its stock in A
Corporation to N Corporation. Corporation N is a domestic corporation
which also uses the calendar year as a taxable year. For 1965, A
Corporation has a decrease of $16 in investments in export trade assets.
Corporation A's earnings and profits for 1963 and 1964 (determined
under the provisions of subparagraph (2) of this paragraph) are $22 ($30
minus $8). Corporation A's earnings and profits for 1965 are $6
(determined under the provisions of subparagraph (2) of this paragraph).
For 1965, M Corporation's pro rata share of A Corporation's decrease in
investments in export trade assets which is includible in M
Corporation's gross income under section 951(a)(1)(A)(ii) is $9, and N
Corporation's pro rata share includible in gross income under such
section is $0, determined as follows:
(d) Investments in export trade assets -- (1) Amount of investments.
For purposes of sections 970 through 972 and 1.970-1 to 1.972-1,
inclusive, export trade assets shall be taken into account on the
following bases:
(i) Working capital. Working capital to which section 971(c)(1)
applies shall be taken into account at the adjusted basis of current
assets, determined as of the applicable determination date, less any
current liabilities (except as provided in subdivision (iii) of this
subparagraph).
(ii) Other export trade assets. Inventory to which section 971(c)(2)
applies, facilities to which section 971(c)(3) applies, and evidences of
indebtedness to which section 971(c)(4) applies, shall be taken into
account at their adjusted bases as of the applicable determination date,
reduced by any liabilities (except as provided in subdivision (iii) of
this subparagraph) to which such property is subject on such date. To
be taken into account under this subparagraph, a liability must
constitute a specific charge against the property involved. Thus, a
liability evidenced by an open account or a liability secured only by
the general credit of the controlled foreign corporation will not be
taken into account. On the other hand, if a liability constitutes a
specific charge against several items of property and cannot definitely
be allocated to any single item of property, the liability shall be
apportioned against each of such items of property in that ratio which
the adjusted basis of such item on the applicable determination date
bears to the adjusted basis of all such items on such date. A liability
in excess of the adjusted basis of the property which is subject to such
liability will not be taken into account for the purpose of reducing the
adjusted basis of other property which is not subject to such liability.
See paragraph (c)(6) of 1.971-1 for treatment of export trade assets
which constitute working capital to which section 971(c)(1) applies and
which also constitute inventory to which section 971(c)(2) applies or
evidences of indebtedness to which section 971(c)(4) applies.
(iii) Treatment of certain liabilities. For purposes of subdivisions
(i) and (ii) of this subparagraph, a current liability, or a specific
charge created with respect to any item of property, principally for the
purpose of artificially increasing or decreasing the amount of a
controlled foreign corporation's investments in export trade assets
shall be taken into account in such a manner as to properly reflect the
controlled foreign corporation's investments in export trade assets;
whether a specific charge or current liability is created principally
for such purpose will depend upon all the facts and circumstances of
each case. One of the factors that will be considered in making such a
determination with respect to a loan is whether the loan is from a
related person, as defined in section 954(d)(3) and paragraph (e) of
1.954-1.
(iv) Statement required. If for purposes of this section a United
States shareholder of a controlled foreign corporation reduces the
adjusted basis of property which constitutes an export trade asset on
the ground that such property is subject to a liability, he shall attach
to his return a statement setting forth the adjusted basis of the
property before the reduction and the amount and nature of the
reduction.
(2) Increase in investments in export trade assets. For purposes of
section 970(a) and paragraph (b) of this section, the amount of increase
in investments in export trade assets of a controlled foreign
corporation for a taxable year shall be, except as provided in 1.970-2,
the amount by which --
(i) The amount of its investments in export trade assets at the close
of such taxable year, exceeds
(ii) The amount of its investments in export trade assets at the
close of the preceding taxable year.
(3) Decrease in investments in export trade assets. For purposes of
section 970(b) and paragraph (c) of this section, the amount of the
decrease in investments in export trade assets of a controlled foreign
corporation for a taxable year shall be, except as provided in 1.970-2,
the amount by which --
(i) The amount of its investments in export trade assets at the close
of the preceding taxable year, minus
(ii) An amount equal to the excess of recognized losses over
recognized gains on sales, exchanges, involuntary conversions, assets or
other dispositions, of export trade during the taxable year, exceeds
(iii) The amount of its investments in export trade assets at the
close of the taxable year.
For purposes of subdivision (ii) of this subparagraph, recognized
losses include a write-down of inventory to lower of cost or market in
accordance with a method of inventory valuation established or adopted
by or on behalf of such foreign corporation under paragraph (c) of
1.964-1.
(T.D. 6755, 29 FR 12704, Sept. 9, 1964, as amended by T.D. 6795, 30
FR 947, Jan. 29, 1965; T.D. 6892, 31 FR 11144, Aug. 23, 1966; T.D.
7293, 38 FR 32802, Nov. 28, 1973; T.D. 7893, 48 FR 22511, May 19, 1983)
26 CFR 1.970-2 Elections as to date of determining investments in
export trade assets.
(a) Nature of elections -- (1) In general. In lieu of determining
the increase under the provisions of paragraph (d)(2) of 1.970-1, or
the decrease under the provisions of paragraph (d)(3) of 1.970-1, in a
controlled foreign corporation's investments in export trade assets for
a taxable year in the manner provided in such provisions, a United
States shareholder of such corporation may elect, under the provisions
of section 970(c)(4) and this section, to determine such increase or
decrease in accordance with the provisions of subparagraph (2) of this
paragraph or, in the case of export trade assets which are facilities
described in section 971(c)(3), in accordance with the provisions of
subparagraph (3) of this paragraph. Separate elections may be made
under subparagraph (2) and/or (3) of this paragraph with respect to each
controlled foreign corporation with respect to which a person is a
United States shareholder, within the meaning of section 951(b).
(2) Election of 75-day rule. A United States shareholder of a
controlled foreign corporation may elect with respect to a taxable year
of such corporation to make the determinations under subparagraphs
(2)(i) and (3)(iii) of paragraph (d) of 1.970-1 of the amount of such
corporation's investments in export trade assets as of the 75th day
after the close of the taxable year referred to in such subparagraphs of
paragraph (d) of 1.970-1. The election provided by this subparagraph
may be made with respect to export trade assets other than facilities
described in section 971(c)(3) or with respect to export trade assets
which are facilities or with respect to both types of export trade
assets (but the election under this paragraph with respect to export
trade assets which are facilities or with respect to both types of
export trade assets may be made only if the election provided by
subparagraph (3) of this paragraph is not made). If the election
provided by this subparagraph is made, the amount of export trade assets
with respect to which such election is made at the close of the
preceding taxable year which is described in subparagraphs (2)(ii) and
(3)(i) of paragraph (d) of 1.970-1 shall be the amount of export trade
assets which was considered by application of the 75-day rule to be the
amount of export trade assets at the close of such preceding taxable
year; except that for the first taxable year of the controlled foreign
corporation for which the 75-day rule is elected the amount of
investments in export trade assets with respect to which such election
is made at the close of such preceding year described in subparagraphs
(2)(ii) and (3)(i) of paragraph (d) of 1.970-1 shall be the amount of
investments in export trade assets at the actual close of such preceding
year. In the case of a taxable year of such corporation beginning after
December 31, 1962, and before December 31, 1963, the amount of
investments in export trade assets with respect to which such election
is made alternatively may be determined by the United States shareholder
as of the 75th day after the close of the preceding taxable year
referred to in subparagraphs (2)(ii) and (3)(i) of paragraph (d) of
1.970-1 rather than as of the close of such preceding taxable year.
(3) Election for export trade assets which are facilities. A United
States shareholder of a controlled foreign corporation may elect with
respect to a taxable year of such corporation to make the determinations
under subparagraphs (2)(i) and (3)(iii) of paragraph (d) of 1.970-1 of
the amount of such corporation's investments in export trade assets
which are facilities described in section 971(c)(3) as of the close of
such corporation's taxable year following the taxable year referred to
in such subparagraphs of paragraph (d) of 1.970-1. The election
provided by this subparagraph may be made only if the United States
shareholder does not elect the 75-day rule of subparagraph (2) of this
paragraph with respect to export trade assets which are facilities. If
the election provided by this subparagraph is made, the amount of
investments in export trade assets which are facilities at the close of
the preceding taxable year which is described in subparagraphs (2)(ii)
and (3)(i) of paragraph (d) of 1.970-1 shall be the amount of export
trade assets which are facilities which was considered, by reason of the
application of the following-year rule provided in this subparagraph
with respect to such preceding taxable year, to be the amount of export
trade assets which are facilities at the close of such preceding taxable
year; except that for the first taxable year of the controlled foreign
corporation for which such following-year rule is elected the amount of
investments in export trade assets which are facilities at the close of
the preceding taxable year described in subparagraphs (2)(ii) and (3)(i)
of paragraph (d) of 1.970-1 shall be the amount of investments in
export trade assets which are facilities at the actual close of such
preceding taxable year.
(b) Time and manner of making elections -- (1) Without consent. A
United States shareholder may, with respect to any controlled foreign
corporation, make one or both of the elections described in paragraph
(a) (2) or (3) of this section without the consent of the Commissioner
by filing a statement to such effect with his return for his taxable
year in which or with which ends the first taxable year of such
corporation in which --
(i) Such shareholder owns, within the meaning of section 958(a), or
is considered as owning, by applying the rules of section 958(b), 10
percent or more of the total combined voting power of all classes of
stock entitled to vote of such corporation, and
(ii) Such corporation realizes subpart F income which is reduced
under section 970(a) and paragraph (b) of 1.970-1.
The statement shall contain the name and address of the controlled
foreign corporation, identification of such first taxable year of such
corporation, and an indication as to which election or elections
described in paragraph (a) of this section the United States shareholder
is making. If such return has been filed on or before the 90th day
after the date these regulations are published in the Federal Register,
such United States shareholder shall file such statement with the
district director with which the return was filed on or before such 90th
day.
(2) With consent. A United States shareholder may make one or both
of the elections described in paragraph (a) (2) or (3) of this section
with respect to any controlled foreign corporation at any time with the
consent of the Commissioner. Consent will not be granted unless the
shareholder and the Commissioner agree to the terms, conditions, and
adjustments under which the election will be effected. The application
for consent to elect shall be made by the shareholder's mailing a letter
for such purpose to the Commissioner of Internal Revenue, Washington, DC
20224. The application shall be mailed before the close of the first
taxable year of the controlled foreign corporation with respect to which
the shareholder desires to determine an exclusion under section 970(a)
in accordance with one or both of the elections provided in paragraph
(a) of this section. The application shall include the following
information:
(i) The name, address, and taxable year of the United States
shareholder;
(ii) The name, address, and taxable year of the controlled foreign
corporation;
(iii) A statement indicating which of the elections the shareholder
desires to make;
(iv) The amount of the foreign corporation's investments in export
trade assets (by a category which includes export trade assets other
than facilities and a category which includes only export trade assets
which are facilities) at the close of its preceding taxable year;
(v) The shareholder's pro rata share of the sum of the amounts by
which the subpart F income of the foreign corporation, for all prior
taxable years during which such shareholder was a United States
shareholder of such corporation, was reduced under section 970(a) and
paragraph (b) of 1.970-1;
(vi) The shareholder's pro rata share of the sum of the amounts which
were not included in the subpart F income of the foreign corporation,
for all prior taxable years during which such shareholder was a United
States shareholder of such corporation, by reason of the application of
section 972 and 1.972-1; and
(vii) The shareholder's pro rata share of the sum of the amounts
which were previously included in his gross income, for all prior
taxable years during which such shareholder was a United States
shareholder of such corporation, under section 951(a)(1)(A)(ii) by
reason of the application of section 970(b) and paragraph (b) of
1.970-1 to the foreign corporation.
(c) Effect of elections -- (1) In general. Except as provided in
subparagraphs (3) and (4) of this paragraph, an election made under
paragraph (a) of this section with respect to a controlled foreign
corporation shall be binding on the United States shareholder and --
(i) In the case of the election described in paragraph (a)(2) of this
section, shall apply to all investments in export trade assets with
respect to which such election is made acquired, or disposed of, by such
corporation during the 75-day period following its taxable year for
which subpart F income is first computed under the election and during
all succeeding corresponding 75-day periods of such corporation, or
(ii) In the case of the election described in paragraph (a)(3) of
this section, shall apply to all investments in export trade assets
which are facilities acquired, or disposed of, by such corporation
during the taxable year following its taxable year for which subpart F
income is first computed under the election and during all succeeding
corresponding taxable years of such corporation.
(2) Returns. Any return of a United States shareholder required to
be filed before the completion of a period with respect to which
determinations are to be made as to a controlled foreign corporation's
investments in export trade assets for purposes of computing such
shareholder's taxable income shall be filed on the basis of an estimate
of the amount of such corporation's investments in export trade assets
at the close of the period. If the actual amount of such investments is
not the same as the amount of the estimate, the shareholder shall
immediately notify the Commissioner. The Commissioner will thereupon
redetermine the amount of such shareholder's tax for the year or years
with respect to which the incorrect amount was taken into account. The
amount of tax, if any, due upon such redetermination shall be paid by
the shareholder upon notice and demand by the district director. The
amount of tax, if any, shown by such redetermination to have been
overpaid shall be credited or refunded to the shareholder in accordance
with the provisions of sections 6402 and 6511 and the regulations
thereunder.
(3) Revocation -- (i) In general -- (a) Consent required. Upon
application by the United States shareholder, an election made under
paragraph (a) of this section may, subject to the approval of the
Commissioner, be revoked. Approval will not be granted unless the
shareholder and the Commissioner agree to the terms, conditions, and
adjustments under which the revocation will be effected.
(b) Revocation of 75-day rule. In the case of the revocation of an
election described in paragraph (a)(2) of this section, the change in
the controlled foreign corporation's investments in export trade assets
with respect to which such election was made for its first taxable year
for which subpart F income or a decrease in investments in export trade
assets is computed without regard to the election previously made shall,
unless the agreement with the Commissioner provides otherwise, be
considered to be the amount by which --
(1) Such corporation's investments in export trade assets with
respect to which such election was made at the close of such taxable
year exceeds or, if applicable, is exceeded by
(2) Such corporation's investments in export trade assets with
respect to which such election was made at the close of the 75th day
after the close of the preceding taxable year of such corporation.
(c) Revocation of following-year rule. In the case of the revocation
of an election described in paragraph (a)(3) of this section, the change
in the controlled foreign corporation's investments in export trade
assets which are facilities for its first taxable year for which subpart
F income or a decrease in investments in export trade assets is computed
without regard to the election previously made shall, unless the
agreement with the Commissioner provides otherwise, be considered to be
zero.
(ii) Time and manner of applying for consent to revocation -- (a)
Application to Commissioner. The application for consent to revocation
of an election shall be made by the United States shareholder's mailing
a letter for such purpose to the Commissioner of Internal Revenue,
Washington, DC, 20224. The application shall be mailed before the close
of the first taxable year of the controlled foreign corporation with
respect to which the shareholder desires to determine an exclusion under
section 970(a) or an inclusion under section 970(b) without regard to
such election.
(b) Information required. The application shall include the
following information:
(1) The name, address, and taxable year of the United States
shareholder;
(2) The name, address, and taxable year of the controlled foreign
corporation;
(3) A statement indicating the election the shareholder desires to
revoke under this subparagraph;
(4) The information required under subdivisions (iv) through (vii) of
paragraph (b)(2) of this section;
(5) In the case of an application for consent to revocation of an
election made under paragraph (a)(2) of this section, the amount of the
foreign corporation's investments in export trade assets with respect to
which such election was made at the close of the 75th day after the
close of such corporation's taxable year immediately preceding the
taxable year of such corporation; and
(6) The reasons for the request for consent to revocation.
(4) Transfer of stock -- (i) Election of 75-day rule in force. (a)
If during any taxable year of a controlled foreign corporation --
(1) A United States shareholder who has made the election described
in paragraph (a)(2) of this section with respect to such corporation
sells, exchanges, or otherwise disposes of all or part of his stock in
such corporation, and
(2) The foreign corporation is a controlled foreign corporation
immediately after the sale, exchange, or other disposition,
then, with respect to the stock so sold, exchanged, or disposed of,
the successor in interest shall consider the controlled foreign
corporation's change during the first 75 days of such taxable year in
investments in export trade assets with respect to which such election
is made to be zero.
(b) If the United States shareholder's successor in interest makes an
election under paragraph (a)(2) of this section in order to determine an
exclusion under section 970(a) for the taxable year of such corporation
in which the acquires such stock, the amount of the controlled foreign
corporation's investments in export trade assets with respect to which
such election is made at the close of its preceding taxable year shall
be considered, with respect to the stock so acquired, to be the amount
of such corporation's investments in export trade assets with respect to
which such election is made at the close of the 75th day after the close
of such preceding taxable year.
(c) If the United States shareholder's successor in interest makes an
election under paragraph (a)(2) of this section in order to determine an
exclusion under section 970(a) for a taxable year of such corporation
subsequent to the taxable year in which he acquired the stock, the
amount of the controlled foreign corporation's investments in export
trade assets with respect to which such election is made at the close of
its taxable year immediately preceding such subsequent taxable year
shall, with respect to the stock so acquired, be the amount of such
corporation's investments in such assets at the actual close of such
preceding taxable year.
(ii) Election in force with respect to export trade assets which are
facilities. (a) If during any taxable year of a controlled foreign
corporation --
(1) A United States shareholder who has made the election described
in paragraph (a)(3) of this section with respect to such corporation
sells, exchanges, or otherwise disposes of all or part of his stock in
such corporation, and
(2) The foreign corporation is a controlled foreign corporation
immediately after the sale, exchange or other disposition,
then, with respect to the stock so sold, exchanged, or disposed of,
the successor in interest shall consider the controlled foreign
corporation's change for such taxable year in investments in export
trade assets which are facilities to be zero.
(b) If the United States shareholder's successor in interest makes an
election under paragraph (a)(3) of this section in order to determine an
exclusion under section 970(a) for the taxable year of such corporation
in which he acquires such stock, the amount of the controlled foreign
corporation's investments in export trade assets which are facilities at
the close of its preceding taxable year shall be considered, with
respect to the stock so acquired, to be the amount of such corporation's
investments in export trade assets which are facilities at the close of
the taxable year in which such stock is acquired.
(c) If the United States shareholder's successor in interest makes an
election under paragraph (a)(3) of this section in order to determine an
exclusion under section 970(a) for a taxable year of such corporation
subsequent to the taxable year in which he acquired the stock, the
amount of the controlled foreign corporation's investments in export
trade assets which are facilities at the close of its taxable year
immediately preceding such subsequent taxable year shall, with respect
to the stock so acquired, be the amount of such corporation's
investments in such assets at the actual close of such preceding taxable
year.
(d) Illustrations. The principles contained in this section are
illustrated by the examples set forth in paragraph (d) of 1.955.3.
(T.D. 6755, 29 FR 12707, Sept. 9, 1964)
26 CFR 1.970-3 Effective date of subpart G.
Sections 970 through 972 and 1.970-1 through 1.972-1 shall apply
with respect to taxable years of foreign corporations beginning after
December 31, 1962, and to taxable years of United States shareholders
within which or with which such taxable years of such corporations end.
(T.D. 6755, 29 FR 12709, Sept. 9, 1964)
26 CFR 1.971-1 Definitions with respect to export trade corporations.
(a) Export trade corporations -- (1) In general. For purposes of
sections 970 through 972 and 1.970-1 to 1.972-1, inclusive, the term
''export trade corporation'' means a controlled foreign corporation
which for the period specified in subparagraph (2) of this paragraph
satisfies the conditions specified in subparagraph (3) of this
paragraph. However, no controlled foreign corporation may qualify as an
export trade corporation for any taxable year beginning after October
31, 1971, unless it qualified as an export trade corporation for any
taxable year beginning before such date. In addition, if a corporation
fails to qualify as an export trade corporation for a period of any 3
consecutive taxable years beginning after October 31, 1971, then for any
taxable year beginning after such 3 year period, such corporation shall
not be included within the term ''export trade corporation''.
(2) Three-year period. The period referred to in subparagraph (1) of
this paragraph is the 3-year period ending with the close of the
controlled foreign corporation's current taxable year, or such part of
such 3-year period as occurs on and after the beginning of the
corporation's first taxable year beginning after December 31, 1962,
whichever period is shorter.
(3) Gross income requirements. The conditions referred to in
subparagraph (1) of this paragraph are that the controlled foreign
corporation derives --
(i) 90 percent or more of its gross income from sources without the
United States, and
(ii) (a) 75 percent of more of its gross income from transactions,
activities, or interest described in section 971(b) and paragraph (b) of
this section, or
(b) 50 percent or more of its gross income from transactions,
activities, or interest described in section 971(b) and paragraph (b) of
this section in respect of agricultural products grown in the United
States.
(4) Determination of sources of gross income. The sources of gross
income of a controlled foreign corporation shall be determined for
purposes of subparagraph (3)(i) of this paragraph in accordance with the
rules for determining sources of gross income set forth in sections 861
through 864 and the regulations thereunder.
(b) Export trade income -- (1) General rule. For purposes of
sections 970 through 972 and 1.970-1 to 1.972-1, inclusive, the term
''export trade income'' means the gross export trade income of a
controlled foreign corporation derived from transactions, activities, or
interest described in subdivisions (i) through (vii) of this
subparagraph, less deductions allowed under subdivision (viii) of this
subparagraph.
(i) Sale of export property. Gross export trade income of a
controlled foreign corporation includes gross income it derives from the
sale of export property (as defined in paragraph (e) of this section)
which it purchases, if the sale is made to an unrelated person for use,
consumption, or disposition outside the United States. See section
971(b)(1). As a general rule, property will be presumed to have been
sold for use, consumption, or disposition in the country of destination
of the sale. However, if at the time of the sale the controlled foreign
corporation knows, or should have known from the facts and circumstances
surrounding the sales transaction, that the property will probably be
used, consumed, or disposed of in the United States, such property will
be presumed to have been sold for use, consumption, or disposition in
the United States unless the controlled foreign corporation establishes
that such property was used, consumed, or disposed of outside the United
States. For purposes of this subdivision, export property must be sold
by a controlled foreign corporation in essentially the same form in
which such property is purchased. Whether export property sold is in
essentially the same form in which such property is purchased shall be
determined on the basis of all the facts and circumstances in each case.
Storage, handling, transportation, packaging, or servicing of property
will be considered not to alter the form in which property is purchased.
However, manufacture or production, within the meaning of paragraph
(a)(4) of 1.954-3, will be considered to alter the form in which
property is purchased and no part of the gross income from the sale of
such property will be treated as export trade income. The application
of this subdivision may be illustrated by the following example:
Example. Controlled foreign corporation A, incorporated under the
laws of foreign country Y, purchases articles manufactured in the United
States from domestic corporation M and sells them in the form in which
purchased to foreign corporation B, unrelated to A Corporation, for use
in foreign countries, X, Y, and Z. The gross income of A Corporation
from the purchase and sale of the articles constitutes gross export
trade income.
(ii) Commissions and other income derived in connection with the sale
of export property. Gross export trade income of a controlled foreign
corporation includes gross commissions, fees, compensation, or other
income derived by such corporation from the performance for any person
of commercial, industrial, financial, technical, scientific, managerial,
engineering, architectural, skilled, or other services in respect of a
sale by such corporation in a transaction described in subdivision (i)
of this subparagraph or in respect of the sale by any other person of
export property to a person unrelated to the controlled foreign
corporation for use, consumption, or disposition outside the United
States. Such gross export trade income includes payments received for
surveys made prior to, and in connection with, the sale of such export
property (whether or not such sales are ultimately consummated). See
section 971(b)(1). The term ''any person'' or ''any other person'' as
used in this subdivision includes a related person as defined in section
954(d)(3) and paragraph (e) of 1.954-1. The application of this
subdivision may be illustrated by the following examples:
Example 1. Controlled foreign corporation A, incorporated under the
laws of foreign country X, receives from M Corporation a commission
equal to 6 percent of the gross selling price of all personal property
shipped by M Corporation as a result of services performed by A
Corporation in soliciting orders in foreign countries X, Y, and Z. In
fulfillment of such orders, M Corporation ships products manufactured by
it in the United States. Corporation A does not assume title to the
property sold. Gross commissions received by A Corporation from M
Corporation in connection with the sale of such property to persons
unrelated to A Corporation for use, consumption, or disposition outside
the United States constitute gross export trade income.
Example 2. Foreign corporation B, incorporated under the laws of
foreign country X, is a wholly owned subsidiary of domestic corporation
N. Corporation N, is engaged in the business of manufacturing heavy
duty electrical equipment in the United States. By contract, N
Corporation engages B Corporation for the purpose of conducting
engineering, technical, and financial studies required by N Corporation
in the preparation of bids to supply foreign country Y with electrical
equipment for a construction project to be undertaken by such country.
Corporation N pays B Corporation a fee for the services, all of which
are performed in country Y, which is based upon the number of hours of
work performed without regard to whether a sale is ultimately
consummated. Corporation N does not receive a contract from country Y
on its bid to supply equipment. Income derived by B Corporation from
performance of the service contract constitutes gross export trade
income.
(iii) Commissions and other income derived in connection with the
installation or maintenance of export property. Gross export trade
income of a controlled foreign corporation includes gross commissions,
fees, compensation, or other income derived by such corporation from the
performance for any person of commercial, industrial, financial,
technical, scientific, managerial, engineering, architectural, skilled,
or other services in respect of the installation or maintenance of
export property which has been sold by such corporation in a transaction
described in subdivision (i) of this subparagraph or by any other person
to a person unrelated to the controlled foreign corporation for use,
consumption, or disposition outside the United States. See section
971(b)(1). The term ''any person'' or ''any other person'' as used in
this subdivision includes a related person as defined in section
954(d)(3) and paragraph (e) of 1.954-1.
(iv) Commissions and other income derived in connection with the use
of patents, copyrights, and other like property. Gross export trade
income of a controlled foreign corporation includes gross commissions,
fees, compensation, or other income derived by such corporation from the
performance for any person of commercial, industrial, financial,
technical, scientific, managerial, engineering, architectural, skilled,
or other services in connection with the use outside of the United
States by an unrelated person of patents, copyrights, secret processes
and formulas, goodwill, trademarks, trade brands, franchises, and other
like property, including gross income derived from obtaining licensees
for patents, but only if the patent, copyright, or other like property
is acquired, or developed, and owned by the manufacturer, producer,
grower, or extractor of any export property, in respect of which the
controlled foreign corporation also derives gross export trade income
within the meaning of subdivision (i), (ii), or (iii) of this
subparagraph. See section 971(b)(2). The application of this
subdivision may be illustrated by the following example:
Example. Foreign corporation A incorporated under the laws of foreign
country X, is a wholly owned subsidiary of domestic corporation M.
Corporation M, the owner of a patent registered in foreign country X,
grants B Corporation, a corporation unrelated to A Corporation, the
right to use such patent in foreign country Y in exchange for payment of
a royalty. By a separate contract with B Corporation, A Corporation
agrees for a gross fee of $100,000 to furnish, by maintaining a staff of
technical representatives at the offices of B Corporation, technical
services to B Corporation in connection with B Corporation's use of the
patent. Corporation A also derives export trade income from the sale of
export property which it purchases from M Corporation, the manufacturer
of such property, and sells to C Corporation, an unrelated person, for
use in country Y by C Corporation. The gross fee of $100,000 received
by A Corporation for the furnishing of technical services in connection
with B Corporation's use of M Corporation's patent constitutes gross
export trade income since the service for which the fee is paid is
performed in connection with the use outside the United States by an
unrelated person (B Corporation) of a patent owned by a manufacturer (M
Corporation) of export property in respect of which the controlled
foreign corporation (A Corporation) derives gross export trade income
from the sale to an unrelated person (C Corporation) for use outside the
United States of export property purchased by it from the manufacturer
(M Corporation).
(v) Income attributable to use of export property by an unrelated
person. Gross export trade income of a controlled foreign corporation
includes gross commissions, fees, rents, compensation, or other income
which is received by such corporation from an unrelated person and is
attributable to the use of export property by such unrelated person.
See section 971(b)(3). The application of this subdivision may be
illustrated by the following example:
Example. Foreign corporation A, incorporated under the laws of
foreign country X, is a wholly owned subsidiary of domestic corporation
M. Corporation A acquires by purchase bottling machines manufactured in
the United States and leases the machines to B Corporation, a
corporation unrelated to A Corporation, for use by B Corporation in
foreign country Y. Gross rental income of A Corporation from the lease
of the machines to B Corporation constitutes gross export trade income.
(vi) Income attributable to the use of export property in the
rendition of technical, scientific, or engineering services -- (a)
General. Gross export trade income of a controlled foreign corporation
includes gross commissions, fees, compensation, or other income which is
received by such corporation from an unrelated person and is
attributable to the use of export property in the performance of
technical, scientific, or engineering services to such unrelated person.
See section 971(b)(3).
(b) Rule of apportionment. If a commission, fee, or other income
received by a controlled foreign corporation from an unrelated person
under a contract or arrangement for the performance of technical,
scientific, or engineering services is not solely attributable to the
use of export property in the performance of such services and the
amount of the gross income attributable to such use of export property
cannot be established by reference to transactions between other
unrelated persons, such gross income shall be an amount which bears the
same ratio to total gross income from the contract or arrangement as the
cost of the export property consumed in the performance of such
services, including a reasonable allowance for depreciation with respect
to the export property so used, bears to the total costs and expenses
attributable to the production of income under the contract or
arrangement.
(c) Illustration. The application of this subdivision may be
illustrated by the following example:
Example. Foreign corporation A, incorporated under the laws of
foreign country X, is a wholly owned subsidiary of domestic corporation
M. Corporation A is engaged in the seismograph service business in
foreign country X. In an effort to establish the probable existence of
oil in a concession area it owns in foreign country Y, B Corporation
which is unrelated to A Corporation enters into a contract with A
Corporation whereby A Corporation is required to make seismographic
tests of the area in country Y for a fixed fee of $100,000. In
performance of the contract, A Corporation hires a skilled crew to carry
out the contract and utilizes equipment and supplies (for example,
trucks, seismographic equipment, etc.) which constitute export property.
Corporation A cannot establish by reference to transactions between
other unrelated persons, the income attributable to the use of the
export property in the performance of the contract. Corporation A's
total costs and expenses (for example, salaries of the crew,
administrative expenses, all supplies, total depreciation on property
used in performance of the contract, etc.) incurred in performance of
the contract are $80,000. The cost of export property consumed in
performance of the contract (for example, dynamite, motor oil, and other
supplies which were produced in the United States, reasonable
depreciation on trucks and seismographic equipment manufactured in the
United States and used in performance of the contract, etc.) is $30,000.
Corporation A's gross export trade income from the contract is $37,500,
that is, the amount which bears the same ratio to total gross income
from the contract ($100,000) as the cost of the export property consumed
in the rendition of the services ($30,000) bears to total costs and
expenses attributable to the contract ($80,000).
(vii) Interest from export trade assets. Gross export trade income
of a controlled foreign corporation includes interest derived by it from
export trade assets described in section 971(c)(4) and paragraph (c)(5)
of this section. See section 971(b)(4).
(viii) Deductions to be taken into account. Export trade income of a
controlled foreign corporation for any taxable year shall be the amount
determined by deducting from the items or categories of gross income
described in subdivisions (i) through (vii) of this subparagraph the
entire amount of those expenses, taxes, and other deductions properly
allocable to such items or categories of income. For purposes of this
section, expenses, taxes, and other deductions shall first be allocated
to items or categories of gross income to which they directly relate;
then, expenses, taxes, and other deductions which cannot definitely be
allocated to some item or category of gross income shall be ratably
apportioned among all items or categories of gross income, except that
no expense, tax, or other deduction shall be allocated to an item or
category of income to which it clearly does not apply and no deduction
allowable to such controlled foreign corporation under section 882(c)
and the regulations thereunder shall be taken into account.
(2) Cross reference. For rules governing the determination of gross
income and taxable income of a foreign corporation, see 1.952-2.
(c) Export trade assets -- (1) In general. For purposes of sections
970 through 972 and 1.970-1 to 1.972-1, inclusive, the term ''export
trade assets'' means --
(i) Working capital reasonably necessary for the production of export
trade income,
(ii) Inventory of export property held for use, consumption, or
disposition outside the United States,
(iii) Facilities located outside the United States for the storage,
handling, transportation, packaging, servicing, sale, or distribution of
export property, and
(iv) Evidences of indebtedness executed by unrelated persons in
connection with payment for purchases of export property for use,
consumption, or disposition outside the United States, or in connection
with the payment for services described in section 971(b) (2) or (3) and
paragraph (b)(1) (iv), (v), or (vi) of this section.
(2) Working capital. For purposes of subparagraph (1)(i) of this
paragraph, working capital of a controlled foreign corporation is the
excess of its current assets over its current liabilities. Liabilities
maturing in one year or less shall be considered current liabilities. A
determination of the amount of working capital of a controlled foreign
corporation which is reasonably necessary for the production of export
trade income will depend upon the nature and volume of the activities of
the controlled foreign corporation which produce export trade income as
they exist on the applicable determination date. In determining working
capital which is reasonably necessary for the production of export trade
income, the anticipated future needs of the business will be taken into
account to the extent that such needs relate to the year of the
controlled foreign corporation following the applicable determination
date; anticipated future needs relating to a later period will not be
taken into account unless it is clearly established that such needs are
reasonably related to the production of export trade income as of the
applicable determination date.
(3) Inventory of export property. For purposes of subparagraph
(1)(ii) of this paragraph, the inclusion of items in inventory shall be
determined in accordance with rules applicable to domestic corporations.
See 1.471-1 through 1.471-9. Inventory of export property of a
controlled foreign corporation includes export property held for use,
consumption, or disposition outside the United States regardless of
where it is located on the applicable determination date. Thus, such
property may be physically located in the United States on such date.
However, for property physically located in the United States to
constitute export property, it must have been acquired by the controlled
foreign corporation with a clear intent that it would dispose of the
property for use, consumption, or disposition outside the United States.
As a general rule, if during the year following the applicable
determination date export property which was physically located in the
United States on such date is actually exported for use, consumption, or
disposition outside the United States, such property will be deemed held
for such purpose on the applicable determination date. On the other
hand, the indefinite warehousing of export property in the United States
by the controlled foreign corporation, or the subsequent sale of export
property by such corporation for use, consumption, or disposition in the
United States, will evidence a lack of intent by such corporation on the
applicable determination date to hold such property for use,
consumption, or disposition outside the United States.
(4) Facilities located outside the United States -- (i) In general.
For purposes of subparagraph (1)(iii) of this paragraph, a facility, as
defined in subdivision (ii)(a) of this subparagraph, will be considered
an export trade asset only --
(a) If such facility is located outside the United States, and
(b) To the extent that such facility is used, within the meaning of
subdivision (ii)(c) of this subparagraph, by the controlled foreign
corporation for the storage, handling, transportation, packaging,
servicing, sale, or distribution of export property in essentially the
same form in which such property is acquired by such corporation.
Thus, a facility in which property is manufactured or produced, even
though export property is used or consumed in the production or becomes
a component part of the manufactured article, will not qualify as an
export trade asset.
(ii) Special rules -- (a) Facility defined. For purposes of
subdivision (i) of this subparagraph, the term ''facility'' includes any
asset or group of assets used for the storage, handling, transportation,
packaging, servicing, sale, or distribution of export property. Thus,
such term includes warehouse, storage, or sales facilities (for example,
sales office equipment), transportation equipment (for example, motor
trucks, vessels, etc.), and machinery and equipment (for example,
packaging equipment, servicing equipment, cranes, forklift trucks used
in warehouses, etc.).
(b) Determination of location of transportation facilities. A
transportation facility shall be considered to be located outside the
United States for purposes of subdivision (i)(a) of this subparagraph if
such property is predominantly located outside the United States. As a
general rule, on an applicable determination date a transportation
facility will be considered to be predominantly located outside the
United States if 70 percent or more of the miles traversed (during the
12-month period immediately preceding such determination date or for
such part of such period as such facility is owned by the controlled
foreign corporation) in the use of such facility are traversed outside
the United States or if such facility is located outside the United
States at least 70 percent of the time during such period or such part
thereof.
(c) Determination of use. For purposes of subdivision (i)(b) of this
subparagraph, the extent to which a facility is used in carrying on the
activities described in such subdivision depends on the use made of the
facility for the 12-month period immediately preceding the applicable
determination date or for such part of such period as such facility is
owned by the controlled foreign corporation. The method of measuring
such use will depend upon the facts and circumstances in each case.
However, such determinations of use will generally be made for a
facility as a whole and not on the basis of individual items used in the
operation of a facility. Thus, a determination as to the use of a
warehouse facility will generally be made with respect to the entire
facility and not separately for the items used in such warehouse, such
as forklift trucks, storage bins, etc.
(5) Evidences of indebtedness. For purposes of subparagraph (1)(iv)
of this paragraph, the term ''evidence of indebtedness'' shall mean a
note, installment sales contract, a time bill of exchange evidencing a
sale on credit, or similar written instrument executed by an unrelated
person which evidences the obligation of an unrelated person to pay for
export property which an unrelated person purchases for use,
consumption, or disposition outside the United States or to pay for
services described in section 971(b) (2) or (3) and paragraph (b)(1)
(iv), (v), or (vi) of this section which are performed for an unrelated
person. Receivables which arise out of the delivery of export property,
or the performance of services, which are evidenced by invoices, bills
of lading, bills of exchange which do not evidence a sale on credit,
sales slips, and similar documents created by the unilateral act of a
creditor shall not be considered evidences of indebtedness for purposes
of section 971(c)(4).
(6) Duplication of treatment and priority of application. No asset
which constitutes an export trade asset shall be taken into account more
than once in determining the investments in export trade assets of a
controlled foreign corporation. Assets which constitute working capital
and also constitute inventory to which section 971(c)(2) applies or
evidences of indebtedness to which section 971(c)(4) applies shall be
taken into account in determining whether the amount of working capital
of the controlled foreign corporation is reasonably necessary for the
production of export trade income. However, to the extent that the
amount of inventory to which section 971(c)(2) applies or evidences of
indebtedness to which section 971(c)(4) applies is not included in
working capital to which section 971(c)(1) applies on the ground that
such amount is not reasonably necessary for the production of export
trade income, the amount shall be included under section 971(c)(2) or
971(c)(4), as the case may be, in a controlled foreign corporation's
investments in export trade assets.
(d) Export promotion expenses -- (1) In general. For purposes of
sections 970 through 972 and 1.970-1 to 1.972-1, inclusive, the term
''export promotion expenses'' means, subject to the provisions of
subparagraph (2) of this paragraph, all the ordinary and necessary
expenses paid or incurred during the taxable year by the controlled
foreign corporation which are reasonably allocable to the receipt or
production of export trade income including --
(i) A reasonable allowance for salaries or other compensation for
personal services actually rendered for such purpose,
(ii) Rentals or other payments for the use of property actually used
for such purpose, and
(iii) A reasonable allowance for the exhaustion, wear and tear, or
obsolescence of property actually used for such purpose.
In determining for purposes of this subparagraph whether expenses are
reasonably allocable to the receipt or production of export trade
income, consideration shall be given to the facts and circumstances of
each case. As a general rule, if export trade income results from the
sale of export property, export promotion expenses allocable to such
income shall include warehousing, advertising, selling, billing,
collection, other administrative, and similar costs properly allocable
to the marketing activity, but shall not include cost of goods sold,
income or similar tax, any expense which does not advance the
distribution or sale of export property for use, consumption, or
disposition outside the United States, or any expense for which the
controlled foreign corporation is reimbursed. If export trade income
results from the rental of export property, export promotion expenses
allocable to such income shall include a reasonable allowance for
depreciation and servicing of such property, and the administrative and
similar costs properly allocable to the rental activity. If export
trade income results from the performance of services, export promotion
expenses shall include a reasonable allowance for compensation of the
persons performing services for the controlled foreign corporation in
the execution of the service contract or arrangement and administrative
expenses reasonably allocable to the service activity. In no case shall
income taxes be included in export promotion expenses.
(2) Expenses incurred within the United States. No expense incurred
within the United States shall be treated as an export promotion expense
for purposes of section 971(d) and subparagraph (1) of this paragraph
unless at least --
(i) 90 percent of all salaries and other personal service
compensation incurred in the receipt or the production of export trade
income,
(ii) 90 percent of rents and other payments for the use of property
used in the receipt or the production of export trade income,
(iii) 90 percent of the allowances for the exhaustion, wear and tear,
or obsolescence of property used in the receipt or the production of
export trade income, and
(iv) 90 percent of all other ordinary and necessary expenses
reasonably allocable to the receipt or the production of export trade
income,
is incurred outside the United States. For this purpose, personal
service compensation will be considered incurred at the place where the
service is performed (for example, salaries will be considered incurred
at the place where the employee works; payments for art work will be
considered incurred at the place where the art work is prepared, etc.);
rent, depreciation, and other expenses related to real or personal
property will be considered incurred at the place where the property is
located; and expenses for media advertising will be considered incurred
at the place where the advertising is consumed. For such purpose,
newspaper or periodical advertising will be considered consumed where
the newspaper or periodical is principally distributed, and television
and radio advertising will be considered consumed at the place where the
audience is primarily located. Technicalities of contract or payment,
for example, the place where a contract is executed or the location of a
bank account from which payment is made, shall not be determinative of
the place where an expense is incurred.
(e) Export property. For purposes of sections 970 through 972 and
1.970-1 to 1.972-1, inclusive, the term ''export property'' means
property, or any interest in property, which is manufactured, produced,
grown, or extracted in the United States. Whether property will be
considered manufactured or produced in the United States will depend on
the facts and circumstances of each case. As a general rule, if --
(1) The property sold, serviced, used, or rented by the controlled
foreign corporation is substantially transformed in the United States
prior to its export from the United States, or
(2) The operations conducted in the United States with respect to the
property sold, serviced, used, or rented by the controlled foreign
corporation, whether performed in the United States by one person or a
series of persons in a chain of distribution, are substantial in nature
and are generally considered to constitute the manufacture or production
of property,
then the property sold, serviced, used, or rented will be considered
to have been manufactured or produced in the United States. The rules
under paragraph (a)(4)(ii) of 1.954-3, relating to the substantial
transformation of property, and paragraph (a)(4)(iii) of such section,
dealing with a substantive test for determining whether property will be
treated as having been manufactured or produced, shall apply for
purposes of making determinations under this paragraph.
(f) Unrelated person. For purposes of sections 970 through 972 and
1.970-1 to 1.972-1, inclusive, the term ''unrelated person'' means a
person other than a related person as defined in section 954(d)(3) and
paragraph (e) of 1.954-1.
(T.D. 6755, 29 FR 12710, Sept. 9, 1964, as amended by T.D. 7293, 38
FR 32802, Nov. 28, 1973; T.D. 7533, 43 FR 6603, Feb. 15, 1978)
26 CFR 1.972-1 Consolidation of group of export trade corporations.
(a) Election to consolidate -- (1) In general. One or more United
States shareholders (as defined in section 951(b)) owning (within the
meaning of section 958(a)) or who are considered as owning by applying
the rules of ownership of section 958(b) more than 50 percent of the
total combined voting power of all classes of stock entitled to vote of
an export trade corporation, which is the top-tier corporation in a
chain (within the meaning of subparagraph (2) of this paragraph) of
export trade corporations, may, subject to the provisions of this
section, elect to consolidate such chain for purposes of determining --
(i) The limitations, described in section 970(a) and paragraph (b)(2)
of 1.970-1, on the amount by which subpart F income of an export trade
corporation in such chain shall be reduced as provided in section 970(a)
and paragraph (b)(1) of 1.970-1, and
(ii) The amount includible in gross income of such shareholders under
section 951(a)(1)(A)(ii) with respect to such a corporation's decrease
in investments in export trade assets to which section 970(b) applies as
described in paragraph (c) of 1.970-1.
(2) ''Chain'' defined. A chain of export trade corporations shall
include --
(i) The top-tier export trade corporation referred to in subparagraph
(1) of this paragraph which is the first export trade corporation in a
chain of ownership described in section 958(a);
(ii) All export trade corporations 80 percent or more of the total
combined voting power of all classes of stock entitled to vote of which
is owned directly by such top-tier export trade corporation on the last
day of its taxable year; and
(iii) All export trade corporations 80 percent or more of the total
combined voting power of all classes of stock entitled to vote of which
is owned directly by the export trade corporations described in
subdivision (ii) of this subparagraph on the last day of the taxable
year of the export trade corporation described in subdivision (i) of
this subparagraph.
For purposes of this section, a reference to a top-tier corporation
shall mean an export trade corporation described in subdivision (i) of
this subparagraph, a reference to a second-tier corporation shall mean
an export trade corporation described in subdivision (ii) of this
subparagraph, and a reference to a third-tier corporation shall mean an
export trade corporation described in subdivision (iii) of this
subparagraph.
(3) Inclusion requirement. If an election is made by a United States
shareholder under this paragraph with respect to a chain of export trade
corporations (as defined in subparagraph (2) of this paragraph), all
export trade corporations which are included in the chain must be
included in the consolidation. If such an election is made, the
determinations under section 970 shall be made on a consolidated basis
with respect to the entire interest which the electing United States
shareholder owns in each of the export trade corporations in the chain,
including any minority interests owned directly or indirectly by such
shareholder in second-tier and third-tier corporations in the chain. A
United States shareholder may elect to consolidate his interest in
export trade corporations in one chain of such corporations without
electing to consolidate his interest in export trade corporations in
other chains.
(4) Conditions for making initial election -- (i) Without consent.
The initial election to consolidate a chain of export trade corporations
may be made without the consent of the Commissioner only if, immediately
before the election to consolidate, each of the export trade
corporations to be included in the consolidation is using the same
taxable year and has the same elections under section 970(c)(4) and
1.970-2 in force, or not in force, as the case may be. The election
shall be made by the electing shareholder or shareholders with respect
to the taxable year in which or with which ends the first taxable year
of the top-tier corporation to which the election to consolidate applies
and at the time of filing such shareholders' returns for such taxable
year or within 90 days after final regulations under this section are
published in the Federal Register, whichever date occurs later. Each
United States shareholder making such an election shall attach to his
return a statement showing:
(a) The name, address, and taxable year of each export trade
corporation in the chain of such corporations for which an election is
made,
(b) The amount and percentage of each class of stock owned by such
shareholder (within the meaning of section 958), corporation by
corporation, in each of such export trade corporations, and
(c) A list of the names and addresses, and a description of the
ownership interests, of all other United States shareholders, if any,
who are making the same election to consolidate and a statement that
such shareholders are also making the election.
(ii) With consent. If, immediately before the election to
consolidate, each of the export trade corporations in a chain of such
corporations does not use the same taxable year or does not have the
same elections under section 970(c)(4) and 1.970-2 in force, or not in
force, as the case may be, the initial election to consolidate such
chain may be exercised by the electing shareholder or shareholders only
with the consent of the Commissioner. Consent will not be granted
unless each electing United States shareholder and the Commissioner
agree to the terms, conditions, and adjustments under which such
consolidation is to be effected and unless, subject to such terms,
conditions, and adjustments as the Commissioner may prescribe, each of
the export trade corporations in the chain adopts a common taxable year
and has the same elections under section 970(c)(4) and 1.970-2 in
force, or not in force, as the case may be. The application for consent
to consolidate shall be made by mailing a letter, signed by each of the
electing United States shareholders, to the Commissioner of Internal
Revenue, Washington, DC 20224. The application shall be mailed before
the close of the first taxable year of the top-tier corporation with
respect to which the electing shareholder or shareholders desire to make
a consolidation or before the close of the 90th day after final
regulations under this section are published in the Federal Register,
whichever date occurs later, and shall include the statement described
in subdivision (i) of this subparagraph.
(5) Effect of election. If an election to consolidate a chain of
export trade corporations is made for a taxable year of a United States
shareholder, such election shall, except as provided in subparagraph (6)
of this paragraph, be binding on such shareholder for such taxable year
and for all succeeding taxable years. If, in a subsequent taxable year
of the United States shareholder, an export trade corporation for the
first time qualifies as a second-tier or third-tier corporation in such
chain on the last day of the taxable year of the top-tier corporation
which ends in or with the subsequent taxable year of such shareholder,
the shareholder's interest in such export trade corporation shall be
included in the consolidation to which the election applies, but only if
such export trade corporation as of such last day uses the same taxable
year and has the same elections under section 970(c)(4) and 1.970-2 in
force, or not in force, as the case may be, as such top-tier
corporation. The United States shareholder shall, with respect to such
additional export trade corporation, submit with his return for such
subsequent taxable year the statement described in subparagraph (4)(i)
of this paragraph.
(6) Termination of election. An election under this paragraph to
consolidate a chain of export trade corporations shall terminate for the
first taxable year of the foreign corporation which during the period of
consolidation is a top-tier corporation --
(i) At the close of which any foreign corporation which was included
in such consolidation for the preceding taxable year ceases to qualify
as an export trade corporation or to be eligible under this paragraph
for inclusion in such chain,
(ii) At the close of which an export trade corporation for the first
time qualifies as a second-tier or third-tier corporation in such chain
but does not as of such close of the year use the same taxable year or
have the same elections under section 970(c)(4) and 1.970-2 in force,
or not in force, as the case may be, as such top-tier corporation, or
(iii) (a) In respect of which the Commissioner, upon application made
by a United States shareholder who made the election to consolidate, or
his successor in interest, consents to a termination of the election.
Approval will not be granted unless the United States shareholder and
the Commissioner agree to the terms, conditions, and adjustments under
which the termination will be effected.
(b) The application for consent to termination shall be made by the
United States shareholder's mailing a letter for such purpose to the
Commissioner of Internal Revenue, Washington, DC 20224. The application
shall be mailed before the close of the taxable year of the foreign
corporations with respect to which the shareholder desires to terminate
the consolidation and shall include the following information:
(1) The name, address, and taxable year of each export trade
corporation in the chain of such corporations for which the election was
made,
(2) The amount and percentage of each class of stock owned by such
shareholder (within the meaning of section 958), corporation by
corporation, in each of such export trade corporations, and
(3) A list of the names and addresses, and a description of the
ownership interests, of all other United States shareholders, if any,
who participated in making the election with such United States
shareholder, or their successors in interest, and a statement whether
such other persons are or are not terminating the election.
(7) Election subsequent to initial election. If a United States
shareholder elects under subparagraph (4) of this paragraph to
consolidate his interest in a chain of export trade corporations and the
election to consolidate such corporations terminates under the
provisions of subparagraph (6) of this paragraph, such shareholder may
not thereafter elect under this section to consolidate his interest in
any corporation which was in that chain of export trade corporations
unless he receives the consent of the Commissioner to do so.
Application to obtain such consent of the Commissioner shall be made by
a letter mailed to the Commissioner of Internal Revenue, Washington, DC,
20224, before the close of the first taxable year of the top-tier
corporation of the chain of export trade corporations in which the
election to include such interest is to apply. Such application for
consent shall include a statement showing:
(i) With respect to such chain, the information required to be shown
in the statement described in subparagraph (4)(i) of this paragraph, and
(ii) The United States shareholder's interest in such chain which was
previously included in a consolidation, the taxable years of such
previous consolidation, and the manner in which such previous
consolidation was terminated.
(8) Illustration. The application of this paragraph may be
illustrated by the following example:
Example. Domestic corporation M owns 60 percent of the only class of
stock of foreign corporation A, and 100 percent of the only class of
stock of foreign corporation F, respectively. Corporation A owns 80
percent of the only class of stock of foreign corporations B and C,
respectively. Corporation M also owns 20 percent of the stock of B
Corporation. Corporation B owns 80 percent of the only class of stock
of foreign corporation D. Corporations B and C each own 50 percent of
the only class of stock of foreign corporation E. Corporation F owns
100 percent of the only class of stock of foreign corporation G, which
owns 100 percent of the only class of stock of foreign corporation H.
Corporation F also owns 20 percent of the stock of C Corporation.
Domestic corporations N and R own 30 percent and 10 percent,
respectively, of the stock of A Corporation. All corporations use the
calendar year as a taxable year, and all foreign corporations qualify as
export trade corporations for 1963. Corporation M may elect for 1963 to
consolidate its interest in the chain (the ''A'' chain) of export trade
corporations which includes corporations A, B, C, D, and E; and
Corporation M need not, but may, elect to consolidate its interest in
the chain (the ''F'' chain) of export trade corporations which includes
corporations F, G, and H. Consolidation of M Corporation's interest in
the ''A'' chain with its interest in the ''F'' chain is not permitted.
If M Corporation elects to consolidate the ''A'' chain, M Corporation
must include in the consolidation its 20 percent directly owned interest
in B Corporation and its 20 percent indirectly owned (through F
Corporation) interest in C Corporation. Either N Corporation or R
Corporation, or both, may join M Corporation in electing to consolidate
their interests in the ''A'' chain. However, neither N Corporation nor
R Corporation may elect to consolidate the ''A'' chain unless M
Corporation also agrees to so elect, because corporations N and R,
neither jointly nor separately, own more than 50 percent of the total
combined voting power of all classes of stock entitled to vote of A
Corporation. If corporations M, N, and R elect to consolidate the ''A''
chain, the determinations specified in subparagraph (1) of this
paragraph will be made on a consolidated basis with respect to such
corporations' respective interest in the chain as shown in the following
tabulation:
(b) Effect of consolidation -- (1) Determination of subpart F income,
export trade income, etc. An election under paragraph (a) of this
section to consolidate export trade corporations in a chain of such
corporations shall have no effect on the determination of the character
of income as subpart F income or on the determination of export trade
income, export trade income which constitutes foreign base company
income, or earnings and profits of the individual export trade
corporations in the chain. Thus, the consolidation of export trade
corporations under this section shall not have the effect of reducing
earnings and profits of such corporations or of changing the
characterization of income from that which is, for example, foreign base
company income to that which is not. The application of this paragraph
may be illustrated by the following example:
Example. Corporation A, incorporated under the laws of foreign
country X, and corporation B, incorporated under the laws of foreign
country Y, are both wholly owned subsidiaries of domestic corporation M.
Corporations A and B both qualify under section 971(a) as export trade
corporations. Corporation A purchases personal property produced in the
United States from an unrelated person and sells the property to B
Corporation for use outside of country X. Corporation B resells the
property to an unrelated person for use in foreign country Z.
Corporations A and B each derive foreign base company sales income
described in 1.954-3 from the purchase and sale transactions.
Consolidation of Corporations A and B under this section does not result
in the two transactions being treated as one transaction which is a
purchase of property from an unrelated person and a sale of property to
an unrelated person or the nonrecognition of gain on the sale of export
property by A Corporation to B Corporation.
(2) Determination of amount by which consolidated subpart F income is
reduced -- (i) In general. In determining the amount by which the
subpart F income of each export trade corporation includible in a
consolidation of export trade corporations shall be reduced as provided
in section 970(a) and paragraph (b)(1) of 1.970-1 for any taxable year
of consolidation, the limitations provided by section 970(a) and
paragraph (b)(2) of 1.970-1 on such amount for each such export trade
corporation shall be determined on the basis of such corporation's
separate share of --
(a) Amounts included in the total export promotion expense,
(b) The total gross receipts from the sale, installation, operation,
maintenance, or use of property in respect of which each such
corporation derives such export trade income as is properly allocable to
the export trade income which constitutes foreign base company income,
and
(c) The total increase in investments in export trade assets,
of all export trade corporations to which the consolidation applies
for the taxable year.
(ii) Limitations not effective. If for any taxable year each of the
limitations under paragraph (b)(2) of 1.970-1, determined on a
consolidated basis, equals or exceeds the total export trade income
which constitutes foreign base company income of all corporations
includible in the consolidation of export trade corporations, the
subpart F income of each includible corporation shall be reduced under
section 970(a) for such year by its separate export trade income which
constitutes foreign base company income.
(iii) Limitation effective. If for any taxable year one of the
limitations under paragraph (b)(2) of 1.970-1, determined on a
consolidated basis, is less than the total export trade income which
constitutes foreign base company income of all corporations includible
in the consolidation of export trade corporations, the amount by which
the subpart F income of each includible corporation shall be reduced
under section 970(a) for such year shall be an amount which bears the
same ratio to the amount by which the subpart F income may be reduced on
a consolidated basis as the export trade income which constitutes
foreign base company income of each includible corporation bears to the
total export trade income which constitutes foreign base company income
of all export trade corporations includible in the consolidation of
export trade corporations.
(iv) Illustration. The application of this subparagraph may be
illustrated by the following example:
Example. (a) Domestic corporation M owns 100 percent of the only
class of stock of controlled foreign corporation A, which, in turn, owns
100 percent of the only class of stock of controlled foreign corporation
B. All corporations use the calendar year as the taxable year, and
corporations A and B are export trade corporations throughout the period
here involved. Corporation M elects under this section to consolidate
corporations A and B for the entire period here involved. Corporation M
elects under paragraph (a)(2) of 1.970-2 for 1963 to determine both A
Corporation's and B Corporation's investments in export trade assets as
of the close of the 75th day after the close of such corporations'
taxable year.
(b) The following amounts are applicable to corporations A and B for
1964:
(c) The amount by which subpart F income of corporations A and B is
reduced for 1964 on a separate-company basis without regard to section
972 may be determined as set forth in items (i) through (vii) below, and
the results of the consolidation of corporations A and B for 1964 are
set forth in items (viii) through (x). Assuming an alternative case in
which for 1964 the facts are the same as set forth in paragraphs (a) and
(b) of this example except that B Corporation incurs export promotion
expenses of $50 (rather than $80) which are allocable to the export
trade income which constitutes foreign base company income, the results
of the consolidation of corporations A and B for such year (a case where
one of the limitations under paragraph (b)(2) of 1.970-1 is effective)
are set forth in items (xi) through (xiii):
(3) Determination of pro rata share of consolidated withdrawal of
previously excluded export trade income -- (i) In general. If, for any
taxable year, there is a decrease in investments in export trade assets
under section 970(b) and paragraph (c)(1) of 1.970-1, determined on a
consolidated basis, of export trade corporations includible in a
consolidated chain of such corporations, each United States shareholder
who has elected under paragraph (a) of this section to consolidate his
interest in such chain of corporations shall include in his gross
income, under section 951(a)(1)(A)(ii) and the regulations thereunder as
an amount to which section 955 (as in effect before the enactment of the
Tax Reduction Act of 1975) applies, his pro rata share of the amount of
such consolidated decrease in investments but only to the extent such
pro rata share does not exceed the lesser of the limitations provided by
section 970(b) and paragraph (c)(2) of 1.970-1 with respect to such
shareholder determined on a consolidated basis. The consolidated
decrease in investments and the consolidated limitations shall be
determined by aggregating the applicable amounts determined under
paragraph (c) of 1.970-1 with respect to such shareholder's interest in
each corporation includible in the consolidation.
(ii) Allocation of pro rata share of consolidated decrease in
investments in export trade assets. For purposes of determining the
amount referred to in paragraph (c)(2)(i)(b)(3) of 1.970-1 for a
subsequent taxable year, a United States shareholder's pro rata share of
a consolidated decrease in investments determined under subdivision (i)
of this subparagraph for the current taxable year shall be allocated to
such shareholder's interest in each of the export trade corporations
includible in the consolidation in that ratio which --
(a) The net amount determined under paragraph (c)(2)(i)(b) of
1.970-1 with respect to such shareholder's interest in such corporation
for all prior taxable years (whether or not a taxable year occurring
during the period of consolidation) bears to
(b) The total of the net amounts determined under paragraph (c)(2)(i)
(b) of 1.970-1 with respect to such shareholder's interests in all
export trade corporations includible in such consolidation for all prior
taxable years (whether or not a taxable year occurring during the period
of consolidation).
(iii) Illustration. The application of this subparagraph may be
illustrated by the following example:
Example. (a) Domestic corporation M owns 60 percent of the only class
of stock of controlled foreign corporation A, which, in turn, owns 100
percent of the only class of stock of controlled foreign corporation B.
All corporations use the calendar year as a taxable year, and
corporations A and B are export trade corporations throughout the period
here involved. Corporation M elects to consolidate corporations A and B
for the entire period here involved.
(b) The following amounts are applicable to corporations A and B for
1964:
Corporation M must include $60 in its gross income for 1964 under
section 951(a)(1)(A)(ii) by reason of the application of section 970(b)
as its pro rata share of the consolidated decrease in investments in
export trade assets; and, for purposes of determining the amount under
paragraph (c)(2)(i)(b)(3) of 1.970-1 with respect to M Corporation's
interest in each of corporations A and B for a subsequent taxable year,
such consolidated decrease for 1964 is allocated as follows: to M
Corporation's interest in A Corporation, $45 ($60 times $180/$240); and
to its interest in B Corporation, $15 ($60 times $60/$240).
(c) The following amounts are applicable to corporations A and B for
1965:
Corporation M must include $80 in its gross income for 1965 under
section 951(a)(1)(A)(ii) by reason of the application of section 970(b)
as its pro rata share of the consolidated decrease in investments in
export trade assets; and, for purposes of determining the amount under
paragraph (c)(2)(i)(b)(3) of 1.970-1 with respect to M Corporation's
interest in each of corporations A and B for a subsequent taxable year,
such consolidated decrease for 1965 is allocated as follows: to M
Corporation's interest in A Corporation, $60 ($80 times $135/$180); and
to its interest in B Corporation, $20 ($80 times $45/$180).
(d) The following amounts are applicable to corporations A and B for
1966:
Corporation M must include $100 in its gross income for 1966 under
section 951(a)(1)(A)(ii) by reason of the application of section 970(b)
as its pro rata share of the consolidated decrease in investments in
export trade assets; and, for purposes of determining the amount under
paragraph (c)(2)(i)(b)(3) of 1.970-1 with respect to M Corporation's
interest in each of corporations A and B for a subsequent taxable year,
such consolidated decrease for 1966 is allocated as follows: to M
Corporation's interest in A Corporation, $75 ($100 times $75/$100); and
to its interest in B Corporation, $25 ($100 times $25/$100).
(T.D. 6754, 29 FR 12714, Sept. 9, 1964, as amended by T.D. 7893, 48
FR 22512, May 19, 1983)
26 CFR 1.981-0 Repeal of section 981; effective dates.
The provisions of section 981 are not effective for taxable years
beginning after December 31, 1976. For the treatment of the community
income of aliens and their spouses for taxable years beginning after
December 31, 1976, see section 879 and the regulations thereunder.
(T.D. 7670, 45 FR 6929, Jan. 31, 1980)
26 CFR 1.981-1 Foreign law community income for taxable years beginning
after December 31, 1966, and before January 1, 1977.
(a) Election for special treatment -- (1) In general. An individual
citizen of the United States who meets the requirements of section
981(a)(1) and subparagraph (2) of this paragraph for any open taxable
year beginning after December 31, 1966, and before January 1, 1977, may
make a binding election with his nonresident alien spouse to have
section 981(b) and paragraph (b) of this section apply to their income
for such year which is treated as community income under the applicable
community property laws of a foreign country or countries. Generally,
the community property laws of a foreign country operate upon land
situated within its jurisdiction and upon personal property owned by
spouses domiciled therein. If the election is made for any taxable
year, it shall also apply for all subsequent open taxable years of such
citizen and his nonresident alien spouse for which all the requirements
of section 981(a)(1) and subparagraph (2) of this paragraph are met,
unless the Director of International Operations consents, in accordance
with paragraph (c)(2) of this section, to a termination of the election.
An election under section 981(a) and this section has no effect for any
taxable year beginning before January 1, 1967, for which a separate
election, if made, must be made under section 981(c)(1) and 1.981-2.
For the definition of ''open taxable year'' see section 981(e)(2) and
paragraph (a) of 1.981-3. If the citizen and his nonresident alien
spouse have different taxable years, see paragraph (c) of 1.981-3. If
one of the spouses is deceased, see paragraph (d) of 1.981-3.
(2) Requirements to be met. In order for a U.S. citizen and his
nonresident alien spouse to make an election under section 981(a) and
this section for any taxable year and in order for the election to apply
for any subsequent taxable year it is required under section 981(a)(1)
that, for each such taxable year, such citizen be (i) a citizen of the
United States, (ii) a bona fide resident of a foreign country or
countries during the entire taxable year, and (iii) married at the close
of the taxable year to an individual who is (a) a nonresident alien
during the entire taxable year and (b), in the case of any such
subsequent taxable year, the same nonresident alien individual to whom
the citizen was married at the close of the earliest of such taxable
years. If either spouse dies during a taxable year, the taxable year of
the surviving spouse shall be treated, solely for purposes of making the
determination under subdivision (iii) of this subparagraph, as ending on
the date of such death. A citizen of the United States shall be
considered as not married at the close of his taxable year if he is
legally separated from his spouse under a decree of divorce or of
separate maintenance. However, the mere fact that spouses have not
lived together during the course of the taxable year shall not cause
them to be considered as not married at the close of the taxable year.
A husband and wife who are separated under an interlocutory decree of
divorce retain the relationship of husband and wife until the decree
becomes final.
(3) Determination of residence. The principles of paragraphs (a)(2)
and (b)(7) of 1.911-1 (26 CFR 1.911-1 (1978)) shall apply in order to
determine for purposes of this paragraph whether a U.S. citizen is a
bona fide resident of a foreign country or countries during the entire
taxable year. The principles of 1.871.2 through 1.871-5 shall apply
in order to determine whether the alien spouse of a U.S. citizen is a
nonresident during the entire taxable year.
(4) Manner of electing. The election under section 981(a) and this
section shall be made in accordance with the applicable rules set forth
in paragraph (c) of this section.
(b) Treatment of community income -- (1) In general. Community
income for any taxable year to which an election under section 981(a)
and this section applies, and the deductions properly allocable to such
income, shall be divided between the electing U.S. citizen and
nonresident alien spouses in accordance with the rules set forth in
section 981(b) and subparagraphs (2) through (6) of this paragraph.
Community income for this purpose means all gross income, whether
derived from sources within or without the United States, which is
treated as community income of the spouses under the community property
laws of the foreign country having jurisdiction to determine the legal
ownership of the income. A spouse has ownership of the income for this
purpose if under the applicable foreign law he has a proprietary vested
interest in the income.
(2) Earned income. Wages, salaries, or professional fees, and other
amounts received as compensation for personal services actually
performed, which are community income for the taxable year, shall be
treated as the income of the spouse who actually performed the personal
services. This subparagraph does not apply, however, to community
income (i) derived from any trade or business carried on by the husband
or the wife, (ii) attributable to a spouse's distributive share of the
income of a partnership to which subparagraph (4) of this paragraph
applies, (iii) consisting of compensation for personal services rendered
to a corporation which represents a distribution of the earnings and
profits of the corporation rather than a reasonable allowance as
compensation for the personal services actually performed, or (iv)
derived from property which is acquired as consideration for personal
services performed.
(3) Trade or business income. If any income derived from a trade or
business carried on by the husband or wife is community income for the
taxable year, all of the gross income, and the deductions attributable
to such income, shall be treated as the gross income and deductions of
the husband unless the wife exercises substantially all of the
management and control of the trade or business, in which case all of
the gross income and deductions shall be treated as the gross income and
deductions of the wife. This subparagraph does not apply to any income
derived from a trade or business carried on by a partnership of which
both or one of the spouses is a member. For purposes of this
subparagraph, income derived from a trade or business includes any
income derived from a trade or business in which both personal services
and capital are material income producing factors. The term
''management and control'' means management and control in fact, not the
management and control imputed to the husband under the community
property laws of a foreign country. For example, a wife who operates a
beauty parlor without any appreciable collaboration on the part of a
husband is considered as having substantially all of the management and
control of the business despite the provisions of any community property
laws of a foreign country vesting in the husband the right of management
and control of community property; and the income and deductions
attributable to the operation of the beauty parlor are considered the
income and deductions of the wife.
(4) Partnership income. If any portion of a spouse's distributive
share of the income of a partnership of which such spouse is a member is
community income for the taxable year, all of that distributive share
shall be treated as the income of that spouse and shall not be taken
into account in determining the income of the other spouse. If both
spouses are members of the same partnership, the distributive share of
the income of each spouse which is community income shall be treated as
the income of that spouse. A spouse's distributive share of such income
of a partnership shall be determined as provided in section 704, and the
regulations thereunder.
(5) Income from separate property. Any community income for the
taxable year, other than income described in section 981(b) (1) or (2)
and subparagraph (2), (3), or (4) of this paragraph, which is derived
from the separate property of one of the spouses shall be treated as the
income of that spouse. The determination of what property is separate
property for this purpose shall be made in accordance with the laws of
the foreign country which, in accordance with subparagraph (1) of this
paragraph, has jurisdiction to determine that the income from such
property is community income.
(6) Other community income. Any community income for the taxable
year, other than income described in section 981(b) (1), (2), or (3),
and subparagraph (2), (3), (4), or (5) of this paragraph, shall be
treated as the income of that spouse who has a proprietary vested
interest in that income under the laws of the foreign country which, in
accordance with subparagraph (1) of this paragraph, has jurisdiction to
determine that such income is community income. Thus, for example, this
subparagraph applies to community income not described in subparagraph
(2), (3), (4), or (5) of this paragraph which consists of dividends,
interest, rents, royalties, or gains, from community property or of the
earnings of unemancipated minor children.
(7) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. H, a nonresident alien individual and W, a U.S. citizen,
each of whose taxable years is the calendar year, were married
throughout 1967. H and W were residents of, and domiciled in, foreign
country Z during the entire taxable year. During 1967, H earned $10,000
from the performance of personal services as an employee. H also
received $500 in dividend income from stock which under the community
property laws of country Z is considered to be the separate property of
H. W had no separate income for 1967. Under the community property
laws of country Z all income earned by either spouse is considered to be
community income, and one-half of such income is considered to belong to
the other spouse. In addition, such laws of country Z provide that all
income derived from property held separately by either spouse is to be
treated as community income and treated as belonging one-half to each
spouse. Thus, under the community property laws of country Z, H and W
are both considered to have realized income of $5,250 during 1967, even
though such laws recognize the stock as the separate property of H. If
the election under this section is in effect for 1967, under the rules
of subparagraphs (2) and (5) of this paragraph all of the income of
$10,500 derived during 1967 shall be treated, for U.S. income tax
purposes, as the income of H.
Example 2. The facts are the same as in example 1 except that H is
the sole proprietor of a retail merchandising company and such company
has a $10,000 profit during 1967. W exercises no management and control
over the business. In addition, H is a partner in a wholesale
distributing company, and his distributive share of the partnership
profit is $5,000. Both of these amounts of income are treated as
community income under the community property laws of country Z, and
under such laws both H and W are treated as realizing $7,500 of such
income. If the election under this section is in effect for 1967, under
the rule of subparagraphs (3) and (4) of this paragraph all $15,000 of
such income shall be treated as the income of H for U.S. income tax
purposes.
Example 3. The facts are the same as in example 1 except that H also
received $1,000 in dividends on stock held separately in his name.
Under the community property laws of country Z the stock is considered
to be community property; and the dividends, to be community income,
one-half of such income being treated as the income of each spouse. If
the election under this section is in effect for 1967, under the rule of
subparagraph (6) of this paragraph, $500 of the dividend income shall be
treated, for U.S. income tax purposes, as the income of each spouse.
(c) Time and manner of making or terminating an election -- (1) In
general. A citizen of the United States and his nonresident alien
spouse shall, for the first taxable year beginning after December 31,
1966, for which an election under section 981(a) and this section is to
apply, make the election by filing a return, an amended return, or a
claim for refund, whichever is proper, for such taxable year and
attaching thereto a statement that the election is being made and that
the requirements of paragraph (a)(2) of this section are met for such
taxable year. The statement must show the name, address, and account
number, if any, of each spouse, the name and address of the executor,
administrator, or other person making the election for a deceased
spouse, the taxable year to which the election applies, and the name of
the foreign country or countries having jurisdiction to determine the
ownership of any income being treated in accordance with section 981(b)
and paragraph (b) of this section. The statement must be signed by both
persons making the election. An election under this section may be made
only for a taxable year which, on the date of the election, as defined
in paragraph (b) of 1.981-3, is open within the meaning of section
981(e)(2) and paragraph (a) of 1.981-3.
(2) Termination only with consent of Director of International
Operations -- (i) In general. An election under this section for any
taxable year is binding and may not be revoked. The election shall also
remain in effect for all subsequent taxable years of the spouses for
which the requirements of paragraph (a)(2) of this section are met and
which on the date of the election are open, within the meaning of
paragraph (a) of 1.981-3, unless the election is terminated for any
such subsequent taxable year or years in accordance with subdivision
(ii) of this subparagraph. Any return, amended return, or claim for
refund in respect of any such subsequent taxable year for which the
election is in effect shall have attached thereto a copy of the
statement filed in accordance with subparagraph (1) of this paragraph
and an additional signed statement that for such subsequent taxable year
the requirements of paragraph (a)(2) of this section are met.
(ii) Written request to terminate required. A request to terminate
an election under this section for a subsequent taxable year or years
shall be made in writing by the persons who made the election and shall
be addressed to the Director of International Operations, Internal
Revenue Service, Washington, DC 20225. The request must include the
name, address, and account number, if any, of each spouse and must be
signed by the persons making the request. It must specify the taxable
year or years for which the termination is to be effective and the
grounds which justify the termination. The request shall be filed not
later than 90 days before the close of the period for assessing a
deficiency against the U.S. citizen for the earliest taxable year of
such citizen for which the termination is to be effective. The Director
of International Operations may require such other information as may be
necessary in order to determine whether the termination will be
permitted. A copy of the consent by the Director of International
Operations to terminate must be attached to an amended income tax return
for each taxable year for which the termination is effective and for
which a return has previously been filed.
(Secs. 913(m) (92 Stat. 3106; 26 U.S.C. 913(m)), and 7805 (68A Stat.
917; 26 U.S.C. 7805), Internal Revenue Code of 1954)
(T.D. 7330, 39 FR 38372, Oct. 31, 1974, as amended by T.D. 7670, 45
FR 6929, Jan. 31, 1980; T.D. 7736, 45 FR 76143, Nov. 18, 1980)
26 CFR 1.981-2 Foreign law community income for taxable years beginning
before January 1, 1967.
(a) Election for special treatment -- (1) In general. For all open
taxable years beginning before January 1, 1967, for which an individual
citizen of the United States meets the requirements of subparagraphs (A)
and (C) of section 981(a)(1) and subparagraph (2) of this paragraph,
such citizen and his nonresident alien spouse may make a joint election
to have section 981(c)(2) and paragraph (b) of this section apply to
their income which is treated as community income under the applicable
community property laws of a foreign country or countries. However, if
the conditions prescribed by section 981(d)(3) and subparagraph (3) of
this paragraph are met, the nonresident alien spouse is not required to
join in the election and such citizen may make a separate election to
have section 981(c)(2) and paragraph (b) of this section apply to such
income for such taxable years. An election under section 981(c)(1) and
this section shall apply to every open taxable year of such citizen and
his nonresident alien spouse beginning before January 1, 1967, for which
all the requirements of subparagraphs (A) and (C) of section 981(a)(1)
and subparagraph (2) of this paragraph are met. It is immaterial
whether such open taxable year is a taxable year subject to the
provisions of the 1954 Code, the 1939 Code, or any other internal
revenue law in effect before the 1939 Code. An election under section
981(c)(1) and this section has no effect for any taxable year beginning
after December 31, 1966. For the definition of ''open taxable year''
see section 981(e)(2) and paragraph (a) of 1.981-3. If the citizen and
his nonresident alien spouse have different taxable years, see paragraph
(c) of 1.981-3. If one of the spouses is deceased, see paragraph (d) of
1.981-3. An election under section 981(c)(1) and this section is
binding and may not be revoked.
(2) Requirements to be met. In order for the citizen of the United
States to make an election under this section, whether required to be
made jointly with his nonresident alien spouse or permitted to be made
separately, it is required under section 981(c)(1) that, for each
taxable year to which the election applies, the citizen making the
election be (i) a citizen of the United States and (ii) married at the
close of the taxable year to an individual who is (a) a nonresident
alien during the entire taxable year and (b), in the case of any such
taxable years subsequent to the first, the same nonresident alien
individual to whom the citizen was married at the close of such first
taxable year. The provisions of paragraph (a)(2) of 1.981-1 apply to
determine whether a U.S. citizen making an election under section
981(c)(1) and this section is married at the close of a taxable year to
an individual who is a nonresident alien during the entire taxable year.
(3) Cases where joint election is not required. A nonresident alien
spouse is not required to join in an election under section 981(c)(1)
and this section if the Director of International Operations determines
in accordance with paragraph (c)(4) of this section --
(i) That an election under section 981(c)(1) and this section would
not affect the liability for Federal income tax of the nonresident alien
spouse for any taxable year, whether beginning on, before, or after
January 1, 1967, or
(ii) That the effect of the election on the liability of the
nonresident alien spouse for Federal income tax for any such taxable
year cannot be ascertained and that to deny the election to the U.S.
citizen spouse would be inequitable and cause undue hardship to the U.S.
citizen.
If in accordance with this subparagraph the nonresident alien spouse
is not required to join in the election by the U.S. citizen, the
provisions of section 981(d)(2) and paragraph (e) of 1.981-3 shall not
apply so as to extend the period for assessing deficiencies or filing a
claim for credit or refund for any taxable year of the nonresident alien
spouse.
(4) Manner of electing. The election under section 981(c)(1) and
this section shall be made in accordance with the applicable rules set
forth in paragraph (c) of this section.
(b) Treatment of community income -- (1) In general. Community
income, as defined in paragraph (b)(1) of 1.981-1, for any taxable year
beginning before January 1, 1967, to which an election under section
981(c)(1) and this section applies, and the deductions properly
allocable to such income, shall be divided between the U.S. citizen and
his nonresident alien spouse in accordance with the rules set forth in
section 981(c)(2) and subparagraphs (2) and (3) of this paragraph. The
income shall be divided in such manner even though the nonresident alien
spouse is not required, in accordance with paragraph (a)(3) of this
section, to join in the election by the U.S. citizen.
(2) Earned income, business income, partnership income, and income
from separate property. All community income for any taxable year to
which this paragraph applies which is treated as the income of one of
the spouses in accordance with section 981(b) (1), (2), or (3) and
paragraph (b) (2), (3), (4), or (5) of 1.981-1 shall be treated as the
income of that spouse for purposes of this paragraph.
(3) Other community income. All community income for any taxable
year to which this paragraph applies, other than income described in
subparagraph (2) of this paragraph, shall be treated as the income of
the spouse who, for such taxable year, has a greater amount of gross
income than the other spouse, determined by adding to the amount of
gross income which is treated as the gross income of that spouse in
accordance with subparagraph (2) of this paragraph the amount of the
gross income for the taxable year which is treated as the separate
income of that spouse under the community property laws of the foreign
country having jurisdiction to determine the legal ownership of the
income. If either spouse dies during a taxable year, the taxable year
of the surviving spouse shall be treated as ending on the date of such
death for the purpose of determining which spouse has the greater amount
of gross income for such taxable year. Moreover, if the U.S. citizen
and his nonresident alien spouse do not have the same taxable year, as
defined in section 441(b) and the regulations thereunder, the periods
for which the amounts of gross income are to be compared under this
subparagraph are (i) the taxable year of the citizen and (ii) that
period falling within the consecutive taxable years of the nonresident
alien spouse which coincides with the period covered by such taxable
year of the citizen. See paragraph (c) of 1.981-3.
(c) Time and manner of making election -- (1) In general. A citizen
of the United States and his nonresident alien spouse or, if
subparagraph (4) of this paragraph applies, such citizen alone may make
an election under section 981(c)(1) and this section at any time on or
after November 13, 1966, for each and every taxable year beginning
before January 1, 1967, which on the date of the election, as defined in
paragraph (b) of 1.981-3, is open within the meaning of section
981(e)(2) and paragraph (a) of 1.981-3. The election shall be made by
filing a return, an amended return, or a claim for refund, whichever is
proper, for each taxable year to which the election applies and
attaching thereto a statement that the election is being made and that
the requirements of paragraph (a)(2) of this section are met for each
such taxable year. The statement must also show the information
required by subparagraph (2) of this paragraph and must, where
applicable, be signed by both persons making the election.
(2) Information required. The statement described in subparagraph
(1) of this paragraph must show --
(i) The name, address, and account number, if any, of each spouse,
(ii) The name and address of the executor, administrator, or other
person making the election for a deceased spouse,
(iii) The taxable years to which the election applies,
(iv) The office of the district director, or the service center,
where the return or returns, if any, for such taxable year or years were
filed,
(v) The dates on which such return or returns, if any, were filed and
on which the tax for such taxable year or years was paid, if the tax has
been paid, and
(vi) The name of the foreign country or countries having jurisdiction
to determine the ownership of any income being treated in accordance
with section 981(c)(2) and paragraph (b) of this section.
(3) Place for filing. Any return, amended return, or claim for
refund filed under subparagraph (1) of this paragraph in respect of any
taxable year shall be filed with the Director of International
Operations, Internal Revenue Service, Washington, DC 20225. (See
1.6091-3.)
(4) Determination that joint election is not required. A U.S.
citizen spouse entitled to make an election under section 981(c)(1) and
this section for open taxable years beginning before January 1, 1967,
may apply to the Director of International Operations for a
determination under section 981(d)(3) that the nonresident alien spouse
is not required to join in the election by such citizen. This
application shall be made by filing with the Director of International
Operations, Internal Revenue Service, Washington, DC 20225, a statement
setting forth the same information required by subparagraph (2) of this
paragraph and such other information as is required by the Director of
International Operations to justify a claim that the requirements of
section 981(d)(3) and paragraph (a)(3) of this section are met. The
Director of International Operations shall notify the U.S. citizen by
letter of his determination with respect to the application. If the
determination is that the nonresident alien spouse is not required to
join in the election, a copy of the letter of determination shall be
attached to each return, amended return, or claim for refund, to be
filed pursuant to subparagraph (1) of this paragraph.
(T.D. 7330, 39 FR 38373, Oct. 31, 1974)
26 CFR 1.981-3 Definitions and other special rules.
(a) Open taxable years. (1) For purposes of paragraph (a) of
1.981-1, and paragraph (a) of 1.981-2, a taxable year of the U.S.
citizen, and the taxable year or years of his nonresident alien spouse
ending or beginning within such taxable year of such citizen, shall be
treated as open if the period prescribed by section 6501(a) (or section
6501(c)(4) if the period is extended by agreement) for assessing a
deficiency against the citizen for his taxable year has not expired
before the date of the election, determined under paragraph (b) of this
section. Thus, for example, a taxable year of a U.S. citizen beginning
before January 1, 1967, is open for purposes of this subparagraph if,
before the election under section 981(c)(1) and 1.981-2, such citizen
has never filed a return for such year and a return was required under
section 6012 without reference to section 981. For example, if a U.S.
citizen spouse on a calendar year basis who has never filed a return for
1960 decides in 1975 that he wishes to make the election under section
981(c)(1) and 1.981-2 in order to avoid being subject to tax for 1960
on his share of the community income for that year, he may in 1975 elect
the benefits of section 981(c)(2) by filing an election in accordance
with paragraph (c) of 1.981-2. In such case, a taxable year or years of
the nonresident alien spouse of such citizen ending or beginning within
1960 shall be treated in 1975 as an open taxable year.
(2) Subparagraph (1) of this paragraph shall apply even though the
period prescribed by section 6501 for assessing a deficiency against the
nonresident alien spouse for his taxable year or years ending or
beginning within the taxable year of the U.S. citizen has expired before
the election is made.
(3) If either spouse dies during a taxable year to which an election
under 1.981-1 or 1.981-2 applies, the taxable year of the decedent and
the surviving spouse shall be determined under this paragraph without
regard to section 981(e)(4), relating to death of spouse during the
taxable year. See paragraph (a)(2) of 1.443-1.
(4) For definition of the term ''taxable year'', see section 441(b)
and the regulations thereunder.
(b) Date of election. (1) For purposes of 1.981-1 and this section
the date of an election made under section 981(a) and 1.981-1 is the
date on which the return, amended return, or claim for refund required
by paragraph (c)(1) of 1.981-1 is filed.
(2) For purposes of 1.981-2 and this section the date of an election
made under section 981(c)(1) and 1.981-2 is the date on which the
returns, amended returns, or claims for refund, required by paragraph
(c)(1) of 1.981-2 are filed.
(3) For provisions treating timely mailing as timely filing, see
section 7502 and the regulations thereunder.
(c) Spouses with different taxable years. If the U.S. citizen and
his nonresident alien spouse do not have the same taxable year, as
defined in section 441(b) and the regulations thereunder, the election
under 1.981-1 or 1.981-2 shall apply to each taxable year of such
citizen in respect of which the election is made and to that period
falling within the consecutive taxable years of the nonresident alien
spouse which coincides with the period covered by such taxable year of
the citizen.
(d) Election on behalf of deceased spouse. Any election, statement,
or request, required to be made under paragraph (c) of 1.981-1, or
paragraph (c) of 1.981-2, by one of the spouses may, if such spouse is
deceased, be made by the executor, administrator, or other person
charged with the property of such deceased spouse.
(e) Extension of period of limitations on assessment or refund -- (1)
Assessment of deficiency. Except as provided in subparagraph (3) of
this paragraph, if an election under section 981(a) and 1.981-1, or
under section 981(c)(1) and 1.981-2, is properly made, the period
within which a deficiency may be assessed for any taxable year to which
the election applies shall, to the extent the deficiency is attributable
to the application of such election, not expire before one year after
the date of the election, determined under paragraph (b) of this
section.
(2) Refund of tax. Except as provided in subparagraph (3) of this
paragraph, if an election under section 981(a) and 1.981-1, or under
section 981(c)(1) and 1.981-2, is properly made, the period within
which a claim for credit or refund of an overpayment for any taxable
year to which the election applies may be filed shall, to the extent the
overpayment is attributable to the application of the election, not
expire before one year after the date of the election, determined under
paragraph (b) of this section.
(3) Exception in case of nonelecting alien. Subparagraphs (1) and
(2) of this paragraph shall not apply to any taxable year of a
nonresident alien spouse who, in accordance with paragraph (a)(3) of
1.981-2, is not required to join in the election by the U.S. citizen
spouse under section 981(c)(1) and 1.981-2.
(f) Payment of interest for extension period. To the extent that an
overpayment or deficiency for any taxable year is attributable to an
election made under 1.981-1 or 1.981-2, no interest shall be allowed
or paid for any period ending with the day before the date which is one
year after the date of the election, determined under paragraph (b) of
this section.
(T.D. 7330, 39 FR 38374, Oct. 31, 1974)
26 CFR 1.985-0 Outline of regulation.
This section lists the paragraphs contained in 1.985-1 through
1.985-6T.
26 CFR 1.985-0 1.985-1 Functional currency.
(a) Applicability and effective date.
(b) Dollar functional currency.
(c) Functional currency of a QBU that is not required to use the
dollar.
(d) Single functional currency for a foreign corporation.
(e) Translation of nonfunctional currency transactions.
(f) Examples.
26 CFR 1.985-0 1.985-2 Election to use the United States dollar as the
functional currency of a QBU.
(a) Background and scope.
(b) Eligible QBU.
(c) Time and manner for dollar election.
(d) Effect of dollar election.
26 CFR 1.985-0 1.985-3 United States dollar approximate separate
transactions method.
(a) Scope.
(b) In general.
(c) Translation into United States dollars.
(d) Currency gain or loss.
26 CFR 1.985-0 1.985-4 Method of accounting.
(a) Adoption or election.
(b) Condition for changing functional currencies.
(c) Relationship to certain other sections of the Code.
26 CFR 1.985-0 1.985-5T Adjustments required upon change in functional
currency (Temporary regulation).
(a) In general.
(b) Step 1 -- Taking into account exchange gain or loss on certain
section 988 transactions.
(c) Step 2 -- Determining the new functional currency basis of
property and the new functional currency amount of liabilities and any
other relevant items.
(d) Step 3A -- Additional adjustments that are necessary when a
branch changes functional currency.
(e) Step 3B -- Additional adjustments that are necessary when a
taxpayer changes functional currency.
(f) Examples.
26 CFR 1.985-0 1.985-6T Transition rules for a QBU that uses the
dollar approximate separate transactions method for its first taxable
year beginning in 1987.
(a) In general.
(b) Certain controlled foreign corporations.
(c) All other foreign corporations.
(d) Net worth branch.
(e) Profit and loss branch.
(T.D. 8263, 54 FR 38653, Sept. 20, 1989)
26 CFR 1.985-1 Functional currency.
(a) Applicability and effective date -- (1) Purpose and scope. These
regulations provide guidance with respect to defining the functional
currency of a taxpayer and each qualified business unit (QBU), as
defined in section 989(a). Generally, a taxpayer and each QBU must make
all determinations under subtitle A of the Code (relating to income
taxes) in its respective functional currency. This section sets forth
rules for determining when the functional currency is the United States
dollar (dollar) or a currency other than the dollar. Section 1.985-2
provides an election to use the dollar as the functional currency for
certain QBUs that absent the election would have a functional currency
that is a hyperinflationary currency, and explains the effect of making
the election. Section 1.985-3 sets forth the accounting method electing
QBUs must use to compute their income or loss or earnings and profits.
Section 1.985-4 provides that the adoption of a functional currency is a
method of accounting and sets forth conditions for a change in
functional currency. Section 1.985-5T provides adjustments that are
required to be made upon a change in functional currency. Finally,
1.985-6T provides transition rules for a QBU that uses the dollar
approximate separate transactions method for its first taxable year
beginning after December 31, 1986.
(2) Effective date. These regulations apply to taxable years
beginning after December 31, 1986. However, any taxpayer desiring to
apply temporary Income Tax Regulations 1.985-0T through 1.985-4T in
lieu of these regulations to all taxable years beginning after December
31, 1986, and on or before October 20, 1989 may (on a consistent basis)
so choose. For the text of the temporary regulations, see 53 FR 20308
(1988).
(b) Dollar functional currency. The dollar shall be the functional
currency of a taxpayer or QBU described in any of the following
regardless of the currency used in keeping its books and records (as
defined in 1.989(a)-1T(d) or any succeeding Final Regulations):
(1) A taxpayer that is not a QBU (e.g., an individual);
(2) A QBU that conducts its activities primarily in dollars. A QBU
conducts its activities primarily in dollars if the currency of the
economic environment in which the QBU conducts its activities is
primarily the dollar. The facts and circumstances test set forth in
paragraph (c)(2) of this section shall apply in making this
determination;
(3) Except as otherwise provided, a QBU that has the United States,
or any possession or territory of the United States where the dollar is
the standard currency, as its residence (as defined in section
988(a)(3)(B));
(4) A QBU that elects to use, or is otherwise required to use, the
dollar as its functional currency under 1.985-2;
(5) A QBU that does not keep books and records in the currency of any
economic environment in which a significant part of its activities is
conducted. Whether a QBU keeps such books and records is determined in
accordance with paragraph (c)(3) of this section; or
(6) Any activity (wherever conducted and regardless of its frequency)
that produces income or loss that is, or is treated as, effectively
connected with the conduct of a trade or business within the United
States shall be treated as a separate QBU with a dollar functional
currency.
Regardless of any change in circumstances, a QBU described in this
paragraph (b) may change its functional currency only if the QBU
complies with 1.985-4.
(c) Functional currency of a QBU that is not required to use the
dollar -- (1) General rule. The functional currency of a QBU that is
not required to use the dollar under paragraph (b) of this section shall
be the currency of the economic environment in which a significant part
of the QBU's activities is conducted, if the QBU keeps, or is presumed
under paragraph (c)(3) of this section to keep, its books and records in
such currency.
(2) Economic environment. For purposes of section 985 and the
regulations thereunder, the economic environment in which a significant
part of a QBU's activities is conducted shall be determined by taking
into account all the facts and circumstances.
(i) Facts and circumstances. The facts and circumstances that are
considered in determining the economic environment in which a
significant part of a QBU's activities is conducted include, but are not
limited to, the following:
(A) The currency of the country in which the QBU is a resident as
determined under section 988(a)(3)(B);
(B) The currencies of the QBU's cash flows;
(C) The currencies in which the QBU generates revenues and incurs
expenses;
(D) The currencies in which the QBU borrows and lends;
(E) The currencies of the QBU's sales markets;
(F) The currencies in which pricing and other financial decisions are
made;
(G) The duration of the QBU's business operations; and
(H) The significance and/or volume of the QBU's independent
activities.
(ii) Rate of inflation. The rate of inflation (regardless of how it
is determined) shall not be a factor used to determine a QBU's economic
environment.
(iii) Consistency. A taxpayer must consistently apply the facts and
circumstances test set forth in this paragraph (c)(2) in evaluating the
economic environment of its QBUs, e.g., its branches, that engage in the
same or similar trades or businesses.
(3) Books and records presumption. A QBU shall be presumed to keep
books and records in the currency of the economic environment in which a
significant part of its activities are conducted. The presumption may
be overcome only if the QBU can demonstrate to the satisfaction of the
district director that a substantial nontax purpose exists for not
keeping any books and records in such currency. A taxpayer may not use
this presumption affirmatively in determining a QBU's functional
currency.
(4) Multiple currencies. If a QBU has more than one currency that
satisfies the requirements of paragraph (c)(1) of this section, the QBU
may choose any such currency as its functional currency.
(5) Relationship of United States accounting principles. In making
the functional currency determination under this paragraph (c), the
currency of the QBU for purposes of United States generally accepted
accounting principles (GAAP) will ordinarily be accepted as the
functional currency of the QBU for income tax purposes, provided that
the GAAP determination is based on facts and circumstances substantially
similar to those set forth in paragraph (c)(2) of this section.
(6) Effect of changed circumstances. Regardless of any change in
circumstances, a QBU may change its functional currency determined under
this paragraph (c) only if the QBU complies with 1.985-4 or the
Commissioner's consent is considered to have been granted under
1.985-2(d)(4).
(d) Single functional currency for a foreign corporation -- (1)
General rule. This paragraph (d) applies to a foreign corporation that
has two or more QBUs that do not have the same functional currency. The
foreign corporation shall be treated as having a single functional
currency for the corporation as a whole that is different from the
functional currency of one or more of its QBUs. The determination of a
foreign corporation's functional currency shall be made by first
applying paragraph (d)(1)(i) and then paragraph (d)(l)(ii) of this
section.
(i) Step 1. Each QBU of the foreign corporation determines its
functional currency in accordance with the rules set forth in paragraphs
(b) and (c) of this section and 1.985-2.
(ii) Step 2. The foreign corporation determines its functional
currency applying the principles of paragraphs (b) and (c) of this
section to the corporation's activities as a whole. Thus, if a foreign
corporation has two branches, the corporation shall determine its
functional currency by applying the principles of paragraphs (b) and (c)
of this section to the combined activities of the corporation and the
branches.
For purposes of this paragraph (d)(1), if a QBU of a foreign
corporation has the dollar as its functional currency under 1.985-2,
the QBU's activities shall be considered dollar activities of the
corporation.
(2) Translation of income or loss of QBUs having different functional
currencies than the foreign corporation as a whole. Where the
functional currency of a foreign corporation as a whole differs from the
functional currency of one or more of its QBUs, each such QBU shall
determine the amount of its income or loss or earnings and profits (or
deficit in earnings and profits) in its functional currency under the
principles of section 987 (relating to branch transactions). The amount
of income or loss or earnings and profits (or deficit in earnings and
profits) of each QBU in its functional currency shall then be translated
into the foreign corporation's functional currency using the appropriate
exchange rate as defined in section 989(b)(4) for purposes of
determining the corporation's income or loss or earnings and profits (or
deficit in earnings and profits).
(e) Translation of nonfunctional currency transactions. Except for a
QBU using the dollar approximate separate transactions method described
in 1.985-3, see section 988 and the regulations thereunder for the
treatment of nonfunctional currency transactions.
(f) Examples. The provisions of this section are illustrated by the
following examples:
Example 1. P, a domestic corporation, operates exclusively through
foreign branch X in Country A. X is a QBU within the meaning of section
989(a) and its residence is Country A as determined under section 988
(a)(3)(B). The currency of Country A is the LC. All of X's purchases,
sales, and expenses are in the LC. The laws of A require X to keep
books and records in the LC. It is determined that the LC is the
currency of X under United States generally accepted accounting
principles. This determination is based on facts and circumstances
substantially similar to those set forth in paragraph (c)(2) of this
section. Under these facts, while the functional currency of P is the
dollar since its residence is the United States, the functional currency
of X is the LC.
Example 2. P, a publicly-held domestic regulated investment company
(as defined under section 851), operates exclusively through foreign
branch B in Country R. B is a QBU within the meaning of section 989(a)
and its residence is Country R as determined under section 988(a)(3)(B).
The currency of Country R is the LC. B's principal activities consist
of purchasing and selling stock and securities of Country R companies
and securities issued by Country R. It is determined that the dollar is
the currency of B under United States generally accepted accounting
principles. This determination is not based on facts and circumstances
substantially similar to those set forth in paragraph (c)(2) of this
section. Under these facts, while the functional currency of P is the
dollar since its residence is the United States, B may choose the LC as
its functional currency because it has significant activities in the LC
provided it keeps books and records in the LC. The fact that the dollar
is the currency of B under generally accepted accounting principles is
irrelevant for purposes of determining B's functional currency because
the GAAP determination was not based on factors similar to those set
forth in paragraph (c)(2) of this section.
Example 3. P, a domestic bank, operates through foreign branch X in
Country R. X is a QBU within the meaning of section 989(a) and its
residence is Country R as determined under section 988(a)(3)(B). The
currency of Country R is the LC. The laws of R require X to keep books
and records in the LC. The branch customarily loans dollars and LCs.
In the case of its LC loans, X ordinarily fixes the terms of the loans
by reference to a contemporary London Inter-Bank Offered Rate (LIBOR) on
dollar deposits. For instance, the interest on the amount of the
outstanding LC loan principal might equal LIBOR plus 2 percent and the
amount of the outstanding LC loan principal would be adjusted to reflect
changes in the dollar value of the LC. X is primarily funded with
dollar-denominated funds borrowed from related and unrelated parties.
X's only LC activities are paying local taxes, employee wages, and local
expenses such as rent and electricity. Under these facts, X's
activities are primarily conducted in dollars. Thus, although X keeps
its books and records in LCs, X's functional currency is the dollar.
Example 4. S, a foreign corporation organized in Country U, is
wholly-owned by P, a domestic corporation. The currency of Country U is
the LC. S's sole function is acting as a financing vehicle for P and
domestic corporations that are affiliated with P. All borrowing and
lending transactions between S and P and its domestic affiliates are in
dollars. Furthermore, primarily all of S's other borrowings are
dollar-denominated or based on a dollar index. S's only LC activities
are paying local taxes, employee wages, and local expenses such as rent
and electricity. S keeps its books and records in the LC. Under these
facts, S's activities are primarily conducted in dollars. Thus,
although S keeps its books and records in LCs, S's functional currency
is the dollar.
Example 5. D is a domestic corporation whose primary activity is the
extraction of natural gas and oil through foreign branch X in Country Y.
X is a QBU within the meaning of section 989(a) and its residence is
Country Y as determined under section 988(a)(3)(B). The currency of
Country Y is the LC. X bills a significant amount of its natural gas
and oil sales in dollars and a significant amount in LCs. X also incurs
significant LC and dollar expenses and liabilities. The laws of Country
Y require X to keep its books and records in the LC. It is determined
that the LC is the currency of X under United States generally accepted
accounting principles. This determination is based on facts and
circumstances substantially similar to those set forth in paragraph
(c)(2) of this section. Absent other factors indicating that X
primarily conducts its activities in the dollar, D could choose either
the dollar or the LC as X's functional currency because X has
significant activities in both the dollar and the LC, provided the books
and records requirement is satisfied. If, instead, X's activities were
determined to be primarily in the dollar, then X would have to use the
dollar as its functional currency.
Example 6. S, a foreign corporation organized in Country U, is
wholly-owned by P, a domestic corporation. The currency of U is the LC.
S purchases the products it sells from related and unrelated parties,
including P. These purchases are made in the LC. In addition, most of
S's gross receipts are generated by transactions denominated in the LC.
S attempts to determine its LC price for goods sold in such a manner as
to obtain an LC equivalent of a certain dollar amount after reduction
for all LC costs. However, local market conditions sometimes result in
pricing adjustments. Thus, changes in the LC-dollar exchange rate from
period to period generally result in corresponding changes in the LC
price of S's products. S pays local taxes, employee wages, and other
local expenses in the LC. It is determined that the dollar is the
currency of S under United States generally accepted accounting
principles. This determination is not based on facts and circumstances
substantially similar to those set forth in paragraph (c)(2) of this
section. Under these facts, S could choose either the dollar or the LC
as its functional currency because S has significant activities in both
the dollar and the LC, provided that the books and records requirement
is satisfied.
Example 7. S, a foreign corporation organized in Country X, is
wholly-owned by P, a domestic corporation. S conducts all of its
operations through two branches. Branch A is located in Country F and
branch B is located in Country G. S, A, and B are QBUs within the
meaning of section 989(a). Branch A's and branch B's residences are
Country F and Country G respectively as determined under section
988(a)(3)(B). The currency of Country F is the FC and the currency of
Country G is the LC. The functional currencies of S, A, and B are
determined in a two step procedure.
Step 1: The functional currency of branches A and B. Branch A and
branch B both conduct all activities in their respective local
currencies. The FC is the currency of branch A and the LC is the
currency of branch B under United States generally accepted accounting
principles. This determination is based on facts and circumstances
substantially similar to those set forth in paragraph (c)(2) of this
section. Under these facts, the functional currency of branch A is the
FC and the functional currency of branch B is the LC.
Step 2: The functional currency of S. S's functional currency is
determined by disregarding the fact that A and B are branches. When A's
activities and B's activities are viewed as a whole, S determines that
it only conducts significant activities in the LC. Therefore, S's
functional currency is the LC. See Examples 9, 10, and 11 for how the
earnings and profits of a foreign corporation, which has branches with
different functional currencies, are determined.
Example 8. Assume the same facts as in Example 7, except that S does
not exist and P conducts all of its operations through branch A and
branch B. In this instance P's functional currency in Step 2 is the
dollar, regardless of the fact that its branches' activities viewed as a
whole are in the LC, because P is a taxpayer whose residence is the
United States under section 988(a)(3)(B)(i). Therefore, while the
functional currency of branch A is the FC and the functional currency of
branch B is the LC, the functional currency of P is the dollar because
its residence is the United States.
Example 9. The facts are the same as in Example 7. ln addition,
assume that in 1987 branch A has earnings of 100 FC and branch B has
earnings of 100 LC as determined under section 987. The weighted
average exchange rate for the year is 1 FC/2 LC. Branch A's earnings
are translated into 200 LC for purposes of computing S's earnings and
profits in 1987. Thus, the total earnings and profits of S from branch
A and branch B for 1987 is 300 LC.
Example 10. (i) X, a foreign corporation organized in Country W, is
wholly-owned by P, a domestic corporation. Both X and P are calendar
year taxpayers that began business during 1987. X operates exclusively
through two branches, A and B both of which are located outside of
Country W. The functional currency of X and A is the LC, while the
functional currency of B is the DC as determined under section 985 and
1.985-1. The earnings of B must be computed under section 987, relating
to branch transactions. In 1987, A earns 900 LCs of nonsubpart F income
and B earns 200 DCs of nonsubpart F income. Under section 904(d)(2),
A's income is financial service income and B's income is general
limitation income. In order to determine X's earnings and profits, B's
income must be translated into LCs (the functional currency of X). The
weighted average exchange rate for 1987 is 1 LC/2 DC. Thus, in 1987 X's
current earnings and profits (and its post-1986 undistributed earnings)
are 1000 LCs consisting of 900 LCs of financial services income earned
by A and 100 LCs (200 DC/2) of general limitation income earned by B.
Neither A nor B makes any remittances during 1987.
(ii) In 1988, neither A nor B earns any income or generates any loss.
On December 31, 1988, A remits 50 LCs directly to P. The remittance to
P is considered to be remitted by A to X and then immediately
distributed by X as a dividend. The 50 LC remittance does not result in
an exchange gain or loss under section 987 to X because the functional
currency of X and A is the LC. See section 987(3). Under section
904(d)(3)(D), the 50 LC dividend is treated as income in a separate
category to the extent of the dividend's pro rata share of X's earnings
and profits in each separate limitation category. Thus, 90 percent, or
45 LCs, is treated as financial services income, and 10 percent, or 5
LCs, is treated as general limitation income. After the dividend
distribution, X has 950 LCs of accumulated earnings and profits (and
post-1986 undistributed earnings) consisting of 855 LCs of financial
service limitation income and 95 LCs of general limitation income.
Example 11. The facts are the same as in Example 10, except that A
makes no remittance during 1988 but B remits 120 DCs to X on December
31, 1988, which X immediately converts into LCs, and X makes no dividend
distribution during 1988. Assume that the appropriate exchange rate for
the remittance is 1 LC/3 DCs. B's remittance triggers exchange loss to
X. See section 987(3). Under section 987, the exchange loss on the
remittance is 20 LCs calculated as follows: 40 LCs, which is the LC
value of the 120 DC remittance (120 DCs/3), less 60 LCs, their LC basis
(120 DCs/2). This loss is sourced and characterized under section 987
and regulations thereunder.
Example 12. F, a foreign corporation, has gain from the disposition
of a United States real property interest (as defined in section
897(c)). The gain is taken into account as if F were engaged in a trade
or business within the United States during the taxable year and as if
such gain were effectively connected with such trade or business. F's
disposition activity shall be treated as a separate QBU with a dollar
functional currency because such activity produced income that is
treated as effectively connected with a trade or business within the
United States. Therefore, F must compute its gain from the disposition
by giving the United States real property interest an historic dollar
basis.
(T.D. 8263, 54 FR 38653, Sept. 20, 1989)
26 CFR 1.985-2 Election to use the United States dollar as the
functional currency of a QBU.
(a) Background and scope. Section 985(b)(3) of the Code provides
that a qualified business unit (''QBU'') with a functional currency
other than the United States dollar (the ''dollar'') under section
985(b) (1) and (2) may, to the extent provided in regulations, elect to
use the dollar as its functional currency. Pursuant to the regulatory
authority provided by section 985(b)(3), this section permits an
eligible QBU to elect to use the dollar as its functional currency. An
election to use a dollar functional currency is not permitted for a QBU
other than an eligible QBU. Paragraph (b) of this section defines an
eligible QBU. Paragraph (c) of this section describes the time and
manner for making the dollar election, and paragraph (d) of this section
describes the effect of making the election. For the definition of a
QBU, see section 989(a).
(b) Eligible QBU -- (1) In general. The term ''eligible QBU'' means
a QBU that could have used a hyperinflationary currency as its
functional currency absent the dollar election. See 1.985-1 for how a
QBU determines its functional currency absent the dollar election.
(2) Hyperinflationary currency. The term ''hyperinflationary
currency'' means the currency of a country in which there is cumulative
inflation during the base period of at least 100 percent as determined
by reference to the consumer price index of the country listed in the
monthly issues of ''International Financial Statistics'' or a successor
publication of the International Monetary Fund. If a country is not
listed in the ''International Financial Statistics,'' a QBU may use any
other reasonable method consistently applied for determining the
country's consumer price index. Base period means, with respect to any
taxable year, the thirty-six calendar months immediately preceding the
last day of the preceding taxable year.
(c) Time and manner for dollar election -- (1) QBUs that are branches
of United States persons -- (i) Rule. If an eligible QBU is a branch of
a United States person, the dollar election shall be made by attaching a
completed Form 8819 to the United States person's timely filed (taking
extensions into account) tax return for the first taxable year for which
the election is to be effective.
(ii) Procedure prior to the issuance of Form 8819. In the absence of
Form 8819, the election shall be made in accordance with
1.985-2T(c)(1). Failure to file an amended return within the time period
prescribed in 1.985-2T(c)(1) shall not invalidate the dollar election
if it is established to the satisfaction of the district director that
reasonable cause existed for such failure. A subsequent election for
1988 will not prejudice the taxpayer with respect to such reasonable
cause determination. Nevertheless, each United States person making an
election under the 1.985-2T(c)(1) must file a Form 8819 in the time and
manner provided in the Form's instructions.
(2) Eligible QBUs that are controlled foreign corporations or
branches of controlled foreign corporations -- (i) Rule. If an eligible
QBU is a controlled foreign corporation (as described in section 957),
or a branch of a controlled foreign corporation, the election may be
made either by the foreign corporation or by the controlling United
States shareholders on behalf of the foreign corporation by --
(A) Filing a completed Form 8819 in the time and manner provided in
the Form's instructions, and
(B) Providing the written notice required by paragraph (c)(2)(ii) of
this section at the time and in the manner prescribed therein.
The term controlling United States shareholders means those United
States shareholders (as defined in section 951(b)) who, in the
aggregate, own (within the meaning of section 958(a)) greater than 50
percent of the total combined voting power of all classes of stock of
the foreign corporation entitled to vote. If the foreign corporation is
a controlled foreign corporation (as described in section 957) but the
United States shareholders do not, in the aggregate, own the requisite
voting power, the term ''controlling United States shareholders'' means
all the United States shareholders (as defined in section 951(b)) who
own (within the meaning of section 958(a)) stock of the controlled
foreign corporation.
(ii) Notice. Prior to filing Form 8819, the controlling United
States shareholders (or the foreign corporation, if the dollar election
is made by the corporation) shall provide written notice that the dollar
election will be made to all United States persons known to be
shareholders who own (within the meaning of section 958(a)) stock of the
foreign corporation. Such notice shall also include all information
required in Form 8819.
(iii) Reasonable cause exception. Failure of the controlling United
States shareholders (or the foreign corporation, if the dollar election
is made by the corporation) to timely file Form 8819 or provide written
notice to a United States person required to be notified by paragraph
(c)(2)(ii) of this section shall not invalidate the dollar election, if
it is established to the satisfaction of the district director that
reasonable cause existed for such failure.
(iv) Procedure prior to the issuance of Form 8819. In the absence of
Form 8819, an eligible QBU described in paragraph (c)(2)(i) of this
section shall make the dollar election in accordance with
1.985-2T(c)(2). Nevertheless, the person or persons that made such
election must file a Form 8819 in the time and manner provided in the
Form's instructions.
(3) Eligible QBUs that are noncontrolled foreign corporations or
branches of noncontrolled foreign corporations -- (i) Rule. If an
eligible QBU is a noncontrolled foreign corporation (a foreign
corporation not described in section 957), or a branch of a
noncontrolled foreign corporation, the dollar election must be made by
the corporation or the majority domestic corporate shareholders on
behalf of the corporation by applying the rules provided in paragraph
(c)(2) (i) (A) and (B), (ii), (iii), and (iv) of this section
substituting ''majority domestic corporate shareholders'' for
''controlling United States shareholders'' wherever it appears therein.
The term ''majority domestic corporate shareholders'' means those
domestic corporate shareholders (as described in section 902(a)) who, in
the aggregate, own (within the meaning of section 958(a)) greater than
50 percent of the total combined voting stock of all classes of stock of
the noncontrolled foreign corporation entitled to vote that is owned
(within the meaning of section 958(a)) by all the domestic corporate
shareholders.
(ii) Procedure prior to the issuance of Form 8819. In the absence of
Form 8819, an eligible QBU described in paragraph (c)(3)(i) of this
section shall make the dollar election in accordance with
1.985-2T(c)(3). Nevertheless, the person or persons that made such
election must file a Form 8819 in the time and manner provided in the
Form's instructions.
(4) Others. Any other person making a dollar election under this
section shall elect by filing Form 8819 and fulfilling any other notice
requirements that may be required by the Commissioner.
(d) Effect of dollar election -- (1) General rule. If a dollar
election is made (or considered made under paragraph (d)(3) of this
section) by or on behalf of an eligible QBU, the QBU shall be deemed to
have the dollar as its functional currency. Each United States person
that owns (within the meaning of section 958(a)) stock of a foreign
corporation which has the dollar as its functional currency under
1.985-2 must make all of its federal income tax calculations with
respect to the foreign corporation using the dollar as the corporation's
functional currency (regardless of when ownership was acquired or
whether the United States person received the written notice required by
paragraph (c)(2)(i)(B) of this section).
(2) Computation -- (i) In general. Except as provided in paragraph
(d)(2)(ii) of this section, any eligible QBU that pursuant to this
1.985-2 has a dollar functional currency must compute income or loss or
earnings and profits (or deficit in earnings and profits) in dollars
using the dollar approximate separate transactions method described in
1.985-3.
(ii) Alternative method. An eligible QBU that has a dollar
functional currency pursuant to this 1.985-2 may use a method other
than the dollar approximate separate transactions method described in
1.985-3 only if the QBU demonstrates to the satisfaction of the
Commissioner that it can properly employ such method. Generally, the
QBU must show that it could compute foreign currency gain or loss under
the principles of section 988 with respect to each of its section 988
transactions. If subsequently the QBU can no longer demonstrate to the
satisfaction of the district director that it can properly employ such
an alternative method, then the QBU will be deemed to have changed its
method of accounting to the dollar approximate separate transactions
method described in 1.985-3. This change in accounting will be treated
as having been made with the consent of the Commissioner. No
adjustments under either 1.985-5T (or any succeeding final regulation)
or section 481(a) shall be required solely because of the change.
Rather the QBU shall begin accounting for its operations under 1.985-3
based on its dollar books and records as of the time of the change.
(3) Conformity -- (i) General rule. If a dollar election is made
under this 1.985-2 for an eligible QBU (''electing QBU''), then the
dollar shall be the functional currency of any related person
(regardless of when such person became related to the electing QBU) that
is an eligible QBU, or any branch of any such related person that is an
eligible QBU. For purposes of the preceding sentence, the term
''related person'' means any person with a relationship defined in
section 267 (b) to the electing QBU (or to the United States or foreign
person of which the electing QBU is a part). In determining whether two
or more corporations are members of the same controlled group under
section 267(b)(3), a person is considered to own stock owned directly by
such person, stock owned with the application of section 1563(e)(1), and
stock owned with the application of section 267(c).
(ii) Branches of United States and foreign persons. If a dollar
election is made for a QBU branch of any person, each eligible QBU
branch of such person shall have the dollar as its functional currency.
(4) Required adjustments. If an eligible QBU's functional currency
changes due to a dollar election, or due to the conformity requirements
of paragraph (d)(3) of this section, such change shall be deemed for
purposes of 1.9B5-4 to be consented to by the Commissioner. No
adjustments under section 481(a) shall be required solely because of the
change. However, the QBU must make those adjustments required by
1.985-5T (or any succeeding final regulation).
(5) Taxable year conformity required. Generally, the adjustments
required by paragraph (d)(4) of this section shall be made for a related
person's taxable year --
(i) That includes the date in which the electing QBU made the dollar
election if the person was related to such electing QBU at any time
during the QBU's taxable year that includes such date, or
(ii) During which the person first becomes related to any electing
QBU, in all other cases.
For purposes of this paragraph (d)(5), the date in which the electing
QBU makes the dollar election shall be the last day of the electing
QBU's taxable year. The district director may permit the related party
to make such adjustments beginning one taxable year later if, in the
district director's sole judgment, reasonable cause exists for the
related party not being able to make the required adjustments for the
earlier year.
(6) Availability of election. A dollar election may be made by or on
behalf of a QBU, or considered made under the conformity rule of
paragraph (d)(3), in any year in which the QBU is an eligible QBU. If a
dollar election is not made by or on behalf of a QBU for its first
taxable year beginning after December 31, 1986 in which it is an
eligible QBU, then any dollar election made by or on behalf of the QBU,
or considered made under the conformity rules of paragraph (d)(3) of
this section, that results in a change in the QBU's functional currency
shall be treated as having been made with the consent of the
Commissioner. In such a case, however, the taxpayer must make those
adjustments required by 1.985-5T (or any succeeding final regulation).
(7) Effect of changed circumstances. Regardless of any change in
circumstances (e.g., a currency ceases to qualify as hyperinflationary),
a QBU whose functional currency is the dollar under this section may
change its functional currency only if the QBU complies with 1.985-4.
(8) Examples. The provisions of this section are illustrated by the
following examples.
Example 1. X is a calendar year domestic corporation that in 1987
establishes a branch, A, in Country Z. A's functional currency under
section 985(b) (1) and (2) and 1.985-1 is the ''h'', the currency of
Country Z. The cumulative inflation in Country Z exceeds 100 percent
for the thirty-six months prior to January 1987, as measured by the
consumer price index of Country Z listed in the monthly issues of the
''International Financial Statistics''. Accordingly, A is an eligible
QBU in 1987 because the h is a hyperinflationary currency. Thus, X may
elect the dollar as the functional currency of A for 1987.
Example 2. The facts are the same as in Example (1). X does not
elect the dollar as the functional currency of A for 1987. Rather, X
elects the dollar as the functional currency of A for l991, a year A is
an eligible QBU. The election constitutes a change in A's functional
currency that is made with the consent of the Commissioner. However, A
must make the adjustments required under 1.985-5T (or any succeeding
final regulation).
Example 3. X is a domestic corporation that establishes A, an
eligible QBU branch. X is wholly owned by domestic corporation Y. Y
has an eligible QBU branch, B. Both X and Y are calendar year
taxpayers. X makes a dollar election for A in 1987. Thus, A is an
electing QBU. X and Y are related persons as defined in section 267(b)
(i.e., Y has a relationship under section 267(b)(3) to X, the
corporation of which A is a part). Therefore, the dollar election by X
for A in 1987 results in B, the eligible QBU branch of Y, also having
the dollar as its functional currency for 1987.
Example 4. The facts are the same as in Example 3, except that Y
does not have an eligible QBU branch but owns all the stock of C, a
calendar year controlled foreign corporation, which is not itself an
eligible QBU but which has an eligible QBU branch, D. X and C are
related persons as defined in section 267(b) (i.e., C has a relationship
under section 267(b)(3) to X, the corporation of which A is a part).
Therefore, the dollar election by X for A in 1987 results in D, the
eligible QBU branch of C, also having the dollar as its functional
currency for 1987.
Example 5. X, whose taxable year ends September 30, is an eligible
QBU that does not use the dollar as its functional currency. X is
wholly-owned by domestic corporation W. On January 1, 1989, X acquires
all the stock of Y, an unrelated eligible QBU that made the dollar
election under 1.985-2. Y is a calendar year taxpayer. After the stock
purchase, X and Y are related persons as defined in section 267(b).
Under 1.985-2(d) (3) and (5), the dollar shall be the functional
currency of X, any person related to X, and any branch of such related
person that is an eligible QBU beginning with the taxable year that
includes December 31, 1989. Thus, X must change to the dollar for its
taxable year beginning October 1, 1988. However, the district director
may allow X to change to the dollar for its taxable year beginning
October 1, 1989, provided reasonable cause exists. Those QBUs changing
to the dollar as their functional currency as the result of the
conformity requirements must make the adjustments required under
1.985-5T (or any succeeding final regulation).
Example 6. The facts are the same as in Example 5, except that
before X purchased the Y stock, X made the dollar election under
1.985-2 but Y did not use the dollar as its functional currency. Under
1.985-2(d) (3) and (5) the dollar shall be the functional currency of Y,
any person related to Y, and any branch of such related person that is
an eligible QBU beginning with the taxable year that includes September
30, 1989. Thus, Y must change to the dollar for its taxable year
beginning January 1, 1989. However the district director may allow Y to
change to the dollar for its taxable year beginning January 1, 1990,
provided reasonable cause exists. Those QBUs changing to the dollar as
their functional currency as the result of the conformity requirements
must make the adjustments required under 1.985-5T (or any succeeding
final regulation).
(T.D. 8263, 54 FR 38656, Sept. 20, 1989)
26 CFR 1.985-3 United States dollar approximate separate transactions
method.
(a) Scope. This section describes the United States dollar (dollar)
approximate separate transactions method of accounting. Except as
provided in 1.985-2(d)(2)(ii), this method of accounting must be used
to compute income or loss or earnings and profits (or deficit in
earnings and profits) of a QBU (as defined in section 989(a) of the
Code) that has the dollar as its functional currency pursuant to
1.985-2.
(b) In general. Under the dollar approximate separate transactions
method of accounting, income or loss or earnings and profits (or deficit
in earnings and profits) of a QBU for its taxable year shall be
determined in dollars by --
(1) Preparing an income or loss statement from the QBU's books and
records (within the meaning of 1.989(a)-1T(d) or its successor) as
recorded in the QBU's hyperinflationary currency (as described in
1.985-2(b)(1));
(2) Making the adjustments necessary to conform such statement to
those United States accounting and tax principles as provided by the
appropriate Code section, such as sections 987 and 988 or sections 986
and 964(a);
(3) Translating the amounts of hyperinflationary currency as shown on
such adjusted statement into dollars in accordance with paragraph (c) of
this section; and
(4) Adjusting the resulting dollar income or loss or earnings and
profits (or deficit in earnings and profits) in accordance with
paragraph (d) of this section to reflect the amount of currency gain or
loss as determined thereunder.
(c) Translation into United States dollars -- (1) In general. Except
as provided in paragraphs (c) (2), (3), (4), (5), and (8) of this
section, the amounts shown on the income or loss statement, as adjusted
under paragraph (b)(2) of this section, shall be translated into dollars
at the average exchange rate (as defined in paragraph (c)(6) of this
section) for the translation period (as defined in paragraph (c)(7) of
this section) to which they relate.
(2) Cost of goods sold. The dollar value of cost of goods sold shall
equal the sum of the dollar values of beginning inventory and purchases
less the dollar value of ending inventory as these amounts are
determined under paragraph (c)(3) of this section.
(3) Beginning inventory, purchases, and closing inventory -- (i)
Beginning inventory. Amounts representing beginning inventory shall be
translated so as to obtain the same amount of dollars which represented
such items in the closing inventory balance for the preceding taxable
year.
(ii) Purchases. Amounts representing items purchased or otherwise
first included in inventory during the taxable year shall be translated
at the average exchange rate for the translation period in which the
cost of such items was incurred.
(iii) Closing inventory -- (A) In general. Amounts representing
items included in the closing inventory balance shall be translated at
the average exchange rate for the translation period in which the cost
of such items was incurred. However, if amounts representing items
included in closing inventory balance are either valued at market or
written down to market value, they shall be translated at the exchange
rate existing on the last day of the taxable year. For purposes of
determining lower of cost or market, items of inventory included in the
closing inventory balance shall be translated into dollars at the
average exchange rate for the translation period in which the cost of
such items was incurred and compared with market as determined in the
QBU's hyperinflationary currency translated into dollars at the exchange
rate existing on the last day of the taxable year.
(B) Determination of translation period. The method used to
determine the translation period of amounts representing items of
closing inventory for purposes of paragraph (c)(2)(iii)(A) of this
section may be based upon reasonable approximations and averages,
including rates of turnover, provided the method is consistently used
from year to year.
(4) Depreciation, depletion, and amortization. Amounts representing
allowances for depreciation, depletion, or amortization shall be
translated at the average exchange rate for the translation period in
which the cost of the underlying asset was incurred.
(5) Prepaid expenses or income. Amounts representing expense or
income paid or received in a prior taxable year shall be translated at
the average exchange rate for the translation period during which they
were paid or received.
(6) Average exchange rate. The average exchange rate for any
translation period is the average of the daily exchange rates
(determined by reference to a qualified source of exchange rates within
the meaning of 1.964-1(d)(5)), excluding weekends, holidays and any
other nonbusiness days within the translation period, or if these rates
are unavailable any other reasonable rate consistently applied that
clearly reflects income.
(7) Translation period -- (i) In general. Except as provided in
paragraph (c)(3)(iii)(B) and paragraph (c)(7)(ii) of this section, a
translation period shall be each month within a QBU's taxable year.
(ii) Election. A QBU may elect to divide its taxable year into
translation periods that are less than a month. The election is made if
the QBU computes its income or loss or earnings and profits (or deficit
in earnings and profits) using translation periods that are less than
one month. The translation period elected may not be changed without
the consent of the district director.
(8) Dollar transactions. Notwithstanding any other provisions of
this section, no currency gain or loss is permitted with respect to
dollar transactions since the dollar is the functional currency of the
QBU. Thus, the amount of any payment or receipt of dollars shall be
reflected in the income or loss statement by the amount of such dollars.
Also, any transaction in which the amount that a QBU is entitled to
receive (or is required to pay) by reason of such transaction is either
denominated in terms of the dollar or is determined by reference to the
value of the dollar, must be computed transaction-by-transaction. For
example, if a foreign corporation lends 20 LC when 20 LC=$20 and is
entitled to receive the LC equivalent of $20 at maturity plus a market
rate of interest, the loan is a dollar transaction. Similarly, this
paragraph applies to any transaction that is determined to be a dollar
transaction under section 988.
(9) Examples. The provisions of this paragraph (c) are illustrated
by the following examples.
Example 1. S is an accrual basis eligible QBU that makes a dollar
election for its first taxable year beginning in 1987. S's
hyperinflationary currency is the ''h''. During 1987 S received 100
dollars attributable to sales. Because this is a dollar transaction
under paragraph (c)(8) of this section, S's income or loss for 1987
shall reflect the 100 dollars (not the hyperinflationary value of such
dollars when accrued). If 120 British pounds were received rather than
100 dollars, S's income or loss would reflect the ''h'' amount (as
determined under section 988) of the 120 British pounds translated into
dollars at the average rate for the appropriate translation period.
Example 2. S is an accrual basis eligible QBU that makes the dollar
election for its first taxable year beginning in 1987. S's
hyperinflationary currency is the ''h''. During 1987, S's sales
amounted to 240,000,000h, its currently deductible expenses were
26,000,000h, and its total inventory purchases amounted to 100,000,000h.
During January and February of 1987, S purchased depreciable assets for
80,000,000h and was allowed depreciation of 4,000,000h. At the end of
1987, S's closing inventory was 23,000,000h. No election to use a
translation period other than the month is made, S had no transactions
described in paragraph (c)(8) of this section, and S's closing inventory
was computed on the first-in, first-out inventory method. S's adjusted
income or loss statement for 1987 is translated into dollars as follows:
(d) Currency gain or loss -- (1) In general. Currency gain or loss
determined in accordance with paragraph (d)(2) of this section shall
increase or decrease the amount of dollar income or loss or earnings and
profits (or deficit in earnings and profits) as determined pursuant to
paragraphs (a), (b), and (c) of this section. For the manner in which
the currency gain or loss is allocated against subpart F income, see
1.954-2T(g)(2) or its successor. For the manner in which the currency
gain or loss is treated under section 904(d), see 1.904-4(j).
(2) Determination of currency gain or loss. Currency gain or loss of
a QBU shall be the amount which equals --
(i) The net worth for the taxable year as determined under paragraph
(d)(4) of this section; plus
(ii) The dollar amount of any item that decreased net worth for the
taxable year but does not generally affect income or loss or earnings
and profits (or deficit in earnings and profits) for the taxable year
(''additions''), such as remittances, dividends, and returns of capital.
Furthermore, foreign income taxes paid by a QBU branch elected to be
credited under section 901 shall also be treated as an addition. The
amount of a remittance, dividend, return of capital, or foreign tax that
is paid by a QBU branch and is elected to be credited under section 901,
shall be translated on the date the amount is paid or accrued. The
amount of any other additions shall be translated by applying the
principles of paragraph (c) of this section; minus
(iii) The net worth for the preceding taxable year as determined
under paragraph (d)(4) of this section; minus
(iv) The amount of dollar income or earnings and profits (or plus the
amount of any dollar loss or deficit in earnings and profits) as
determined for the taxable year pursuant to paragraph (b) (1) through
(3) of this section; minus
(v) The dollar amount of any item that increased net worth for the
taxable year but does not generally affect income or loss or earnings
and profits (or deficit in earnings and profits) (''subtractions''),
such as capital contributions. The amount of a capital contribution
shall be translated on the date the contribution is made. The amount of
any other subtractions shall be translated by applying the principles of
paragraph (c) of this section.
(3) Character. The amount of currency gain or loss determined under
paragraph (d)(2) of this section shall be ordinary income or loss.
(4) Net worth. Net worth for any taxable year shall be the dollar
amount equal to the aggregate dollar amount representing assets on the
balance sheet (as adjusted and translated under this paragraph (d)(4)
(ii) and (iii)) less the aggregate dollar amount representing
liabilities on the balance sheet (as adjusted and translated under this
paragraph (d)(4) (ii) and (iii)). Net worth shall be determined by
first --
(i) Preparing a balance sheet as of the end of such year from the
QBU's books and records (within the meaning of section 989 (a)) as
recorded in the QBU's hyperinflationary currency;
(ii) Making adjustments necessary to conform such balance sheet to
United States accounting and tax principles as provided by the
appropriate Code section, such as sections 987 and 988 or sections 986
and 964(a); and
(iii) Translating the asset and liability amounts shown on the
balance sheet into United States dollars in accordance with paragraph
(d)(5) of this section.
(5) Translation of balance sheet. Asset and liability amounts shown
on the balance sheet as adjusted pursuant to paragraph (d)(4)(ii) of
this section shall be translated into dollars as follows:
(i) Inventory. Amounts representing items of inventory included in
the closing inventory balance shall be translated in accordance with
paragraph (c)(3)(iii) of this section.
(ii) Bad debt reserves. Amounts representing bad debt reserves shall
be translated at the average exchange rate for the last translation
period of the taxable year.
(iii) Prepaid income or expense. Amounts representing expenses or
income paid or received in a prior taxable year shall be translated in
accordance with paragraph (c)(5) of this section.
(iv) Hyperinflationary cash. Amounts representing hyperinflationary
cash on hand or in a checking or savings account shall be translated at
the average exchange rate for the last translation period of the taxable
year.
(v) Certain assets -- (A) In general. Amounts representing plant,
real property, equipment, goodwill, patents, and other intangibles shall
be translated at the average exchange rate for the translation period in
which the cost of the asset was incurred.
(B) Adjustment to certain assets. Amounts representing depreciation,
depletion, and amortization reserves shall be translated in accordance
with paragraph (c)(4) of this section.
(vi) Long-term liabilities. Amounts representing long-term
liabilities, including any amounts of a long-term liability that become
short-term, shall be translated at the average exchange rate for the
translation period in which incurred.
(vii) Accrued taxes. Amounts representing an accrued tax shall be
translated at the average exchange rate for the translation period
during which the tax was accrued.
(viii) Other assets and liabilities -- (A) In general. Except as
provided in paragraph (d)(5)(viii)(B) of this section, amounts
representing assets and liabilities other than those specifically
described in paragraphs (d)(5) (i) through (vii) of this section shall
be translated at the average exchange rate for the translation period in
which the cost of the asset was incurred or for the translation period
in which the amount of the liability was incurred. For purposes of the
preceding sentence, the method used to determine the translation period
in which the cost of an asset or amount of a liability was incurred may
be based upon reasonable approximations and averages, including rates of
turnover and aging of accounts, provided the method is consistently used
from year to year.
(B) Accounts payable. Amounts representing accounts payable shall be
translated at the average rate for the last translation period of the
taxable year unless the taxpayer establishes to the satisfaction of the
district director that any such amounts relate to a different
translation period. In such a case, the average exchange rate for that
translation period shall apply.
(6) Dollar transactions. Notwithstanding any other provisions of
this paragraph (d), where the amount representing an item shown on the
balance sheet reflects a transaction described in paragraph (c)(8) of
this section, such transaction shall be taken into account in accordance
with that paragraph.
(7) Example. The provisions of this paragraph (d) are illustrated by
the following example.
Example. S, an accrual method calendar year foreign corporation,
makes the dollar election. S's hyperinflationary currency is the ''h''.
S's net worth at December 31, 1987 was $3,246,495. For 1988, S's
operating profit is 81,340,000h, or $2,038,200. S made a 5,000,000h
distribution in April and December of 1988. S's translation period is
the month. None of S's assets or liabilities reflect a transaction
described in paragraph (c)(8) of this section. The average exchange
rate for each month in 1988 is as follows:
At the end of 1988, S's assets and liabilities, as adjusted and
translated pursuant to this paragraph (d)(4) (ii) and (iii), are as
follows:
The currency loss of S for 1988 is computed as follows:
(T.D. 8263, 54 FR 38658, Sept. 20, 1989)
26 CFR 1.985-4 Method of Accounting.
(a) Adoption of election. The adoption of, or the election to use, a
functional currency shall be treated as a method of accounting. The
functional currency shall be used for the year of adoption (or election)
and for all subsequent taxable years unless permission to change is
granted, or considered to be granted under 1.985-2, by the
Commissioner.
(b) Condition for changing functional currencies. Generally,
permission to change functional currencies shall not be granted unless
significant changes in the facts and circumstances of the QBU's economic
environment occur. If the determination of the functional currency of
the QBU for purposes of United States generally accepted accounting
principles (GAAP) is based on facts and circumstances substantially
similar to those set forth in 1.985-1(c)(2), then ordinarily the
Commissioner will grant a taxpayer's request to change its functional
currency (or the functional currency of its branch that is a QBU) to a
new functional currency only if the taxpayer (or its QBU) also changes
to the new functional currency for purposes of GAAP. However,
permission to change will not necessarily be granted merely because the
new functional currency will conform to the taxpayer's GAAP functional
currency.
(c) Relationship to certain other sections of the Code. Nothing in
this section shall be construed to override the provisions of any other
sections of the Code of regulations that require the use of consistent
accounting methods. Such provisions must be independently satisfied
separate and apart from the identification of a functional currency.
For instance, while separate geographical divisions of a taxpayer's
trade or business may have different functional currencies, such
geographical divisions may nevertheless be required to consistently use
other methods of accounting.
(T.D. 8263, 54 FR 38661, Sept. 20, 1989)
26 CFR 1.985-5T Adjustments required upon change in functional currency
(temporary).
(a) In general. A QBU that changes from one functional currency (old
functional currency) to another functional currency (new functional
currency) shall make the adjustments set forth in the 3-step procedure
described in paragraphs (b) through (e) of this section. The
adjustments shall be made on the last day of the taxable year ending
before the year of change as defined in 1.481-1(a)(1). Except as
provided in 1.985-6T, QBU with a functional currency for its first
taxable year beginning in 1987 that is different from the currency in
which it had kept its books and records for United States accounting and
tax accounting purposes for its prior taxable year shall apply the
principles of this 1.985-5T for purposes of computing the relevant
functional currency items, such as earnings and profits, basis of an
asset, and amount of a liability, as of the first day of a taxpayer's
first taxable year beginning in 1987.
(b) Step 1 -- Taking into account exchange gain or loss on certain
section 988 transactions. The QBU shall recognize or otherwise take
into account for all purposes of the Code the amount of any unrealized
exchange gain or loss attributable to a section 988 transaction (as
defined in section 988(c)(1) (A), (B), and (C)) that, after applying
section 988(d), is denominated in terms of or determined by reference to
the new functional currency. The amount of such gain or loss shall be
determined without regard to the limitations set forth in section 988(b)
(i.e., regardless of whether there is any market gain or loss derived on
the transaction as a whole).
(c) Step 2 -- Determining the new functional currency basis of
property and the new functional currency amount of liabilities and any
other relevant items. The new functional currency adjusted basis of
property and the new functional currency amount of liabilities and any
other relevant items (e.g., items described in section
988(c)(1)(B)(iii)) shall equal the product of the amount of the old
functional currency adjusted basis or amount multiplied by the spot new
functional currency/old functional currency exchange rate.
(d) Step 3A -- Additional adjustments that are necessary when a
branch changes functional currency -- (1) Branch changing to a
functional currency other than the taxpayer's functional currency. If a
QBU of a taxpayer (i.e. a branch) changes to a functional currency other
than the taxpayer's functional currency, the branch shall make the
adjustments set forth in either subparagraph (i) or (ii) for purposes of
section 987.
(i) Where prior to the change the branch and taxpayer had different
functional currencies. Where the branch and the taxpayer had different
functional currencies prior to the change, the branch's new functional
currency equity pool (computed under the principles of 1.987-1T(b)(1),
53 Fed. Reg. 32384 (1988)) shall equal the product of the old functional
currency amount of the equity pool multiplied by the spot new functional
currency/old functional currency exchange rate.
(ii) Where prior to the change the branch and taxpayer had the same
functional currency. Where the branch and the taxpayer had the same
functional currency prior to the change, the branch's equity basis pool
(computed under the principles of 1.987-1T(b)(2), 53 FR 32384 (1988))
shall equal the difference between the branch's total old functional
currency basis of its assets and its total old functional currency
amount of its liabilities. The branch's equity pool shall equal the
product of the equity basis pool multiplied by the spot new functional
currency/old functional currency exchange rate.
(2) Branch changing to the taxpayer's functional currency. If a
branch changes to the taxpayer's functional currency, the branch shall
be treated as if it terminated. In such a case, the taxpayer shall
realize gain or loss attributable to the branch's equity pool under the
principles of section 987. This gain or loss is not subject to section
481.
(e) Step 3B -- Additional adjustments that are necessary when a
taxpayer changes functional currency -- (1) Corporations. The amount of
a corporation's new functional currency earnings and profits and the
amount of its new functional currency paid-in capital shall equal the
product of the old functional currency amounts of such items multiplied
by the spot new functional currency/old functional currency exchange
rate.
(2) Collateral consequences to a United States shareholder of a
corporation changing to the United States dollar as its functional
currency. A United States shareholder (within the meaning of section
951(b)) of a controlled foreign corporation (within the meaning of
section 957) changing to the United States dollar (dollar) as its
functional currency shall recognize foreign currency gain or loss
computed under section 986(c) as if all previously taxed earnings and
profits, if any, were distributed immediately prior to the change and
will also recognize gain or loss attributable to the corporation's
paid-in capital to the extent provided, if any, under section 367(b) or
future final regulations under section 985. This gain or loss is not
subject to section 481.
(3) Taxpayers that are not corporations. (Reserved)
(4) Adjustments necessary for a branch of a taxpayer changing
functional currencies -- (i) Taxpayer changing to a functional currency
other than the branch's functional currency. If a taxpayer changes to a
functional currency other than the functional currency of a branch of
the taxpayer, the branch shall make the adjustments set forth in
paragraph (d)(1)(i) of this section if the taxpayer's old functional
currency was different from the branch's functional currency, or make
the adjustments set forth in paragraph (d)(1)(ii) of this section if the
taxpayer's old functional currency was the same as the branch's
functional currency.
(ii) Taxpayer changing to the same functional currency as the branch.
If a taxpayer changes to the same functional currency as a branch of
the taxpayer, the taxpayer shall realize gain or loss as set forth in
paragraph (d)(2) of this section.
(f) Examples. The provisions of this section are illustrated by the
following examples.
Example 1. S, a calendar year foreign corporation, is wholly owned
by domestic corporation P. The Commissioner granted permission to
change S's functional currency from the LC to the FC beginning January
1, 1990. The LC/FC exchange rate on December 31, 1989, is 1 LC/2 FC.
The following shows how S must convert the items on its balance sheet
from the LC to the FC.
Example 2. P, a domestic corporation, operates a foreign branch, S.
The Commissioner granted permission to change S's functional currency
from the LC to the FC beginning January 1, 1990. As of December 31,
1989, S's equity pool was 2,000 LC and its equity basis pool was $4,000.
The LC/FC exchange rate on December 31, 1989 is 1 LC/2 FC. On January
1, 1990, the new functional currency amount of S's equity pool is 4,000
FC. The equity basis pool is not affected.
(T.D. 8263, 54 FR 38662, Sept. 20, 1989)
26 CFR 1.985-6T Transition rules for a QBU that uses the dollar
approximate separate transactions method for its first taxable year
beginning in 1987 (temporary).
(a) In general. This section sets forth transition rules for those
QBUs that use the dollar approximate separate transactions method set
forth in 1.985-3 or 1.985-3T for their first taxable year beginning in
1987 (''net worth'' QBUs). In order for a net worth QBU to apply the
dollar approximate separate transactions method of accounting for its
first taxable year beginning in 1987, the QBU must determine the United
States dollar (dollar) and hyperinflationary currency basis of its
assets and the dollar and hyperinflationary currency amount of the QBU's
liabilities that were acquired or incurred in taxable years beginning
before January 1, 1987. In addition, the QBU must also determine its
net worth including its retained earnings at the end of the QBU's last
taxable year beginning before January 1, 1987. This section provides
rules for controlled foreign corporations (as defined in section 957),
noncontrolled foreign corporations, and new worth and profit and loss
branches of United States persons that must make these determinations.
(b) Certain controlled foreign corporations. If a net worth QBU was
a controlled foreign corporation for its last taxable year beginning
before January 1, 1987, and had a significant event as described in
1.964-1(c)(6) in a taxable year beginning before January 1, 1987, then
the rules of this paragraph (b) shall apply.
(1) Basis in assets and amount of liabilities. The hyperinflationary
currency adjusted basis in the QBU's assets and the hyperinflationary
currency amount of the QBU's liabilities acquired or incurred by the QBU
in a taxable year beginning before January 1, 1987, shall be the basis
or the amount as determined under 1.964-1(e) prior to translation under
1.964-1(e)(4). The dollar adjusted basis in such assets and the dollar
amount of such liabilities shall be the adjusted basis or the amount as
determined under the rules of 1.964-1(e) after translation under
1.964-1(e)(4).
(2) Retained earnings. The dollar amount of the QBU's retained
earnings at the end of its last taxable year beginning before January 1,
1987, shall be the dollar amount determined under 1.964-1(e)(3).
(c) All other foreign corporations. If a foreign corporation is a
net worth QBU not described in paragraph (b) of this section, then
(1) The hyperinflationary currency and dollar adjusted basis in the
QBU's assets acquired in taxable years beginning before January 1, 1987,
(2) The hyperinflationary currency and dollar amount of the QBU's
liabilities acquired or incurred in taxable years beginning before
January 1, 1987, and
(3) The dollar amount of the QBU's net worth including its retained
earnings at the end of its last taxable year beginning before January 1,
1987, shall be determined by applying the principles of 1.985-3T or
1.985-3.
(d) Net worth branch. If a net worth QBU is a branch of a United
States person and the QBU used a net worth method of accounting for its
last taxable year beginning before January 1, 1987, then the rules of
this paragraph (d) shall apply. A net worth method of accounting is any
method of accounting under which the taxpayer calculates the taxable
income of a QBU based on the net change in the dollar value of the QBU's
equity (assets less liabilities) during the course of a taxable year,
taking into account any remittances made during the year.
(1) Basis in assets and amount of liabilities -- (i)
Hyperinflationary amounts. For the first taxable year beginning in
1987, the hyperinflationary currency adjusted basis of a QBU's assets or
the hyperinflationary currency amounts of its liabilities acquired or
incurred in a taxable year beginning before January 1, 1987 is the
hyperinflationary currency basis or amount at the date when acquired or
incurred according to United States generally accepted accounting and
tax accounting principles. The hyperinflationary currency adjusted
basis of an asset or hyperinflationary currency amount of a liability
for which a hyperinflationary currency basis or amount was not
determined at such date shall be that hyperinflationary currency amount
which is determined by using the appropriate spot exchange rate on the
date when the asset or amount of the liability was acquired or incurred,
as adjusted according to United States generally accepted accounting and
tax accounting principles.
(ii) Dollar amount. For the first taxable year beginning in 1987,
the dollar adjusted basis of the QBU's assets and the amounts of its
liabilities shall be those amounts reflected on the QBU's dollar books
and records at the end of the taxpayer's last taxable year beginning
before January 1, 1987, after adjusting the books and records according
to United States generally accepted accounting and tax accounting
principles.
(2) Ending net worth. The dollar amount of the QBU's net worth at
the end of its last taxable year beginning before January 1, 1987, shall
equal the QBU's net worth at that date as determined under paragraph
(d)(1)(ii) of this section.
(e) Profit and loss branch. If a net worth QBU is a branch of a
United States person and the QBU used a profit and loss method of
accounting for its last taxable year beginning before January 1, 1987,
then the QBU shall apply the transition rules of 1.987-1T (as
promulgated in 53 FR 32384 (1988)) or its successor provision in order
to establish the branch's pre-87 equity and dollar equity and the
branch's hyperinflationary currency basis of its assets and
hyperinflationary currency amounts of its liabilities. A profit and
loss method of accounting is any method of accounting under which the
taxpayer calculates the profits of a QBU by computing the QBU's profits
in its functional currency and translating the net result into dollars.
See 1.985-5T (or any succeeding final regulation) for the further
adjustments that are necessary when a QBU changes functional currencies.
(T.D. 8263, 54 FR 38663, Sept. 20, 1989)
1.987-1 Profit and loss method of accounting for a qualified
business unit of a taxpayer having a different functional currency from
the taxpayer. (Reserved)
1.987-2 Accounting for gain or loss on certain transfers of
property. (Reserved)
1.987-3 Termination. (Reserved)
1.987-4 Special rules relating to QBU branches of foreign taxpayers.
(Reserved)
1.987-5 Transition rules for certain qualified business units using
a profit and loss method of accounting for taxable years beginning
before January 1, 1987.
(a) Applicability -- (1) In general. This section applies to
qualified business unit (QBU) branches of United States persons, whose
functional currency (as defined in section 985 of the Code and the
regulations thereunder) is other than the United States dollar (dollar)
and that used a profit and loss method of accounting for their last
taxable year beginning before January 1, 1987. Generally, a profit and
loss method of accounting is any method of accounting under which the
taxpayer calculates the profits of a QBU branch in its functional
currency and translates the net result into dollars. For all taxable
years beginning after December 31, 1986, such QBU branches must use the
profit and loss method of accounting as described in section 987, except
to the extent otherwise provided in regulations under section 985 or any
other provision of the Code. See 1.989(c)-1 regarding transition rules
for QBU branches of United States persons that have a nondollar
functional currency and that used a net worth method of accounting for
their last taxable year beginning before January 1, 1987.
(2) Insolvent QBU branches. A taxpayer may apply the principles of
this section to a QBU branch that used a profit and loss method of
accounting for its last taxable year beginning before January 1, 1987,
whose $E pool (as defined in paragraph (d)(3)(i) of this section) is
negative. For taxable years beginning on or after October 25, 1991, the
principles of this section shall apply to insolvent QBU branches.
(b) General rules. Generally, section 987 gain or loss occurs when a
QBU branch makes a remittance. A remittance is considered to be made
from one or more functional currency pools under rules provided in
paragraph (c) of this section. In general, the amount of section 987
gain or loss from a remittance equals the difference between the dollar
value of the functional currency adjusted basis of the property remitted
and the portion of the dollar basis in the applicable pool. Section 987
gain or loss is calculated under a 4-step procedure described in
paragraph (d) of this section. Section 987 gain or loss attributable to
a remittance is realized and must be recognized in the taxable year of
the remittance except to the extent otherwise provided in regulations.
(c) Determining the pool(s) from which a remittance is made -- (1)
Remittances made during taxable years beginning after December 31, 1986,
and before October 25, 1991. A remittance made during taxable years
beginning after December 31, 1986 and before October 25, 1991, first
represents an amount of the QBU branch's post-86 profits pool (including
functional currency profits for the current taxable year determined
without regard to remittances made during the current year). To the
extent the functional currency amount of the remittance exceeds the
post-86 profits pool, it is considered to come out of the EQ pool.
Paragraph (d)(2) of this section describes the EQ pool and the post-86
profits pool.
(2) Remittances made in taxable years beginning on or after October
25, 1991. For remittances made in taxable years beginning on or after
October 25, 1991, the post-86 profits and EQ pools are combined into one
pool called the equity pool. Therefore, remittances made during those
taxable years will only come from the equity pool. The dollar basis of,
and section 987 gain or loss on, such remittances shall be calculated
utilizing the principles set forth in paragraph (d) (4) and (5) of this
section.
(d) Calculation of section 987 gain or loss -- (1) In general. This
paragraph (d) describes the 4-step procedure for calculating section 987
gain or loss.
(2) Step 1 -- Calculate the amount of the functional currency pools
-- (i) EQ pool. (A) Beginning pool. The beginning amount of the EQ
pool is equal to the functional currency adjusted bases of a QBU
branch's assets less the functional currency amount of the QBU branch's
liabilities at the end of the taxpayer's last taxable year beginning
before January 1, 1987, as these amounts are determined under the rules
of paragraphs (e) and (f) of the section. The district director may
allow for additional adjustments to the beginning amount of the EQ pool
to prevent the recognition of section 987 gain or loss due to factors
unrelated to the movement of exchange rates.
(B) Adjusting the EQ pool. The EQ pool is increased by the
functional currency amount of any transfer (as determined under section
987) to the QBU branch made during the current taxable year or any prior
taxable year beginning after December 31, 1986. If the transfer is made
in a nonfunctional currency, this amount is translated into the QBU
branch's functional currency at the spot rate (determined under the
principles of section 988 and the regulations thereunder) on the date of
the transfer. The method for determining the rate must be applied
consistently each quarter. The EQ pool is decreased by the functional
currency amount of any remittance (as determined under section 987) made
during a prior taxable year beginning after December 31, 1986, that is
considered remitted from the EQ pool under paragraph (c) of this
section. The EQ pool must also be decreased by any transfer from the
QBU branch that is not a remittance.
(ii) Post-86 profits pool. The amount of a QBU branch's post-86
profits pool is calculated at the end of each taxable year beginning
after December 31, 1986. The opening balance of the post-86 profits
pool at the beginning of the first taxable year beginning after December
31, 1986, is zero. The post-86 profits pool is increased by the
functional currency amount of the QBU branch's profits (determined under
section 987) for the taxable year. The post-86 profits pool is
decreased by the functional currency amount of the QBU branch's losses
(determined under section 987) for the taxable year and the amount of
any remittances by the QBU branch during the taxable year from the
post-86 profits pool as provided under paragraph (c) of this section.
(iii) Adjustments to the equity pool. For remittances made in
taxable years beginning on or after October 25, 1991 under paragraph
(c)(2) of this section, the post-86 profits and EQ pools are combined
into one pool called the equity pool. Additions to and subtractions
from the equity pool shall be made utilizing the principles of
paragraphs (d)(2) (i)(B) and (ii) of this section. For example,
remittances shall reduce the equity pool.
(3) Step 2 -- Calculate the dollar basis of the pools -- (i) Dollar
basis of the EQ pool -- (A) Beginning dollar basis. The beginning
dollar basis of the EQ pool (hereinafter referred to as the $E pool)
equals:
(1) The dollar amount of all the QBU branch's profits reported on the
taxpayer's income tax returns for taxable years beginning before January
1, 1987, plus the total dollar amount of all transfers to the QBU branch
during that period (properly reflected on the taxpayer's books), less
(2) The dollar amount of all the QBU branch's losses reported on the
taxpayer's income tax returns for such years, and the total dollar basis
of all remittances and all transfers made by the QBU branch during that
period (properly reflected on the taxpayer's books).
A QBU branch's profits and losses shall be properly adjusted for
foreign taxes of the QBU branch.
(B) Adjusting the $E pool. The $E pool is increased by the dollar
amount of any transfers to the QBU branch made during the current
taxable year or any prior taxable year beginning after December 31,
1986. If a transfer is made in a currency other than the dollar, the
amount of the currency is translated into dollars at the spot rate
(determined under the principles of section 988 and the regulations
thereunder) on the date of the transfer. The $E pool is decreased by
the dollar basis of any remittance made during a prior taxable year
beginning after December 31, 1986, that is considered remitted from the
$E pool under paragraphs (c) and (d)(4) of these section. The $E pool
is also reduced by the amount of a transfer (other than a remittance)
from the QBU branch translated into dollars at the spot rate (determined
under the principles of section 988 and the regulations thereunder) on
the date of the transfer. The method for determining the spot rate must
be applied consistently to all transfers to and from a QBU branch.
(ii) Dollar basis of the post-86 profits pool. The amount of a QBU
branch's dollar basis in the post-86 profits pool (the $P pool) is
calculated at the end of each taxable year beginning after December 31,
1986. The opening balance of the $P pool at the beginning of the first
taxable year beginning after December 31, 1986, is zero. The $P pool is
increased by the functional currency amount of the QBU branch's profits
(determined under section 987) for the taxable year translated into
dollars at the weighted average exchange rate (as defined in 1.989
(b)-1) for the year. The $P pool is decreased by the functional
currency amount of the QBU branch's losses (determined under section
987) for the taxable year translated into dollars at the weighted
average exchange rate for the year and by the dollar basis of any
remittances made by the QBU branch during the taxable year from the
post-86 profits pool under paragraph (c)(1) of this section.
(iii) Combination of the $E and the $P pools. For taxable years
beginning on or after October 25, 1991 the $P and the $E pools are
combined into one pool called the basis pool. Additions to and
subtractions from the basis pool shall be made utilizing the principles
set forth in paragraph (d)(3) (i) and (ii) of this section.
(4) Step 3 -- Calculation of the dollar basis of a remittance. For
all taxable years beginning after December 31, 1986, the dollar basis of
a remittance is calculated using the following formula:
(5) Step 4 -- Calculation of the section 987 gain or loss on a
remittance. Section 987 gains or loss equals the difference between --
(i) The dollar amount of the remittance, and
(ii) The dollar basis of the remittance as calculated under paragraph
(d)(4) of this section.
(e) Functional currency adjusted basis of QBU branch assets acquired
in taxable years beginning before January 1, 1987 -- (1) Basis of asset.
For taxable years beginning after December 31, 1986, the functional
currency adjusted basis of a QBU branch asset acquired in a taxable year
beginning before January 1, 1987, is the functional currency basis of
the asset at the date of acquisition, as adjusted according to United
States tax principles. The functional currency adjusted basis of an
asset for which a functional currency basis was not determined at the
date of acquisition is the nonfunctional currency basis of the asset at
the date of acquisition multiplied by the spot exchange rate on the date
of acquisition, as adjusted according to United States tax principles.
(2) Adjustment to basis of asset. Any future adjustments to the
functional currency adjusted basis of such an asset are determined with
respect to the appropriate functional currency adjusted basis of the
asset as determined under this paragraph (e).
(f) Functional currency amount of QBU branch liabilities acquired in
taxable years beginning before January 1, 1987. For the first taxable
year beginning after December 31, 1986, the amount of a QBU branch
liability incurred in a taxable year beginning before January 1, 1987,
is the functional currency amount of the liability at the date incurred,
as adjusted according to United States tax principles. The functional
currency amount of a liability for which a functional currency amount
was not determined at the date incurred is the nonfunctional currency
amount of the liability at the date incurred multiplied by the spot
exchange rate on the date incurred, as adjusted according to the United
States tax principles.
(g) Examples. The provisions of this section are illustrated by the
following examples.
Example 1 -- (i) Facts. U.S. is a domestic corporation. B, a QBU
branch of U.S., operates in country X and was established in 1985. B's
functional currency is the FC. U.S. is on a calendar taxable year and,
prior to January 1, 1987, accounted for the operations of B by the
profit and loss method of accounting as set forth in Rev. Rul. 75-107,
1975-1 C.B. 32. B's books and records were kept according to United
States tax principles. B received a transfer of $2,000 in 1985, and had
profits of $3,000 in 1985 and $5,000 in 1986. B made a remittance in
1986, the dollar basis of which was $1,000. As of December 31, 1986,
the adjusted basis of B's functional currency assets exceeded the
functional currency amount of its liabilities by 15,000 FC (the
beginning pool of EQ). Under section 987, B has profits of 8,000 FC in
1987, which are worth $1,000 when translated at the weighted average
exchange rate for 1987 as required by sections 987(2) and 989(b)(4). B
has no profits or loss in 1988. There are no transfers to B in 1987 and
1988. B remits 18,000 FC in 1988. Under section 987, the appropriate
exchange rate for the 1988 remittance is 10 FC/$1.
(ii) Calculation of section 987 loss on remittance -- (A) Post-86
profits. Under paragraph (c)(i) of this section, the 18,000 FC
remittance comes first out of the post-86 profits pool (8,000 FC) and
second out of EQ (10,000 FC). The loss on the 1988 remittance out of
the post-86 profits pool equals:
Dollar value of post-86 profits remitted ^ Dollar basis of post-86
profits remitted=
(8,000 FC 10 FC/$1) ^ $1,000 = $800 ^ $1,000 = $200< loss.
(B) EQ. Under paragraph (d) of this section, U.S. calculates 987
gain or loss on the 10,000 FC remittance of EQ from B as follows:
Step 1. The total EQ pool equals 15,000 FC (the functional currency
adjusted bases of its assets less the functional currency amount of its
liabilities as of December 31, 1986). There are no adjustments
necessary under paragraph (d)(2)(i)(B) of this section.
Step 2. The $E pool is $9,000 (the $2,000 transfer in 1985 plus
profits of $3,000 in 1985 and $5,000 in 1986 and less than $1,000 basis
of the1986 remittance). There are no adjustments necessary under
paragraph (d)(3)(i)(B) of this section.
Step 3. The entire 10,000 FC remittance is deemed to come out of EQ.
Step 4. The dollar basis of the EQ remitted equals: N x $E
determined under paragraph (d)(3)(i)=
Where:
Step 5. Section 987 loss of U.S. on remittance equals:
Dollar value of the EQ remitted ^ Dollar basis of the EQ remitted =
(10,000 FC 10 FC/$1) ^ $6,000 = $1,000 ^ $6,000 = $5,000< loss.
(C) Total loss on remittance. The total combined loss on the
remittance is '$5,200 . The total of amounts determined in paragraphs
(ii) (A) and (B) of this Example 1.
Example 2 -- (i) Facts. D is a domestic corporation. B, a QBU
branch of D, operates in country X. B's functional currency is the FC.
At the end of B's last taxable year beginning before October 25, 1991,
B's EQ pool equals 15,000 FC and B's post-86 profits pool equals 8,000
FC. B's $E amount equals $9,000, and the $P pool equals $1,000. In B's
first taxable year beginning on or after October 25, 1991, B remits
18,000 FC. Under section 987, the appropriate exchange rate for this
remittance is 10FC:$1.
(ii) Computation of the equity pool.
15,000 FC (EQ pool) + 8,000 FC (post-86 profits pool) = 23,000 FC
(equity pool)
(iii) Computation of the basis pool.
(iv) dollar basis in remittance.
(v) Computation of section 987 loss by U.S. on remittance.
(h) Character and source of section 987 gain or loss. Section 987
gain or loss is sourced and characterized as provided by section 987 and
regulations issued under that section.
(T.D. 8367, 56 FR 48434, Sept. 25, 1991; 56 FR 65684, Dec. 18, 1991)
26 CFR 1.988-0 Taxation of gain or loss from a section 988 transaction;
Table of Contents.
This section lists captioned paragraphs contained in 1.988-1
through 1.988-5.
(a) Section 988 transaction.
(1) In general.
(2) Description of transactions.
(3)-(5) (Reserved)
(6) Examples.
(7) Special rules for regulated futures contracts and non-equity
options.
(8) Special rules for qualified funds.
(9) Exception for certain transactions entered into by an individual.
(10) Intra-taxpayer transactions.
(11) Authority of Commissioner to include or exclude transactions
from section 988.
(b) Spot contract.
(c) Nonfunctional currency.
(d) Spot rate.
(1) In general.
(2) Consistency required in valuing transactions subject to section
988.
(3) Use of certain spot rate conventions for payables and receivables
denominated in nonfunctional currency.
(4) Currency where an official government established rate differs
from a free market rate.
(e) Exchange gain or loss.
(f) Hyperinflationary currency.
(g) Fair market value.
(h) Interaction with sections 1092 and 1256 in examples.
(i) Effective date.
(a) Disposition of nonfunctional currency.
(1) Recognition of exchange gain or loss.
(2) Computation of exchange gain or loss.
(b) Translation of interest income or expense and determination of
exchange gain or loss with respect to debt instruments.
(1) Translation of interest income received with respect to a
nonfunctional currency demand account.
(2) Translation of nonfunctional currency interest income or expense
received or paid with respect to a debt instrument described in
1.988-1(a) (1)(ii) and (2)(i).
(3) Exchange gain or loss recognized by the holder with respect to
accrued interest income.
(4) Exchange gain or loss recognized by the obligor with respect to
accrued interest expense.
(5) Exchange gain or loss recognized by the holder of a debt
instrument with respect to principal.
(6) Exchange gain or loss recognized by the obligor of a debt
instrument with respect to principal.
(7) Payment ordering rules.
(8) Limitation of exchange gain or loss on payment or disposition of
a debt instrument.
(9) Examples.
(10) Treatment of bond premium.
(11) Market discount.
(12) Tax exempt bonds.
(13) Nonfunctional currency debt exchanged for stock of obligor.
(14)-(15) (Reserved)
(16) Coordination with section 267 regarding debt instruments.
(17) Coordination with installment method under section 453.
(c) Item of expense or gross income or receipts which is to be paid
or received after the date accrued.
(1) In general.
(2) Determination of exchange gain or loss with respect to an item of
gross income or receipts.
(3) Determination of exchange gain or loss with respect to an item of
expense.
(4) Examples.
(d) Exchange gain or loss with respect to forward contracts, futures
contracts and option contracts.
(1) Scope.
(2) Realization of exchange gain or loss.
(3) Recognition of exchange gain or loss.
(4) Determination of exchange gain or loss.
(5) (Reserved)
(e) Currency swaps and notional principal contracts.
(1) Notional principal contract denominated in a single nonfunctional
currency.
(2) Special rules for currency swaps.
(3) Amortization of swap premium or discount in the case of off
market swaps.
(4) Treatment of taxpayer disposing of a currency swap.
(5) Examples.
(6) Special effective date for rules regarding currency swaps.
(7) (Reserved)
(f) Substance over form.
(1) In general.
(2) Example.
(g) Effective date.
(a) In general.
(b) Election to characterize exchange gain or loss on certain
identified forward contracts, futures contracts and option contracts as
capital gain or loss.
(1) In general.
(2) Special rule for contracts that become part of a straddle after
the election is made.
(3) Requirements for making the election.
(4) Verification.
(5) Independent verification.
(6) Effective date.
(c) Exchange gain or loss treated as interest.
(1) In general.
(2) Exchange loss realized by the holder on nonfunctional currency
tax exempt bonds.
(d) Effective date.
(a) In general.
(b) Qualified business unit.
(1) In general.
(2) Proper reflection on the books of the taxpayer or qualified
business unit.
(c) Effectively connected exchange gain or loss.
(d) Residence.
(1) In general.
(2) Exception.
(3) Partner in a partnership not engaged in a U.S. trade or business
under section 864(b)(2).
(e) Special rule for certain related party loans.
(1) In general.
(2) United States person.
(3) Loans by related person.
(4) 10 percent owned foreign corporation.
(f) Exchange gain or loss treated as interest under 1.988-3.
(g) Exchange gain or loss allocated in the same manner as interest
under 1.861-9T.
(h) Effective date.
(a) Integration of a nonfunctional currency debt instrument and a
1.988-5(a) hedge.
(1) In general.
(2) Exception.
(3) Qualifying debt instrument.
(4) Section 1.988-5(a) hedge.
(5) Definition of integrated economic transaction.
(6) Special rules for legging in and legging out of integrated
treatment.
(7) Transactions part of a straddle.
(8) Identification requirements.
(9) Taxation of qualified hedging transactions.
(10) Transition rules and effective dates.
(b) Hedged executory contracts.
(1) In general.
(2) Definitions.
(3) Identification rules.
(4) Effect of hedged executory contract.
(5) References to this paragraph (b).
(c) Hedges of period between trade date and settlement date on
purchase or sale of publicly traded stock or security.
(d) (Reserved)
(e) Advance rulings regarding net hedging and anticipatory hedging
systems.
(f) (Reserved)
(g) General effective date.
(T.D. 8400, 57 FR 9177, Mar. 17, 1992)
26 CFR 1.988-1 Certain definitions and special rules.
(a) Section 988 transaction -- (1) In general. The term ''section
988 transaction'' means any of the following transactions --
(i) A disposition of nonfunctional currency as defined in paragraph
(c) of this section;
(ii) Any transaction described in paragraph (a)(2) of this section if
any amount which the taxpayer is entitled to receive or is required to
pay by reason of such transaction is denominated in terms of a
nonfunctional currency or is determined by reference to the value of one
or more nonfunctional currencies.
A transaction described in this paragraph (a) need not require or
permit payment with a nonfunctional currency as long as any amount paid
or received is determined by reference to the value of one or more
nonfunctional currencies. The acquisition of nonfunctional currency is
treated as a section 988 transaction for purposes of establishing the
taxpayer's basis in such currency and determining exchange gain or loss
thereon.
(2) Description of transactions. The following transactions are
described in this paragraph (a)(2).
(i) Debt instruments. Acquiring a debt instrument or becoming an
obligor under a debt instrument. The term ''debt instrument'' means a
bond, debenture, note, certificate or other evidence of indebtedness.
(ii) Payables, receivables, etc. Accruing, or otherwise taking into
account, for purposes of subtitle A of the Internal Revenue Code, any
item of expense or gross income or receipts which is to be paid or
received after the date on which so accrued or taken into account. A
payable relating to cost of goods sold, or a payable or receivable
relating to a capital expenditure or receipt, is within the meaning of
this paragraph (a)(2)(ii). Generally, a payable relating to foreign
taxes (whether or not claimed as a credit under section 901) is within
the meaning of this paragraph (a)(2)(ii). However, a payable of a
domestic person relating to accrued foreign taxes of its qualified
business unit (QBU branch) is not within the meaning of this paragraph
(a)(2)(ii) if the QBU branch's functional currency is the U.S. dollar
and the foreign taxes are claimed as a credit under section 901.
(iii) Forward contract, futures contract, option contract, or similar
financial instrument. Except as otherwise provided in this paragraph
(a)(2)(iii) and paragraph (a)(4)(i) of this section, entering into or
acquiring any forward contract, futures contract, option, warrant, or
similar financial instrument.
(A) Limitation for certain derivative instruments. A forward
contract, futures contract, option, warrant, or similar financial
instrument is within this paragraph (a)(2)(iii) only if the underlying
property to which the instrument ultimately relates is a nonfunctional
currency or is otherwise described in paragraph (a)(1)(ii) of this
section. Thus, if the underlying property of an instrument is another
financial instrument (e.g., an option on a futures contract), then the
underlying property to which such other instrument (e.g., the futures
contract) ultimately relates must be a nonfunctional currency. For
example, a forward contract to purchase wheat denominated in a
nonfunctional currency, an option to enter into a forward contract to
purchase wheat denominated in a nonfunctional currency, or a warrant to
purchase stock denominated in a nonfunctional currency is not described
in this paragraph (a)(2)(iii). On the other hand, a forward contract to
purchase a nonfunctional currency, an option to enter into a forward
contract to purchase a nonfunctional currency, an option to purchase a
bond denominated in or the payments of which are determined by reference
to the value of a nonfunctional currency, or a warrant to purchase
nonfunctional currency is described in this paragraph (a)(2)(iii).
(B) Nonfunctional currency notional principal contracts -- (1) In
general. The term ''similar financial instrument'' includes a notional
principal contract only if the payments required to be made or received
under the contract are determined with reference to a nonfunctional
currency.
(2) Definition of notional principal contract. The term ''notional
principal contract'' means a contract (e.g., a swap, cap, floor or
collar) that provides for the payment of amounts by one party to another
at specified intervals calculated by reference to a specified index upon
a notional principal amount in exchange for specified consideration or a
promise to pay similar amounts. For this purpose, a ''notional
principal contract'' shall only include an instrument where the
underlying property to which the instrument ultimately relates is money
(e.g., functional currency), nonfunctional currency, or property the
value of which is determined by reference to an interest rate. Thus,
the term ''notional principal contract'' includes a currency swap as
defined in 1.988-2(e)(2)(ii), but does not include a swap referenced to
a commodity or equity index.
(C) Effective date with respect to certain contracts. This paragraph
(a)(2)(iii) does not apply to any forward contract, futures contract,
option, warrant, or similar financial instrument entered into or
acquired on or before October 21, 1988, if such instrument would have
been marked to market under section 1256 if held on the last day of the
taxable year.
(3)-(5) (Reserved)
(6) Examples. The following examples illustrate the application of
paragraph (a) of this section. The examples assume that X is a U.S.
corporation on an accrual method with the calendar year as its taxable
year. Because X is a U.S. corporation the U.S. dollar is its functional
currency under section 985. The examples also assume that section
988(d) does not apply.
Example 1. On January 1, 1989, X acquires 10,000 Canadian dollars.
On January 15, 1989, X uses the 10,000 Canadian dollars to purchase
inventory. The acquisition of the 10,000 Canadian dollars is a section
988 transaction for purposes of establishing X's basis in such Canadian
dollars. The disposition of the 10,000 Canadian dollars is a section
988 transaction pursuant to paragraph (a)(1) of this section.
Example 2. On January 1, 1989, X acquires 10,000 Canadian dollars.
On January 15, 1989, X converts the 10,000 Canadian dollars to U.S.
dollars. The acquisition of the 10,000 Canadian dollars is a section 988
transaction for purposes of establishing X's basis in such Canadian
dollars. The conversion of the 10,000 Canadian dollars to U.S. dollars
is a section 988 transaction pursuant to paragraph (a)(1) of this
section.
Example 3. On January 1, 1989, X borrows 100,000 British pounds ( )
for a period of 10 years and issues a note to the lender with a face
amount of 100,000. The note provides for payments of interest at an
annual rate of 10% paid quarterly in pounds and has a stated redemption
price at maturity of 100,000. X's becoming the obligor under the note
is a section 988 transaction pursuant to paragraphs (a) (1)(ii) and
(2)(i) of this section. Because X is an accrual basis taxpayer, the
accrual of interest expense under X's note is a section 988 transaction
pursuant to paragraphs (a) (1)(ii) and (2)(ii) of this section. In
addition, the acquisition of the British pounds to make payments under
the note is a section 988 transaction for purposes of establishing X's
basis in such pounds, and the disposition of such pounds is a section
988 transaction under paragraph (a)(1)(i) of this section. See
1.988-2(b) with respect to the translation of accrued interest expense
and the determination of exchange gain or loss upon payment of accrued
interest expense.
Example 4. On January 1, 1989, X purchases an original issue for
74,621.54 British pounds ( ) a 3-year bond maturing on December 31,
1991, at a stated redemption price of 100,000. The bond provides for
no stated interest. The bond has a yield to maturity of 10% compounded
semiannually and has 25,378.46 of original issue discount. The
acquisition of the bond is a section 988 transaction as provided in
paragraphs (a) (1)(ii) and (2)(i) of this section. The accrual of
original issue discount with respect to the bond is a section 988
transaction under paragraphs (a) (1)(ii) and (2)(ii) of this section.
See 1.988-2(b) with respect to the translation of original issue
discount and the determination of exchange gain or loss upon receipt of
such amounts.
Example 5. On January 1, 1989, X sells and delivers inventory to Y
for 10,000,000 Italian lira for payment on April 1, 1989. Under X's
method of accounting, January 1, 1989 is the accrual date. Because X is
an accrual basis taxpayer, the accrual of a nonfunctional currency
denominated item of gross receipts on January 1, 1989, for payment after
the date of accrual is a section 988 transaction under paragraphs (a)
(1)(ii) and (2)(ii) of this section.
Example 6. On January 1, 1989, X agrees to purchase a machine from Y
for delivery on March 1, 1990 for 1,000,000 yen. The agreement calls
for X to pay Y for the machine on June 1, 1990. Under X's method of
accounting, the expenditure for the machine does not accrue until
delivery on March 1, 1990. The agreement to purchase the machine is not
a section 988 transaction. In particular, the agreement to purchase the
machine is not described in paragraph (a)(2)(ii) of this section because
the agreement is not an item of expense taken into account under
subtitle A (but rather is an agreement to purchase a capital asset in
the future). However, the payable that will arise on the delivery date
is a section 988 transaction under paragraphs (a) (1)(ii) and (2)(ii) of
this section even though the payable relates to a capital expenditure.
In addition, the disposition of yen to satisfy the payable on June 1,
1990, is a section 988 transaction under paragraph (a)(1)(i) of this
section.
Example 7. On January 1, 1989, X purchases and takes delivery of
inventory for 10,000 French francs with payment to be made on April 1,
1989. Under X's method of accounting, the expense accrues on January 1,
1989. On January 1, 1989, X also enters into a forward contract with a
bank to purchase 10,000 French francs for $2,000 on April 1, 1989.
Because X is an accrual basis taxpayer, the accrual of a nonfunctional
currency denominated item of expense on January 1, 1989, for payment
after the date of accrual is a section 988 transaction under paragraphs
(a) (1)(ii) and (2)(ii) of this section. Entering into the forward
contract to purchase the 10,000 French francs is a section 988
transaction under paragraphs (a) (1)(ii) and (2)(iii) of this section.
Example 8. On January 1, 1989, X acquires 100,000 Norwegian krone.
On January 15, 1989, X purchases and takes delivery of 1,000 shares of
common stock with the 100,000 krone acquired on January 1, 1989. On
August 1, 1989, X sells the 1,000 shares of common stock and receives
120,000 krone in payment. On August 30, 1989, X converts the 120,000
krone to U.S. dollars. The acquisition of the 100,000 krone on January
1, 1989, and the acquisition of the 120,000 krone on August 1, 1989, are
section 988 transactions for purposes of establishing the basis of such
krone. The disposition of the 100,000 krone on January 15, 1989, and
the 120,000 krone on August 30, 1989, are section 988 transactions as
provided in paragraph (a)(1)(i) of this section. Neither the
acquisition on January 15, 1989, nor the disposition on August 1, 1989,
of the stock is a section 988 transaction.
Example 9. On May 11, 1989, X purchases a one year note at original
issue for its issue price of $1,000. The note pays interest in dollars
at the rate of 4 percent compounded semiannually. The amount of
principal received by X upon maturity is equal to $1,000 plus the
equivalent of the excess, if any, of (a) the Financial Times One Hundred
Stock Index (an index of stocks traded on the London Stock Exchange
hereafter referred to as the FT100) determined and translated into
dollars on the last business day prior to the maturity date, over (b)
2,150, the ''stated value'' of the FT100, which is equal to 110% of the
average value of the index for the six months prior to the issue date,
translated at the exchange rate of 1=$1.50. The purchase by X of the
instrument described above is not a section 988 transaction because the
index used to compute the principal amount received upon maturity is
determined with reference to the value of stock and not nonfunctional
currency.
Example 10. On April 9, 1989, X enters into an interest rate swap
that provides for the payment of amounts by X to its counterparty based
on 4% of a 10,000 yen principal amount in exchange for amounts based on
yen LIBOR rates. Pursuant to paragraphs (a) (1)(ii) and (2)(iii) of
this section, this yen for yen interest rate swap is a section 988
transaction.
Example 11. On August 11, 1989, X enters into an option contract for
sale of a group of stocks traded on the Japanese Nikkei exchange. The
contract is not a section 988 transaction within the meaning of
1.988-1(a)(2)(iii) because the underlying property to which the option
relates is a group of stocks and not nonfunctional currency.
(7) Special rules for regulated futures contracts and non-equity
options -- (i) In general. Except as provided in paragraph (a)(7)(ii)
of this section, paragraph (a)(2)(iii) of this section shall not apply
to any regulated futures contract or non-equity option which would be
marked to market under section 1256 if held on the last day of the
taxable year.
(ii) Election to have paragraph (a)(2)(iii) of this section apply.
Notwithstanding paragraph (a)(7)(i) of this section, a taxpayer may
elect to have paragraph (a)(2)(iii) of this section apply to regulated
futures contracts and non-equity options as provided in paragraph (a)(7)
(iii) and (iv) of this section.
(iii) Procedure for making the election. A taxpayer shall make the
election provided in paragraph (a)(7)(ii) of this section by sending to
the Internal Revenue Service Center, Examination Branch, Stop Number 92,
Kansas City, MO 64999 a statement titled ''Election to Treat Regulated
Futures Contracts and Non-Equity Options as Section 988 Transactions
Under Section 988 (c)(1)(D)(ii)'' that contains the following:
(A) The taxpayer's name, address, and taxpayer identification number;
(B) The date the notice is mailed or otherwise delivered to the
Internal Revenue Service Center;
(C) A statement that the taxpayer (including all members of such
person's affiliated group as defined in section 1504 or in the case of
an individual all persons filing a joint return with such individual)
elects to have section 988(c)(1)(D)(i) and 1.988-1(a)(7)(i) not apply;
(D) The date of the beginning of the taxable year for which the
election is being made;
(E) If the election is filed after the first day of the taxable year,
a statement regarding whether the taxpayer has previously held a
contract described in section 988(c)(1)(D)(i) or 1.988-1(a)(7)(i)
during such taxable year, and if so, the first date during the taxable
year on which such contract was held; and
(F) The signature of the person making the election (in the case of
individuals filing a joint return, the signature of all persons filing
such return).
The election shall be made by the following persons: in the case of
an individual, by such individual; in the case of a partnership, by
each partner separately; effective for taxable years beginning after
March 17, 1992, in the case of tiered partnerships, each ultimate
partner; in the case of an S corporation, by each shareholder
separately; in the case of a trust (other than a grantor trust) or
estate, by the fiduciary of such trust or estate; in the case of any
corporation other than an S corporation, by such corporation (in the
case of a corporation that is a member of an affiliated group that files
a consolidated return, such election shall be valid and binding only if
made by the common parent, as that term is used in 1.1502-77(a)); in
the case of a controlled foreign corporation, by its controlling United
States shareholders under 1.964-1(c)(3). With respect to a corporation
(other than an S corporation), the election, when made by the common
parent, shall be binding on all members of such corporation's affiliated
group as defined in section 1504 that file a consolidated return. The
election shall be binding on any income or loss derived from the
partner's share (determined under the principles of section 702(a)) of
all contracts described in section 988(c)(1)(D)(i) or paragraph
(a)(7)(i) of this section in which the taxpayer holds a direct interest
or indirect interest through a partnership or S corporation; however,
the election shall not apply to any income or loss of a partnership for
any taxable year if such partnership made an election under section
988(c)(1)(E)(iii)(V) for such year or any preceding year. Generally, a
copy of the election must be attached to the taxpayer's income tax
return for the first year it is effective. It is not required to be
attached to subsequent returns. However, in the case of a partner, a
copy of the election must be attached to the taxpayer's income tax
return for every year during which the taxpayer is a partner in a
partnership that engages in a transaction that is subject to the
election.
(iv) Time for making the election -- (A) In general. Unless the
requirements for making a late election described in paragraph
(a)(7)(iv)(B) of this section are satisfied, an election under section
988 (c)(1)(D)(ii) and paragraph (a)(7)(ii) of this section for any
taxable year shall be made on or before the first day of the taxable
year or, if later, on or before the first day during such taxable year
on which the taxpayer holds a contract described in section
988(c)(1)(D)(ii) and paragraph (a)(7)(ii) of this section. The election
under section 988(c)(1)(D)(ii) and paragraph (a)(7)(ii) of this section
shall apply to contracts entered into or acquired after October 21,
1988, and held on or after the effective date of the election. The
election shall be effective as of the beginning of the taxable year and
shall be binding with respect to all succeeding taxable years unless
revoked with the prior consent of the Commissioner. In determining
whether to grant revocation of the election, recapture of the tax
benefit derived from the election in previous taxable years will be
considered.
(B) Late elections. A taxpayer may make an election under section
988(c)(1)(D)(ii) and paragraph (a)(7)(ii) of this section within 30 days
after the time prescribed in the first sentence of paragraph
(a)(7)(iv)(A) of this section. Such a late election shall be effective
as of the beginning of the taxable year; however, any losses recognized
during the taxable year with respect to contracts described in section
988(c)(1)(D)(ii) or paragraph (a)(7)(ii) of this section which were
entered into or acquired after October 21, 1988, and held on or before
the date on which the late election is mailed or otherwise delivered to
the Internal Revenue Service Center shall not be treated as derived from
a section 988 transaction. A late election must comply with the
procedures set forth in paragraph (a)(7)(iii) of this section.
(v) Transition rule. An election made prior to September 21, 1989
which satisfied the requirements of Notice 88-124, 1988-51 I.R.B. 6,
shall be deemed to satisfy the requirements of paragraphs (a)(7) (iii)
and (iv) of this section.
(vi) General effective date provision. This paragraph (a)(7) shall
apply with respect to futures contracts and options entered into or
acquired after October 21, 1988.
(8) Special rules for qualified funds -- (i) Definition of qualified
fund. The term ''qualified fund'' means any partnership if --
(A) At all times during the taxable year (and during each preceding
taxable year to which an election under section 988(c)(1)(E)(iii)(V)
applied) such partnership has at least 20 partners and no single partner
owns more than 20 percent of the interests in the capital or profits of
the partnership;
(B) The principa1 activity of such partnership for such taxable year
(and each such preceding taxable year) consists of buying and selling
options, futures, or forwards with respect to commodities;
(C) At least 90 percent of the gross income of the partnership for
the taxable year (and each such preceding year) consists of income or
gains described in subparagraph (A), (B), or (G) of section 7704(d)(1)
or gain from the sale or disposition of capital assets held for the
production of interest or dividends;
(D) No more than a de minimis amount of the gross income of the
partnership for the taxable year (and each such preceding taxable year)
was derived from buying and selling commodities; and
(E) An election under section 988 (c)(1)(E)(iii)(V) as provided in
paragraph (a)(8)(iv) of this section applies to the taxable year.
(ii) Special rules relating to paragraph (a)(8)(i)(A) of this section
-- (A) Certain general partners. The interest of a general partner in
the partnership shall not be treated as failing to meet the 20 percent
ownership requirement of paragraph (a)(8)(i)(A) of this section for any
taxable year of the partnership if, for the taxable year of the partner
in which such partnership's taxable year ends, such partner (and each
corporation filing a consolidated return with such partner) had no
ordinary income or loss from a section 988 transaction (other than
income from the partnership) which is exchange gain or loss (as the case
may be).
(B) Treatment of incentive compensation. For purposes of paragraph
(a)(8)(i)(A) of this section, any income allocable to a general partner
as incentive compensation based on profits rather than capital shall not
be taken into account in determining such partner's interest in the
profits of the partnership.
(C) Treatment of tax exempt partners. The interest of a partner in
the partnership shall not be treated as failing to meet the 20 percent
ownership requirements of paragraph (a)(5)(8)(A) of this section if none
of the income of such partner from such partnership is subject to tax
under chapter 1 of subtitle A of the Internal Revenue Code (whether
directly or through one or more pass-through entities).
(D) Look-through rule. In determining whether the 20 percent
ownership requirement of paragraph (a)(8)(i)(A) of this section is met
with respect to any partnership, any interest in such partnership held
by another partnership shall be treated as held proportionately by the
partners in such other partnership.
(iii) Other special rules -- (A) Related persons. Interests in the
partnership held by persons related to each other (within the meaning of
section 267(b) or 707(b)) shall be treated as held by one person.
(B) Predecessors. Reference to any partnership shall include a
reference to any predecessor thereof.
(C) Treatment of certain debt instruments. Solely for purposes of
paragraph (a)(8)(i)(D) of this section, any debt instrument which is
described in both paragraph (a) (1)(ii) and (2)(i) of this section shall
be treated as a commodity.
(iv) Procedure for making the election provided in section
988(c)(1)(E)(iii)(V). A partnership shall make the election provided in
section 988(c)(1)(E)(iii)(V) by sending to the Internal Revenue Service
Center, Examination Branch, Stop Number 92, Kansas City, MO 64999 a
statement titled ''QUALIFIED FUND ELECTION UNDER SECTION
988(c)(1)(E)(iii)(V)'' that contains the following:
(A) The partnership's name, address, and taxpayer identification
number;
(B) The name, address and taxpayer identification number of the
general partner making the election on behalf of the partnership;
(C) The date the notice is mailed or otherwise delivered to the
Internal Revenue Service Center;
(D) A brief description of the activity of the partnership;
(E) A statement that the partnership is making the election provided
in section 988(c)(1)(E)(iii)(V);
(F) The date of the beginning of the taxable year for which the
election is being made;
(G) If the election is filed after the first day of the taxable year,
then a statement regarding whether the partnership previously held an
instrument referred to in section 988(c)(1)(E)(i) during such taxable
year and, if so, the first date during the taxable year on which such
contract was held; and
(H) The signature of the general partner making the election.
The election shall be made by a general partner with management
responsibility of the partnership's activities and a copy of such
election shall be attached to the partnership's income tax return (Form
1065) for the first taxable year it is effective. It is not required to
be attached to subsequent returns.
(v) Time for making the election. The election under section
988(c)(1)(E)(iii)(V) for any taxable year shall be made on or before the
first day of the taxable year or, if later, on or before the first day
during such year on which the partnership holds an instrument described
in section 988(c)(1)(E)(i). The election under section
988(c)(1)(E)(iii)(V) shall apply to the taxable year for which made and
all succeeding taxable years. Such election may only be revoked with
the consent of the Commissioner. In determining whether to grant
revocation of the election, recapture by the partners of the tax benefit
derived from the election in previous taxable years will be considered.
(vi) Operative rules applicable to qualified funds -- (A) In general.
In the case of a qualified fund, any bank forward contract or any
foreign currency futures contract traded on a foreign exchange which is
not otherwise a section 1256 contract shall be treated as a section 1256
contract for purposes of section 1256.
(B) Gains and losses treated as short-term. In the case of any
instrument treated as a section 1256 contract under paragraph
(a)(8)(vi)(A) of this section, subparagraph (A) of section 1256(a)(3)
shall be applied by substituting ''100 percent'' for ''40 percent'' (and
subparagraph (B) of such section shall not apply).
(vii) Transition rule. An election made prior to September 21, 1989,
which satisfied the requirements of Notice 88-124, 1988-51 I.R.B. 6,
shall be deemed to satisfy the requirements of 1.988-1(a)(8) (iv) and
(v).
(viii) General effective date rules -- (A) The requirements of
subclause (IV) of section 988(c)(1)(E)(iii) shall not apply to contracts
entered into or acquired on or before October 21, 1988.
(B) In the case of any partner in an existing partnership, the 20
percent ownership requirements of subclause (I) of section
988(c)(1)(E)(iii) shall be treated as met during any period during which
such partner does not own a percentage interest in the capital or
profits of such partnership greater than 33 1/3 percent (or, if lower,
the lowest such percentage interest of such partner during any period
after October 21, 1988, during which such partnership is in existence).
For purposes of the preceding sentence, the term ''existing
partnership'' means any partnership if --
(1) Such partnership was in existence on October 21, 1988, and
principally engaged on such date in buying and selling options, futures,
or forwards with respect to commodities; or
(2) A registration statement was filed with respect to such
partnership with the Securities and Exchange Commission on or before
such date and such registration statement indicated that the principal
activity of such partnership will consist of buying and selling
instruments referred to in paragraph (a)(8)(viii)(B)(1) of this section.
(9) Exception for certain transactions entered into by an individual
-- (i) In general. A transaction entered into by an individual which
otherwise qualifies as a section 988 transaction shall be considered a
section 988 transaction only to the extent expenses properly allocable
to such transaction meet the requirements of section 162 or 212 (other
than the part of section 212 dealing with expenses incurred in
connection with taxes).
(ii) Examples. The following examples illustrate the application of
paragraph (a)(9) of this section.
Example 1. X is a U.S. citizen who therefore has the U.S. dollar as
his functional currency. On January 1, 1990, X enters into a spot
contract to purchase 10,000 British pounds ( ) for $15,000 for delivery
on January 3, 1990. Immediately upon delivery, X acquires at original
issue a pound denominated bond with an issue price of 10,000. The bond
matures on January 3, 1993, pays interest in pounds at a rate of 10%
compounded semiannually, and has no original issue discount. Assume
that all expenses properly allocable to these transactions would meet
the requirements of section 212. Under 1.988-2(d)(1)(ii), entering
into the spot contract on January 1, 1990, is not a section 988
transaction. The acquisition of the pounds on January 3, 1990, under
the spot contract is a section 988 transaction for purposes of
establishing X's basis in the pounds. The disposition of the pounds and
the acquisition of the bond by X are section 988 transactions. These
transactions are not excluded from the definition of a section 988
transaction under paragraph (a)(9) of this section because expenses
properly allocable to such transactions meet the requirements of section
212.
Example 2. X is a U.S. citizen who therefore has the dollar as his
functional currency. In preparation for X's vacation, X purchases 1,000
British pounds ( ) from a bank on June 1, 1989. During the period of
X's vacation in the United Kingdom beginning June 10, 1989, and ending
June 20, 1989, X spends 500 for hotel rooms, 300 for food and 200 for
miscellaneous vacation expenses. The expenses properly allocable to
such dispositions do not meet the requirements of section 162 or 212.
Thus, the disposition of the pounds by X on his vacation are not section
988 transactions.
(10) Intra-taxpayer transactions -- (i) In general. Except as
provided in paragraph (a)(10)(ii) of this section, transactions between
or among the taxpayer and/or qualified business units of that taxpayer
(''intra-taxpayer transactions'') are not section 988 transactions. See
section 987 and the regulations thereunder.
(ii) Certain transfers. Exchange gain or loss with respect to
nonfunctional currency or any item described in paragraph (a)(2) of this
section entered into with another taxpayer shall be realized upon an
intra-taxpayer transfer of such currency or item where as the result of
the transfer the currency or other such item --
(A) Loses its character as nonfunctional currency or an item
described in paragraph (a)(2) of this section; or
(B) Where the source of the exchange gain or loss could be altered
absent the application of this paragraph (a)(10)(ii).
Such exchange gain or loss shall be computed in accordance with
1.988-2 (without regard to 1.988-2(b)(8)) as if the nonfunctional
currency or item described in paragraph (a)(2) of this section had been
sold or otherwise transferred at fair market value between unrelated
taxpayers. For purposes of the preceding sentence, a taxpayer must use
the translation rate that it uses for purposes of computing section 987
gain or loss with respect to the QBU branch that makes the transfer. In
the case of a gain or loss incurred in a transaction described in this
paragraph (a)(10)(ii) that does not have a significant business purpose,
the Commissioner, may defer such gain or loss.
(iii) Example. The following example illustrates the provisions of
this paragraph (a)(10).
Example. (A) X, a corporation with the U.S. dollar as its functional
currency, operates through foreign branches Y and Z. Y and Z are
qualified business units as defined in section 989(a) with the LC as
their functional currency. X computes Y's and Z's income under section
987 (relating to branch transactions). On November 12, 1988, Y
transfers $25 to the home office of X when the fair market value of such
amount equals LC120. Y has a basis of LC100 in the $25. Under
paragraph (a)(10)(ii) of this section, Y realizes foreign source
exchange gain of LC20 (LC120 -- LC100) as the result of the $25
transfer. For purposes of determining whether the transfer is a
remittance resulting in additional gain or loss, see section 987 and the
regulations thereunder.
(B) If instead Y transfers the $25 to Z, exchange gain is not
realized because the $25 is nonfunctional currency with respect to Z and
if Z were to immediately convert the $25 into LCs, the gain would be
foreign source. For purposes of determining whether the transfer is a
remittance resulting in additional gain or loss, see section 987 and the
regulations thereunder.
(11) Authority to include or exclude transactions from section 988 --
(i) In general. The Commissioner may recharacterize a transaction (or
series of transactions) in whole or in part as a section 988 transaction
if the effect of such transaction (or series of transactions) is to
avoid section 988. In addition, the Commissioner may exclude a
transaction (or series of transactions) which in form is a section 988
transaction from the provisions of section 988 if the substance of the
transaction (or series of transactions) indicates that it is not
properly considered a section 988 transaction.
(ii) Example. The following example illustrates the provisions of
this paragraph (a)(11).
Example. B is an individual with the U.S. dollar as its functional
currency. B holds 500,000 Swiss francs which have a basis of $100,000
and a fair market value of $400,000 as of October 15, 1989. On October
16, 1989, B transfers the 500,000 Swiss francs to a newly formed U.S.
corporation, X, with the dollar as its functional currency. On October
16, 1989, B sells the stock of X for $400,000. Assume the transfer to X
qualified for nonrecognition under section 351. Because the sale of the
stock of X is a substitute for the disposition of an asset subject to
section 988, the Commissioner may recharacterize the sale of the stock
as a section 988 transaction. The same result would obtain if B
transferred the Swiss francs to a partnership and then sold the
partnership interest.
(b) Spot contract. A spot contract is a contract to buy or sell
nonfunctional currency on or before two business days following the date
of the execution of the contract. See 1.988-2 (d)(1)(ii) for operative
rules regarding spot contracts.
(c) Nonfunctional currency. The term ''nonfunctional currency''
means with respect to a taxpayer or a qualified business unit (as
defined in section 989 (a)) a currency (including the European Currency
Unit) other than the taxpayer's or the qualified business unit's
functional currency as defined in section 985 and the regulations
thereunder. For rules relating to nonrecognition of exchange gain or
loss with respect to certain dispositions of nonfunctional currency, see
1.988-2 (a)(1)(iii).
(d) Spot rate -- (1) In general. Except as otherwise provided in
this paragraph, the term ''spot rate'' means a rate demonstrated to the
satisfaction of the District Director or the Assistant Commissioner
(International) to reflect a fair market rate of exchange available to
the public for currency under a spot contract in a free market and
involving representative amounts. In the absence of such a
demonstration, the District Director or the Assistant Commissioner
(International), in his or her sole discretion, shall determine the spot
rate from a source of exchange rate information reflecting actual
transactions conducted in a free market. For example, the taxpayer or
the District Director or the Assistant Commissioner (International) may
determine the spot rate by reference to exchange rates published in the
pertinent monthly issue of ''International Financial Statistics'' or a
successor publication of the International Monetary Fund; exchange
rates published by the Board of Governors of the Federal Reserve System
pursuant to 31 U.S.C. section 5151; exchange rates published in
newspapers, financial journals or other daily financial news sources;
or exchange rates quoted by electronic financial news services.
(2) Consistency required in valuing transactions subject to section
988. If the use of inconsistent sources of spot rate quotations results
in the distortion of income, the District Director or the Assistant
Commissioner (International) may determine the appropriate spot rate.
(3) Use of certain spot rate conventions for payables and receivables
denominated in nonfunctional currency. If consistent with the
taxpayer's financial accounting, a taxpayer may utilize a spot rate
convention determined at intervals of one quarter year or less for
purposes of computing exchange gain or loss with respect to payables and
receivables denominated in a nonfunctional currency that are incurred in
the ordinary course of business with respect to the acquisition or sale
of goods or the obtaining or performance of services. For example, if
consistent with the taxpayer's financial accounting, a taxpayer may
accrue all payables and receivables incurred during the month of January
at the spot rate on December 31 or January 31 (or at an average of any
spot rates occurring between these two dates) and record the payment or
receipt of amounts in satisfaction of such payables and receivables
consistent with such convention. The use of a spot rate convention
cannot be changed without the consent of the Commissioner.
(4) Currency where an official government established rate differs
from a free market rate -- (i) In general. If a currency has an
official government established rate that differs from a free market
rate, the spot rate shall be the rate which most clearly reflects the
taxpayer's income. Generally, this shall be the free market rate.
(ii) Examples. The following examples illustrate the application of
this paragraph (d)(4).
Example 1. X is an accrual method U.S. corporation with the dollar
as its functional currency. X owns all the stock of a Country L
subsidiary, CFC. CFC has the currency of Country L, the LC, as its
functional currency. Country L imposes restrictions on the remittance
of dividends. On April 1, 1990, CFC pays a dividend to X in the amount
of LC100. Assume that the official governnent established rate is
$1=LC1 and the free market rate, which takes into account the remittance
restrictions and which is the rate that most clearly reflects income, is
$1=LC4. On April 1, 1990, X donates the LC100 in a transaction that
otherwise qualifies as a charitable contribution under section 170 (c).
Both the amount of the dividend income and the deduction under section
170 is $25 (LC100 x the free market rate, $.25).
Example 2. X, a corporation with the U.S. dollar as its functional
currency, operates in foreign country L through branch Y. Y is a
qualified business unit as defined in section 989 (a). X computes Y's
income under the dollar approximate separate transactions method as
described in 1.985-3. The currency of L is the LC. X can purchase
legally United States dollars ($) in L only from the L government. In
order to take advantage of an arbitrage between the official and
secondary dollar to LC exchange rates in L:
(i) X purchases LC100 for $60 in L on the secondary market when the
official exchange rate is S1=LC1;
(ii) X transfers the LC100 to Y;
(iii) Y purchases $100 for LC100; and
(iv) Y transfers $65 ($100 less an L tax withheld of $35 on the
transfer) to the home office of X.
Under paragraph (a)(7) of this section, the transfer of the LC100 by
X to Y is a realization event. X has a basis of $60 in the LC100.
Under these facts, the appropriate dollar to LC exchange rate for
computing the amount realized by X is the official exchange rate.
Therefore, X realizes $40 ($100-$60) of U.S. source gain from the
transfer to Y. The same result would obtain if Y rather than X
purchased the LC100 on the secondary market in L with $60 supplied by X,
because the substance of this transaction is that X is performing the
arbitrage.
(e) Exchange gain or loss. The term ''exchange gain or loss'' means
the amount of gain or loss realized as determined in 1.988-2 with
respect to a section 988 transaction. Except as otherwise provided in
these regulations (e.g., 1.98B-5), the amount of exchange gain or loss
from a section 988 transaction shall be separately computed for each
section 988 transaction, and such amount shall not be integrated with
gain or loss recognized on another transaction (whether or not such
transaction is economically related to the section 988 transaction).
See 1.988-2 (b)(8) for a special rule with respect to debt instruments.
(f) Hyperinflationary currency. For the definition of
hyperinflationary currency see 1.985-2 (b)(2). Unless otherwise
provided, the currency in any example used in 1.988-1 through 1.988-5
is not a hyperinflationary currency.
(g) Fair market value. The fair market value of an item shall, where
relevant, reflect an appropriate premium or discount for the time value
of money (e.g., the fair market value of a forward contract to buy or
sell nonfunctional currency shall reflect the present value of the
difference between the units of nonfunctional currency times the market
forward rate at the time of valuation and the units of nonfunctional
currency times the forward rate set forth in the contract). However, if
consistent with the taxpayer's method of financial accounting (and
consistently applied from year to year), the preceding sentence shall
not apply to a financial instrument that matures within one year from
the date of issuance or acquisition. Unless otherwise provided, the
fair market value given in any example used in 1.988-1 through 1.988-5
is deemed to reflect appropriately the time value of money. If the use
of inconsistent sources of forward or other market rate quotations
results in the distortion of income, the District Director or the
Assistant Commissioner (International) may determine the appropriate
rate.
(h) Interaction with sections 1092 and 1256. Unless otherwise
provided, it is assumed for purposes of 1.988-1 through 1.988-5 that
any contract used in any example is not a section 1256 contract and is
not part of a straddle as defined in section 1092. No inference is
intended regarding the application of section 1092 or 1256 unless
expressly stated.
(i) Effective date. Except as otherwise provided in this section,
this section shall be effective for taxable years beginning after
December 31, 1986. Thus, except as otherwise provided in this section,
any payments made or received with respect to a section 988 transaction
in taxable years beginning after December 31, 1986, are subject to this
section.
(T.D. 8400, 57 FR 9178, Mar. 17, 1992)
26 CFR 1.988-2 Recognition and computation of exchange gain or loss.
(a) Disposition of nonfunctional currency -- (1) Recognition of
exchange gain or loss -- (i) In general. Except as otherwise provided
in this section, 1.988-1(a)(7)(ii), and 1.988-5, the recognition of
exchange gain or loss upon the sale or other disposition of
nonfunctional currency shall be governed by the recognition provisions
of the Internal Revenue Code which apply to the sale or disposition of
property (e.g., section 1001 or, to the extent provided in regulations,
section 1092). The disposition of nonfunctional currency in settlement
of a forward contract, futures contract, option contract, or similar
financial instrument is considered to be a sale or disposition of the
nonfunctional currency for purposes of the preceding sentence.
(ii) Clarification of section 1031. An amount of one nonfunctional
currency is not ''property of like kind'' with respect to an amount of a
different nonfunctional currency.
(iii) Coordination with section 988(c)(1)(C)(ii). No exchange gain
or loss is recognized with respect to the following transactions --
(A) An exchange of units of nonfunctional currency for different
units of the same nonfunctional currency;
(B) The deposit of nonfunctional currency in a demand or time deposit
or similar instrument (including a certificate of deposit) issued by a
bank or other financial institution if such instrument is denominated in
such currency;
(C) The withdrawal of nonfunctional currency from a demand or time
deposit or similar instrument issued by a bank or other financial
institution if such instrument is denominated in such currency;
(D) The receipt of nonfunctional currency from a bank or other
financial institution from which the taxpayer purchased a certificate of
deposit or similar instrument denominated in such currency by reason of
the maturing or other termination of such instrument; and
(E) The transfer of nonfunctional currency from a demand or time
deposit or similar instrument issued by a bank or other financial
institution to another demand or time deposit or similar instrument
denominated in the same nonfunctional currency issued by a bank or other
financial institution.
The taxpayer's basis in the units of nonfunctional currency or other
property received in the transaction shall be the adjusted basis of the
units of nonfunctional currency or other property transferred. See
paragraph (b) of this section with respect to the timing of interest
income or expense and the determination of exchange gain or loss
thereon.
(iv) Example. The following example illustrates the provisions of
paragraph (a)(1)(iii) of this section.
Example. X is a corporation on the accrual method of accounting with
the U.S. dollar as its functional currency. On January 1, 1989, X
acquires 1,500 British pounds ( ) for $2,250 ( 1 = $1.50). On January 3,
1989, when the spot rate is 1 = $1.49, X deposits the 1,500 with a
British financial institution in a non-interest bearing demand account.
On February 1, 1989, when the spot rate is 1 = $1.45, X withdraws the
1,500. On February 5, 1989, when the spot rate is 1 = $1.42, X
purchases inventory in the amount of 1,500. Pursuant to paragraph
(a)(1)(iii) of this section, no exchange loss is realized until February
5, 1989, when X disposes of the 1,500 for inventory. At that time, X
realizes exchange loss in the amount of $120 computed under paragraph
(a)(2) of this section. The loss is not an adjustment to the cost of
the inventory.
(2) Computation of gain or loss -- (i) In general. Exchange gain
realized from the sale or other disposition of nonfunctional currency
shall be the excess of the amount realized over the adjusted basis of
such currency, and exchange loss realized shall be the excess of the
adjusted basis of such currency over the amount realized.
(ii) Amount realized -- (A) In general. The amount realized from the
disposition of nonfunctional currency shall be determined under section
1001(b). A taxpayer that uses a spot rate convention under
1.988-1(d)(3) to determine exchange gain or loss with respect to a
payable shall determine the amount realized upon the disposition of
nonfunctional currency paid in satisfaction of the payable in a manner
consistent with such convention.
(B) Exchange of nonfunctional currency for property. For purpose of
paragraph (a)(2) of this section, the exchange of nonfunctional currency
for property (other than nonfunctional currency) shall be treated as --
(1) An exchange of the units of nonfunctional currency for units of
functional currency at the spot rate on the date of the exchange, and
(2) The purchase or sale of the property for such units of functional
currency.
(C) Example. The following example illustrates the provisions of
paragraph (a)(2)(ii)(B) of this section.
Example. G is a U.S. corporation with the U.S. dollar as its
functional currency. On January 1, 1989, G enters into a contract to
purchase a paper manufacturing machine for 10,000,000 British pounds ( )
for delivery on January 1, 1991. On January 1, 1991, when G exchanges
10,000,000 (which G purchased for $12,000,000) for the machine, the fair
market value of the machine is 17,000,000. On January 1, 1991, the
spot exchange rate is 1 = $1.50. Under paragraph (a)(2)(ii)(B) of this
section, the transaction is treated as an exchange of 10,000,000 for
$15,000,000 and the purchase of the machine for $15,000,000.
Accordingly, in computing G's exchange gain of $3,000,000 on the
disposition of the 10,000,000, the amount realized is $15,000,000. G's
basis in the machine is $15,000,000. No gain is recognized on the
bargain purchase of the machine.
(iii) Adjusted basis -- (A) In general. Except as provided in
paragraph (a)(2)(iii)(B) of this section, the adjusted basis of
nonfunctional currency is determined under the applicable provisions of
the Internal Revenue Code (e.g., sections 1011 through 1023). A
taxpayer that uses a spot rate convention under 1.988-1 (d)(3) to
determine exchange gain or loss with respect to a receivable shall
determine the basis of nonfunctional currency received in satisfaction
of such receivable in a manner consistent with such convention.
(B) Determination of the basis of nonfunctional currency withdrawn
from an account with a bank or other financial institution -- (1) In
general. The basis of nonfunctional currency withdrawn from an account
with a bank or other financial institution shall be determined under any
reasonable method that is consistently applied from year to year by the
taxpayer to all accounts denominated in a nonfunctional currency. For
example, a taxpayer may use a first in first out method, a last in first
out method, a pro rata method (as illustrated in the example below), or
any other reasonable method that is consistently applied. However, a
method that consistently results in units of nonfunctional currency with
the highest basis being withdrawn first shall not be considered
reasonable.
(2) Example. The following example illustrates the provisions of
this paragraph (a)(2)(iii)(B).
Example. (i) X, a cash basis individual with the dollar as his
functional currency, opens a demand account with a Swiss bank. Assume
expenses associated with the demand account are deductible under section
212. The following chart indicates Swiss franc deposits to the account,
Swiss franc interest credited to the account, the dollar basis of each
deposit, and the determination of the aggregate dollar basis of all
Swiss francs in the account. Assume that the taxpayer has properly
translated all the amounts specified in the chart and that all
transactions are subject to section 988.
(ii) On January 1, 1990, X withdraws 500 Swiss francs from the
account. X may determine his basis in the Swiss francs by multiplying
the aggregate U.S. dollar basis of Swiss francs in the account by a
fraction the numerator of which is the number of Swiss francs withdrawn
from the account and the denominator is the total number of Swiss francs
in the account. Under this method, X's basis in the 500 Swiss francs is
$250 computed as follows:
(iii) X's basis in the Swiss francs remaining in the account is $350
($600^$250). X must use this method consistently from year to year with
respect to withdrawals of nonfunctional currency from all of X's
accounts.
(iv) Purchase and sale of stock or securities traded on an
established securities market by cash basis taxpayer --
(A) Amount realized. If stock or securities traded on an established
securities market are sold by a cash basis taxpayer for nonfunctional
currency, the amount realized with respect to the stock or securities
(as determined on the trade date) shall be computed by translating the
units of nonfunctional currency received into functional currency at the
spot rate on the settlement date of the sale. This rule applies
notwithstanding that the stock or securities are treated as disposed of
on a date other than the settlement date under another section of the
Code. See section 453(k).
(B) Basis. If stock or securities traded on an established
securities market are purchased by a cash basis taxpayer for
nonfunctional currency, the basis of the stock or securities shall be
determined by translating the units of nonfunctional currency paid into
functional currency at the spot rate on the settlement date of the
purchase.
(C) Example. The following example illustrates the provisions of
this paragraph (a)(2)(iv).
Example. On November 1, 1989 (the trade date), X, a calendar year
cash basis U.S. individual, purchases stock for 100 for settlement on
November 5, 1989. On November 1, 1989, the spot value of the 100 is
$140. On November 5, 1989, X purchases 100 for $141 which X uses to
pay for the stock. X's basis in the stock is $141. On December 30,
1990 (the trade date), X sells the stock for 110 for settlement on
January 5, 1991. On December 30, 1990, the spot value of 110 is $165.
On January 5, 1991, X transfers the stock and receives 110 which,
translated at the spot rate, equal $166. Under section 453(k), the
stock is considered disposed of on December 30, 1990. The amount
realized with respect to such disposition is the value of the 110 on
January 5, 1991 ($166). Accordingly, X's gain realized on December 30,
1990, from the disposition of the stock is $25 ($166 amount realized
less $141 basis). X's basis in the 110 received from the sale of the
stock is $166.
(v) Purchase and sale of stock or securities traded on an established
securities market by accrual basis taxpayer. For taxable years
beginning after March 17, 1992, an accrual basis taxpayer may elect to
apply the rules of paragraph (a)(2)(iv) of this section. The election
shall be made by filing a statement with the taxpayer's first return in
which the election is effective clearly indicating that the election has
been made. A method so elected must be applied consistently from year
to year and cannot be changed without the consent of the Commissioner.
(b) Translation of interest income or expense and determination of
exchange gain or loss with respect to debt instruments -- (1)
Translation of interest income received with respect to a nonfunctional
currency demand account. Interest income received with respect to a
demand account with a bank or other financial institution which is
denominated in (or the payments of which are determined by reference to)
a nonfunctional currency shall be translated into functional currency at
the spot rate on the date received or accrued or pursuant to any
reasonable spot rate convention consistently applied by the taxpayer to
all taxable years and to all accounts denominated in nonfunctional
currency in the same financial institution. For example, a taxpayer may
translate interest income received with respect to a demand account on
the last day of each month of the taxable year, on the last day of each
quarter of the taxable year, on the last day of each half of the taxable
year, or on the last day of the taxable year. No exchange gain or loss
is realized upon the receipt or accrual of interest income with respect
to a demand account subject to this paragraph (b)(1).
(2) Translation of nonfunctional currency interest income or expense
received or paid with respect to a debt instrument described in
1.988-1(a) (1)(ii) and (2)(i) -- (i) Scope -- (A) In general. Paragraph
(b) of this section only applies to debt instruments described in
1.988-1(a) (1)(ii) and (2)(i) where all payments are denominated in, or
determined with reference to, a single nonfunctional currency. Except
as provided in paragraph (b)(2)(i)(B) of this section, this paragraph
(b) shall not apply to contingent payment debt instruments.
(B) Nonfunctional currency contingent payment debt instruments -- (1)
Operative rules. (Reserved)
(2) Certain instruments are not contingent payment debt instruments.
For purposes of section 1275(d), a debt instrument denominated in, or
all payments of which are determined with reference to, a single
nonfunctional currency (with no contingencies) is not a contingent
payment debt instrument. See 1.988-1(a) (4) and (5) for the treatment
of dual currency and multi-currency debt instruments.
(ii) Determination and translation of interest income or expense --
(A) In general. Interest income or expense on a debt instrument
described in paragraph (b)(2)(i) of this section (including original
issue discount determined in accordance with sections 1271 through 1275
and 163(e) as adjusted for acquisition premium under section 1272(a)(7),
and acquisition discount determined in accordance with sections 1281
through 1283) shall be determined in units of nonfunctional currency and
translated into functional currency as provided in paragraphs (b)(2)(ii)
(B) and (C) of this section. For purposes of sections 483, 1273(b)(5)
and 1274, the nonfunctional currency in which an instrument is
denominated (or by reference to which payments are determined) shall be
considered money.
(B) Translation of interest income or expense that is not required to
be accrued prior to receipt or payment. With respect to an instrument
described in paragraph (b)(2)(i) of this section, interest income or
expense received or paid that is not required to be accrued by the
taxpayer prior to receipt or payment shall be translated at the spot
rate on the date of receipt or payment. No exchange gain or loss is
realized with respect to the receipt or payment of such interest income
or expense (other than the exchange gain or loss that might be realized
under paragraph (a) of this section upon the disposition of the
nonfunctional currency so received or paid).
(C) Translation of interest income or expense that is required to be
accrued prior to receipt or payment. With respect to an instrument
described in paragraph (b)(2)(i) of this section, interest income or
expense that is required to be accrued prior to receipt or payment
(e.g., under section 1272, 1281 or 163(e) or because the taxpayer uses
an accrual method of accounting) shall be translated at the average rate
(or other rate specified in paragraph (b)(2)(iii)(B) of this section)
for the interest accrual period or, with respect to an interest accrual
period that spans two taxable years, at the average rate (or other rate
specified in paragraph (b)(2)(iii)(B) of this section) for the partial
period within the taxable year. See paragraphs (b) (3) and (4) of this
section for the determination of exchange gain or loss on the receipt or
payment of accrued interest income or expense.
(iii) Determination of average rate or other accrual convention --
(A) In general. For purposes of this paragraph (b), the average rate
for an accrual period (or partial period) shall be a simple average of
the spot exchange rates for each business day of such period or other
average exchange rate for the period reasonably derived and consistently
applied by the taxpayer.
(B) Election to use spot accrual convention. For taxable years
beginning after March 17, 1992, a taxpayer may elect to translate
interest income and expense at the spot rate on the last day of the
interest accrual period (and in the case of a partial accrual period,
the spot rate on the last day of the taxable year). If the last day of
the interest accrual period is within five business days of the date of
receipt or payment, the taxpayer may translate interest income or
expense at the spot rate on the date of receipt or payment. The
election shall be made by filing a statement with the taxpayer's first
return in which the election is effective clearly indicating that the
election has been made. A method so elected must be applied
consistently to all debt instruments from year to year and cannot be
changed without the consent of the Commissioner.
(3) Exchange gain or loss recognized by the holder with respect to
accrued interest income. The holder of a debt instrument described in
paragraph (b)(2)(i) of this section shall realize exchange gain or loss
with respect to accrued interest income on the date such accrued
interest income is received or the instrument is disposed of (including
a deemed disposition under section 1001 that results from a material
change in terms of the instrument). Except as otherwise provided in
this paragraph (b) (e.g., paragraph (b)(8) of this section), exchange
gain or loss realized with respect to accrued interest income shall be
recognized in accordance with the applicable recognition provisions of
the Internal Revenue Code. The amount of exchange gain or loss so
realized with respect to accrued interest income is determined for each
accrual period by --
(i) Translating the units of nonfunctional currency interest income
received with respect to such accrual period (as determined under the
ordering rules of paragraph (b)(7) of this section) into functional
currency at the spot rate on the date the interest income is received or
the instrument is disposed of (or deemed disposed of), and
(ii) Subtracting from such amount the amount computed by translating
the units of nonfunctional currency interest income accrued with respect
to such income received at the average rate (or other rate specified in
paragraph (b)(2)(iii)(B) of this section) for the accrual period.
(4) Exchange gain or loss recognized by the obligor with respect to
accrued interest expense. The obligor under a debt instrument described
in paragraph (b)(2)(i) of this section shall realize exchange gain or
loss with respect to accrued interest expense on the date such accrued
interest expense is paid or the obligation to make payments is
transferred or extinguished (including a deemed disposition under
section 1001 that results from a material change in terms of the
instrument). Except as otherwise provided in this paragraph (b) (e.g.,
paragraph (b)(8) of this section), exchange gain or loss realized with
respect to accrued interest expense shall be recognized in accordance
with the applicable recognition provisions of the Internal Revenue Code.
The amount of exchange gain or loss so realized with respect to accrued
interest expense is determined for each accrual period by --
(i) Translating the units of nonfunctional currency interest expense
accrued with respect to the amount of interest paid into functional
currency at the average rate (or other rate specified in paragraph
(b)(2)(iii)(B) of this section) for such accrual period; and
(ii) Subtracting from such amount the amount computed by translating
the units of nonfunctional currency interest paid (or, if the obligation
to make payments is extinguished or transferred, the units accrued) with
respect to such accrual period (as determined under the ordering rules
in paragraph (b)(7) of this section) into functional currency at the
spot rate on the date payment is made or the obligation is transferred
or extinguished (or deemed extinguished).
(5) Exchange gain or loss recognized by the holder of a debt
instrument with respect to principal. The holder of a debt instrument
described in paragraph (b)(2)(i) of this section shall realize exchange
gain or loss with respect to the principal amount of such instrument on
the date principal (determined under the ordering rules of paragraph
(b)(7) of this section) is received from the obligor or the instrument
is disposed of (including a deemed disposition under section 1001 that
results from a material change in terms of the instrument). For
purposes of computing exchange gain or loss, the principal amount of a
debt instrument is the holder's purchase price in units of nonfunctional
currency. See paragraph (b)(10) of this section for rules regarding the
amortization of that part of the principal amount that represents bond
premium and the computation of exchange gain or loss thereon. If,
however, the holder acquired the instrument in a transaction in which
exchange gain or loss was realized but not recognized by the transferor,
the nonfunctional currency principal amount of the instrument with
respect to the holder shall be the same as that of the transferor.
Except as otherwise provided in this paragraph (b) (e.g., paragraph
(b)(8) of this section), exchange gain or loss realized with respect to
such principal amount shall be recognized in accordance with the
applicable recognition provisions of the Internal Revenue Code. The
amount of exchange gain or loss so realized by the holder with respect
to principal is determined by --
(i) Translating the units of nonfunctional currency principal at the
spot rate on the date payment is received or the instrument is disposed
of (or deemed disposed of); and
(ii) Subtracting from such amount the amount computed by translating
the units of nonfunctional currency principal at the spot rate on the
date the holder (or a transferor from whom the nonfunctional principal
amount is carried over) acquired the instrument (is deemed to acquire
the instrument).
(6) Exchange gain or loss recognized by the obligor of a debt
instrument with respect to principal. The obligor under a debt
instrument described in paragraph (b)(2)(i) of this section shall
realize exchange gain or loss with respect to the principal amount of
such instrument on the date principal (determined under the ordering
rules of paragraph (b)(7) of this section) is paid or the obligation to
make payments is transferred or extinguished (including a deemed
disposition under section 1001 that results from a material change in
terms of the instrument). For purposes of computing exchange gain or
loss, the principal amount of a debt instrument is the amount received
by the obligor for the debt instrument in units of nonfunctional
currency. See paragraph (b)(10) of this section for rules regarding the
amortization of that part of the principal amount that represents bond
premium and the computation of exchange gain or loss thereon. If,
however, the obligor became the obligor in a transaction in which
exchange gain or loss was realized but not recognized by the transferor,
the nonfunctional currency principal amount of the instrument with
respect to such obligor shall be the same as that of the transferor.
Except as otherwise provided in this paragraph (b) (e.g., paragraph
(b)(8) of this section), exchange gain or loss realized with respect to
such principal shall be recognized in accordance with the applicable
recognition provisions of the Internal Revenue Code. The amount of
exchange gain or loss so realized by the obligor is determined by --
(i) Translating the units of nonfunctional currency principal at the
spot rate on the date the obligor (or a transferor from whom the
principal amount is carried over) became the obligor (or is deemed to
have become the obligor); and
(ii) Subtracting from such amount the amount computed by translating
the units of nonfunctional currency principal at the spot rate on the
date payment is made or the obligation is transferred or extinguished
(or deemed extinguished).
(7) Payment ordering rules -- (i) Debt instruments subject to the
rules of sections 163(e), or 1271 through 1288. In the case of a debt
instrument described in paragraph (b)(2)(i) of this section that is
subject to the rules of sections 163(e), or 1272 through 1288, units of
nonfunctional currency (or an amount determined with reference to
nonfunctional currency) received or paid with respect to such debt
instrument shall be treated first as a receipt or payment of periodic
interest under the principles of section 1273 and the regulations
thereunder, second as a receipt or payment of original issue discount to
the extent accrued as of the date of the receipt or payment, and finally
as a receipt or payment of principal. Units of nonfunctional currency
(or an amount determined with reference to nonfunctional currency)
treated as a receipt or payment of original issue discount under the
preceding sentence are attributed to the earliest accrual period in
which original issue discount has accrued and to which prior receipts or
payments have not been attributed. No portion thereof shall be treated
as prepaid interest. These rules are illustrated by Example 10 of
paragraph (b)(9) of this section.
(ii) Other debt instruments. In the case of a debt instrument
described in paragraph (b)(2)(i) of this section that is not subject to
the rules of section 163(e) or 1272 through 1288, whether units of
nonfunctional currency (or an amount determined with reference to
nonfunctional currency) received or paid with respect to such debt
instrument are treated as interest or principal shall be determined
under section 163 or other applicable section of the Code.
(8) Limitation of exchange gain or loss on payment or disposition of
a debt instrument. When a debt instrument described in paragraph
(b)(2)(i) of this section is paid or disposed of, or when the obligation
to make payments thereunder is satisfied by another person, or
extinguished or assumed by another person, exchange gain or loss is
computed with respect to both principal and any accrued interest
(including original issue discount), as provided in paragraph (b)(3)
through (7) of this section. However, pursuant to section 988(b) (1)
and (2), the sum of any exchange gain or loss with respect to the
principal and interest of any such debt instrument shall be realized
only to the extent of the total gain or loss realized on the
transaction. The gain or loss realized shall be recognized in
accordance with the general principles of the Code. See Examples 3, 4
and 6 of paragraph (b)(9) of this section.
(9) Examples. The preceding provisions are illustrated in the
following examples. The examples assume that any transaction involving
an individual is a section 988 transaction.
Example 1. (i) X is an individual on the cash method of accounting
with the dollar as his functional currency. On January 1, 1992, X
converts $13,000 to 10,000 British pounds ( ) at the spot rate of 1 =
$1.30 and loans the 10,000 to Y for 3 years. The terms of the loan
provide that Y will make interest payments of 1,000 on December 31 of
1992, 1993, and 1994, and will repay X's 10,000 principal on December
31, 1994. Assume the spot rates for the pertinent dates are as follows:
(ii) Under paragraph (b)(2)(ii)(B) of this section, X will trans1ate
the 1,000 interest payments at the spot rate on the date received.
Accordingly, X will have interest income of $1,350 in 1992, $1,400 in
1993, and $1,450 in 1994. Because X is a cash basis taxpayer, X does
not realize exchange gain or loss on the receipt of interest income.
(iii) Under paragraph (b)(5) of this section, X will realize exchange
gain upon repayment of the 10,000 principal amount determined by
translating the 10,000 at the spot rate on the date it is received (
10,000 $1.45 = $14,500) and subtracting from such amount, the amount
determined by translating the 10,000 at the spot rate on the date the
loan was made ( 10,000 $1.30 = $13,000). Accordingly, X will realize an
exchange gain of $1,500 on the repayment of the loan on December 31,
1994.
Example 2. (i) Assume the same facts as in Example 1 except that X
is an accrual method taxpayer and that average rates are as follows:
(ii) Under paragraph (b)(2)(ii)(C) of this section, X will accrue the
1,000 interest payments at the average rate for the accrual period.
Accordingly, X will have interest income of $1,320 in 1992, $1,370 in
1993, and $1,420 in 1994. Because X is an accrual basis taxpayer, X
determines exchange gain or loss for each interest accrual period by
translating the units of nonfunctional currency interest income received
with respect to such accrual period at the spot rate on the date
received and subtracting the amounts of interest income accrued for such
period. Thus, X will realize $90 of exchange gain with respect to
interest received under the loan, computed as follows:
(iii) Under paragraph (b)(5) of this section, X will realize exchange
gain upon repayment of the 10,000 loan principal determined in the same
manner as in Example 1. Accordingly, X will realize an exchange gain of
$1,500 on the repayment of the loan principal on December 31, 1994.
Example 3. Assume the same facts as in Example 1 except that X is a
calendar year taxpayer on the accrual method of accounting that elects
to use a spot rate convention to translate interest income as provided
in 1.988-2(b)(2)(iii)(B). Interest income is received by X on the last
day of each accrual period. Under paragraph (b)(2)(ii)(C), X will
translate the interest income at the spot rate on the last day of each
interest accrual period. Accordingly, X will have interest income of
$1,350 in 1992, and $1,400 in 1993, $1,450 in 1994. Because the rate at
which the interest income is translated is the same as the rate on the
day of receipt, X will not realize any exchange gain or loss with
respect to the interest income. Under paragraph (b)(5) of this section,
X will realize exchange gain upon repayment of the 10,000 loan
principal determined in the same manner as in Example 1. Accordingly, X
will realize an exchange gain of $1,500 on the repayment of the loan
principal on December 31, 1994.
Example 4. Assume the same facts as in Example 1 except that on
December 31, 1993, X sells Y's note for 9,821.13 British pounds ( )
after the interest payment. Under paragraph (b)(8) of this section, X
will compute exchange gain on the 10,000 principal. The exchange gain
is $1,000 (( 10,000 $1.40)^( 10,000 $1.30)). This exchange gain,
however, is only realized to the extent of the total gain on the
disposition. X's total gain is $749.58 (( 9,821.13 $1.40)^( 10,000
$1.30)). Thus, X will realize $749.58 of exchange gain (and will realize
no market loss).
Example 5. (i) The facts are the same as in Example 1 except that Y
becomes insolvent and fails to repay the full 10,000 principal when
due. Instead, X and Y agree to compromise the debt for a payment of
8,000 on December 31, 1994. Under paragraph (b)(8) of this section, X
will compute exchange gain on the 10,000 originally booked. The
exchange gain is $1,500 (( 10,000 $1.45)^( 10,000 $1.30) = $1,500).
This exchange gain, however, is only realized to the extent of the total
gain on the disposition. X realizes an overall loss on the disposition
of $1,400 (( 8,000 $1.45)^( 10,000 $1.30) = ($1,400)). Thus, X will
realize no exchange gain (and a $1400 market loss).
(ii) If the exchange rate on December 31, 1994, were 1 = $1.25,
rather than 1 = $1.45, X would compute exchange loss under paragraph
(b)(8) of this section, on the 10,000 originally booked. The exchange
loss would be $500 (( 10,000 $1.25)^( 10,000 $1.30) = ($500)). X's
total loss on the disposition would be $3,000 (( 8,000 $1.25)-( 10,000
$1.30) = ($3,000)). Thus, X would realize $500 of exchange loss and a
$2,500 market loss on the disposition.
Example 6. (i) X is an individual with the dollar as his functional
currency. X is on the cash method of accounting. On January 1, 1989, X
borrows 10,000 British pounds ( ) from Y, an unrelated person. The
terms of the loan provide that X will make interest payments of 1,200
on December 31 of 1989 and 1990 and will repay Y's 10,000 principal on
December 31, 1990. The spot rates for the pertinent dates are as
follows:
Assume that the basis of the 1,200 paid as interest by X on December
31, 1989 is $2,000, the basis of the 1,200 paid as interest by X on
December 31, 1990, is $2,020 and the basis of the 10,000 principal paid
by X on December 31, 1990 is $16,000.
(ii) Under paragraph (b)(2)(ii)(B) of this section, X translates the
1,200 interest payments at the spot rate on the day paid. Thus, X paid
$1,920 ( 1,200 $1.60) of interest on December 31, 1989 and $2,040 (
1,200 $1.70) of interest on December 31, 1990. In addition, X will
realize exchange gain or loss on the disposition of the 1,200 on
December 31, 1989 and 1990, under paragraph (a) of this section.
Pursuant to paragraph (a)(2) of this section, X will realize an exchange
loss of $80 (( 1,200 $1.60)^$2,000) on December 31, 1989 and exchange
gain of $20 (( 1,200 $1.70)^$2,020) on December 31, 1990.
(iii) Under paragraph (b)(6) of this section, X will realize exchange
loss on December 31, 1990 upon repayment of the 10,000 principal amount
determined by translating the 10,000 received at the spot rate on
January 1, 1989 ( 10,000 $1.50 = $15,000) and subtracting from such
amount, the amount determined by translating the 10,000 paid at the
spot rate on December 31, 1990 ( 10,000 $1.70 = $17,000). Thus, under
paragraph (b)(6) of this section, X has an exchange loss with respect to
the 10,000 principal of $2,000. Further, under paragraph (a)(2) of
this section, X will realize an exchange gain upon disposition of the
10,000 on December 31, 1990. Under paragraph (a)(2) of this section, X
will subtract his adjusted basis in the 10,000 ($16,000) from the
amount realized upon the disposition of the 10,000 ( 10,000 $1.70 =
$17,000) resulting in a gain of $1,000. Accordingly, X's combined
exchange gain and loss realized on December 31, 1990 with respect to the
repayment of the 10,000 is a $1,000 exchange loss.
Example 7. (i) X is a calendar year corporation on the accrual
method of accounting and with the dollar as its functional currency. On
January 1, 1989, X purchases at original issue for 82.64 Canadian
dollars (C$) M corporation's 2 year note maturing on December 31, 1990,
at a stated redemption price of C$100. The yield to maturity in
Canadian dollars is 10 percent and the accrual period is the one year
period beginning January 1 and ending December 31. The note has C$17.36
of original issue discount. Assume that the spot rates are as follows:
C$1 = U.S.$.72 on January 1, 1989; C$1 = U.S.$.80 on January 1, 1990;
C$1 = U.S.$ .82 on December 31, 1990. Assume further that the average
rate for 1989 is C$1 = U.S.$ .76 and for 1990 is C$1 = U.S. $.81.
(ii) Under paragraph (b)(2)(ii)(A) of this section, X will determine
its interest income in Canadian dollars. Accordingly, under section
1272, X must take into account original issue discount in the amount of
C$8.26 on December 31, 1989 and C$9.10 on December 31, 1990. Pursuant
to paragraph (b)(2)(ii)(C) of this section, X will translate these
amounts into U.S. dollars at the average exchange rate for the relevant
accrual period. Thus, the amount of interest income taken into account
in 1989 is U.S.$6.28 (C$8.26 U.S.$.76) and in 1990 is U.S.$7.37 (C$9.10
U.S.$.81). Pursuant to paragraph (b)(3)(ii) of this section, X will
realize exchange gain or loss with respect to the accrued interest
determined for each accrual period by translating the Canadian dollars
received with respect to such accrual period into U.S. dollars at the
spot rate on the date the interest is received and subtracting from that
amount the amount accrued in U.S. dollars. Thus, the amount of exchange
gain realized on December 31, 1990, is U.S.$.58 (U.S.$.49 from
1989+U.S.$.09 from 1990). Pursuant to paragraph (b)(5) of this section,
X shall realize exchange gain or loss with respect to the principal
(C$82.64) on December 31, 1990, computed by translating the C$82.64 at
the spot rate on December 31, 1990 (U.S.$67.76) and subtracting the
C$82.64 translated at the spot rate on January 1, 1989 (U.S.$59.50) for
an exchange gain of U.S.$8.26. Thus, X's combined exchange gain is
U.S.$8.84 (U.S.$.49+U.S.$.09+U.S.$8.26).
(iii) Assume instead that on January 1, 1990, X sells the note for
C$86.95, which it immediately converts to U.S. dollars. X's exchange
gain is computed under paragraph (b)(8) of this section with reference
to the nonfunctional currency denominated principal amount (C$82.64) and
the nonfunctional currency denominated accrued original issue discount
(C$8.26). X will compute an exchange gain of U.S.$6.61 with respect to
the issue price ((C$82.64 U.S.$ .80)^(C$82.64 U.S.$.72)) and an exchange
gain of U.S.$.33 with respect to the accrued original issue discount
((C$8.26 U.S.$.80)^(C$8.26 U.S.$ .76)). Accordingly, prior to the
application of paragraph (b)(8) of this section, X's total exchange gain
is U.S.$6.94 (U.S.$6.61+U.S.$.33), and X's market loss is U.S.$3.16
((C$90.90^C$86.95) U.S.$.80). Pursuant to paragraph (b)(8) of this
section, however, X's market loss on the note of U.S.$3.16 is netted
against X's exchange gain of U.S.$6.94, resulting in a realized exchange
gain of U.S.$3.78 and no market loss.
Example 8. (i) The facts are the same as in Example 7 (i) except
that on January 1, 1990, X contributes the M corporation note to Y, a
wholly-owned U.S. subsidiary of X with the dollar as its functional
currency, and Y collects C$100 from M corporation at maturity on
December 31, 1990, when the spot rate is C$1 = U.S.$.82. The transfer of
the note from X to Y qualifies for nonrecognition of gain under section
351(a). On December 31, 1990, Y includes C$9.10 of accrued interest in
income which translated at the average exchange rate of C$1 = U.S.$.81
for the year results in U.S.$7.37 of interest income.
(ii) Y's exchange gain is computed under paragraph (b)(3) of this
section with respect to accrued interest income and paragraph (b)(5) of
this section with respect to the nonfunctional currency principal
amount. Under paragraph (b)(3) of this section, Y will realize exchange
gain or loss for each accrual period computed by translating the units
of nonfunctional currency interest income received with respect to such
accrual period at the spot rate on the day received and subtracting the
amounts of interest income accrued for such period. Thus, Y will
realize $.49 of exchange gain with respect to original issue discount
accrued in 1989 ((C$8.26 U.S.$.82)^(C$8.26 U.S.$.76) = U.S. $.49) and
$.09 of exchange gain with respect to original issue discount accrued in
1990 ((C$9.10 U.S.$.82)^(C$9.10 U.S.$.81) = $.09).
(iii) Pursuant to paragraph (b)(5) of this section, the nonfunctional
currency principal amount of the M bond in the hands of Y is C$82.64,
the amount carried over from X, the transferor. Y's exchange gain with
respect to the nonfunctional currency principal amount is $8.26
((C$82.64 U.S.$.82)^(C$82.64 U.S.$.72) = U.S. $8.26). Accordingly, Y's
combined exchange gain is U.S. $8.84 ($.49+$.09+$8.26). Because the
amount realized in Canadian dollars equals the adjusted issue price
(C$100) on retirement of the M note, there is no market loss, and the
netting rule of paragraph (b)(8) of this section does not limit
realization of the exchange gain.
Example 9. (i) X is a calendar year corporation on the accrual
method of accounting and with the dollar as its functional currency. X
elects to use the spot rate convention to translate interest income as
provided in paragraph (b)(2)(iii)(B) of this section. On January 31,
1992, X loans 1000 to Y, an unrelated person. Under the terms of the
loan, Y will pay X interest of 50 on July 31, 1992, and January 31,
1993, and will repay the 1000 principal on January 31, 1993. Assume
the following spot exchange rates:
(ii) Under paragraph (b)(2)(ii)(C) of this section, X will translate
the interest income at the spot rate on the last day of each interest
accrual period (and in the case of a partial accrual period, at the spot
rate on the last day of the taxable year). Accordingly, X will have
interest income of $77.50 ( 50 $1.55) on July 31, 1992. Assuming under
X's method of accounting that interest is accrued daily, X will accrue
$66.50 (153/184 50) $1.60) of interest income on December 31, 1992. On
January 31, 1993, X will have interest income of $13.60 ((31/184 50)
$1.61). Because the rate at which the interest income is translated is
the same as the rate on the day of receipt, X will not realize any
exchange gain or loss with respect to the interest income received on
July 31, 1992. However, X will realize exchange gain on the 41.50
(153/184 50) of accrued interest income of $.41 (( 41.50 $1.61)^( 41.50
$1.60) = $.41).
(iii) Under paragraph (b)(5) of this section, X will realize exchange
gain upon repayment of the 100 principal amount determined by
translating the 100 at the spot rate on the date it is received ( 100
$1.61 = $161.00) and subtracting from such amount, the amount determined
by translating the 100 at the spot rate on the date the loan was made (
100 $1.50 = $150.00). Accordingly, X will realize an exchange gain of
$11 on the repayment of the loan on January 31, 1993.
Example 10. (i) X, a cash basis taxpayer with the dollar as its
functional currency, has the calendar year as its taxable year. On
January 1, 1992, X purchases at original issue for 65.88 British pounds
( ) M corporation's 5-year bond maturing on December 31, 1996, having a
stated redemption price at maturity of 100. The bond provides for
annual payments of interest in pounds of 1 pound per year on December 31
of each year. The bond has 34.12 British pounds of original issue
discount. The yield to maturity is 10 percent in British pounds and the
accrual period is the one year period beginning January 1 and ending
December 31 of each calendar year. The amount of original issue
discount is determined in pounds for each accrual period by multiplying
the adjusted issue price expressed in pounds by the yield and
subtracting from such amount the periodic interest payments expressed in
pounds for such period. The periodic interest payments are translated
at the spot rate on the payment date (December 31 of each year). The
original issue discount is translated at the average rate for the
accrual period (January 1 through December 31). The following chart
describes the determination of interest income with respect to the facts
presented and provides other pertinent information.
(ii) Because X is a cash basis taxpayer, X does not realize exchange
gain or loss on the receipt of the 1 periodic interest payments.
However, X will realize exchange gain on December 31, 1996 totaling
$7.88 with respect to the original issue discount. Exchange gain is
determined for each interest accrual period by translating the units of
nonfunctional currency interest income received with respect to such
accrual period at the spot rate on the date received and subtracting
from such amount, the amount computed by translating the units of
nonfunctional currency interest income accrued for such period at the
average rate for the period. The following chart illustrates this
computation:
(iii) X will also realize exchange gain with respect to the principal
of the loan (i.e., the issue price of 65.88 British pounds) on December
31, 1996 computed by translating the units of nonfunctional curreny
principal received at the spot rate on the date principal is received
(65.88 British pounds $1.70 = $112.00) and subtracting from such
amount, the units of nonfunctional currency principal received
translated at the spot rate on the date the instrument was acquired
(65.88 British pounds $1.20 = $79.06). Accordingly, X's exchange gain
on the principal is $32.94 and X's total exchange gain with respect to
the accrued interest and principal is $40.82. It should be noted that,
under this fact pattern, the total exchange gain may be determined in an
alternative fashion. Exchange gain may be computed by subtracting the
adjusted issue price in dollars at maturity ($129.18 -- see column 10 of
Table 1) from the amount computed by multiplying the stated redemption
price at maturity in pounds times the spot rate on the maturity date (
100 $1.70 = $170), which equals $40.82.
Example 11. (i) The facts are the same as in Example 10 except that
X makes an election under paragraph (b)(2)(iii) of this section to
translate accrued interest on the last day of the accrual period.
Accordingly, columns 8, 9 and 10 in Table 1 would change as follows:
(ii) Because X is a cash basis taxpayer, X does not realize exchange
gain or loss on the receipt of the 1 periodic interest payments.
However, X will realize exchange gain on December 31, 1993 totaling
$6.18 with respect to the original issue discount. Exchange gain is
determined for each interest accrual period by translating the units of
nonfunctional currency interest income received with respect to such
accrual period at the spot rate on the date received and subtracting
from such amount, the amount computed by translating the units of
nonfunctional currency interest income accrued for such period at the
spot rate on the last day of the accrual period. Accordingly, columns
5, 6 and 7 of Table 2 would change as follows:
(iii) X wi11 realize exchange gain with respect to the principal
amount of the loan as provided in the preceding example.
Example 12. (i) C is a corporation that is a calendar year accrual
method taxpayer with the dollar as its functional currency. On January
1, 1989, C lends 100 British pounds ( ) in exchange for a note under the
terms of which C will receive two equal payments of 57.62 on December
31, 1989, and December 31, 1990. Each payment of 57.62 represents the
annual payment necessary to amortize the 100 principal amount at a rate
of 10% compounded annually over a two year period. The following tables
reflect the amounts of principal and interest that compose each payment
and assumptions as to the relevant exchange rates:
(ii) Because each interest payment is equal to the product of the
outstanding principal balance of the obligation and a single fixed rate
of interest, each stated interest payment constitutes periodic interest
under the principles of section 1273. Accordingly, there is no original
issue discount.
(iii) Because C is an accrual basis taxpayer, C will translate the
interest income at the average rate for the annual accrual period
pursuant to paragraph (b)(2)(ii)(C) of this section. Thus, C's interest
income is $13.50 ( 10.00 $1.35) in 1989, and $7.60 ( 5.24 $1.45) in
1990. C will realize exchange gain or loss upon receipt of accrued
interest computed in accordance with paragraph (b)(3) of this section.
Thus, C will realize exchange gain in the amount of $.50 (( 10.00
$1.40)^$13.50) in 1989, and $.26 (( 5.24 $1.50)^$7.60) in 1990.
(iv) In addition, C will realize exchange gain or loss upon the
receipt of principal each year computed under paragraph (b)(5) of this
section. Thus, C will realize exchange gain in the amount of $4.76 ((
47.62 $1.40)^( 47.62 $1.30)) in 1989, and $10.48 (( 52.38 $1.50)^( 52.38
$1.30)) in 1990.
(10) Treatment of bond premium -- (i) In general. Amortizable bond
premium on a bond described in paragraph (b)(2)(i) of this section shall
be computed in the units of nonfunctional currency in which the bond is
denominated (or in which the payments are determined). Amortizable bond
premium properly taken into account under section 171 or 1.61-12 (or
the successor provision thereof) shall reduce interest income or expense
in units of nonfunctional currency. Exchange gain or loss is realized
with respect to bond premium described in the preceding sentence by
treating the portion of premium amortized with respect to any period as
a return of principal. With respect to a holder that does not elect to
amortize bond premium under section 171, the amount of bond premium will
constitute a market loss when the bond matures. See paragraph (b)(8) of
this section. The principles set forth in this paragraph (b)(10) shall
apply to determine the treatment of acquisition premium described in
section 1272(a)(7).
(ii) Example. The following example illustrates the provisions of
this paragraph (b)(10).
Example. (A) X is an individual on the cash method of accounting with
the dollar as his functional currency. On January 1, 1989, X purchases
Y corporation's note for 107.99 British pounds ( ) from Z, an unrelated
party. The note has an issue price of 100, a stated redemption price
at maturity of 100, pays interest in pounds at the rate of 10%
compounded annually, and matures on December 31, 1993. X elects to
amortize the bond premium of 7.99 under the rules of section 171.
Pursuant to paragraph (b)(10)(i) of this section, bond premium is
determined and amortized in British pounds. Assume the amortization
schedule is as follows:
(B) The bond premium reduces X's pound interest income under the
note. For example, the 10 stated interest payment made in 1989 is
reduced by 1.36 of bond premium, and the resulting 8.64 interest
income is translated into dollars at the spot rate on December 31, 1989.
Exchange gain or loss is realized on the 1.36 bond premium based on
the difference between the spot rates on January 1, 1989, the date the
premium is paid to acquire the bond, and December 31, 1989, the date the
bond premium is returned as part of the stated interest. The 1.36 bond
premium reduces the unamortized premium plus principal to 106.63 (
107.99^ 1.36). On December 31, 1993, when the bond matures and the 7.99
of bond premium has been fully amortized, X will realize exchange gain
or loss with respect to the remaining purchase price of 100.
(11) Market discount -- (i) In general. Market discount as defined
in section 1278(a)(2) shall be determined in units of nonfunctional
currency in which the market discount bond is denominated (or in which
the payments are determined). Accrued market discount (other than
market discount currently included in income pursuant to section
1278(b)) shall be translated into functional currency at the spot rate
on the date the market discount bond is disposed of. No part of such
accrued market discount is treated as exchange gain or loss. Accrued
market discount currently includible in income pursuant to section
1278(b) shall be translated into functional currency at the average
exchange rate for the accrual period. Exchange gain or loss with
respect to accrued market discount currently includible in income under
section 1278(b) shall be determined in accordance with paragraph (b)(3)
of this section relating to accrued interest income.
(ii) Example. The following example illustrates the provisions of
this paragraph (b)(11).
Example. (A) X is a calendar year corporation with the U.S. dollar as
its functional currency. On January 1, 1990, X purchases a bond of M
corporation for 96,530 British pounds ( ). The bond, which was issued
on January 1, 1989, has an issue price of 100,000, a stated redemption
price at maturity of 100,000, and provides for annual pound payments of
interest at 8 percent. The bond matures on December 31, 1991. X
purchased the bond at a market discount of 3,470 pounds and did not
elect to include the market discount currently in income under section
1278(b). X holds the bond to maturity and on December 31, 1991,
receives payment of 100,000 (plus 8,000 interest) when the exchange
rate is 1 = $1.50.
(B) Pursuant to paragraph (b)(11) of this section, X computes market
discount in units of nonfunctional currency. Thus, the market discount
as defined under section 1278(a)(2) is 3,470. Accrued market discount
(other than market discount currently included in income pursuant to
section 1278(b)) is translated at the spot rate on the date the market
discount bond is disposed of. Accordingly, X will translate the accrued
market discount of 3,470 at the spot rate on December 31, 1991 ( 3,470
$1.50 = $5,205). No exchange gain or loss is realized with respect to
the 3,470 of accrued market discount. See paragraphs (b) (3) and (5)
of this section for the realization and recognition of exchange gain or
loss with respect to accrued interest and principal.
(12) Tax exempt bonds. See 1.988-3(c)(2), which characterizes
exchange loss realized with respect to a nonfunctional currency tax
exempt bond as a reduction of interest income.
(13) Nonfunctional currency debt exchanged for stock of obligor --
(i) In general. Notwithstanding any other section of the Code other
than section 267, 1091 or 1092, exchange gain or loss shall be realized
and recognized by the holder and the obligor in accordance with the
rules of paragraphs (b) (3) through (7) of this section with respect to
the principal and accrued interest of a debt instrument described in
paragraph (b)(2)(i) of this section that is acquired by the obligor in
exchange for its stock, provided however, that such gain or loss shall
be recognized only to the extent of the total gain or loss on the
exchange (regardless of whether such gain or loss would otherwise be
recognized). This rule shall apply whether the debt instrument is
converted into stock according to its terms or exchanged pursuant to a
separate agreement between the obligor and the holder. A debt
instrument that is acquired by the obligor from a shareholder as a
contribution to capital shall be treated for purposes of this section as
exchanged for stock, whether or not additional stock is issued.
(ii) Coordination with section 108. Section 988 and this section
shall apply before section 108. Exchange gain realized by the obligor
on an exchange described in paragraph (b)(13)(i) of this section shall
not be treated as discharge of indebtedness income, but shall be
considered to reduce the amount of the liability for purposes of
computing the obligor's income on the exchange under section 108(e)(4),
section 108(e)(6) or section 108(e)(10).
(iii) Effective date. This paragraph (b)(13) shall be effective for
exchanges of debt for stock effected after September 21, 1989.
(iv) Examples. The following examples illustrate the operation of
this paragraph (b)(13). In each such example, assume that sections 267,
1091 and 1092 do not apply.
Example 1. (i) X is a calendar year U.S. corporation with the U.S.
dollar as its functional currency. On January 1, 1990 (the issue date),
X acquired a convertible bond maturing on December 31, 1998, issued by Y
corporation, a U.K. corporation with the British pound ( ) as its
functional currency. The issue price of the bond is 100,000, the
stated redemption price at maturity is 100,000, and the bond provides
for annual pound interest payments at the rate of 10%. The terms of the
bond also provide that at any time prior to December 31, 1998, the
holder may surrender all of his interest in the bond in exchange for 20
shares of Y common stock. On January 1, 1994, X surrenders his interest
in the bond for 20 shares of Y common stock. Assume the following: (a)
The spot rate on January 1, 1990, is 1 = $1.30, (b) The spot rate on
January 1, 1994, is 1 = $1.50, and (c) The 20 shares of Y common stock
have a market value of 200,000 on January 1, 1994.
(ii) Pursuant to paragraph (b)(13) of this section, X will realize
and recognize exchange gain with respect to the issue price ( 100,000)
of the bond on January 1, 1994, when the bond is converted to stock. X
will compute exchange gain pursuant to paragraph (b)(5) of this section
by translating the issue price at the spot rate on the conversion date (
100.000 $1.50 = $150,000) and subtracting from such amount the issue
price translated at the spot rate on the date X acquired the bond (
100,000 $1.30 = $130,000). Thus, X will realize and recognize $20,000
of exchange gain. X's basis in the 20 shares of Y common stock is
$150,000 ($130,000 substituted basis + $20,000 recognized gain).
Example 2. (i) X, a foreign corporation with the British pound ( )
as its functional currency, lends 100 at a market rate of interest to
Y, its wholly-owned U.S. subsidiary, on January 1, 1990, on which date
the spot exchange rate is 1 = $1. Y's functional currency is the U.S.
dollar. On January 1, 1992, when the spot exchange rate is 1 = $.50, X
cancels the debt as a contribution to capital. Pursuant to paragraph
(b)(13) of this section, Y will realize and recognize exchange gain with
respect to the 100 issue price of the debt instrument on January 1,
1992. Y will compute exchange gain pursuant to paragraph (b)(6) of this
section by translating the issue price at the spot rate on the date Y
became the obligor ( 100 $1 = $100) and subtracting from such amount the
issue price translated at the spot rate on the date of extinguishment (
100 $.50 = $50). Thus, Y will realize and recognize $50 of exchange
gain.
(ii) Under section 108(e)(6), on the acquisition of its indebtedness
from X as a contribution to capital Y is treated as having satisfied the
debt with an amount of money equal to X's adjusted basis in the debt (
100). For purposes of section 108(e)(6), X's adjusted basis is
translated into United States dollars at the spot rate on the date Y
acquires the debt ( 1 = $.50). Therefore, Y is treated as having
satisfied the debt for $50. Pursuant to paragraph (b)(13) of this
section, for purposes of section 108 the amount of the indebtedness is
considered to be reduced by the exchange gain from $100 to $50.
Accordingly, Y recognizes $50 of exchange gain and no discharge of
indebtedness income on the extinguishment of its debt to X.
(iii) If X were a United States taxpayer with a dollar functional
currency and a $100 basis in Y's obligation. X would realize and
recognize an exchange loss of $50 under paragraph (b)(5) of this section
on the contribution of the debt to Y. The recognized loss would reduce
X's adjusted basis in the debt from $100 to $50, so that for purposes of
applying section 108(e)(6) Y is treated as having satisfied the debt for
$50. Accordingly, under these facts as well Y would recognize $50 of
exchange gain and no discharge of indebtedness income.
Example 3. (i) X and Y are unrelated calendar year U.S.
corporations with the U.S. dollar as their functional currency. On
January 1, 1990 (the issue date), X acquires Y's bond maturing on
December 31, 1999. The issue price of the bond is 100,000, the stated
redemption price at maturity is 100,000, and the bond provides for
annual pound interest payments at the rate of 10%. On January 1, 1994,
X and Y agree that Y will redeem its bond from X in exchange for 20
shares of Y common stock. Assume the following:
(a) The spot rate on January 1, 1990, is 1 = $1.00,
(b) The spot rate on January 1, 1994, is 1 = $.50,
(c) Interest rates on equivalent bonds have increased so that as of
January 1, 1994, the value of Y's bond has declined to 90,000, and
(d) The 20 shares of Y common stock have a market value of 90,000 as
of January 1, 1994.
(ii) Pursuant to paragraph (b)(13) of this section, X will realize
and recognize exchange loss with respect to the issue price ( 100,000)
of the bond on January 1, 1994, when the bond is exchanged for stock. X
will compute exchange loss pursuant to paragraph (b)(5) of this section
by translating the issue price at the spot rate on the exchange date (
100,000 $.50 = $50,000) and subtracting from such amount the issue price
translated at the spot rate on the date X acquired the bond ( 100,000
$1.00 = $100,000). Thus, X will compute $50,000 of exchange loss, all
of which will be realized and recognized because it does not exceed the
total $55,000 realized loss on the exchange ($45,000 worth of stock
received less $100,000 basis in the exchanged bond).
(iii) Pursuant to paragraph (b)(13) of this section, Y will realize
and recognize exchange gain with respect to the issue price, computed
under paragraph (b)(6) of this section by translating the issue price at
the spot rate on the date Y became the obligor ( 100,000 $1.00 =
$100,000) and subtracting from such amount the issue price translated at
the spot rate on the exchange date ( 100,000 $.50 = $50,000). Thus, Y
will realize and recognize $50,000 of exchange gain. Under section
108(e)(10), on the transfer of stock to X in satisfaction of its
indebtedness Y is treated as having satisfied the indebtedness with an
amount of money equal to the fair market value of the stock ( 90,000
$.50 = $45,000). Pursuant to paragraph (b)(13) of this section, for
purposes of section 108 the amount of the indebtedness is considered to
be reduced by the recognized exchange gain from $100,000 to $50,000.
Accordingly, Y recognizes an additional $5,000 of discharge of
indebtedness income on the exchange.
Example 4. (i) The facts are the same as in Example 3 except that
interest rates on equivalent bonds have declined, rather than increased,
so that the value of Y's bond on January 1, 1994, has risen to 112,500;
and X and Y agree that Y will redeem its bond from X on that date in
exchange for 25 shares of Y common stock worth 112,500. Pursuant to
paragraphs (b)(13) and (b)(5) of this section, X will compute $50,000 of
exchange loss on the exchange with respect to the 100,000 issue price
of the bond. See Example 3. However, because X's total loss on the
exchange is only $43,750 ($56,250 worth of stock received less $100,000
basis in the exchanged bond), under the netting rule of paragraph
(b)(13) of this section the realized exchange loss is limited to
$43,750.
(ii) Pursuant to paragraphs (b)(13) and (b)(6) of this section, Y
will compute $50,000 of exchange gain with respect to the issue price.
See Example 3. Under section 108(e)(10), Y is treated as having
satisfied the $100,000 indebtedness with an amount of money equal to the
fair market value of the stock ( 112,500 $.50 = $56,250), resulting in a
total gain on the exchange of $43,750. Accordingly, under paragraph
(b)(13) of this section Y's realized (and recognized) exchange gain on
the exchange is limited to $43,750. Also pursuant to paragraph (b)(13)
of this section, for purposes of section 108 the amount of the
indebtedness is considered to be reduced by the recognized exchange gain
from $100,000 to $56,250. Accordingly, Y recognizes no discharge of
indebtedness income on the exchange.
(14)-(15) (Reserved)
(16) Coordination with section 267 regarding debt instruments -- (i)
Treatment of a creditor. For rules applicable to a corporation included
in a controlled group that is a creditor under a debt instrument see
1.267(f)--1(h).
(ii) Treatment of a debtor. (Reserved)
(17) Coordination with installment method under section 453.
(Reserved)
(c) Item of expense or gross income or receipts which is to be paid
or received after the date accrued -- (1) In general. Except as
provided in 1.988-5, exchange gain or loss with respect to an item
described in 1.988-1(a) (1)(ii) and (2)(ii) (other than accrued
interest income or expense subject to paragraph (b) of this section)
shall be realized on the date payment is made or received. Except as
provided in the succeeding sentence, such exchange gain or loss shall be
recognized in accordance with the applicable recognition provisions of
the Internal Revenue Code. If the taxpayer's right to receive income,
or obligation to pay an expense, is transferred or modified in a
transaction in which gain or loss would otherwise be recognized,
exchange gain or loss shall be realized and recognized only to the
extent of the total gain or loss on the transaction.
(2) Determination of exchange gain or loss with respect to an item of
gross income or receipts. Exchange gain or loss realized on an item of
gross income or receipts described in paragraph (c)(1) of this section
shall be determined by multiplying the units of nonfunctional currency
received by the spot rate on the payment date, and subtracting from such
amount the amount determined by multiplying the units of nonfunctional
currency received by the spot rate on the booking date. The term ''spot
rate on the payment date'' means the spot rate determined under
1.988-1(d) on the date payment is received or otherwise taken into
account. Pursuant to 1.988-1(d)(3), a taxpayer may use a spot rate
convention for purposes of determining the spot rate on the payment
date. The term ''spot rate on the booking date'' means the spot rate
determined under 1.988-1(d) on the date the item of gross income or
receipts is accrued or otherwise taken into account. Pursuant to
1.988-1(d)(3), a taxpayer may use a spot rate convention for purposes of
determining the spot rate on the booking date.
(3) Determination of exchange gain or loss with respect to an item of
expense. Exchange gain or loss realized on an item of expense described
in paragraph (c)(1) of this section shall be determined by multiplying
the units of nonfunctional currency paid by the spot rate on the booking
date and subtracting from such amount the amount determined by
multiplying the units of nonfunctional currency paid by the spot rate on
the payment date. The term ''spot rate on the booking date'' means the
spot rate determined under 1.988-1(d) on the date the item of expense
is accrued or otherwise taken into account. Pursuant to 1.988-1(d)(3),
a taxpayer may use a spot rate convention for purposes of determining
the spot rate on the booking date. The term ''spot rate on the payment
date'' means the spot rate determined under 1.988-1(d) on the date
payment is made or otherwise taken into account. Pursuant to
1.988-1(d)(3), a taxpayer may use a spot rate convention for purposes of
determining the spot rate on the date.
(4) Examples. The following examples illustrate the application of
paragraph (c) of this section.
Example 1. X is a calendar year corporation with the dollar as its
functional currency. X is on the accrual method of accounting. On
January 15, 1989, X sells inventory for 10,000 Canadian dollars (C$).
The spot rate on January 15, 1989, is C$1 = U.S. $.55. On February 23,
1989, when X receives payment of the C$10,000, the spot rate is C$1 =
U.S. $.50. On February 23, 1989, X will realize exchange loss. X's loss
is computed by multiplying the C$10,000 by the spot rate on the date the
C$10,000 are received (C$10,000 .50 = U.S. $5,000) and subtracting from
such amount, the amount computed by multiplying the C$10,000 by the spot
rate on the booking date (C$10,000 .55 = U.S. $5,500). Thus, X's
exchange loss on the transaction is U.S. $500 (U.S. $5,000^U.S. $5,500).
Example 2. The facts are the same as in Example 1 except that X uses
a spot rate convention to determine the spot rate as provided in
1.988-1(d)(3). Pursuant to X's spot rate convention, the spot rate at
which a payable or receivable is booked is determined monthly for each
nonfunctional currency payable or receivable by adding the spot rate at
the beginning of the month and the spot rate at the end of the month and
dividing by two. All payables and receivables in a nonfunctional
currency booked during the month are translated into functional currency
at the rate described in the preceding sentence. Further, the
translation of nonfunctional currency paid with respect to a payable,
and nonfunctional currency received with respect to a receivable, is
also performed pursuant to the spot rate convention. Assume the spot
rate determined under the spot rate convention for the month of January
is C$1 = U.S. $.54 and for the month of February is C$1 = U.S. $.51. On
the last date in February, X will realize exchange loss. X's loss is
computed by multiplying the C$10,000 by the spot rate convention for the
month of February (C$10,000 U.S. $.51 = U.S. $5,100) and subtracting
from such amount, the amount computed by multiplying the C$10,000 by the
spot rate convention for the month of January (C$10,000 U.S. $.54 =
$5,400). Thus, X's exchange loss on the transaction is U.S. $300 (U.S.
$5,100-U.S. $5,400). X's basis in the C$10,000 is U.S. $5,400.
Example 3. The facts are the same as in Example 2 except that X has
a standing order with X's bank for the bank to convert any nonfunctional
currency received in satisfaction of a receivable into U.S. dollars on
the day received and to deposit those U.S. dollars in X's U.S. dollar
bank account. X may use its convention to translate the amount booked
into U.S. dollars, but must use the U.S. dollar amounts received from
the bank with respect to such receivables to determine X's exchange gain
or loss. Thus, if X receives payment of the C$10,000 on February 23,
1989, when the spot rate is C$1 = U.S.$ .50, X determines exchange gain
or loss by subtracting the amount booked under X's convention
(U.S.$5,400) from the amount of U.S. dollars received from the bank
under the standing conversion order (assume $5,000). X's exchange loss
is U.S.$400.
(d) Exchange gain or loss with respect to forward contracts, futures
contracts and option contracts -- (1) Scope -- (i) In general. This
paragraph (d) applies to forward contracts, futures contracts and option
contracts described in 1.988-1(a) (1)(ii) and (2)(iii). For rules
applicable to currency swaps and notional principal contracts described
in 1.988-1(a) (1)(ii) and (2)(iii), see paragraph (e) of this section.
(ii) Treatment of spot contracts. Solely for purposes of this
paragraph (d), a spot contract as defined in 1.988-1(b) to buy or sell
nonfunctional currency is not considered a forward contract or similar
transaction described in 1.988-1(a)(2)(iii) unless such spot contract
is disposed of (or otherwise terminated) prior to making or taking
delivery of the currency. For example, if a taxpayer with the dollar as
its functional currency enters into a spot contract to purchase British
pounds, and takes delivery of such pounds under the contract, the
delivery of the pounds is not a realization event under section
988(c)(5) and paragraph (e)(4)(ii) of this section because the contract
is not considered a forward contract or similar transaction described in
1.988-1(a)(2)(iii). However, if the taxpayer sells or otherwise
terminates the contract before taking delivery of the pounds, exchange
gain or loss shall be realized and recognized in accordance with
paragraphs (d) (2) and (3) of this section.
(2) Realization of exchange gain or loss -- (i) In general. Except
as provided in 1.988-5, exchange gain or loss on a contract described
in 1.988-2(d)(1) shall be realized in accordance with the applicable
realization section of the Internal Revenue Code (e.g., sections 1001,
1092, and 1256). See also section 988(c)(5). For purposes of
determining the timing of the realization of exchange gain or loss,
sections 1092 and 1256 shall take precedence over section 988(c)(5).
(ii) Realization by offset -- (A) In general. Except as provided in
paragraphs (d)(2)(ii) (B) and (C) of this section, exchange gain or loss
with respect to a transaction described in 1.988-1(a) (1)(ii) and
(2)(iii) shall not be realized solely because such transaction is offset
by another transaction (or transactions).
(B) Exception where economic benefit is derived. If a transaction
described in 1.988-1(a) (1)(ii) and (2)(iii) is offset by another
transaction or transactions, exchange gain shall be realized to the
extent the taxpayer derives, by pledge or otherwise, an economic benefit
(e.g., cash, property or the proceeds from a borrowing) from any gain
inherent in such offsetting positions. Proper adjustment shall be made
in the amount of any gain or loss subsequently realized for gain taken
into account by reason of the preceding sentence. This paragraph
(d)(2)(ii)(B) shall apply to transactions creating an offset after
September 21, 1989.
(C) Certain contracts traded on an exchange. If a transaction
described in 1.988-1(a) (1)(ii) and (2)(iii) is traded on an exchange
and it is the general practice of the exchange to terminate offsetting
contracts, entering into an offsetting contract shall be considered a
termination of the contract being offset.
(iii) Clarification of section 988(c)(5). If the delivery date of a
contract subject to section 988(c)(5) and paragraph (d)(4)(ii) of this
section is different than the date the contract expires, then for
purposes of determining the date exchange gain or loss is realized, the
term delivery date shall mean expiration date.
(iv) Examples. The following examples illustrate the rules of this
paragraph (d) (1) and (2).
Example 1. On August 1, 1989, X, a calendar year corporation with
the dollar as its functional currency, enters into a forward contract
with Bank A to buy 100 New Zealand dollars for $80 for delivery on
January 31, 1990. (The forward purchase contract is not a section 1256
contract.) On November 1, 1989, the market price for the purchase of 100
New Zealand dollars for delivery on January 31, 1990, is $76. On
November 1, 1989, X cancels its obligation under the forward purchase
contract and pays Bank A $3.95 (the present value of $4 discounted at
12% for the period) in cancellation of such contract. Under section
1001 (a), X realizes an exchange loss of $3.95 on November 1, 1989,
because cancellation of the forward purchase contract for cash results
in the termination of X's contract.
Example 2. X is a corporation with the dollar as its functional
currency. On January 1, 1989, X enters into a currency swap contract
with Bank A under which X is obligated to make a series of Japanese yen
payments in exchange for a series of dollar payments. On February 21,
1992, X has a gain of $100,000 inherent in such contract as a result of
interest rate and exchange rate movements. Also on February 21, 1992, X
enters into an offsetting swap with Bank A to lock in such gain. If on
February 21, 1992, X pledges the gain inherent in such offsetting
positions as collateral for a loan, X's initial swap contract is treated
as being terminated on February 21, 1992, under paragraph (d)(2)(ii)(B)
of this section. Proper adjustment is made in the amount of any gain or
loss subsequently realized for the gain taken into account by reason of
paragraph (d)(2)(ii)(B) of this section.
Example 3. X is a calendar year corporation with the dollar as its
functional currency. On October 1, 1989, X enters into a forward
contract to buy 100,000 Swiss francs (Sf) for delivery on March l, 1990,
for $51,220. Assume that the contract is a section 1256 contract under
section 1256(g)(2) and that section 1256(e) does not apply. Pursuant to
section 1256(a)(1), the forward contract is treated as sold for its fair
market value on December 31, 1989. Assume that the fair market value of
the contract is $1,000 determined under 1.988-1(g). Thus X will realize
an exchange gain of $1,000 on December 31, 1989. Such gain is subject
to the character rules of 1.988-3 and the source rules of 1.988-4.
(v) Extension of the maturity date of certain contracts. An
extension of time for making or taking delivery under a contract
described in paragraph (d)(1) of this section (e.g., a historical rate
rollover as defined in 1.988-5(b)(2)(iii)(C)) shall be considered a
sale or exchange of the contract for its fair market value on the date
of the extension and the establishment of a new contract on such date.
If, under the terms of the extension, the time value of any gain or loss
recognized pursuant to the preceding sentence adjusts the price of the
currency to be bought or sold under the new contract, the amount
attributable to such time value shall be treated as interest income or
expense for all purposes of the Code. However, the preceding sentence
shall not apply and the amount attributable to the time value of any
gain or loss recognized shall be treated as exchange gain or loss if the
period beginning on the first date the contract is rolled over and
ending on the date payment is ultimately made or received with respect
to such contract does not exceed 183 days.
(3) Recognition of exchange gain or loss. Except as provided in
1.988-5 (relating to section 988 hedging transactions), exchange gain or
loss realized with respect to a contract described in paragraph (d)(1)
of this section shall be recognized in accordance with the applicable
recognition provisions of the Internal Revenue Code. For example, a
loss realized with respect to a contract described in paragraph (d)(1)
of this section which is part of a straddle shall be recognized in
accordance with the provisions of section 1092 to the extent such
section is applicable.
(4) Determination of exchange gain or loss -- (i) In general.
Exchange gain or loss with respect to a contract described in
1.988-2(d)(1) shall be determined by subtracting the amount paid (or
deemed paid), if any, for or with respect to the contract (including any
amount paid upon termination of the contract) from the amount received
(or deemed received), if any, for or with respect to the contract
(including any amount received upon termination of the contract). Any
gain or loss determined according to the preceding sentence shall be
treated as exchange gain or loss.
(ii) Special rules where taxpayer makes or takes delivery. If the
taxpayer makes or takes delivery in connection with a contract described
in paragraph (d)(1) of this section, any gain or loss shall be realized
and recognized in the same manner as if the taxpayer sold the contract
(or paid another person to assume the contract) on the date on which he
took or made delivery for its fair market value on such date. See
paragraph (d)(2)(iii) of this section regarding the definition of the
term ''delivery date.'' This paragraph (d)(4)(ii) shall not apply in any
case in which the taxpayer makes or takes delivery before June 11, 1987.
(iii) Examples. The following examples illustrate the application of
paragraph (d)(4) of this section.
Example 1. X is a calendar year corporation with the dollar as its
functional currency. On October 1, 1989, when the six month forward
rate is $.4907, X enters into a forward contract to buy 100,000 New
Zealand dollars (NZD) for delivery on March 1, 1990. On March 1, 1990,
when X takes delivery of the 100,000 NZD, the spot rate is 1NZD equals
$.48. Pursuant to section 988(c)(5) and paragraph (d)(4)(ii) of this
section, a taxpayer that takes delivery of nonfunctional currency under
a forward contract that is subject to section 988 is treated as if the
taxpayer sold the contract for its fair market value on the date
delivery is taken. If X sold the contract on March 1, 1990, the
transferee would require a payment of $1,070 (($.48 100,000NZD)^($.4907
100,000NZD)) to compensate him for the loss in value of the 100,000NZD.
Therefore, X realizes an exchange loss of $1,070. X has a basis in the
100,000NZD of $48,000.
Example 2. Assume the same facts as in Example 1 except that the
contract is for Swiss francs and is a section 1256 contract. Assume
further that on December 31, 1989, the value to X of the contract as
marked to market is $1,000. Pursuant to section 1256(a), X realizes an
exchange gain of $1,000. Such gain, however, is characterized as
ordinary income under 1.988-3 and will be sourced under 1.988-4.
Example 3. X is a calendar year corporation with the dollar as its
functional currency. On May 2, 1989, X enters into an option contract
with Bank A to purchase 50,000 Canadian dollars (C$) for U.S. $42,500
(C$1 = U.S. $.85) for delivery on or before September 18, 1989. X pays
a $285 premium to Bank A to obtain the option contract. On September
18, 1989, when X exercises the option and takes delivery of the
C$50,000, the spot rate is C$1 equals U.S. $.90. Pursuant to section
988(c)(5) and paragraph (d)(4)(ii) of this section, a taxpayer that
takes delivery under an option contract that is subject to section 988
is treated as if the taxpayer sold the contract for its fair market
value on the date delivery is taken. If X sold the contract for its
fair market value on September 18, 1989, X would receive U.S. $2,500
((C$50,000 U.S. $.90)^(C$50,000 U.S. $.85)). Accordingly, X is deemed
to have received U.S. $2,500 on the sale of the contract at its fair
market value. X will realize U.S. $2,215 ($2,500 deemed received less
$285 paid) of exchange gain with respect to the delivery of Canadian
dollars under the option contract. X's basis in the 50,000 Canadian
dollars is U.S. $45,000.
(5) (Reserved)
(e) Currency swaps and other notional principal contracts -- (1) In
general. Except as provided in paragraph (e)(2) of this section or in
1.988-5, the timing of income, deduction and loss with respect to a
notional principal contract that is a section 988 transaction shall be
governed by section 446 and the regulations thereunder. Such income,
deduction and loss is characterized as exchange gain or loss (except as
provided in another section of the Internal Revenue Code (or regulations
thereunder), 1.988-5, or in paragraph (f) of this section).
(2) Special rules for currency swaps -- (i) In general. Except as
provided in paragraph (e)(2)(iii)(B) of this section, the provisions of
this paragraph (e)(2) shall apply solely for purposes of determining the
realization, recognition and amount of exchange gain or loss with
respect to a currency swap contract, and not for purposes of determining
the source of such gain or loss, or characterizing such gain or loss as
interest. Except as provided in 1.988-3(c), any income or loss
realized with respect to a currency swap contract shall be characterized
as exchange gain or loss (and not as interest income or expense). Any
exchange gain or loss realized in accordance with this paragraph (e)(2)
shall be recognized unless otherwise provided in an applicable section
of the Code. For purposes of this paragraph (e)(2), a currency swap
contract is a contract defined in paragraph (e)(2)(ii) of this section.
With respect to a contract which requires the payment of swap principal
prior to maturity of such contract, see paragraph (f) of this section.
For purposes of this paragraph (e), the rules of paragraph (d)(2)(ii) of
this section (regarding realization by offset) apply. See Example 2 of
paragraph (d)(2)(iv) of this section.
(ii) Definition of currency swap contract -- (A) In general. A
currency swap contract is a contract involving different currencies
between two or more parties to --
(1) Exchange periodic interim payments, as defined in paragraph
(e)(2)(ii)(C) of this section, on or prior to maturity of the contract;
and
(2) Exchange the swap principal amount upon maturity of the contract.
A currency swap contract may also require an exchange of the swap
principal amount upon commencement of the agreement.
(B) Swap principal amount. The swap principal amount is an amount of
two different currencies which, under the terms of the currency swap
contract, is used to determine the periodic interim payments in each
currency and which is exchanged upon maturity of the contract. If such
amount is not clearly set forth in the contract, the Commissioner may
determine the swap principal amount.
(C) Exchange of periodic interim payments. An exchange of periodic
interim payments is an exchange of one or more payments in one currency
specified by the contract for one or more payments in a different
currency specified by the contract where the payments in each currency
are computed by reference to an interest index applied to the swap
principal amount. A currency swap contract must clearly indicate the
periodic interim payments, or the interest index used to compute the
periodic interim payments, in each currency.
(iii) Timing and computation of periodic interim payments -- (A) In
general. Except as provided in paragraph (e)(2)(iii)(B) of this section
and 1.988-5, the timing and computation of the periodic interim
payments provided in a currency swap agreement shall be determined by
treating --
(1) Payments made under the swap as payments made pursuant to a
hypothetical borrowing that is denominated in the currency in which
payments are required to be made (or are determined with reference to)
under the swap, and
(2) Payments received under the swap as payments received pursuant to
a hypothetical loan that is denominated in the currency in which
payments are received (or are determined with reference to) under the
swap.
Except as provided in paragraph (e)(2)(v) of this section, the
hypothetical issue price of such hypothetical borrowing and loan shall
be the swap principal amount. The hypothetical stated redemption price
at maturity is the total of all payments (excluding any exchange of the
swap principal amount at the inception of the contract) provided under
the hypothetical borrowing or loan other than periodic interest payments
under the principles of section 1273. For purposes of determining
economic accrual under the currency swap, the number of hypothetical
interest compounding periods of such hypothetical borrowing and loan
shall be determined pursuant to a semiannual compounding convention
unless the currency swap contract indicates otherwise. For purposes of
determining the timing and amount of the periodic interim payments, the
principles regarding the amortization of interest (see generally,
sections 1272 through 1275 and 163(e)) shall apply to the hypothetical
interest expense and income of such hypothetical borrowing and loan.
However, such principles shall not apply to determine the time when
principal is deemed to be paid on the hypothetical borrowing and loan.
See paragraph (d)(2)(iii) of this section and Example 2 of paragraph
(d)(5) of this section with respect to the time when principal is deemed
to be paid. With respect to the translation and computation of exchange
gain or loss on any hypothetical interest income or expense, see
1.988-2(b). The amount treated as exchange gain or loss by the taxpayer
with respect to the periodic interim payments for the taxable year shall
be the amount of hypothetical interest income and exchange gain or loss
attributable to such interest income from the hypothetical borrowing and
loan for such year less the amount of hypothetical interest expense and
exchange gain or loss attributable to the interest expense from such
hypothetical borrowing and loan for such year.
(B) Effect of prepayment for purposes of section 956. For purposes
of section 956, the Commissioner may treat any prepayment of a currency
swap as a loan.
(iv) Timing and determination of exchange gain or loss with respect
to the swap principal amount. Exchange gain or loss with respect to the
swap principal amount shall be realized on the day the units of swap
principal in each currency are exchanged. (See paragraph
(e)(2)(ii)(A)(2) of this section which requires that the entire swap
principal amount be exchanged upon maturity of the contract.) Such gain
or loss shall be determined on the date of the exchange by subtracting
the value (on such date) of the units of swap principal paid from the
value of the units of swap principal received. This paragraph
(e)(2)(iv) does not apply to an equal exchange of the swap principal
amount at the commencement of the agreement at a market exchange rate.
(v) Anti-abuse rules -- (A) Method of accounting does not clearly
reflect income. If the taxpayer's method of accounting for income,
expense, gain or loss attributable to a currency swap does not clearly
reflect income, or if the present value of the payments to be made is
not equivalent to that of the payments to be received (including the
swap premium or discount, as defined in paragraph (e)(3)(ii) of this
section) on the day the taxpayer enters into or acquires the contract,
the Commissioner may apply principles analogous to those of section 1274
or such other rules as the Commissioner deems appropriate to clearly
reflect income. For example, in order to clearly reflect income the
Commissioner may determine the hypothetical issue price, the
hypothetical stated redemption price at maturity, and the amounts
required to be taken into account within a taxable year. Further, if
the present value of the payments to be made is not equivalent to that
of the payments to be received (including the swap premium or discount,
as defined in paragraph (e)(3)(ii) of this section) on the day the
taxpayer enters into or acquires the contract, the Commissioner may
integrate the swap with another transaction (or transactions) in order
to clearly reflect income.
(B) Terms must be clearly stated. If the currency swap contract does
not clearly set forth the swap principal amount in each currency, and
the periodic interim payments in each currency (or the interest index
used to compute the periodic interim payments in each currency), the
Commissioner may defer any income, deduction, gain or loss with respect
to such contract until termination of the contract.
(3) Amortization of swap premium or discount in the case of
off-market currency swaps -- (i) In general. An ''off-market currency
swap'' is a currency swap contract under which the present value of the
payments to be made is not equal to that of the payments to be received
on the day the taxpayer enters into or acquires the contract (absent the
swap premium or discount, as defined in paragraph (e)(3)(ii) of this
section). Generally, such present values may not be equal if the swap
exchange rate (as defined in paragraph (e)(3)(iii) of this section) is
not the spot rate, or the interest indices used to compute the periodic
interim payments do not reflect current values, on the day the taxpayer
enters into or acquires the currency swap.
(ii) Treatment of taxpayer entering into or acquiring an off-market
currency swap. If a taxpayer that enters into or acquires a currency
swap makes a payment (that is, the taxpayer pays a premium, ''swap
premium,'' to enter into or acquire the currency swap) or receives a
payment (that is, the taxpayer enters into or acquires the currency swap
at a discount, ''swap discount'') in order to make the present value of
the amounts to be paid equal the amounts to be received, such payment
shall be amortized in a manner which places the taxpayer in the same
position it would have been in had the taxpayer entered into a currency
swap contract under which the present value of the amounts to be paid
equal the amounts to be received (absent any swap premium or discount).
Thus, swap premium or discount shall be amortized as follows --
(A) The amount of swap premium or discount that is attributable to
the difference between the swap exchange rate (as defined in paragraph
(e)(3)(iii) of this section) and the spot rate on the date the contract
is entered into or acquired shall be taken into account as income or
expense on the date the swap principal amounts are taken into account;
and
(B) The amount of swap premium or discount attributable to the
difference in values of the periodic interim payments shall be amortized
in a manner consistent with the principles of economic accrual. Cf.,
section 171.
Any amount taken into account pursuant to this paragraph (e)(3)(ii)
shall be treated as exchange gain or loss.
(iii) Definition of swap exchange rate. The swap exchange rate is
the single exchange rate set forth in the contract at which the swap
principal amounts are determined. If the swap exchange rate is not
clearly set forth in the contract, the Commissioner may determine such
rate.
(iv) (Reserved)
(4) Treatment of taxpayer disposing of a currency swap. Any gain or
loss realized on the disposition or the termination of a currency swap
is exchange gain or loss.
(5) Examples. The following examples illustrate the application of
this paragraph (e).
Example 1. (i) C is an accrual method calendar year corporation with
the dollar as its functional currency. On January 1, 1989, C enters
into a currency swap with J with the following terms:
(1) the principal amount is $150 and 100 British pounds ( ) (the
equivalent of $150 on the effective date of the contract assuming a spot
rate of 1 = $1.50 on January 1, 1989);
(2) C will make payments equal to 10% of the dollar principal amount
on December 31, 1989, and December 31, 1990;
(3) J will make payments equal to 12% of the pound principal amount
on December 31, 1989, and December 31, 1990; and
(4) on December 31, 1990, C will pay to J the $150 principal amount
and J will pay to C the 100 principal amount.
Assume that the spot rate is 1 = $1.50 on January 1, 1989, 1 =
$1.40 on December 31, 1989, and 1 = $1.30 on December 31, 1990. Assume
further that the average rate for 1989 is 1 = $1.45 and for 1990 is 1
= $1.35.
(ii) Solely for determining the realization of gain or loss in
accordance with paragraph (e)(2) of this section (and not for purposes
of determining whether any payments are treated as interest), C will
treat the dollar payments made by C as payments made pursuant to a
dollar borrowing with an issue price of $150, a stated redemption price
at maturity of $150, and yield to maturity of 10%. C will treat the
pound payments received as payments received pursuant to a pound loan
with an issue price of 100, a stated redemption price at maturity of
100, and a yield of 12% to maturity. Pursuant to 1.988-2(b), C is
required to compute hypothetical accrued pound interest income at the
average rate for the accrual period and then determine exchange gain or
loss on the day payment is received with respect to such accrued amount.
Accordingly, C will accrue $17.40 ( 12 $1.45) in 1989 and $16.20 ( 12
$1.35) in 1990. C also will compute hypothetical exchange loss of $.60
on December 31, 1989 (( 12 $1.40)^( 12 $1.45)) and hypothetical exchange
loss of $.60 on December 31, 1990 (( 12 $1.30)^( 12 $1.35)). All such
hypothetical interest income and exchange loss are characterized and
sourced as exchange gain and loss. Further, C is treated as having paid
$15 ($150 10%) of hypothetical interest on December 31, 1989, and again
on December 31, 1990. Such hypothetical interest expense is
characterized and sourced as exchange loss. Thus, C will have a net
exchange gain of $1.80 ($17.40^$.60^$15.00) with respect to the periodic
interim payments in 1989 and a net exchange gain of $.60
($16.20^$.60^$15.00) with respect to the periodic interim payments in
1990. Finally, C will realize an exchange loss on December 31, 1990
with respect to the exchange of the swap principal amount. This loss is
determined by subtracting the value of the units of swap principal paid
($150) from the value of the units of swap principal received ( 100
$1.30 = $130) resulting in a $20 exchange loss.
Example 2. (i) C is an accrual method calendar year corporation with
the dollar as its functional currency. On January 1, 1989, when the
spot rate is 1 = $1.50, C enters into a currency swap contract with J
under which C agrees to make and receive the following payments:
(ii) Under paragraph (e)(2)(iii) of this section, C must treat the
dollar periodic interim payments under the swap as made pursuant to a
hypothetical dollar borrowing. The hypothetical issue price is $150 and
the stated redemption price at maturity is $206.04. The amount of
hypothetical interest expense must be amortized in accordance with
economic accrual. Thus J must include and C must deduct periodic
interim payment amounts as follows:
(iii) Gain or loss with respect to the periodic interim payments of
the currency swap is determined under paragraph (e)(2)(iii)(A) of this
section with respect to the dollar cash flow amortized as set forth
above and the corresponding pound cash flow as stated in the currency
swap contract. Gain or loss with respect to the principal payments
(i.e., $150 and 100) exchanged on December 31, 1992, is determined
under paragraph (e)(2)(iv) of this section on December 31, 1992,
notwithstanding that under the principles regarding amortization of
interest $26.04 would have been regarded as a payment of principal on
December 31, 1990.
Example 3. (i) X is a corporation on the accrual method of
accounting with the dollar as its functional currency and the calendar
year as its taxable year. On January 1, 1989, X enters into a three
year currency swap contract with Y with the following terms. The swap
principal amount is $100 and the Swiss franc (Sf) equivalent of such
amount which equals Sf200 translated at the swap exchange rate of $1 =
Sf2. There is no initial exchange of the swap principal amount. The
interest rates used to compute the periodic interim payments are 10%
compounded annually for U.S. dollar payments and 5% compounded annually
for Swiss franc payments. Thus, under the currency swap, X agrees to
pay Y $10 (10% $100) on December 31st of 1989, 1990 and 1991 and to pay
Y the swap principal amount of $100 on December 31, 1991. Y agrees to
pay X Sf10 (5% Sf200) on December 31st of 1989, 1990 and 1991 and to pay
X the swap principal amount of Sf200 on December 31, 1991. Assume that
the average rate for 1989 and the spot rate on December 31, 1989, is $1
= Sf2.5.
(ii) Under paragraph (e)(2)(iii) of this section, on December 31,
1989, X will realize an exchange loss of $6 (the sum of $10 of loss by
reason of the $10 periodic interim payment paid to Y and $4.00 of gain,
the value of Sf10 on December 31, 1989, from the receipt of Sf10 on such
date).
(iii) On January 1, 1990, X transfers its rights and obligations
under the swap contract to Z, an unrelated corporation. Z has the
dollar as its functional currency, is on the accrual method of
accounting, and has the calendar year as its taxable year. On January
1, 1990, the exchange rate is $1 = Sf2.50. The relevant dollar interest
rate is 8% compounded annually and the relevant Swiss franc interest
rate is 5% compounded annually. Because of the movement in exchange and
interest rates, the agreement between X and Z to transfer the currency
swap requires X to pay Z $23.56 (the swap discount as determined under
paragraph (e)(3) of this section).
(iv) Pursuant to paragraph (e)(4) of this section, X may deduct the
loss of $23.56 in 1990. The loss is characterized under 1.988-3 and
sourced under 1.988-4.
(v) Pursuant to paragraph (e)(3)(ii) of this section, Z is required
to amortize the $23.56 received as follows. The amount of the $23.56
payment that is attributable to movements in exchange rates ($20) is
taken into account on December 31, 1991, the date the swap principal
amounts are exchanged, under paragraph (e)(3)(ii)(A) of this section.
This amount is the present value (discounted at 10%, the rate under the
currency swap contract used to compute the dollar periodic interim
payments) of the financial asset required to compensate Z for the loss
in value of the hypothetical Swiss franc loan resulting from movements
in exchange rates between January 1, 1989 and January 1, 1990. This
amount is determined by assuming that interest rates did not change from
the date the swap originally was entered into (January 1, 1989), but
that the exchange rate is $1 = Sf2.50. Under this assumption, a taxpayer
undertaking the obligation to pay dollars under the currency swap on
January 1, 1990, would only agree to pay $8 for Sf10 on December 31,
1990 and $88 for Sf210 on December 31, 1991, because the exchange rates
have moved from $1 = Sf2 to $1 = Sf2.50. Thus, Z requires $2 on December
31, 1990 and $22 on December 31, 1991 to compensate for the amount of
dollar payments Z is required to make in exchange for the Swiss francs
received on December 31, 1990 and 1991. The present value of $2 on
December 31, 1990 and $22 on December 31, 1991 discounted at the rate
for U.S. dollar payments of 10% is $20 ($1.82+$18.18). This amount is
discounted at the rate for U.S. dollar payments (i.e., at the historic
rate) because the amount of the $23.56 payment received by Z that is
attributable to movements in interest rates is computed and amortized
separately as provided in the following paragraph.
(vi) Pursuant to paragraph (e)(3)(ii)(B) of this section, Z is
required to amortize the portion of the $23.56 payment attributable to
movements in interest rates under principles of economic accrual over
the term of the currency swap agreement. The amount of the $23.56
payment that is attributable to movements in interest rates (assuming
that exchange rates have not changed) is the present value ($3.56) of
the excess ($2.00 in 1990 and $2.00 in 1991) of the periodic interim
payments Z is required to pay under the currency swap agreement ($10 in
1990 and $10 in 1991) over the amount Z would be required to pay if the
currency swap agreement reflected current interest rates on the day Z
acquired the swap contract ($8 in 1990 and $8 in 1991) discounted at the
appropriate dollar interest rate on January 1, 1990. Thus, under
principles of economic accrual (e.g., see section 171 of the Code), Z
will include in income $1.72 on December 31, 1990, the amount that, when
added to the interest ($.28) on the $3.56 computed at the 8% rate on the
date Z acquired the currency swap contract, will equal the $2.00 needed
to compensate Z for the movement in interest rates between January 1,
1989 and January 1, 1990. Z also will include in income $1.85 on
December 31, 1991, the amount that, when added to the interest ($.15) on
the $1.85 (the remaining balance of the $3.56 payment) computed at the
8% rate on the date Z acquired the currency swap contract, will equal
the $2.00 needed to compensate Z for the movement in interest rates
between January 1, 1990 and January 1, 1991. This amount is computed
assuming exchange rates have not changed because the amount attributable
to movements in exchange rates is computed and amortized separately
under the preceding paragraph.
(6) Special effective date for rules regarding currency swaps.
Paragraph (e)(3) of this section regarding amortization of swap premium
or discount in the case of off-market currency swaps shall be effective
for transactions entered into after September 21, 1989, unless such swap
premium or discount was paid or received pursuant to a binding contract
with an unrelated party that was entered into prior to such date. For
transactions entered into prior to this date, see Notice 89-21, 1989-8
I.R.B. 23.
(7) (Reserved)
(f) Substance over form -- (1) In general. If the substance of a
transaction described in 1.988-1(a)(1) differs from its form, the
timing, source, and character of gains or losses with respect to such
transaction may be recharacterized by the Commissioner in accordance
with its substance. For example, if a taxpayer enters into a
transaction that it designates a ''currency swap contract'' that
requires the prepayment of all payments to be made or to be received
(but not both), the Commissioner may recharacterize the contract as a
loan. In applying the substance over form principle, separate
transactions may be integrated where appropriate. See also
1.861-9T(b)(1).
(2) Example. The following example illustrates the provisions of
this paragraph (f).
Example. (i) On January 1, 1990, X, a U.S. corporation with the
dollar as its functional currency, enters into a contract with Y under
which X will pay Y $100 and Y will pay X LC100 on January 1, 1990, and X
will pay Y LC109.3 and Y will pay X $133 on December 31, 1992. On
January 1, 1990, the spot exchange rate is LC1 = $1 and the 3 year
forward rate is LC1 = $.8218. X's cash flows are summarized below:
(ii) X and Y designate this contract as a ''currency swap.''
Notwithstanding this designation, for purposes of determining the
timing, source, and character with respect to the transaction, the
transaction is characterized by the Commissioner in accordance with its
substance. Thus, the January 1, 1990, exchange by X of $100 for LC 100
is treated as a spot purchase of LCs by X and the December 31, 1992,
exchange by X at 109.3LC for $133 is treated as a forward sale of LCs by
X. Under such treatment there would be no tax consequences to X under
paragraph (e)(2) of this section in 1990, 1991, and 1992 with respect to
this transaction other than the realization of exchange gain or loss on
the sale of the LC109.3 on December 31, 1992. Calculation of such gain
or loss would be governed by the rules of paragraph (d) of this section.
(g) Effective date. Except as otherwise provided in this section,
this section shall be effective for taxable years beginning after
December 31, 1986. Thus, except as otherwise provided in this section,
any payments made or received with respect to a section 988 transaction
in taxable years beginning after December 31, 1986, are subject to this
section.
(T.D. 8400, 57 FR 9183, Mar. 17, 1992)
26 CFR 1.988-3 Character of exchange gain or loss.
(a) In general. The character of exchange gain or loss recognized on
a section 988 transaction is governed by section 988 and this section.
Except as otherwise provided in section 988(c)(1)(E), section 1092,
1.988-5 and this section, exchange gain or loss realized with respect to
a section 988 transaction (including a section 1256 contract that is
also a section 988 transaction) shall be characterized as ordinary gain
or loss. Accordingly, unless a valid election is made under paragraph
(b) of this section, any section providing special rules for capital
gain or loss treatment, such as sections 1233, 1234, 1234A, 1236 and
1256(f)(3), shall not apply.
(b) Election to characterize exchange gain or loss on certain
identified forward contracts, futures contracts and option contracts as
capital gain or loss -- (1) In general. Except as provided in paragraph
(b)(2) of this section, a taxpayer may elect, subject to the
requirements of paragraph (b)(3) of this section, to treat any gain or
loss recognized on a contract described in 1.988-2(d)(1) as capital
gain or loss, but only if the contract --
(i) Is a capital asset in the hands of the taxpayer;
(ii) Is not part of a straddle within the meaning of section 1092(c)
(without regard to subsections (c)(4) or (e)); and
(iii) Is not a regulated futures contract or nonequity option with
respect to which an election under section 988(c)(1)(D)(ii) is in
effect.
If a valid election under this paragraph (b) is made with respect to
a section 1256 contract, section 1256 shall govern the character of any
gain or loss recognized on such contract.
(2) Special rule for contracts that become part of a straddle after
an election is made. If a contract which is the subject of an election
under paragraph (b)(1) of this section becomes part of a straddle within
the meaning of section 1092(c) (without regard to subsections (c)(4) or
(e)) after the date of the election, the election shall be invalid with
respect to gains from such contract and the Commissioner, in his sole
discretion, may invalidate the election with respect to losses.
(3) Requirements for making the election. A taxpayer elects to treat
gain or loss on a transaction described in paragraph (b)(1) of this
section as capital gain or loss by clearly identifying such transaction
on its books and records on the date the transaction is entered into.
No specific language or account is necessary for identifying a
transaction referred to in the preceding sentence. However, the method
of identification must be consistently applied and must clearly identify
the pertinent transaction as subject to the section 988(a)(1)(B)
election. The Commissioner, in his sole discretion, may invalidate any
purported election that does not comply with the preceding sentence.
(4) Verification. A taxpayer that has made an election under
1.988-3(b)(3) must attach to his income tax return a statement which
sets forth the following:
(i) A description and the date of each election made by the taxpayer
during the taxpayer's taxable year;
(ii) A statement that each election made during the taxable year was
made before the close of the date the transaction was entered into;
(iii) A description of any contract for which an election was in
effect and the date such contract expired or was otherwise sold or
exchanged during the taxable year;
(iv) A statement that the contract was never part of a straddle as
defined in section 1092; and
(v) A statement that all transactions subject to the election are
included on the statement attached to the taxpayer's income tax return.
In addition to any penalty that may otherwise apply, the
Commissioner, in his sole discretion, may invalidate any or all
elections made during the taxable year under 1.988-3(b)(1) if the
taxpayer fails to verify each election as provided in this
1.988-3(b)(4). The preceding sentence shall not apply if the taxpayer's
failure to verify each election was due to reasonable cause or bona fide
mistake. The burden of proof to show reasonable cause or bona fide
mistake made in good faith is on the taxpayer.
(5) Independent verification -- (i) Effect of independent
verification. If the taxpayer receives independent verification of the
election in paragraph (b)(3) of this section, the taxpayer shall be
presumed to have satisfied the requirements of paragraphs (b) (3) and
(4) of this section. A contract that is a part of a straddle as defined
in section 1092 may not be independently verified and shall be subject
to the rules of paragraph (b)(2) of this section.
(ii) Requirements for independent verification. A taxpayer receives
independent verification of the election in paragraph (b)(3) of this
section if --
(A) The taxpayer establishes a separate account(s) with an unrelated
broker(s) or dealer(s) through which all transactions to be
independently verified pursuant to this paragraph (b)(5) are conducted
and reported.
(B) Only transactions entered into on or after the date the taxpayer
establishes such account may be recorded in the account.
(C) Transactions subject to the election of paragraph (b)(3) of this
section are entered into such account on the date such transactions are
entered into.
(D) The broker or dealer provides the taxpayer a statement detailing
the transactions conducted through such account and includes on such
statement the following: ''Each transaction identified in this account
is subject to the election set forth in section 988(a)(1)(B).''
(iii) Special effective date for independent verification. The rules
of this paragraph (b)(5) shall be effective for transactions entered
into after March 17, 1992.
(6) Effective date. Except as otherwise provided, this paragraph (b)
is effective for taxable years beginning on or after September 21, 1989.
For prior taxable years, any reasonable contemporaneous election
meeting the requirements of section 988(a)(1)(B) shall satisfy this
paragraph (b).
(c) Exchange gain or loss treated as interest -- (1) In general.
Except as provided in this paragraph (c)(1), exchange gain or loss
realized on a section 988 transaction shall not be treated as interest
income or expense. Exchange gain or loss realized on a section 988
transaction shall be treated as interest income or expense as provided
in paragraph (c)(2) of this section with regard to tax exempt bonds,
1.988-2(e)(2)(ii)(B), 1.988-5, and in administrative pronouncements.
See 1.861-9T(b), providing rules for the allocation of certain items of
exchange gain or loss in the same manner as interest expense.
(2) Exchange loss realized by the holder on nonfunctional currency
tax exempt bonds. Exchange loss realized by the holder of a debt
instrument the interest on which is excluded from gross income under
section 103(a) or any similar provision of law shall be treated as an
offset to and reduce total interest income received or accrued with
respect to such instrument. Therefore, to the extent of total interest
income, no exchange loss shall be recognized. This paragraph (c)(2)
shall be effective with respect to debt instruments acquired on or after
June 24, 1987.
(d) Effective date. Except as otherwise provided in this section,
this section shall be effective for taxable years beginning after
December 31, 1986. Thus, except as otherwise provided in this section,
any payments made or received with respect to a section 988 transaction
in taxable years beginning after December 31, 1986, are subject to this
section. Thus, for example, a payment made prior to January 1, 1987,
under a forward contract that results in the deferral of a loss under
section 1092 to a taxable year beginning after December 31, 1986, is not
characterized as an ordinary loss by virtue of paragraph (a) of this
section because payment was made prior to January 1, 1987.
(T.D. 8400, 57 FR 9197, Mar. 17, 1992)
26 CFR 1.988-4 Source of gain or loss realized on a section 988
transaction.
(a) In general. Except as otherwise provided in 1.988-5 and this
section, the source of exchange gain or loss shall be determined by
reference to the residence of the taxpayer. This rule applies even if
the taxpayer has made an election under 1.988-3(b) to characterize
exchange gain or loss as capital gain or loss. This section takes
precedence over section 865.
(b) Qualified business unit -- (1) In general. The source of
exchange gain or loss shall be determined by reference to the residence
of the qualified business unit of the taxpayer on whose books the asset,
liability, or item of income or expense giving rise to such gain or loss
is properly reflected.
(2) Proper reflection on the books of the taxpayer or qualified
business unit -- (i) In general. Whether an asset, liability, or item
of income or expense is properly reflected on the books of a qualified
business unit is a question of fact.
(ii) Presumption if booking practices are inconsistent. It shall be
presumed that an asset, liability, or item of income or expense is not
properly reflected on the books of the qualified business unit if the
taxpayer and its qualified business units employ inconsistent booking
practices with respect to the same or similar assets, liabilities, or
items of income or expense. If not properly reflected on the books, the
Commissioner may allocate any asset, liability, or item of income or
expense between or among the taxpayer and its qualified business units
to properly reflect the source (or realization) of exchange gain or
loss.
(c) Effectively connected exchange gain or loss. Notwithstanding
paragraphs (a) and (b) of this section, exchange gain or loss that under
principles similar to those set forth in 1.864-4(c) arises from the
conduct of a United States trade or business shall be sourced in the
United States and such gain or loss shall be treated as effectively
connected to the conduct of a United States trade or business for
purposes of sections 871(b) and 882 (a)(1).
(d) Residence -- (1) In general. Except as otherwise provided in
this paragraph (d), for purposes of sections 985 through 989, the
residence of any person shall be --
(i) In the case of an individual, the country in which such
individual's tax home (as defined in section 911(d)(3)) is located;
(ii) In the case of a corporation, partnership, trust or estate which
is a United States person (as defined in section 7701(a)(30)), the
United States; and
(iii) In the case of a corporation, partnership, trust or estate
which is not a United States person, a country other than the United
States.
If an individual does not have a tax home (as defined in section
911(d)(3)), the residence of such individual shall be the United States
if such individual is a United States citizen or a resident alien and
shall be a country other than the United States if such individual is
not a United States citizen or resident alien. If the taxpayer is a
U.S. person and has no principal place of business outside the United
States, the residence of the taxpayer is the United States.
Notwithstanding paragraph (d)(1)(ii) of this section, if a partnership
is formed or availed of to avoid tax by altering the source of exchange
gain or loss, the source of such gain or loss shall be determined by
reference to the residence of the partners rather than the partnership.
(2) Exception. In the case of a qualified business unit of any
taxpayer (including an individual), the residence of such unit shall be
the country in which the principal place of business of such qualified
business unit is located.
(3) Partner in a partnership not engaged in a U.S. trade or business
under section 864(b)(2). The determination of residence shall be made
at the partner level (without regard to whether the partnership is a
qualified business unit of the partners) in the case of partners in a
partnership that are not engaged in a U.S. trade or business by reason
of section 864(b)(2).
(e) Special rule for certain related party loans -- (1) In general.
In the case of a loan by a United States person or a related person to a
10 percent owned foreign corporation, or a corporation that meets the 80
percent foreign business requirements test of section 861(c)(1), other
than a corporation subject to 1.861-11T(e)(2)(i), which is denominated
in, or determined by reference to, a currency other than the U.S. dollar
and bears interest at a rate at least 10 percentage points higher than
the Federal mid-term rate (as determined under section 1274(d)) at the
time such loan is entered into, the following rules shall apply --
(i) For purposes of section 904 only, such loan shall be marked to
market annually on the earlier of the last business day of the United
States person's (or related person's) taxable year or the date the loan
matures; and
(ii) Any interest income earned with respect to such loan for the
taxable year shall be treated as income from sources within the United
States to the extent of any notional loss attributable to such loan
under paragraph (d)(1)(i) of this section.
(2) United States person. For purposes of this paragraph (e), the
term ''United States person'' means a person described in section
7701(a)(30).
(3) Loans by related foreign persons -- (i) In general. (Reserved)
(ii) Definition of related person. For purposes of this paragraph
(e), the term ''related person'' has the meaning given such term by
section 954(d)(3) except that such section shall be applied by
substituting ''United States person'' for ''controlled foreign
corporation'' each place such term appears.
(4) 10 percent owned foreign corporation. For purposes of this
paragraph (e), the term ''10 percent owned foreign corporation'' means
any foreign corporation in which the United States person owns directly
or indirectly (within the meaning of section 318(a)) at least 10 percent
of the voting stock.
(f) Exchange gain or loss treated as interest under 1.988-3.
Notwithstanding the provisions of this section, any gain or loss
realized on a section 988 transaction that is treated as interest income
or expense under 1.988-3(c)(1) shall be sourced or allocated and
apportioned pursuant to section 861(a)(1), 862(a)(1), or 864(e) as the
case may be.
(g) Exchange gain or loss allocated in the same manner as interest
under 1.861-9T. The allocation and apportionment of exchange gain or
loss under 1.861-9T shall not affect the source of exchange gain or
loss for purposes of sections 871(a), 881, 1441, 1442 and 6049.
(h) Effective date. This section shall be effective for taxable
years beginning after December 31, 1986. Thus, any payments made or
received with respect to a section 988 transaction in taxable years
beginning after December 31, 1986, are subject to this section.
(T.D. 8400, 57 FR 9199, Mar. 17, 1992)
26 CFR 1.988-5 Section 988(d) hedging transactions.
(a) Integration of a nonfunctional currency debt instrument and a
1.988-5(a) hedge -- (1) In general. This paragraph (a) applies to a
qualified hedging transaction as defined in this paragraph (a)(1). A
qualified hedging transaction is an integrated economic transaction, as
provided in paragraph (a)(5) of this section, consisting of a qualifying
debt instrument as defined in paragraph (a)(3) of this section and a
1.988-5(a) hedge as defined in paragraph (a)(4) of this section. If a
taxpayer enters into a transaction that is a qualified hedging
transaction, no exchange gain or loss is recognized by the taxpayer on
the qualifying debt instrument or on the 1.988-5(a) hedge for the
period that either is part of a qualified hedging transaction, and the
transactions shall be integrated as provided in paragraph (a)(9) of this
section. However, if the qualified hedging transaction results in a
synthetic nonfunctional currency denominated debt instrument, such
instrument shall be subject to the rules of 1.988-2(b).
(2) Exception. This paragraph (a) does not apply with respect to a
qualified hedging transaction that creates a synthetic asset or
liability denominated in, or determined by reference to, a currency
other than the U.S. dollar if the rate that approximates the Federal
short-term rate in such currency is at least 20 percentage points higher
than the Federal short term rate (determined under section 1274(d)) on
the date the taxpayer identifies the transaction as a qualified hedging
transaction.
(3) Qualifying debt instrument -- (i) In general. A qualifying debt
instrument is a debt instrument described in 1.988-1(a)(2)(i),
regardless of whether denominated in, or determined by reference to,
nonfunctional currency (including dual currency debt instruments,
multi-currency debt instruments and contingent payment debt
instruments). A qualifying debt instrument does not include accounts
payable, accounts receivable or similar items of expense or income.
(ii) Special rule for debt instrument of which all payments are
proportionately hedged. If a debt instrument satisfies the requirements
of paragraph (a)(3)(i) of this section, and all principal and interest
payments under the instrument are hedged in the same proportion, then
for purposes of this paragraph (a), that portion of the instrument that
is hedged is eligible to be treated as a qualifying debt instrument, and
the rules of this paragraph (a) shall apply separately to such
qualifying debt instrument. See Example 8 in paragraph (a)(9)(iv) of
this section.
(4) Section 1.988-5(a) hedge -- (i) In general. A 1.988-5(a) hedge
(hereinafter referred to in this paragraph (a) as a ''hedge'') is a spot
contract, futures contract, forward contract, option contract, notional
principal contract, currency swap contract, similar financial
instrument, or series or combination thereof, that when integrated with
a qualifying debt instrument permits the calculation of a yield to
maturity (under principles of section 1272) in the currency in which the
synthetic debt instrument is denominated (as determined under paragraph
(a)(9)(ii)(A) of this section).
(ii) Retroactive application of definition of currency swap contract.
A taxpayer may apply the definition of currency swap contract set forth
in 1.988-2(e)(2)(ii) in lieu of the definition of swap agreement in
section 2(e)(5) of Notice 87-11, 1987-1 C.B. 423 to transactions entered
into after December 31, 1986 and before September 21, 1989.
(5) Definition of integrated economic transaction. A qualifying debt
instrument and a hedge are an integrated economic transaction if all of
the following requirements are satisfied --
(i) All payments to be made or received under the qualifying debt
instrument (or amounts determined by reference to a nonfunctional
currency) are fully hedged on the date the taxpayer identifies the
transaction under paragraph (a) of this section as a qualified hedging
transaction such that a yield to maturity (under principles of section
1272) in the currency in which the synthetic debt instrument is
denominated (as determined under paragraph (a)(9)(ii)(A) of this
section) can be calculated. Any contingent payment features of the
qualifying debt instrument must be fully offset by the hedge such that
the synthetic debt instrument is not classified as a contingent payment
debt instrument. See Examples 6 and 7 of paragraph (a)(9)(iv) of this
section.
(ii) The hedge is identified in accordance with paragraph (a)(8) of
this section on or before the date the acquisition of the financial
instrument (or instruments) constituting the hedge is settled or closed.
(iii) None of the parties to the hedge are related. The term
''related'' means the relationships defined in section 267(b) or section
707(b).
(iv) In the case of a qualified business unit with a residence, as
defined in section 988(a)(3)(B), outside of the United States, both the
qualifying debt instrument and the hedge are properly reflected on the
books of such qualified business unit throughout the term of the
qualified hedging transaction.
(v) Subject to the limitations of paragraph (a)(5) of this section,
both the qualifying debt instrument and the hedge are entered into by
the same individual, partnership, trust, estate, or corporation. With
respect to a corporation, the same corporation must enter into both the
qualifying debt instrument and the hedge whether or not such corporation
is a member of an affiliated group of corporations that files a
consolidated return.
(vi) With respect to a foreign person engaged in a U.S. trade or
business that enters into a qualifying debt instrument or hedge through
such trade or business, all items of income and expense associated with
the qualifying debt instrument and the hedge (other than interest
expense that is subject to 1.882-5), would have been effectively
connected with such U.S. trade or business throughout the term of the
qualified hedging transaction had this paragraph (a) not applied.
(6) Special rules for legging in and legging out of integrated
treatment -- (i) Legging in. ''Legging in'' to integrated treatment
under this paragraph (a) means that a hedge is entered into after the
date the qualifying debt instrument is entered into or acquired, and the
requirements of this paragraph (a) are satisfied on the date the hedge
is entered into (''leg in date''). If a taxpayer legs into integrated
treatment, the following rules shall apply --
(A) Exchange gain or loss shall be realized with respect to the
qualifying debt instrument determined solely by reference to changes in
exchange rates between --
(1) The date the instrument was acquired by the holder, or the date
the obligor assumed the obligation to make payments under the
instrument; and
(2) The leg in date.
(B) The recognition of such gain or loss will be deferred until the
date the qualifying debt instrument matures or is otherwise disposed of.
(C) The source and character of such gain or loss shall be determined
on the leg in date as if the qualifying debt instrument was actually
sold or otherwise terminated by the taxpayer.
(ii) Legging out. With respect to a qualifying debt instrument and
hedge that are properly identified as a qualified hedging transaction,
''legging out'' of integrated treatment under this paragraph (a) means
that the taxpayer disposes of or otherwise terminates all or a part of
the qualifying debt instrument or hedge prior to maturity of the
qualified hedging transaction, or the taxpayer changes a material term
of the qualifying debt instrument (e.g., exercises an option to change
the interest rate or index, or the maturity date) or hedge (e.g.,
changes the interest or exchange rates underlying the hedge, or the
expiration date) prior to maturity of the qualified hedging transaction.
A taxpayer that disposes of or terminates a qualified hedging
transaction (i.e., disposes of or terminates both the qualifying
transaction and the hedge on the same day) shall be considered to have
disposed of or otherwise terminated the synthetic debt instrument rather
than as legging out. If a taxpayer legs out of integrated treatment,
the following rules shall apply --
(A) The transaction will be treated as a qualified hedging
transaction during the time the requirements of this paragraph (a) were
satisfied.
(B) If the hedge is disposed of or otherwise terminated, the
qualifying debt instrument shall be treated as sold for its fair market
value on the date the hedge is disposed of or otherwise terminated (the
''leg-out date''), and any gain or loss (including gain or loss
resulting from factors other than movements in exchange rates) from the
identification date to the leg-out date is realized and recognized on
the leg-out date. The spot rate on the leg-out date shall be used to
determine exchange gain or loss on the debt instrument for the period
beginning on the leg-out date and ending on the date such instrument
matures or is disposed of or otherwise terminated. Proper adjustment to
the principal amount of the debt instrument must be made to reflect any
gain or loss taken into account. The netting rule of 1.988-2(b)(8)
shall apply.
(C) If the qualifying debt instrument is disposed of or otherwise
terminated, the hedge shall be treated as sold for its fair market value
on the date the qualifying debt instrument is disposed of or otherwise
terminated (the ''leg-out date''), and any gain or loss from the
identification date to the leg-out date is realized and recognized on
the leg-out date. The spot rate on the leg-out date shall be used to
determine exchange gain or loss on the hedge for the period beginning on
the leg-out date and ending on the date such hedge is disposed of or
otherwise terminated.
(D) Except as provided in paragraph (a)(8)(iii) of this section
(regarding identification by the Commissioner), that part of the
qualified hedging transaction that has not been terminated (i.e., the
remaining debt instrument in its entirety even if partially hedged, or
hedge) cannot be part of a qualified hedging transaction for any period
subsequent to the leg out date.
(E) If a taxpayer legs out of a qualified hedging transaction and
realizes a gain with respect to the terminated instrument, then
paragraph (a)(6)(ii) (B) or (C) of this section, as appropriate, shall
not apply if during the period beginning 30 days before the leg-out date
and ending 30 days after that date the taxpayer enters into another
transaction that hedges at least 50% of the remaining currency flow with
respect to the qualifying debt instrument which was part of the
qualified hedging transaction (or, if appropriate, an equivalent amount
under the 1.988-5 hedge which was part of the qualified hedging
transaction).
(7) Transactions part of a straddle. At the discretion of the
Commissioner, a transaction shall not satisfy the requirements of
paragraph (a)(5) of this section if the debt instrument making up the
qualified hedging transaction is part of a straddle as defined in
section 1092(c) prior to the time the qualified hedging transaction is
identified.
(8) Identification requirements -- (i) Identification by the
taxpayer. A taxpayer must establish a record and before the close of
the date the hedge is entered into, the taxpayer must enter into the
record for each qualified hedging transaction the following information
--
(A) The date the qualifying debt instrument and hedge were entered
into;
(B) The date the qualifying debt instrument and the hedge are
identified as constituting a qualified hedging transaction;
(C) The amount that must be deferred, if any, under paragraph (a)(6)
of this section and the source and character of such deferred amount;
(D) A description of the qualifying debt instrument and the hedge;
and
(E) A summary of the cash flow resulting from treating the qualifying
debt instrument and the hedge as a qualified hedging transaction.
(ii) Identification by trustee on behalf of beneficiary. A trustee
of a trust that enters into a qualified hedging transaction may satisfy
the identification requirements described in paragraph (a)(8)(i) of this
section on behalf of a beneficiary of such trust.
(iii) Identification by the Commissioner. If --
(A) A taxpayer enters into a qualifying debt instrument and a hedge
but fails to comply with one or more of the requirements of this
paragraph (a), and
(B) On the basis of all the facts and circumstances, the Commissioner
concludes that the qualifying debt instrument and the hedge are, in
substance, a qualified hedging transaction,
then the Commissioner may treat the qualifying debt instrument and
the hedge as a qualified hedging transaction. The Commissioner may
identify a qualifying debt instrument and a hedge as a qualified hedging
transaction regardless of whether the qualifying debt instrument and the
hedge are held by the same taxpayer.
(9) Taxation of qualified hedging transactions -- (i) In general --
(A) General rule. If a transaction constitutes a qualified hedging
transaction, the qualifying debt instrument and the hedge are integrated
and treated as a single transaction with respect to the taxpayer that
has entered into the qualified hedging transaction during the period
that the transaction qualifies as a qualified hedging transaction.
Neither the qualifying debt instrument nor the hedge that makes up the
qualified hedging transaction shall be subject to section 263(g), 1092
or 1256 for the period such transactions are integrated. However, the
qualified hedging transaction may be subject to section 263(g) or 1092
if such transaction is part of a straddle.
(B) Special rule for income or expense of foreign persons effectively
connected with a U.S. trade or business. Interest income of a foreign
person resulting from a qualified hedging transaction entered into by
such foreign person that satisfies the requirements of paragraph
(a)(5)(vii) of this section shall be treated as effectively connected
with a U.S. trade or business. Interest expense of a foreign person
resulting from a qualified hedging transaction entered into by such
foreign person that satisfies the requirements of paragraph (a)(5)(vii)
of this section shall be allocated and apportioned under 1.882-5 of the
regulations.
(C) Special rule for foreign persons that enter into qualified
hedging transactions giving rise to U.S. source income not effectively
connected with a U.S. trade or business. If a foreign person enters
into a qualified hedging transaction that gives rise to U.S. source
interest income (determined under the source rules for synthetic asset
transactions as provided in this section) not effectively connected with
a U.S. trade or business of such foreign person, for purposes of
sections 871(a), 881, 1441, 1442 anT3Income tax effects of integration.
The effect of integrating and treating a transaction as a single
transaction is to create a synthetic debt instrument for income tax
purposes, which is subject to the original issue discount provisions of
sections 1272 through 1288 and 163(e), the terms of which are determined
as follows:
(A) Denomination of synthetic debt instrument. In the case where the
qualifying debt instrument is a borrowing, the denomination of the
synthetic debt instrument is the same as the currency paid under the
terms of the hedge to acquire the currency used to make payments under
the qualifying debt instrument. In the case where the qualifying debt
instrument is a lending, the denomination of the synthetic debt
instrument is the same as the currency received under the terms of the
hedge in exchange for amounts received under the qualifying debt
instrument. For example, if the hedge is a forward contract to acquire
British pounds for dollars, and the qualifying debt instrument is a
borrowing denominated in British pounds, the synthetic debt instrument
is considered a borrowing in dollars.
(B) Term and accrual periods. The term of the synthetic debt
instrument shall be the period beginning on the identification date and
ending on the date the qualifying debt instrument matures or such
earlier date that the qualifying debt instrument or hedge is disposed of
or otherwise terminated. Unless otherwise clearly indicated by the
payment interval under the hedge, the accrual period shall be a six
month period which ends on the dates determined under section
1272(a)(5).
(C) Issue price. The issue price of the synthetic debt instrument is
the adjusted issue price of the qualifying debt instrument translated
into the currency in which the synthetic debt instrument is denominated
at the spot rate on the identification date.
(D) Stated redemption price at maturity. In the case where the
qualifying debt instrument is a borrowing, the stated redemption price
at maturity shall be determined under section 1273(a)(2) on the
identification date by reference to the amounts to be paid under the
hedge to acquire the currency necessary to make interest and principal
payments on the qualifying debt instrument. In the case where the
qualifying debt instrument is a lending, the stated redemption price at
maturity shall be determined under section 1273(a)(2) on the
identification date by reference to the amounts to be received under the
hedge in exchange for the interest and principal payments received
pursuant to the terms of the qualifying debt instrument.
(iii) Source of interest income and allocation of expense. Interest
income from a synthetic debt instrument described in paragraph
(a)(9)(ii) of this section shall be sourced by reference to the source
of income under sections 861 (a)(1) and 862(a)(1) of the qualifying debt
instrument. The character for purposes of section 904 of interest
income from a synthetic debt instrument shall be determined by reference
to the character of the interest income from qualifying debt instrument.
Interest expense from a synthetic debt instrument described in
paragraph (a)(9)(ii) of this section shall be allocated and apportioned
under 1.861-8T through 1.861-12T or the successor sections thereof or
under 1.882-5.
(iv) Examples. The following examples illustrate the application of
this paragraph (a)(9).
Example 1. (i) K is a U.S. corporation with the U.S. dollar as its
functional currency. On December 24, 1989, K agrees to close the
following transaction on December 31, 1989. K will borrow from an
unrelated party on December 31, 1989, 100 British pounds ( ) for 3 years
at a 10 percent rate of interest, payable annually, with no principal
payment due until the final installment. K will also enter into a
currency swap contract with an unrelated counterparty under the terms of
which --
(a) K will swap, on December 31, 1989, the 100 obtained from the
borrowing for $100; and
(b) K will exchange dollars for pounds pursuant to the following
table in order to obtain the pounds necessary to make payments on the
pound borrowing:
(ii) The interest rate on the borrowing is set and the exchange rates
on the swap are fixed on December 24, 1989. On December 31, 1989, K
borrows the 100 and swaps such pounds for $100. Assume x has satisfied
the identification requirements of paragraph (a)(8) of this section.
(iii) The pound borrowing (which constitutes a qualifying debt
instrument under paragraph (a)(3) of this section) and the currency swap
contract (which constitutes a hedge under paragraph (a)(4) of this
section) are a qualified hedging transaction as defined in paragraph
(a)(1) of this section. Accordingly, the pound borrowing and the swap
are integrated and treated as one transaction with the following
consequences:
(A) The integration of the pound borrowing and the swap results in a
synthetic dollar borrowing with an issue price of $100 under section
1273(b)(2).
(B) The total amount of interest and principal of the synthetic
dollar borrowing is equal to the dollar payments made by K under the
currency swap contract (i.e., $8 in 1990, $8 in 1991, and $108 in 1992).
(C) The stated redemption price at maturity (defined in section
1273(a)(2)) is $100. Because the stated redemption price equals the
issue price, there is no OlD on the synthetic dollar borrowing.
(D) K may deduct the annual interest payments of $8 under section
163(a) (subject to any limitations on deductibility imposed by other
provisions of the Code) according to its regular method of accounting.
K has also paid $100 as a return of principal in 1992.
(E) K must allocate and apportion its interest expense with respect
to the synthetic dollar borrowing under the rules of 1.861-8T through
1.861-12T.
Example 2. (i) K, a U.S. corporation, has the U.S. dollar as its
functional currency. On December 24, 1989, when the spot rate for Swiss
francs (Sf) is Sf1 = $1, K enters into a forward contract to purchase
Sf100 in exchange for $100.04 for delivery on December 31, 1989. The
Sf100 are to be used for the purchase of a franc denominated debt
instrument on December 31, 1989. The instrument will have a term of 3
years, an issue price of Sf100, and will bear interest at 6 percent,
payable annually, with no repayment of principal until the final
installment. On December 24, 1989, K also enters into a series of
forward contracts to sell the franc interest and principal payments that
will be received under the terms of the franc denominated debt
instrument for dollars according to the following schedule:
(ii) On December 31, 1989, K takes delivery of the Sf100 and
purchases the franc denominated debt instrument. Assume K satisfies the
identification requirements of paragraph (a)(8) of this section. The
purchase of the franc debt instrument (which constitutes a qualifying
debt instrument under paragraph (a)(3) of this section) and the series
of forward contracts (which constitute a hedge under paragraph (a)(4) of
this section) are a qualified hedging transaction under paragraph (a)(1)
of this section. Accordingly, the franc debt instrument and all the
forward contracts are integrated and treated as one transaction with the
following consequences:
(A) The integration of the franc debt instrument and the forward
contracts results in a synthetic dollar debt instrument in an amount
equal to the dollars exchanged under the forward contract to purchase
the francs necessary to acquire the franc debt instrument. Accordingly,
the issue price is $100.04 (section 1273(b)(2) of the Code).
(B) The total amount of interest and principal received by K with
respect to the synthetic dollar debt instrument is equal to the dollars
received under the forward sales contracts (i.e., $6.12 in 1990, $6.23
in 1991, and $112.16 in 1992).
(C) The synthetic dollar debt instrument is an installment obligation
and its stated redemption price at maturity is $106.15 (i.e., $6.12 of
the payments in 1990, 1991, and 1992 are treated as periodic interest
payments under the principles of section 1273). Because the stated
redemption price at maturity exceeds the issue price, under section
1273(a)(1) the synthetic dollar debt instrument has OID of $6.11.
(D) The yield to maturity of the synthetic dollar debt instrument is
8.00 percent, compounded annually. Assuming K is a calendar year
taxpayer, it must include interest income of $8.00 in 1990 (of which
$1.88 constitutes OID), $8.15 in 1991 (of which $2.03 constitutes OID),
and $8.32 in 1992 (of which $2.20 constitutes OID). The amount of the
final payment received by K in excess of the interest income includible
is a return of principal and a payment of previously accrued OID.
(E) The source of the interest income shall be determined by applying
sections 861(a)(1) and 862(a)(1) with reference to the franc interest
income that would have been received had the transaction not been
integrated.
Example 3. (i) K is an accrual method U.S. corporation with the U.S.
dollar as its functional currency. On January 1, 1992, K borrows 100
British pounds ( ) for 3 years at a 10% rate of interest payable on
December 31 of each year with no principal payment due until the final
installment. The spot rate on January 1, 1992, is 1 = $1.50. On
January 1, 1993, when the spot rate is 1 = $1.60, K enters into a
currency swap contract with an unrelated counterparty under the terms of
which K will exchange dollars for pounds pursuant to the following table
in order to obtain the pounds necessary to make the remaining payments
on the pound borrowing:
(ii) Assume that British pound interest rates are still 10% and that
K properly identifies the pound borrowing and the currency swap contract
as a qualified hedging transaction as provided in paragraph (a)(8) of
this section. Under paragraph (a)(6)(i) of this section, K must realize
exchange gain or loss with respect to the pound borrowing determined
solely by reference to changes in exchange rates between January 1, 1992
and January 1, 1993. (Thus, gain or loss from other factors such as
movements in interest rates or changes in credit quality of K are not
taken into account). Recognition of such gain or loss is deferred until
K terminates its pound borrowing. Accordingly, K must defer exchange
loss in the amount of $10 (( 100 1.50)^( 100 1.60)).
(iii) Additionally, the qualified hedging transaction is treated as a
synthetic U.S. dollar debt instrument with an issue date of January 1,
1993, and a maturity date of December 31, 1994. The issue price of the
synthetic debt instrument is $160 ( 100 1.60, the spot rate on January
1, 1993) and the total amount of interest and principal is $185.60. The
accrual period is the one year period beginning on January 1 and ending
December 31 of each year. The stated redemption price at maturity is
$160. Thus, K is treated as paying $12.80 of interest in 1993, $12.80
of interest in 1994, and $160 of principal in 1994. The interest
expense from the synthetic instrument is allocated and apportioned in
accordance with the rules of 1.861-8T through 1.861-12T. Sections
263(g), 1092, and 1256 do not apply to the positions comprising the
synthetic dollar borrowing.
Example 4. (i) K is an accrual method U.S. corporation with the U.S.
dollar as its functional currency. On January 1, 1990, K borrows 100
British pounds ( ) for 3 years at a 10% rate of interest payable on
December 31 of each year with no principal payment due until the final
installment. The spot rate on January 1, 1990, is 1 = $1.50. Also on
January 1, 1990, K enters into a currency swap contract with an
unrelated counterparty under the terms of which K will exchange dollars
for pounds pursuant to the following table in order to obtain the pounds
necessary to make the remaining payments on the pound borrowing:
(ii) Assume that K properly identifies the pound borrowing and the
currency swap contract as a qualified hedging transaction as provided in
paragraph (a)(1) of this section.
(iii) The pound borrowing (which constitutes a qualifying debt
instrument under paragraph (a)(3) of this section) and the currency swap
contract (which constitutes a hedge under paragraph (a)(4) of this
section) are a qualified hedging transaction as defined in paragraph
(a)(1) of this section. Accordingly, the pound borrowing and the swap
are integrated and treated as one transaction with the following
consequences:
(A) The integration of the pound borrowing and the swap results in a
synthetic dollar borrowing with an issue price of $150 under section
1273(b)(2).
(B) The total amount of interest and principal of the synthetic
dollar borrowing is equal to the dollar payments made by K under the
currency swap contract (i.e., $12 in 1990, $12 in 1991, and $162 in
1992).
(C) The stated redemption price at maturity (defined in section
1273(a)(2)) is $150. Because the stated redemption price equals the
issue price, there is no OID on the synthetic dollar borrowing.
(D) K may deduct the annual interest payments of $12 under section
163(a) (subject to any limitations on deductibility imposed by other
provisions of the Code) according to its regular method of accounting.
K has also paid $150 as a return of principal in 1992.
(E) K must allocate and apportion its interest expense from the
synthetic instrument under the rules of 1.861-8T through 1.861-12T.
(iv) Assume that on January 1, 1991, the spot exchange rate is 1 =
$1.60, interest rates have not changed since January 1, 1990,
(accordingly, assume that the market value of K's bond in pounds has not
changed) and that K transfers its rights and obligations under the
currency swap contract in exchange for $10. Under 1.988-2(e)(3)(iii),
K will include in income as exchange gain $10 on January 1, 1991.
Pursuant to paragraph (a)(6)(ii) of this section, the pound borrowing
and the currency swap contract are treated as a qualified hedging
transaction for 1990. The loss inherent in the pound borrowing from
January 1, 1990, to January 1, 1991, is realized and recognized on
January 1, 1991. Such loss is exchange loss in the amount of $10.00 ((
100 $1.50, the spot rate on January 1, 1990) -- ( 100 $1.60, the spot
rate on January 1, 1991)). For purposes of determining exchange gain or
loss on the 100 principal amount of the debt instrument for the period
January 1, 1991, to December 31, 1992, the spot rate on January 1, 1991
is used rather than the spot rate on the issue date. Thus, assuming
that the spot rate on December 31, 1992, the maturity date, is 1 =
$1.80, K realizes exchange loss in the amount of $20 (( 100 $1.60)^( 100
$1.80)). Except as provided in paragraph (a)(8)(iii) (regarding
identification by the Commissioner), the pound borrowing cannot be part
of a qualified hedging transaction for any period subsequent to the leg
out date.
Example 5. (i) K, a U.S. corporation, has the U.S. dollar as its
functional currency. On January 1, 1990, when the spot rate for Swiss
francs (Sf) is Sf1 = $.50, K converts $100 to Sf200 and purchases a
franc denominated debt instrument. The instrument has a term of 3
years, an adjusted issue price of Sf200, and will bear interest at 5
percent, payable annually, with no repayment of principal until the
final installment. The U.S. dollar interest rate on an equivalent
instrument is 8% on January 1, 1990, compounded annually. On January 1,
1990, K also enters into a series of forward contracts to sell the franc
interest and principal payments that will be received under the terms of
the franc denominated debt instrument for dollars according to the
following schedule:
(ii) Assume K satisfies the identification requirements of paragraph
(a)(8) of this section. Assume further that on January 1, 1991, the
spot exchange rate is Sf1 = U.S.$.5143, the U.S. dollar interest rate is
10%, compounded annually, and the Swiss franc interest rate is the same
as on January 1, 1990 (5%, compounded annually). On January 1, 1991, K
disposes of the forward contracts that were to mature on December 31,
1991, and December 31, 1992 and incurs a loss of $3.62 (the present
value of $.10 with respect to the 1991 contract and $4.27 with respect
to the 1992 contract).
(iii) The purchase of the franc debt instrument (which constitutes a
qualifying debt instrument under paragraph (a)(3) of this section) and
the series of forward contracts (which constitute a hedge under
paragraph (a)(4) of this section) are a qualified hedging transaction
under paragraph (a)(1) of this section. Accordingly, the franc debt
instrument and all the forward contracts are integrated for the period
beginning January 1, 1990, and ending January 1, 1991.
(A) The integration of the franc debt instrument and the forward
contracts results in a synthetic dollar debt instrument with an issue
price of $100.
(B) The total amount of interest and principal to be received by K
with respect to the synthetic dollar debt instrument is equal to the
dollars to be received under the forward sales contracts (i.e., $5.14 in
1990, $5.29 in 1991, and $114.26 in 1992).
(C) The synthetic dollar debt instrument is an installment obligation
and its stated redemption price at maturity is $109.27 (i.e., $5.14 of
the payments in 1990, 1991, and 1992 is treated as periodic interest
payments under the principles of section 1273). Because the stated
redemption price at maturity exceeds the issue price, under section
1273(a)(1) the synthetic dollar debt instrument has OID of $9.27.
(D) The yield to maturity of the synthetic dollar debt instrument is
8.00 percent, compounded annually. Assuming K is a calendar year
taxpayer, it must include interest income of $8.00 in 1990 (of which
$2.86 constitutes OID).
(E) The source of the interest income is determined by applying
sections 861(a)(1) and 862(a)(1) with reference to the franc interest
income that would have been received had the transaction not been
integrated.
(iv) Because K disposed of the forward contracts on January 1, 1991,
the rules of paragraph (a)(6)(ii) of this section shall apply.
Accordingly, the $3.62 loss from the disposition of the forward
contracts is realized and recognized on January 1, 1991. Additionally,
K is deemed to have sold the franc debt instrument for $102.86, its fair
market value in dollars on January 1, 1991. K will compute gain or loss
with respect to the deemed sale of the franc debt instrument by
subtracting its adjusted basis in the instrument ($102.86 -- the value
of the Sf200 issue price at the spot rate on the identification date
plus $2.86 of original issue discount accrued on the synthetic dollar
debt instrument for 1990) from the amount realized on the deemed sale of
$102.86. Thus K realizes and recognizes no gain or loss from the deemed
sale of the debt instrument. The dollar amount used to determine
exchange gain or loss with respect to the franc debt instrument is the
Sf200 issue price on January 1, 1991, translated into dollars at the
spot rate on January 1, 1991, of Sf1 = U.S.$.5143. Except as provided in
paragraph (a)(8)(iii) of this section (regarding identification by the
Commissioner), the franc borrowing cannot be part of a qualified hedging
transaction for any period subsequent to the leg out date.
Example 6. (i) K is a U.S. corporation with the dollar as its
functional currency. On January 1, 1992, K issues a debt instrument
with the following terms: the issue price is $1,000, the instrument
pays interest annually at a rate of 8% on the $1,000 principal amount,
the instrument matures on December 31, 1996, and the amount paid at
maturity is the greater of zero or $2,000 less the U.S. dollar value
(determined on December 31, 1996) of 150,000 Japanese yen.
(ii) Also on January 1, 1992, K enters into the following hedges with
respect to the instrument described in the preceding paragraph: a
forward contract under which K will sell 150,000 yen for $1,000 on
December 31, 1996 (note that this forward rate assumes that interest
rates in yen and dollars are equal); and an option contract that
expires on December 31, 1996, under which K has the right (but not the
obligation) to acquire 150,000 yen for $2,000. K will pay for the
option by making payments to the writer of the option equal to $5 each
December 31 from 1992 through 1996.
(iii) The net economic effect of these transactions is that K has
created a liability with a principal amount and amount paid at maturity
of $1,000, with an interest cost of 8.5% (8% on debt instrument, 0.5%
option price) compounded annually. For example, if on December 31,
1996, the spot exchange rate is $1 = 100 yen, K pays $500 on the bond
($2,000^(150,000 yen/$100)), and $500 in satisfaction of the forward
contract ($1,000^(150,000 yen/$100)). If instead the spot exchange rate
on December 31, 1996 is $1 = 200 yen, K pays $1,250 on the bond
($2,000^(150,000 yen/$200)) and K receives $250 in satisfaction of the
forward contract ($1,000^(150,000 yen/$200)). Finally, if the spot
exchange rate on December 31, 1996 is $1 = 50 yen, K pays $0 on the bond
($2,000^(150,000 yen/$50), but the bond holder is not required under the
terms of the instrument to pay additional principal); K exercises the
option to buy 150,000 yen for $2,000; and K then delivers the 150,000
yen as required by the forward contract in exchange for $1,000.
(iv) Assume K satisfies the identification requirements of paragraph
(a)(8) of this section. The debt instrument described in paragraph (i)
of this Example 6 (which constitutes a qualifying debt instrument under
paragraph (a)(3) of this section) and the forward contract and option
contract described in paragraph (ii) of this example (which constitute a
hedge under paragraph (a)(4) of this section and are collectively
referred to hereafter as ''the contracts'') together are a qualified
hedging transaction under paragraph (a)(1) of this section.
Accordingly, with respect to K, the debt instrument and the contracts
are integrated, resulting in a synthetic dollar debt instrument with an
issue price of $1000, a stated redemption price at maturity of $1000 and
a yield to maturity of 8.5% compounded annually (with no original issue
discount). K must allocate and apportion its annual interest expense of
$85 under the rules of 1.861-8T through 1.861-12T.
Example 7. (i) R is a U.S. corporation with the dollar as its
functional currency. On January 1, 1995, R issues a debt instrument
with the following terms: the issue price is 504 British pounds ( ),
the instrument pays interest at a rate of 3.7% (compounded
semi-annually) on the 504 principal amount, the instrument matures on
December 31, 1999, with a repayment at maturity of the 504 principal
plus the proportional gain, if any, in the ''Financial Times'' 100 Stock
Exchange (FTSE) index (determined by the excess of the value of the FTSE
index on the maturity date over the value of the FTSE on the issue date,
divided by the value of the FTSE index on the issue date, multiplied by
the number of FTSE index contracts that could be purchased on the issue
date for 504).
(ii) Also on January 1, 1995, R enters into a contract with a bank
under which on January 1, 1995, R will swap the 504 for $1,000 (at the
current spot rate). R will make U.S. dollar payments to the bank equal
to 8.15% on the notional principal amount of $1,000 (compounded
semi-annually) for the period beginning January 1, 1995 and ending
December 31, 1999. R will receive pound payments from the bank equal to
3.7% on the notional principal amount of 504 (compounded semi-annually)
for the period beginning January 1, 1995 and ending December 31, 1999.
On December 31, 1999, R will swap with the bank $1,000 for 504 plus the
proportional gain, if any, in the FTSE index (computed as provided
above).
(iii) Economically, both the indexed debt instrument and the hedging
contract are hybrid instruments with the following components. The
indexed debt instrument is composed of a par pound debt instrument that
is assumed to have a 10.85% coupon (compounded semi-annually) plus an
embedded FTSE equity index option for which the investor pays a premium
of 7.15% (amortized semi-annually) on the pound principal amount. The
combined effect is that the premium paid by the investor partially
offsets the coupon payments resulting in a return of 3.7%
(10.85%^7.15%). Similarly, the dollar payments under the hedging
contract to be made by R are computed by multiplying the dollar notional
principal amount by an 8.00% rate (compounded semi-annually) which the
facts assume would be the rate paid on a conventional currency swap plus
a premium of 0.15% (amortized semi-annually) on the dollar notional
principal amount for an embedded FTSE equity index option.
(iv) Assume R satisfies the identification requirements of paragraph
(a)(8) of this section. The indexed debt instrument described in
paragraph (i) of this Example 7 constitutes a qualifying debt instrument
under paragraph (a)(3) of this section. The hedging contract described
in paragraph (ii) of this Example 7 constitutes a hedge under paragraph
(a)(4) of this section. Since both the pound exposure of the indexed
debt instrument and the exposure to movements of the FTSE embedded in
the indexed debt instrument are hedged such that a yield to maturity can
be determined in dollars, the transaction satisfies the requirement of
paragraph (a)(5)(i) of this section. Assuming the transactions satisfy
the other requirements of paragraph (a)(5) of this section, the indexed
debt instrument and hedge are a qualified hedging transaction under
paragraph (a)(1) of this section. Accordingly, with respect to R, the
debt instrument and the contracts are integrated, resulting in a
synthetic dollar debt instrument with an issue price of $1000, a stated
redemption price at maturity of $1000 and a yield to maturity of 8.15%
compounded semi-annually (with no original issue discount). K must
allocate and apportion its interest expense from the synthetic
instrument under the rules 1.861-8T through 1.861-12T.
Example 8. (i) K is a U.S. corporation with the U.S. dollar as its
functional currency. On December 24, 1992, K agrees to close the
following transaction on December 31, 1992. K will borrow from an
unrelated party on December 31, 1992, 200 British pounds ( ) for 3 years
at a 10 percent rate of interest, payable annually, with no principal
payment due until the final installment. K will also enter into a
currency swap contract with an unrelated counterparty under the terms of
which --
(A) K will swap, on December 31, 1992, 100 obtained from the
borrowing for $100; and
(B) K will exchange dollars for pounds pursuant to the following
table:
(ii) The interest rate on the borrowing is set and the exchange rates
on the swap are fixed on December 24, 1992. On December 31, 1992, K
borrows the 200 and swaps 100 for $100. Assume K has satisfied the
identification requirements of paragraph (a)(8) of this section.
(iii) The 200 debt instrument satisfies the requirements of
paragraph (a)(3)(i) of this section. Because all principal and interest
payments under the instrument are hedged in the same proportion (50% of
all interest and principal payments are hedged), 50% of the payments
under the 200 instrument (principal amount of 100 and annual interest
of 10) are treated as a qualifying debt instrument for purposes of
paragraph (a) of this section. Thus, the distinct 100 borrowing and
the currency swap contract (which constitutes a hedge under paragraph
(a)(4) of this section) are a qualified hedging transaction as defined
in paragraph (a)(1) of this section. Accordingly, 100 of the pound
borrowing and the swap are integrated and treated as one synthetic
dollar transaction with the following consequences:
(A) The integration of 100 of the pound borrowing and the swap
results in a synthetic dollar borrowing with an issue price of $100
under section 1273(b)(2).
(B) The total amount of interest and principal of the synthetic
dollar borrowing is equal to the dollar payments made by K under the
currency swap contract (i.e., $8 in 1993, $8 in 1994, and $108 in 1995).
(C) The stated redemption price at maturity (defined in section
1273(a)(2)) is $100. Because the stated redemption price equals the
issue price, there is no OID on the synthetic dollar borrowing.
(D) K may deduct the annual interest payments of $8 under section
163(a) (subject to any limitations on deductibility imposed by other
provisions of the Code) according to its regular method of accounting.
K has also paid $100 as a return of principal in 1995.
(E) K must allocate and apportion its interest expense from the
synthetic instrument under the rules of l.861-8T through 1.861-12T.
That portion of the 200 pound debt instrument that is not hedged
(i.e., 100) is treated as a separate debt instrument subject to the
rules of 1.988-2 (b) and l.861-8T through 1.861-12T.
Example 9. (i) K is an accrual method U.S. corporation with the U.S.
dollar as its functional currency. On January 1, 1992, K borrows 100
British pounds ( ) for 3 years at a 10% rate of interest payable on
December 31 of each year with no principal payment due until the final
installment. On the same day, K enters into a currency swap agreement
with an unrelated bank under which K agrees to the following:
(A) On January 1, 1992, K will exchange the 100 borrowed for $150.
(B) For the period beginning January 1, 1992 and ending December 31,
1994, K will pay at the end of each month an amount determined by
multiplying $150 by one month LIBOR less 65 basis points and receive
from the bank on December 31st of 1992, 1993, and 1994, 10.
(C) On December 31, 1994, K will exchange $150 for 100.
Assume K satisfies the identification requirements of paragraph
(a)(8) of this section.
(ii) The pound borrowing (which constitutes a qualifying debt
instrument under paragraph (a)(3) of this section) and the currency swap
contract (which constitutes a hedge under paragraph (a)(4) of this
section) are a qualified hedging transaction as defined in paragraph
(a)(1) of this section. Accordingly, the pound borrowing and the swap
are integrated and treated as one transaction with the following
consequences:
(A) The integration of the pound borrowing and the swap results in a
synthetic dollar borrowing with an issue price of $150 under section
1273(b)(2).
(B) The total amount of interest and principal of the synthetic
dollar borrowing is equal to the dollar payments made by K under the
currency swap contract.
(C) The stated redemption price at maturity (defined in section
1273(a)(2)) is $150. Because the stated redemption price equals the
issue price, there is no OlD on the synthetic dollar borrowing.
(D) K may deduct the monthly variable interest payments under section
163(a) (subject to any limitations on deductibility imposed by other
provisions of the Code) according to its regular method of accounting.
K has also paid $150 as a return of principal in 1994.
(E) K must allocate and apportion its interest expense from the
synthetic instrument under the rules of 1.861-8T through 1.861-12T.
Example 10. (i) K is an accrual method U.S. corporation with the
U.S. dollar as its functional currency. On January 1, 1992, K loans 100
British pounds ( ) for 3 years at a 10% rate of interest payable on
December 31 of each year with no principal payment due until the final
installment. The spot rate on January 1, 1992, is 1 = $1.50. Also on
January 1, 1992, K enters into a currency swap contract with an
unrelated counterparty under the terms of which K will exchange pounds
for dollars pursuant to the following table:
(ii) Assume that K properly identifies the pound borrowing and the
currency swap contract as a qualified hedging transaction as provided in
paragraph (a)(1) of this section.
(iii) The pound loan (which constitutes a qualifying debt instrument
under paragraph (a)(3) of this section) and the currency swap contract
(which constitutes a hedge under paragraph (a)(4) of this section) are a
qualified hedging transaction as defined in paragraph (a)(1) of this
section. Accordingly, the pound loan and the swap are integrated and
treated as one transaction with the following consequences:
(A) The integration of the pound loan and the swap results in a
synthetic dollar loan with an issue price of $150 under section
1273(b)(2).
(B) The total amount of interest and principal of the synthetic
dollar loan is equal to the dollar payments received by K under the
currency swap contract (i.e., $12 in 1992, $12 in 1993, and $162 in
1994).
(C) The stated redemption price at maturity (defined in section
1273(a)(2)) is $150. Because the stated redemption price equals the
issue price, there is no OlD on the synthetic dollar loan.
(D) K must include in income as interest $12 in 1992, 1993, and 1994.
(E) The source of the interest income shall be determined by applying
sections 861(a)(1) and 862(a)(1) with reference to the pound interest
income that would have been received had the transaction not been
integrated.
(iv) On January 1, 1993, K transfers both the pound loan and the
currency swap to B, its wholly owned U.S. subsidiary, in exchange for B
stock in a transfer that satisfies the requirements of section 351.
Under paragraph (a)(6) of this section, the transfer of both instruments
is not ''legging out.'' Rather, K is considered to have transferred the
synthetic dollar loan to B in a transaction in which gain or loss is not
recognized. B's basis in the loan under section 362 is $100.
(10) Transition rules and effective dates for certain provisions --
(i) Coordination with Notice 87-11. Any transaction entered into prior
to September 21, 1989 which satisfied the requirements of Notice 87-11,
1987-1 C.B. 423, shall be deemed to satisfy the requirements of
paragraph (a) of this section.
(ii) Prospective application to contingent payment debt instruments.
In the case of a contingent payment debt instrument, the definition of
qualifying debt instrument set forth in paragraph (a)(3)(i) of this
section applies to transactions entered into after March 17, 1992.
(iii) Prospective application of partial hedging rule. Paragraph
(a)(3)(ii) of this section is effective for transactions entered into
after March 17, 1992.
(iv) Effective date for paragraph (a)(6)(i) of this section. The
rules of paragraph (a)(6)(i) of this section are effective for qualified
hedging transactions that are legged into after March 17, 1992.
(b) Hedged executory contracts -- (1) In general. If the taxpayer
enters into a hedged executory contract as defined in paragraph (b)(2)
of this section, the executory contract and the hedge shall be
integrated as provided in paragraph (b)(4) of this section.
(2) Definitions -- (i) Hedged executory contract. A hedged executory
contract is an executory contract as defined in paragraph (b)(2)(ii) of
this section that is the subject of a hedge as defined in paragraph
(b)(2)(iii) of this section, provided that the following requirements
are satisfied --
(A) The executory contract and the hedge are identified as a hedged
executory contract as provided in paragraph (b)(3) of this section.
(B) The hedge is entered into (i.e., settled or closed, or in the
case of nonfunctional currency deposited in an account with a bank or
other financial institution, such currency is acquired and deposited) on
or after the date the executory contract is entered into and before the
accrual date as defined in paragraph (b)(2)(iv) of this section.
(C) The executory contract is hedged in whole or in part throughout
the period beginning with the date the hedge is identified in accordance
with paragraph (b)(3) of this section and ending on or after the accrual
date.
(D) None of the parties to the hedge are related. The term related
means the relationships defined in section 267(b) and section 707(c)(1).
(E) In the case of a qualified business unit with a residence, as
defined in section 988(a)(3)(B), outside of the United States, both the
executory contract and the hedge are properly reflected on the books of
the same qualified business unit.
(F) Subject to the limitations of paragraph (b)(2)(i)(E) of this
section, both the executory contract and the hedge are entered into by
the same individual, partnership, trust, estate, or corporation. With
respect to a corporation, the same corporation must enter into both the
executory contract and the hedge whether or not such corporation is a
member of an affiliated group of corporations that files a consolidated
return.
(G) With respect to a foreign person engaged in a U.S. trade or
business that enters into an executory contract or hedge through such
trade or business, all items of income and expense associated with the
executory contract and the hedge would have been effectively connected
with such U.S. trade or business throughout the term of the hedged
executory contract had this paragraph (b) not applied.
(ii) Executory contract -- (A) In general. Except as provided in
paragraph (b)(2)(ii)(B) of this section, an executory contract is an
agreement entered into before the accrual date to pay nonfunctional
currency (or an amount determined with reference thereto) in the future
with respect to the purchase of property used in the ordinary course of
the taxpayer's business, or the acquisition of a service (or services),
in the future, or to receive nonfunctional currency (or an amount
determined with reference thereto) in the future with respect to the
sale of property used or held for sale in the ordinary course of the
taxpayer's business, or the performance of a service (or services), in
the future. Notwithstanding the preceding sentence, a contract to buy
or sell stock shall be considered an executory contract. (Thus, for
example, a contract to sell stock of an affiliate is an executory
contract for this purpose.) On the accrual date, such agreement ceases
to be considered an executory contract and is treated as an account
payable or receivable.
(B) Exceptions. An executory contract does not include a section 988
transaction. For example, a forward contract to purchase nonfunctional
currency is not an executory contract. An executory contract also does
not include a transaction described in paragraph (c) of this section.
(C) Effective date for contracts to buy or sell stock. That part of
paragraph (b)(2)(ii)(A) of this section which provides that a contract
to buy or sell stock shall be considered an executory contract applies
to contracts to buy or sell stock entered into on or after March 17,
1992.
(iii) Hedge -- (A) In general. For purposes of this paragraph (b),
the term hedge means a deposit of nonfunctional currency in a hedging
account (as defined paragraph (b)(3)(iii)(D) of this section), a forward
or futures contract described in 1.988-1(a) (1)(ii) and (2)(iii), or
combination thereof, which reduces the risk of exchange rate
fluctuations by reference to the taxpayer's functional currency with
respect to nonfunctional currency payments made or received under an
executory contract. The term hedge also includes an option contract
described in 1.988-1(a) (1)(ii) and (2)(iii), but only if the option's
expiration date is on or before the accrual date. The premium paid for
an option that lapses shall be integrated with the executory contract.
(B) Special rule for series of hedges. A series of hedges as defined
in paragraph (b)(3)(iii)(A) of this section shall be considered a hedge
if the executory contract is hedged in whole or in part throughout the
period beginning with the date the hedge is identified in accordance
with paragraph (b)(3)(i) of this section and ending on or after the
accrual date. A taxpayer that enters into a series of hedges will be
deemed to have satisfied the preceding sentence if the hedge that
succeeds a hedge that has been terminated is entered into no later than
the business day following such termination.
(C) Special rules for historical rate rollovers -- (1) Definition. A
historical rate rollover is an extension of the maturity date of a
forward contract where the new forward rate is adjusted on the rollover
date to reflect the taxpayer's gain or loss on the contract as of the
rollover date plus the time value of such gain or loss through the new
maturity date.
(2) Certain historical rate rollovers considered a hedge. A
historical rate rollover is considered a hedge if the rollover date is
before the accrual date.
(3) Treatment of time value component of certain historical rate
rollovers that are hedges. Interest income or expense determined under
1.988-2(d)(2)(v) with respect to a historical rate rollover shall be
considered part of a hedge if the period beginning on the first date a
hedging contract is rolled over and ending on the date payment is made
or received under the executory contract does not exceed 183 days. Such
interest income or expense shall not be recognized and shall be an
adjustment to the income from, or expense of, the services performed or
received under the executory contract, or to the amount realized or
basis of the property sold or purchased under the executory contract.
For the treatment of such interest income or expense that is not
considered part of a hedge, see 1.988-2(d)(2)(v).
(D) Special rules regarding deposits of nonfunctional currency in a
hedging account. A hedging account is an account with a bank or other
financial institution used exclusively for deposits of nonfunctional
currency used to hedge executory contracts. For purposes of determining
the basis of units in such account that comprise the hedge, only those
units in the account as of the accrual date shall be taken into
consideration. A taxpayer may adopt any reasonable convention
(consistently applied to all hedging accounts) to determine which units
comprise the hedge as of the accrual date and the basis of the units as
of such date.
(E) Interest income on deposit of nonfunctional currency in a hedging
account. Interest income on a deposit of nonfunctional currency in a
hedging account may be taken into account for purposes of determining
the amount of a hedge if such interest is accrued on or before the
accrual date. However, such interest income shall be included in income
as provided in section 61. For example, if a taxpayer with the dollar
as its functional currency enters into an executory contract for the
purchase and delivery of a machine in one year for 100 British pounds (
), and on such date deposits 90.91 in a properly identified bank
account that bears interest at the rate of 10%, the interest that
accrues prior to the accrual date shall be included in income and may be
considered a hedge.
(iv) Accrual date. The accrual date is the date when the item of
income or expense (including a capital expenditure) that relates to an
executory contract is required to be accrued under the taxpayer's method
of accounting.
(v) Payment date. The payment date is the date when payment is made
or received with respect to an executory contract or the subsequent
corresponding account payable or receivable.
(3) Identification rules -- (i) Identification by the taxpayer. A
taxpayer must establish a record and before the close of the date the
hedge is entered into, the taxpayer must enter into the record a clear
description of the executory contract and the hedge and indicate that
the transaction is being identified in accordance with paragraph (b)(3)
of this section.
(ii) Identification by the Commissioner. If a taxpayer enters into
an executory contract and a hedge but fails to satisfy one or more of
the requirements of paragraph (b) of this section and, based on the
facts and circumstances, the Commissioner concludes that the executory
contract in substance is hedged, then the Commissioner may apply the
provisions of paragraph (b) of this section as if the taxpayer had
satisfied all of the requirements therein, and may make appropriate
adjustments. The Commissioner may apply the provisions of paragraph (b)
of this section regardless of whether the executory contract and the
hedge are held by the same taxpayer.
(4) Effect of hedged executory contract -- (i) In general. If a
taxpayer enters into a hedged executory contract, amounts paid or
received under the hedge by the taxpayer are treated as paid or received
by the taxpayer under the executory contract, or any subsequent account
payable or receivable, or that portion to which the hedge relates.
Also, the taxpayer recognizes no exchange gain or loss on the hedge. If
an executory contract, on the accrual date, becomes an account payable
or receivable, the taxpayer recognizes no exchange gain or loss on such
payable or receivable for the period covered by the hedge.
(ii) Partially hedged executory contracts. The effect of integrating
an executory contract and a hedge that partially hedges such contract is
to treat the amounts paid or received under the hedge as paid or
received under the portion of the executory contract being hedged, or
any subsequent account payable or receivable. The income or expense of
services performed or received under the executory contract, or the
amount realized or basis of property sold or purchased under the
executory contract, that is attributable to that portion of the
executory contract that is not hedged shall be translated into
functional currency on the accrual date. Exchange gain or loss shall be
realized when payment is made or received with respect to any payable or
receivable arising on the accrual date with respect to such unhedged
amount.
(iii) Disposition of a hedge or executory contract prior to the
accrual date -- (A) In general. If a taxpayer identifies an executory
contract as part of a hedged executory contract as defined in paragraph
(b)(2) of this section, and disposes of (or otherwise terminates) the
executory contract prior to the accrual date, the hedge shall be treated
as sold for its fair market value on the date the executory contract is
disposed of and any gain or loss shall be realized and recognized on
such date. Such gain or loss shall be an adjustment to the amount
received or expended with respect to the disposition or termination, if
any. The spot rate on the date the hedge is treated as sold shall be
used to determine subsequent exchange gain or loss on the hedge. If a
taxpayer identifies a hedge as part of a hedged executory contract as
defined in paragraph (b)(2) of this section, and disposes of the hedge
prior to the accrual date, any gain or loss realized on such disposition
shall not be recognized and shall be an adjustment to the income from,
or expense of, the services performed or received under the executory
contract, or to the amount realized or basis of the property sold or
purchased under the executory contract.
(B) Certain events in a series of hedges treated as a termination of
the hedged executory contract. If the rules of paragraph (b)(2)(iii)(B)
of this section are not satisfied, the hedged executory contract shall
be terminated and the provisions of paragraph (b)(4)(iii)(A) of this
section shall apply to any gain or loss previously realized with respect
to such hedge. Any subsequent hedging contracts entered into to reduce
the risk of exchange rate movements with respect to such executory
contract shall not be considered a hedge as defined in paragraph
(b)(2)(iii) of this section.
(C) Executory contracts between related persons. If an executory
contract is between related persons as defined in sections 267(b) and
707(b), and the taxpayer disposes of the hedge or terminates the
executory contract prior to the accrual date, the Commissioner may
redetermine the timing, source, and character of gain or loss from the
hedge or the executory contract if he determines that a significant
purpose for disposing of the hedge or terminating the executory contract
prior to the accrual date was to affect the timing, source, or character
of income, gain, expense, or loss for Federal income tax purposes.
(iv) Disposition of a hedge on or after the accrual date. If a
taxpayer identifies a hedge as part of a hedged executory contract as
defined in paragraph (b)(2) of this section, and disposes of the hedge
on or after the accrual date, no gain or loss is recognized on the hedge
and the booking date as defined in 1.988-2(c)(2) of the payable or
receivable for purposes of computing exchange gain or loss shall be the
date such hedge is disposed of. See Example 3 of paragraph (b)(4)(iv)
of this section.
(v) Sections 263(g), 1092, and 1256 do not apply. Sections 263(g),
1092, and 1256 do not apply with respect to an executory contract or
hedge which comprise a hedged executory contract as defined in paragraph
(b)(2) of this section. However, sections 263(g), 1092 and 1256 may
apply to the hedged executory contract if such transaction is part of a
straddle.
(vi) Examples. The principles set forth in paragraph (b) of this
section are illustrated in the following examples. The examples assume
that K is an accrual method, calendar year U.S. corporation with the
dollar as its functional currency.
Example 1. (i) On January 1, 1992, K enters into a contract with
JPF, a Swiss machine manufacturer, to pay 500,000 Swiss francs for
delivery of a machine on June 1, 1993. Also on January 1, 1992, K
enters into a foreign currency forward agreement to purchase 500,000
Swiss francs for $250,000 for delivery on June 1, 1993. K properly
identifies the executory contract and the hedge in accordance with
paragraph (b)(3)(i) of this section. On June 1, 1993, K takes delivery
of the 500,000 Swiss francs (in exchange for $250,000) under the forward
contract and makes payment of 500,000 Swiss francs to JPF in exchange
for the machine. Assume that the accrual date is June 1, 1993.
(ii) Under paragraph (b)(1) of this section, the hedge is integrated
with the executory contract. Therefore, K is deemed to have paid
$250,000 for the machine and there is no exchange gain or loss on the
foreign currency forward contract. K's basis in the machine is
$250,000. Section 1256 does not apply to the forward contract.
Example 2. (i) On January 1, 1992, K enters into a contract with S,
a Swiss machine manufacturer, to pay 500,000 Swiss francs for delivery
of a machine on June 1, 1993. Under the contract, K is not obligated to
pay for the machine until September 1, 1993. On February 1, 1992, K
enters into a foreign currency forward agreement to purchase 500,000
Swiss francs for $250,000 for delivery on September 1, 1993. K properly
identifies the executory contract and the hedge in accordance with
paragraph (b)(3) of this section. On June 1, 1993, K takes delivery of
machine. Assume that under K's method of accounting the delivery date
is the accrual date. On September 1, 1993, K takes delivery of the
500,000 Swiss francs (in exchange for $250,000) under the forward
contract and makes payment of 500,000 Swiss francs to S.
(ii) Under paragraph (b)(1) of this section, the hedge is integrated
with the executory contract. Therefore K is deemed to have paid
$250,000 for the machine and there is no exchange gain or loss on the
foreign currency forward contract. Thus K's basis in the machine is
$250,000. In addition, no exchange gain or loss is recognized on the
payable in existence from June 1, 1993, to September 1, 1993. Section
1256 does not apply to the forward contract.
Example 3. The facts are the same as in Example 2 except that K
disposed of the forward contract on August 1, 1993 for $10,000.
Pursuant to paragraph (b)(4)(iv) of this section, K does not recognize
the $10,000 gain. K's basis in the machine is $250,000 (the amount
fixed by the forward contract), regardless of the amount in dollars that
K actually pays to acquire the Sf500,000 when K pays for the machine. K
has a payable with a booking date of August 1, 1993, payable on
September 1, 1993 for 500,000 Swiss francs. Thus, K will realize
exchange gain or loss on the difference between the amount booked on
August 1, 1993 and the amount paid on September 1, 1993 under
1.988-2(c).
Example 4. (i) On January 1, 1992, K enters into a contract with S,
a Swiss machine repair firm, to pay 500,000 Swiss francs for repairs to
be performed on June 1, 1992. Under the contract, K is not obligated to
pay for the repairs until September 1, 1992. On February 1, 1992, K
enters into a foreign currency forward agreement to purchase 500,000
Swiss francs for $250,000 for delivery on August 1, 1992. K properly
identifies the executory contract and the hedge in accordance with
paragraph (b)(3) of this section. On June 1, 1992, S performs the
repair services. Assume that under K's method of accounting this date
is the accrual date. On August 1, 1992, K takes delivery of the 500,000
Swiss francs (in exchange for $250,000) under the forward contract. On
the same day, K deposits the Sf500,000 in a separate account with a bank
and properly identifies the transaction as a continuation of the hedged
executory contract. On September 1, 1992, K makes payment of the
Sf500,000 in the account to S.
(ii) Under paragraph (b)(1) of this section, the hedge is integrated
with the executory contract. Therefore K is deemed to have paid
$250,000 for the services and there is no exchange gain or loss on the
foreign currency forward contract or on the disposition of Sf500,000 in
the account. Any interest on the Swiss francs in the account is
included in income but is not considered part of the hedge (because the
amount paid for the services must be set on or before the accrual date).
In addition, no exchange gain or loss is recognized on the payable in
existence from June 1, 1992, to September 1, 1992. Section 1256 does
not apply to the forward contract.
Example 5. (i) On January 1, 1992, K enters into a contract with S,
a Swiss machine manufacturer, to pay 500,000 Swiss francs for delivery
of a machine on June 1, 1993. Under the contract, K is not obligated to
pay for the machine until September 1, 1993. On February 1, 1992, K
enters into a foreign currency forward agreement to purchase 250,000
Swiss francs for $125,000 for delivery on September 1, 1993. K properly
identifies the executory contract and the hedge in accordance with
paragraph (b)(3) of this section. On June 1, 1993, K takes delivery of
the machine. Assume that under K's method of accounting the delivery
date is the accrual date. Assume further that the exchange rate is Sf1
= $.50 on June 1, 1993. On August 30, 1993, K purchases Sf250,000 for
$135,000. On September 1, 1993, K takes delivery of the 250,000 Swiss
francs (in exchange for $125,000) under the forward contract and makes
payment of 500,000 Swiss francs (the Sf250,000 received under the
contract plus the Sf250,000 purchased on August 30, 1993) to S. Assume
the spot rate on September 1, 1993, is 1 Sf = $.5420 (Sf250,000 equal
$135,500).
(ii) Under paragraph (b)(1) of this section, the partial hedge is
integrated with the executory contract. K is deemed to have paid
$250,000 for the machine ($125,000 on the hedged portion of the
Sf500,000 and $125,000 ($.50, the spot rate on June 1, 1993, times
Sf250,000) on the unhedged portion of the Sf500,000). K's basis in the
machine therefore is $250,000. K recognizes no exchange gain or loss on
the foreign currency forward contract but K will realize exchange gain
of $500 on the disposition of the Sf250,000 purchased on August 30, 1993
under 1.988-2(a). In addition, exchange loss is realized on the
unhedged portion of the payable in existence from June 1, 1993, to
September 1, 1993. Thus, K will realize exchange loss of $10,500
($125,000 booked less $135,500 paid) under 1.988-2(c) on the payable.
Section 1256 does not apply to the forward contract.
Example 6. (i) On January 1, 1990, K enters into a contract with S,
a Swiss steel manufacturer, to buy steel for 1,000,000 Swiss francs (Sf)
for delivery and payment on December 31, 1990. On January 1, 1990, the
spot rate is Sf1 = $.50, the U.S. dollar interest rate is 10% compounded
annually, and the Swiss franc rate is 5% compounded annually. Under K's
method of accounting, the delivery date is the accrual date.
(ii) Assume that on January 1, 1990, K enters into a foreign currency
forward contract to buy Sf1,000,000 for $523,800 for delivery on
December 31, 1990. K properly identifies the executory contract and the
hedge in accordance with paragraph (b)(3) of this section. Pursuant to
paragraph (b)(2)(iii) of this section, the forward contract constitutes
a hedge. Assuming that the requirements of paragraph (b)(2)(i) of this
section are satisfied, the executory contract to buy steel and the
forward contract are integrated under paragraph (b)(1) of this section.
Thus, K is deemed to have paid $523,800 for the steel and will have a
basis in the steel of $523,800. No gain or loss is realized with
respect to the forward contract and section 1256 does not apply to such
contract.
(iii) Assume instead that on January 1, 1990, K enters into a foreign
currency forward contract to buy Sf1,000,000 for $512,200 for delivery
on July 1, 1990. K properly identifies the executory contract and the
hedge in accordance with paragraph (b)(3) of this section. On July 1,
1990, when the spot rate is Sf1 = $.53, K cancels the forward contract
in exchange for $17,800 ($530,000^$512,200). On July 1, 1990, K enters
into a second forward agreement to buy Sf1,000,000 for $542,900 for
delivery on December 31, 1990. K properly identifies the second forward
agreement as a hedge in accordance with paragraph (b)(3) of this
section. Pursuant to paragraph (b)(2)(iii) of this section, the forward
contract entered into on January 1, 1990, and the forward contract
entered into on July 1, 1990, constitute a hedge. Assuming that the
requirements of paragraph (b)(2)(i) of this section are satisfied, the
executory contract to buy steel and the forward agreements are
integrated under paragraph (b)(1) of this section. Thus, K is deemed to
have paid $525,100 for the steel (the forward price in the second
forward agreement of $542,900 less the gain on the first forward
agreement of $17,800) and will have a basis in the steel of $525,100.
No gain is realized with respect to the forward contracts and section
1256 does not apply to such contracts.
(iv) Assume instead that on January 1, 1990, K enters into a foreign
currency forward contract to buy Sf1,000,000 for $512,200 for delivery
on July 1, 1990. K properly identifies the executory contract and the
hedge in accordance with paragraph (b)(3) of this section. On July 1,
1990, when the spot rate is Sf1 = $.53, K enters into a historical rate
rollover of its $17,800 gain ($530,000^$512,200) on the forward
agreement. Thus, K enters into a second foreign currency forward
agreement to buy Sf1,000,000 for $524,210 for delivery on December 31,
1990. (The forward price of $524,210 is the market forward price on
July 1, 1990 for the purchase of Sf1,000,000 for delivery on December
31, 1990 of $542,900 less the $17,800 gain on January 1, 1990 contract
and less the time value of such gain of $890.) K properly identifies the
second forward agreement as a hedge in accordance with paragraph (b)(3)
of this section. On December 31, 1990, when the spot rate is Sf1 =
$.54, K takes delivery of the Sf1,000,000 (in exchange for $524,210) and
purchases the steel for Sf1,000,000. Pursuant to paragraph (b)(2)(iii)
of this section, the forward contract entered into on January 1, 1990,
and the forward contract entered into on July 1, 1990, which
incorporates the rollover of K's gain on the January 1, 1990 contract,
constitute a hedge. Assuming that the requirements of paragraph
(b)(2)(i) of this section are satisfied, the executory contract to buy
steel and the forward agreements are integrated under paragraph (b)(1)
of this section. Because the period from the rollover date to the date
payment is made under the executory contract does not exceed 183 days,
the $890 of interest income is considered part of the hedge and is not
recognized. Thus, K is deemed to have paid $524,210 for the steel and
will have a basis in the steel of $524,210. No gain is realized with
respect to the forward contracts and section 1256 does not apply to such
contracts.
(v) Assume instead that on January 1, 1990, K purchases Sf952,380.95
(the present value of Sf1,000,000 to be paid on December 31, 1990) for
$476,190.48 and on the same day deposits the Swiss francs in a separate
bank account that bears interest at a rate of 5%, compounded annually.
K properly identifies the transaction as a hedged executory contract.
Over the period beginning January 1, 1990, and ending December 31, 1990,
K receives Sf47,619.05 in interest on the account that is included in
income and that has a basis of $25,714.29. (Assume that under
1.988-2(b)(1), K uses the spot rate of Sf1 = $.54 to translate the
interest income). On December 31, 1990, K makes payment of the
Sf1,000,000 principal and accrued interest in the account to S.
Pursuant to paragraph (b)(2)(iii) of this section, the principal in the
bank account and the interest constitute a hedge. Under paragraph
(b)(1) of this section, the hedge is integrated with the executory
contract. Therefore K is deemed to have paid $501,904.77 (the basis of
the principal deposited plus the basis of the interest) for the steel
and there is no exchange gain or loss on the disposition of the
Sf1,000,000. K's basis in the steel therefore is $501,904.77.
(5) References to this paragraph (b). If the rules of this paragraph
(b) are referred to in another paragraph of this section (e.g.,
paragraph (c) of this section), then the rules of this paragraph (b)
shall be applied for purposes of such other paragraph by substituting
terms appropriate for such other paragraph. For example, paragraph
(c)(2) of this section refers to the identification rules of paragraph
(b)(3) of this section. Accordingly, for purposes of paragraph (c)(2),
the rules of paragraph (b)(3) will be applied by substituting the term
''stock or security'' for ''executory contract''.
(c) Hedges of period between trade date and settlement date on
purchase or sale of publicly traded stock or security. If a taxpayer
purchases or sells stocks or securities which are traded on an
established securities market and --
(1) Hedges all or part of such purchase or sale for any part of the
period beginning on the trade date and ending on the settlement date;
and
(2) Identifies the hedge and the underlying stock or securities as an
integrated transaction under the rules of paragraph (b)(3) of this
section;
then any gain or loss on the hedge shall be an adjustment to the
amount realized or the adjusted basis of the stock or securities sold or
purchased (and shall not be taken into account as exchange gain or
loss). The term hedge means a deposit of nonfunctional currency in a
hedging account (within the meaning of paragraph (b)(2)(iii)(D) of this
section), or a forward or futures contract described in 1.988-1(a)
(1)(ii) and (2)(iii), or combination thereof, which reduces the risk of
exchange rate fluctuations for any portion of the period beginning on
the trade date and ending on the settlement date. The provisions of
paragraphs (b)(2)(i) (D) through (G), and (b)(2)(iii) (D) and (E) of
this section shall apply. Sections 263(g), 1092, and 1256 do not apply
with respect to stock or securities and a hedge which are subject to
this paragraph (c).
(d) (Reserved)
(e) Advance rulings regarding net hedging and anticipatory hedging
systems. In his sole discretion, the Commissioner may issue an advance
ruling addressing the income tax consequences of a taxpayer's system of
hedging either its net nonfunctional currency exposure or anticipated
nonfunctional currency exposure. The ruling may address the character,
source, and timing of both the section 988 transaction(s) making up the
hedge and the underlying transactions being hedged. The procedures for
obtaining a ruling shall be governed by such pertinent revenue
procedures and revenue rulings as the Commissioner may provide. The
Commissioner will not issue a ruling regarding hedges of a taxpayer's
investment in a foreign subsidiary.
(f) (Reserved)
(g) General effective date. Except as otherwise provided in this
section, the rules of this section shall apply to qualified hedging
transactions, hedged executory contracts and transactions described in
paragraph (c) of this section entered into on or after September 21,
1989. This section shall apply even if the transaction being hedged
(e.g., the debt instrument) was entered into or acquired prior to such
date. The effective date regarding advance rulings for net and
anticipatory hedging shall be governed by such revenue procedures that
the Commissioner may publish.
(T.D. 8400, 57 FR 9199, Mar. 17, 1992)
26 CFR 1.989(a)-1 Definition of a qualified business unit.
(a) Applicability -- (1) In general. This section provides rules
relating to the definition of the term ''qualified business unit'' (QBU)
within the meaning of section 989.
(2) Effective date. These rules shall apply to taxable years
beginning after December 31, 1986. However, any person may apply on a
consistent basis 1.989(a)-1T (c) of the Temporary Income Tax
Regulations in lieu of 1.989(a)-1 (c) to all taxable years beginning
after December 31, 1986, and on or before February 5, 1990. For the
text of the temporary regulation, see 53 FR 20612 (June 8, 1988).
(b) Definition of a qualified business unit -- (1) In general. A QBU
is any separate and clearly identified unit of a trade or business of a
taxpayer provided that separate books and records are maintained.
(2) Application of the QBU definition -- (i) Persons. A corporation
is QBU. An individual is not a QBU. A partnership, trust, or estate is
a QBU of a partner or beneficiary.
(ii) Activities. Activities of a corporation, partnership, trust,
estate, or individual qualify as a QBU if --
(A) The activities constitute a trade or business; and
(B) A separate set of books and records is maintained with respect to
the activities.
(3) Special rule. Any activity (wherever conducted and regardless of
its frequency) that produces income or loss that is, or is treated as,
effectively connected with the conduct of a trade or business within the
United States shall be treated as a separate QBU, provided the books and
records requirement of paragraph (d)(2) of this section is satisfied.
(c) Trade or business -- The determination as to whether activities
constitute a trade or business is ultimately dependent upon an
examination of all the facts and circumstances. Generally, a trade or
business for purposes of section 989(a) is a specific unified group of
activities that constitutes (or could constitute) an independent
economic enterprise carried on for profit, the expenses related to which
are deductible under section 162 or 212 (other than that part of section
212 dealing with expenses incurred in connection with taxes). To
constitute a trade or business, a group of activities must ordinarily
include every operation which forms a part of, or a step in, a process
by which an enterprise may earn income or profit. Such group of
activities must ordinarily include the collection of income and the
payment of expenses. It is not necessary that the activities carried
out by a QBU constitute a different trade or business from those carried
out by other QBUs of the taxpayer. A vertical, functional, or
geographic division of the same trade or business may be a trade or
business for this purpose provided that the activities otherwise qualify
as trade or business under this paragraph (c). However, activities that
are merely ancillary to a trade or business will not constitute a trade
or business under this paragraph (c). Activities of an individual as an
employee are not considered by themselves to constitute a trade or
business under this paragraph (c).
(d) Separate books and records -- (1) General rule. Except as
provided in paragraph (d)(2) of this section, a separate set of books
and records shall include books of original entry and ledger accounts,
both general and subsidiary, or similar records. For example, in the
case of a taxpayer using the cash receipts and disbursements method of
accounting, the books of original entry include a cash receipts and
disbursements journal where each receipt and each disbursement is
recorded. Similarly, in the case of a taxpayer using an accrual method
of accounting, the books of original entry include a journal to record
sales (accounts receivable) and a journal to record expenses incurred
(accounts payable). In general, a journal represents a chronological
account of all transactions entered into by an entity for an accounting
period. A ledger account, on the other hand, chronicles the impact
during an accounting period of the specific transactions recorded in the
journal for that period upon the various items shown on the entity's
balance sheet (i.e., assets, liabilities, and capital accounts) and
income statement (i.e., revenues and expenses).
(2) Special rule. For purposes of paragraph (b)(3) of this section,
books and records include books and records used to determine income or
loss that is, or is treated as, effectively connected with the conduct
of a trade or business within the United States.
(e) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. Corporation X is a domestic corporation. Corporation X
manufactures widgets in the U.S. for export. Corporation X sells
widgets in the United Kingdom through a branch office in London. The
London office has its own employees and solicits and processes orders.
Corporation X maintains in the U.S. a separate set of books and records
for all transactions conducted by the London office. Corporation X is a
QBU under paragraph (b)(2)(i) of this section because of its corporate
status. The London branch office is a QBU under paragraph (b)(2)(ii) of
this section because (1) the sale of widgets is a trade or business as
defined in paragraph (c) of this section; and (2) a complete and
separate set of books and records (as described in paragraph (d) of this
section) is maintained with respect to its sales operations.
Example 2. A domestic corporation incorporates a wholly-owned
subsidiary in Switzerland. The domestic corporation is a manufacturer
that markets its product abroad primarily through the Swiss subsidiary.
To facilitate sales of the parent's product in Europe, the Swiss
subsidiary has branch offices in France and West Germany that are
responsible for all marketing operations in those countries. Each
branch has its own employees, solicits and processes orders, and
maintains a separate set of books and records. The domestic corporation
and the Swiss subsidiary are both QBUs under paragraph (b)(2)(i) of this
section because of their corporate status. The French and West German
branches are QBUs of the Swiss subsidiary. They satisfy paragraph
(b)(2)(ii) because each constitutes a trade or business (as defined in
paragraph (c) of this section) and because separate sets of books and
records (as described in paragraph (d) of this section) of their
respective operations is maintained. Each branch is considered to have
a trade or business although each is a geographical division of the same
trade or business.
Example 3. W is a domestic corporation that manufactures product X
in the United States for sale worldwide. All of W's sales functions are
conducted exclusively in the United States. W employs individual Q to
work in France. Q's sole function is to act as a courier to deliver
sales documents to customers in France. With respect to Q's activities
in France, a separate set of books and records as described in paragraph
(d) is maintained. Under paragraph (c) of this section, Q's activities
in France do not constitute a QBU since they are merely ancillary to W's
manufacturing and selling business. Q is not considered to have a QBU
because an individual's activities as an employee are not considered to
constitute a trade or business of the individual under paragraph (c).
Example 4. The facts are the same as in example (3) except that the
courier function is the sole activity of a wholly-owned French
subsidiary of W. Under paragraph (b)(2)(i) of this section, the French
subsidiary is considered to be a QBU.
Example 5. A corporation incorporated in the Netherlands is a
subsidiary of a domestic corporation and a holding company for the stock
of one or more subsidiaries incorporated in other countries. The Dutch
corporation's activities are limited to paying its directors and its
administrative expenses, receiving capital contributions from its United
States parent corporation, contributing capital to its subsidiaries,
receiving dividend distributions from its subsidiaries, and distributing
dividends to its domestic parent corporation. Under paragraph (b)(2)(i)
of this section, the Netherlands corporation is considered to be a QBU.
Example 6. Taxpayer A, an individual resident of the United States,
is engaged in a trade or business wholly unrelated to any type of
investment activity. A also maintains a portfolio of foreign
currency-denominated investments through a foreign broker. The broker
is responsible for all activities necessary to the management of A's
investments and maintains books and records as described in paragraph
(d) of this section, with respect to all investment activities of A.
A's investment activities qualify as a QBU under paragraph (b)(2)(ii) of
this section to the extent the activities engaged in by A generate
expenses that are deductible under section 212 (other than that part of
section 212 dealing with expenses incurred in connection with taxes).
Example 7. Taxpayer A, an individual resident of the United States,
is the sole shareholder of foreign corporation (FC) whose activities are
limited to trading in stocks and securities. FC is a QBU under
paragraph (b)(2)(i) of this section.
Example 8. Taxpayer A, an individual resident of the United States,
markets and sells in Spain and in the United States various products
produced by other United States manufacturers. A has an office and
employs a salesman to manage A's activities in Spain, maintains a
separate set of books and records with respect to his activities in
Spain, and is engaged in a trade or business as defined in paragraph (c)
of this section. Therefore, under paragraph (b)(2)(ii) of this section,
the activities of A in Spain are considered to be a QBU.
Example 9. Foreign corporation FX is incorporated in Mexico and is
wholly owned by a domestic corporation. The domestic corporation elects
to treat FX as a domestic corporation under section 1504(d). FX
operates entirely in Mexico and maintains a separate set of books and
records with respect to its activities in Mexico. FX is a QBU under
paragraph (b)(2)(i) of this section. The activities of FX in Mexico
also constitute a QBU under paragraph (b)(2)(ii) of this section.
Example 10. F, a foreign corporation, computes a gain of $100 from
the disposition of a United States real property interest (as defined in
section 897(c)). The gain is taken into account as if F were engaged in
a trade or business in the United States and as if such gain were
effectively connected with such trade or business. F is a QBU under
paragraph (b)(2)(i) of this section because of its corporate status.
F's disposition activity constitutes a separate QBU under paragraph
(b)(3) of this section.
(T.D. 8279, 55 FR 284, Jan. 4, 1990)
26 CFR 1.989(b)-1 Definition of weighted average exchange rate.
For purposes of section 989(b) (3) and (4), the term ''weighted
average exchange rate'' means the simple average of the daily exchange
rates (determined by reference to a qualified source of exchange rates
within the meaning of 1.964-1(d)(5)), excluding weekends, holidays and
any other nonbusiness days for the taxable year.
(T.D. 8263, 54 FR 38664, Sept. 20, 1989. Redesignated by T.D. 8367,
56 FR 48437, Nov. 15, 1991; 57 FR 6060, Feb. 18, 1992)
26 CFR 1.989(c)-1 Transition rules for certain branches of United
States persons using a net worth method of accounting for taxable years
beginning before January 1, 1987.
(a) Applicability -- (1) In general. This section applies to
qualified business units (QBU) branches of United States persons, whose
functional currency (as defined in section 985 of the Code and
regulations issued thereunder) is other than the United States dollar
(dollar) and that used a net worth method of accounting for their last
taxable year beginning before January 1, 1987. Generally, a net worth
method of accounting is any method of accounting under which the
taxpayer calculates the taxable income of a QBU branch based on the net
change in the dollar value of the QBU branch's equity over the course of
a taxable year, taking into account any remittance made during the year.
QBU branch equity is the excess of QBU branch assets over QBU branch
liabilities. For all taxable years beginning after December 31, 1986,
such QBU branches must use the profit and loss method of accounting as
described in section 987, except to the extent otherwise provided in
regulations under section 985 or any other provision of the Code.
(2) Insolvent QBU branches. A taxpayer may apply the principles of
this section to a QBU branch that used a net worth method of accounting
for its last taxable year beginning before January 1, 1987, whose $E
pool (as defined in paragraph (d)(3)(i) of this section) is negative.
For taxable years beginning on or after October 25, 1991, the principles
of this section shall apply to insolvent QBU branches.
(b) General rules. For the general rules, see 1.987-5(b).
(c) Determining the pool(s) from which a remittance is made. To
determine from which pool(s) a remittance is made, see 1.987-5(c).
(d) Calculation of Section 987 gain or loss -- (1) In general. See
1.987-5(d)(1) for rules to make this calculation.
(2) Step 1 -- Calculate the amount of the functional currency pools.
For calculation of the amount of the functional currency pools, see
1.987-5(d)(2).
(3) Step 2 -- Calculate the dollar basis pools -- (i) Dollar basis of
the EQ pool -- (A) Beginning dollar basis. The beginning dollar basis
of the EQ pool (hereinafter referred to as the $E pool) equals the final
net worth of the QBU branch. Final net worth of the QBU branch equals
the QBU branch's equity value (assets less liabilities) measured in
dollars at the end of the taxpayer's last taxable year beginning before
January 1, 1987, determined on the basis of the QBU branch's books and
records as adjusted according to United States tax principles.
(B) Adjusting the $E pool. For adjustments to be made to the $E
pool, see 1.987-5(d)(3)(i)(B).
(ii) Dollar basis of the post-86 profits pool. To calculate the
dollar basis of the post-86 profits pool, see 1.987-5(d)(3)(ii).
(iii) Dollar basis of the equity pool. To calculate the dollar basis
of the equity pool, see 1.987-5(d)(3)(iii).
(4) Step 3 -- Calculation of the dollar basis of a remittance. To
calculate the dollar basis of the EQ remitted, see 1.987-5(d)(4).
(5) Step 4 -- Calculation of the section 987 gain or loss on a
remittance. To calculate 987 gain or loss determined on a remittance,
see 1.987-5(d)(5).
(e) Functional currency adjusted basis of QBU branch assets acquired
in taxable years beginning before January 1, 1987. To determine the
functional currency adjusted basis of QBU branch assets acquired in
taxable years beginning before January 1, 1987, see 1.987-5(e).
(f) Functional currency amount of QBU branch liabilities acquired in
taxable years beginning before January 1, 1987. To determine the
functional currency amount of QBU branch liabilities acquired in taxable
years beginning before January 1, 1987, see 1.987-5(f).
(T.D. 8367, 56 FR 48437, Sept. 25, 1991)
26 CFR 1.989(c)-1 Domestic International Sales Corporations
26 CFR 1.991-1 Taxation of a domestic international sales corporation.
(a) In general. A corporation which is a DISC for a taxable year is
not subject to any tax imposed by subtitle A of the Code (sections 1
through 1564) for such taxable year, except for the tax imposed by
chapter 5 thereof (sections 1491 through 1494) on certain transfers to
avoid tax. Thus, for example, a corporation which is a DISC for a
taxable year is not subject for such year to the corporate income tax
(section 11), the minimum tax on tax preferences (sections 56 through
58), or the accumulated earnings tax (sections 531 through 537). A DISC
is liable for the payment of all taxes payable by corporations under
other subtitles of the Code, such as, for example, income taxes withheld
at the source and other employment taxes under subtitle C and the
interest equalization tax and other miscellaneous excise taxes imposed
by subtitle D. In addition, a DISC is subject to the provisions of
chapter 3 of subtitle A (including section 1461), relating to
withholding of tax on nonresident aliens and foreign corporations and
tax-free covenant bonds. See 1.992-1 for the definition of the term
''DISC.''
(b) Determination of taxable income -- (1) In general. Although a
DISC is not subject to tax under subtitle A of the Code (other than
chapter 5 thereof), a DISC's taxable income shall be determined for each
taxable year in order to determine, for example, the amount deemed
distributed for that taxable year to its shareholders pursuant to
1.995-2. Except as otherwise provided in the Code and the regulations
thereunder, the taxable income of a DISC shall be determined in the same
manner as if the DISC were a domestic corporation which had not elected
to be treated as a DISC. Thus, for example, a DISC chooses its method
of depreciation, inventory method, and annual accounting period in the
same manner as if it were a corporation which had not elected to be
treated as a DISC. Any elections affecting the determination of taxable
income shall be made by the DISC. Thus, as a further example, a DISC
which makes an installment sale described in section 453 is able to
avail itself of the benefits of section 453: Provided, The DISC
complies with the election requirements of such section. See
1.995-2(e) and 1.996-8 and the regulations thereunder for rules
relating to the application for a taxable year of a DISC of a deduction
under section 172 for a net operating loss carryback or carryover or of
a capital loss carryback or carryover under section 1212.
(2) Choice of method of accounting. A DISC may, generally, choose
any method of accounting permissible under section 446(c) and the
regulations thereunder. However, if a DISC is a member of a controlled
group (as defined in 1.993-1(k)), the DISC may not choose a method of
accounting which, when applied to transactions between the DISC and
other members of the controlled group, will result in a material
distortion of the income of the DISC or any other member of the
controlled group. Such a material distortion of income would occur, for
example, if a DISC chooses to use the cash method of accounting where
the DISC acts as commission agent in a substantial volume of sales of
property by a related corporation which uses the accrual method of
accounting and which customarily pays commissions to the DISC more than
2 months after such sales. As a further example, a material distortion
of income would occur if a DISC chooses to use the accrual method of
accounting where the DISC leases a substantial amount of property from a
related corporation which uses the cash method of accounting, if the
DISC customarily accrues any portion of the rent on such property more
than 2 months before the rent is paid. Changes in the method of
accounting of a DISC are subject to the requirements of section 446(e)
and the regulations thereunder.
(3) Choice of annual accounting period -- (i) In general. A DISC may
choose its annual accounting period without regard to the annual
accounting period of any of its stockholders. In general, changes in
the annual accounting period of a DISC are subject to the requirements
of section 442 and the regulations thereunder.
(ii) Transition rule for change in taxable year in order to become a
DISC. A corporation may, without the consent of the Commissioner,
change its annual accounting period and adopt a new taxable year
beginning on the first day of any month in 1972: Provided, That --
(a) Such change has the effect of accelerating the time as of which
such corporation can become a DISC,
(b) The Commissioner is notified of such change by means of a
statement filed (with the regional service center with which such
corporation files its election to be treated as a DISC) not later than
the end of the period during which such corporation may file an election
to be treated as a DISC for such new taxable year, and
(c) The short period required to effect such change is not a taxable
year in which such corporation has a net operating loss as defined in
section 172.
Thus, for example, if a corporation which uses the calendar year for
its taxable year does not complete arrangements to become a DISC until
May 15, 1972, such corporation can, pursuant to this subdivision, change
its annual accounting period and adopt a taxable year beginning on the
first day of any month in 1972 after May. A change to a new annual
accounting period made pursuant to this subdivision is effective only if
the corporation which makes such change qualifies as a DISC for such new
period. A corporation may change its annual accounting period and adopt
a new taxable year pursuant to this subdivision without regard to the
provisions of 1.1502-76 (relating to the taxable year of members of a
group). A copy of the statement described in (b) of this subdivision
shall be attached to the return of a corporation for the new taxable
year to which such corporation changes pursuant to this subdivision. A
corporation which changes its annual accounting period pursuant to this
subparagraph will not be permitted under section 442 to change its
annual accounting period at any time before 1982, except with the
consent of the Commissioner as provided in 1.442-1(b)(1) or pursuant to
subparagraph (4) of this paragraph.
(4) Transition rule for change of taxable year of certain DISC's. In
the case of a DISC all of the shares of which are held by a single
shareholder or by members of a group who file a consolidated return,
such DISC may (without the consent of the Commissioner) change its
annual accounting period and adopt a taxable year beginning in 1972
which is the same as the taxable year of such shareholder or the members
of such group. A change to a new annual accounting period may be made
by a DISC pursuant to this subparagraph even if such DISC has changed
its annual accounting period pursuant to subparagraph (3)(ii) of this
paragraph.
(5) Transition rule for beginning of first taxable year of certain
corporations. If a corporation organized before January 1, 1972,
neither acquires assets (other than cash or other property acquired as
consideration for the issuance of stock) nor begins doing business prior
to January 1, 1972, the first taxable year of such corporation is deemed
to begin at the time such corporation acquires any asset (other than
cash or other property acquired as consideration for the issuance of
stock) or begins doing business, whichever is earlier: Provided, That
such corporation is a DISC for such first taxable year. For purposes of
1.6012-2(a), such corporation is treated as not coming into existence
until the beginning of such first taxable year.
(c) Effective date. The provisions of this section and the
regulations under sections 992 through 997 apply with respect to taxable
years ending after December 31, 1971, except that a corporation may not
be a DISC for any taxable year beginning before January 1, 1972.
(d) Related statutes. For rules relating to the transfer, during a
taxable year beginning before January 1, 1976, to a DISC of assets of an
export trade corporation (as defined in section 971), where a parent
owns all the outstanding stock of both such DISC and such export trade
corporation, see section 505(b) of the Revenue Act of 1971 (85 Stat.
551). For rules regarding limitations on the qualification of a
corporation as an export trade corporation for any taxable year
beginning after October 31, 1971, see section 971(a)(3).
(T.D. 7323, 39 FR 34402, Sept. 25, 1974, as amended by T.D. 7854, 47
FR 51738, Nov. 17, 1982)
26 CFR 1.992-1 Requirements of a DISC.
(a) ''DISC'' defined. The term ''DISC'' refers to a domestic
international sales corporation. The term ''DISC'' means a corporation
which, for a taxable year --
(1) Is duly incorporated and existing under the laws of any State or
the District of Columbia,
(2) Satisfies the gross receipts test described in paragraph (b) of
this section,
(3) Satisfies the assets test described in paragraph (c) of this
section,
(4) Satisfies the capitalization requirement described in paragraph
(d) of this section,
(5) Satisfies the requirement that an election to be treated as a
DISC be in effect for such year, as described in paragraph (e) of this
section,
(6) (Reserved)
(7) Maintains separate books and records, and
(8) Is not an ineligible corporation described in paragraph (f) of
this section.
A corporation which satisfies the requirements described in
subparagraphs (1) through (8) of this paragraph for a taxable year is
treated as a separate corporation for Federal tax purposes and qualifies
as a DISC, even though such corporation would not be treated (if it were
not a DISC) as a corporate entity for Federal income tax purposes. An
association cannot qualify as a DISC even if such association is taxable
as a corporation pursuant to section 7701(a)(3). In addition, a
corporation created or organized in, or under the law of, a possession
of the United States cannot qualify as a DISC. The rules contained in
this paragraph constitute a relaxation of the general rules of corporate
substance otherwise applicable under the Code. The separate
incorporation of a DISC is required under section 992(a)(1) to make it
possible to keep a better record of the income which is subject to the
special treatment provided by sections 991 through 996, but this does
not necessitate in all other respects the separate relationships which
otherwise would be required between a parent corporation and its
subsidiary. However, this relaxation of the general rules of corporate
substance does not apply with respect to other corporations in other
contexts. In the case of a transaction between a DISC and a person
related to such DISC for purposes of section 482, see 1.993-1(l) for
rules for determining whether income is income of a DISC to which the
intercompany pricing rules authorized by section 994 apply.
(b) Gross receipts test. In order for a corporation described in
paragraph (a)(1) of this section to be a DISC for a taxable year, 95
percent or more of its gross receipts (as defined in 1.993-6) for such
year must consist of qualified export receipts (as defined in 1.993-1).
Gross receipts for a taxable year are determined in accordance with the
method of accounting adopted by the corporation pursuant to
1.991-1(b)(2). However, for rules regarding gross receipts in the case
of a commission sale by such corporation, see 1.993-6.
(c) Assets test -- (1) In general. In order for a corporation
described in paragraph (a)(1) of this section to be a DISC for a taxable
year, the adjusted basis (determined under section 1011) of its
qualified export assets at the close of such year must equal or exceed
95 percent of the sum of the adjusted bases (determined under section
1011) of all assets of such corporation at the close of such year.
(2) Assets acquired to meet assets test. For purposes of determining
whether the requirements of subparagraph (1) of this paragraph are
satisfied by a corporation at the end of a taxable year, an asset which
is a qualified export asset is treated as not being an asset of such
corporation at such time if such asset is held for a total of 60 days or
less and is acquired directly or indirectly through borrowing, unless
the acquisition of such asset is established to the satisfaction of the
Commissioner or his delegate to have been for bona fide purposes. Such
acquisition is deemed to have been for bona fide purposes if, for
example, it is made in the usual course of the corporation's trade or
business.
(d) Capitalization requirement -- (1) In general. To qualify as a
DISC for a taxable year, a corporation must have, on each day of that
taxable year, only one class of stock. The par value (or, in the case
of stock without par value, the stated value) of the corporation's
outstanding stock must be on each day of the taxable year at least
$2,500. In the case of a corporation which elects to be treated as a
DISC for its first taxable year, the requirements of this paragraph
(d)(1) are satisfied if the corporation has no more than one class of
stock at any time during the year and if the par value (or, in the case
of stock without par value, the stated value) of the corporation's
outstanding stock is at least $2,500 on the last day of the period
within which the election must be made and on each succeeding day of the
year. For purposes of this paragraph (d)(1), the stated value of shares
is the aggregate amount of the consideration paid for such shares which
is not allotted to paid in surplus, or other surplus. The law of the
State of incorporation of the DISC determines what consideration may be
used to capitalize the DISC. A corporation will not be a qualified DISC
unless at least $2,500 of valid consideration was used for this purpose.
If a corporation has a realized or unrealized loss during a taxable
year which results in the impairment of all or part of the capital
required under this paragraph (d)(1), that impairment does not result in
disqualification under this paragraph (d)(1), provided that the
corporation does not take any legal or formal action under State law to
reduce capital for that year below the amount required under this
paragraph (d)(1).
(2) Treatment of debt payable to shareholders -- (i) In general.
Purported debt of a DISC payable to any person, whether or not such
person is a shareholder or a member of a controlled group (as defined in
1.993-1(k)) of which such DISC is a member, is treated as debt for all
purposes of the Code, provided that such purported debt --
(a) Would qualify as debt for purposes of the Code if the DISC were a
corporation which did not qualify as a DISC,
(b) Qualifies under subdivision (ii) of this subparagraph, or
(c) Are trade accounts payable described in subdivision (iii) of this
subparagraph.
Such debt is not treated as stock, and interest payable by the DISC
on such debt is treated as interest by both the DISC and the holder of
such debt. Payment of the principal of such debt by a DISC does not
constitute the payment of a dividend by such DISC. The provisions of
this subparagraph apply for a taxable year of a DISC, even though debt
described in this subparagraph would be treated as stock of the
corporation if such corporation did not qualify as a DISC for such year.
(ii) Safe harbor rule. Purported debt of a DISC will in no event be
treated as other than debt for purposes of subdivision (i) of this
subparagraph if --
(a) It is a written obligation to pay a sum certain on or before a
fixed maturity date,
(b) Interest is payable on such purported debt at an arm's length
interest rate (as determined under 1.482-2(a)(2)), expressed as a fixed
dollar amount or a fixed percentage of principal,
(c) Such purported debt is not convertible into stock or into other
purported debt unless such other purported debt qualifies under this
subparagraph as debt of the DISC,
(d) Such purported debt does not confer voting rights upon its
holder, except in the event of default thereon, and
(e) Interest and principal are paid in accordance with the terms of
such purported debt or with any modification of such terms consistent
with (a) through (d) of this subdivision.
The determination of whether purported debt of a DISC constitutes
debt described in this subdivision is made without regard to the
proportion of debt of the DISC held by any of its shareholders, to the
ratio of the outstanding debt of the DISC to its equity, or to the
amount of outstanding debt of such DISC. The provisions of (e) of this
subdivision do not prevent the modification of the terms of debt of a
DISC where, for example, a DISC becomes unable to make timely payments
of principal required under such terms, provided that such modification
is consistent with (a) through (d) of this subdivision.
(iii) Trade accounts payable. Trade accounts payable of a DISC which
arise in the normal course of its trade or business (such as in
consideration for inventory or supplies) constitute debt of the DISC
(whether or not such accounts payable are debt described in subdivision
(i) (a) or (b) of this subparagraph), provided that such accounts are
payable within 15 months after they arise. If such accounts are payable
more than 15 months after they arise, they are debt of such DISC only if
they are debt described in subdivision (i) (a) or (b) of this
subparagraph.
(iv) Relation of subparagraph to other corporations. The provisions
of this subparagraph generally constitute a relaxation of the ordinary
rules used in determining whether purported debt of a corporation is
debt or equity. This relaxation is in recognition of the principle that
a corporation may qualify as a DISC even though it has relatively little
capital. This relaxation does not apply with respect to purported debt
of other corporations in other contexts. The provisions of subdivisions
(i), (ii), and (iii) of this subparagraph apply only for taxable years
for which a corporation qualifies (or is treated) as a DISC.
(3) Classes of stock. (Reserved)
(e) Election in effect. In order for a corporation to be a DISC for
a taxable year, an election to be treated as a DISC must be made by such
corporation pursuant to 1.992-2 and must be in effect for such taxable
year. A corporation does not become or remain a DISC solely by making
such an election. A corporation is a DISC for a taxable year only if
such an election is in effect for that year and the corporation also
satisfies the requirements of paragraphs (a) through (d) of this
section. See 1.992-2 for rules regarding the time and manner of making
such an election.
(f) Ineligible corporations. The following corporations shall not be
eligible to be treated as a DISC --
(1) A corporation exempt from tax by reason of section 501,
(2) A personal holding company (as defined in section 542),
(3) A financial institution to which section 581 or 593 applies,
(4) An insurance company subject to the tax imposed by subchapter L,
(5) A regulated investment company (as defined in section 851(a)),
(6) A China Trade Act corporation receiving the special deduction
provided in section 941(a), or
(7) An electing small business corporation (as defined in section
1371(b)).
(g) Status as DISC after having filed return as a DISC. Under
section 992(a)(2), notwithstanding the failure of a corporation to meet
the requirements of paragraph (a) of this section for a taxable year,
such corporation will be treated as a DISC for purposes of the Code for
such taxable year (and, thus, will not be able to claim that it is not
eligible to be a DISC) if --
(1) Such corporation files a return as a DISC for such taxable year,
(2) Such corporation does not notify the district director, more than
30 days before the expiration of the period of limitation (including
extensions thereof) on assessment for underpayment of tax for such
taxable year (as determined under section 6501 and the regulations
thereunder), that it is not a DISC for such taxable year, and
(3) The Internal Revenue Service has not issued, within such period
of limitation (including extensions thereof) on assessment for
underpayment of tax for such taxable year, a notice of deficiency based
on a determination that such corporation is not a DISC for such taxable
year.
A corporation is treated as a DISC, for all purposes, pursuant to the
provisions of this paragraph for any taxable year for which it meets the
requirements of this paragraph, even if such corporation is an
ineligible corporation described in paragraph (f) of this section for
such taxable year. Thus, for example, a corporation which is treated as
a DISC for a taxable year pursuant to this paragraph is treated as a
DISC for that taxable year for purposes of 1.992-2(e)(3) (relating to
the termination of a DISC election if a corporation is not a DISC for
each of any 5 consecutive taxable years). If a corporation is treated
as a DISC for a taxable year pursuant to this paragraph, persons who
held stock of such corporation at any time during such taxable year are
treated, with respect to such stock, as holders of stock in a DISC for
the period or periods during which they held such stock within such
taxable year.
(h) Definition of ''former DISC''. Under section 992(a)(3), the term
''former DISC'' refers to a corporation which is not a DISC for a
taxable year but which was (or was treated as) a DISC for a prior
taxable year. However, a corporation is not a former DISC for a taxable
year unless such corporation has, at the beginning of such taxable year,
undistributed previously taxed income (as defined in 1.996-3(c) or
accumulated DISC income (as defined in 1.996-3(b)). A corporation which
is a former DISC for a taxable year is a former DISC for all purposes of
the Code.
(Secs. 385 and 7805 of the Internal Revenue Code of 1954 (83 Stat.
613 and 68A Stat. 917; 26 U.S.C. 385 and 7805))
(T.D. 7323, 39 FR 34403, Sept. 25, 1974, as amended by T.D. 7420, 41
FR 20654, May 20, 1976; 41 FR 22267, June 2, 1976; T.D. 7747, 45 FR
86459, Dec. 31, 1980; T.D. 7920, 48 FR 50712, Nov. 3, 1983; T.D.
8371, 56 FR 55234, Oct. 25, 1991)
26 CFR 1.992-2 Election to be treated as a DISC.
(a) Manner and time of election -- (1) Manner -- (i) In general. A
corporation can elect to be treated as a DISC for a taxable year
beginning after December 31, 1971. Except as provided in paragraph
(a)(1)(ii) of this section, the election is made by the corporation
filing Form 4876 with the service center with which it would file its
income tax return if it were subject for such taxable year to all the
taxes imposed by subtitle A of the Internal Revenue Code of 1954. The
form shall be signed by any person authorized to sign a corporation
return under section 6062, and shall contain the information required by
such form. Except as provided in paragraphs (b)(3) and (c) of this
section, such election to be treated as a DISC shall be valid only if
the consent of every person who is a shareholder of the corporation as
of the beginning of the first taxable year for which such election is
effective is on or attached to such Form 4876 when filed with the
service center.
(ii) Transitional rule for corporations electing during 1972. If the
first taxable year for which an election by a corporation to be treated
as a DISC is a taxable year beginning after December 31, 1971, and on or
before December 31, 1972, such election may be made either in the manner
prescribed in subdivision (i) of this subparagraph or by filing, at the
place prescribed in subdivision (i) of this subparagraph, a statement
captioned ''Election to be Treated as a DISC.'' Such statement of
election shall be valid only if the consent of each shareholder is filed
with the service center in the form, and at the time, prescribed in
paragraph (b) of this section. Such statement shall be signed by any
person authorized to sign a corporation return under section 6062 and
shall include the name, address, and employer identification number (if
known) of the corporation, the beginning date of the first taxable year
for which the election is effective, the number of shares of stock of
the corporation issued and outstanding as of the earlier of the
beginning of the first taxable year for which the election is effective
or the time the statement is filed, the number of shares held by each
shareholder as of the earlier of such dates, and the date and place of
incorporation. As a condition of the election being effective, a
corporation which elects to become a DISC by filing a statement in
accordance with this subdivision must furnish (to the service center
with which the statement was filed) such additional information as is
required by Form 4876 by March 31, 1973.
(2) Time of making election -- (i) In general. In the case of a
corporation making an election to be treated as a DISC for its first
taxable year, such election shall be made within 90 days after the
beginning of such taxable year. In the case of a corporation which
makes an election to be treated as a DISC for any taxable year beginning
after March 31, 1972 (other than the first taxable year of such
corporation), the election shall be made during the 90-day period
immediately preceding the first day of such taxable year.
(ii) Transitional rules for certain corporations electing during
1972. In the case of a corporation which makes an election to be
treated as a DISC for a taxable year beginning after December 31, 1971,
and on or before March 31, 1972 (other than its first taxable year), the
election shall be made within 90 days after the beginning of such
taxable year.
(b) Consent by shareholders -- (1) In general -- (i) Time and manner
of consent. Under paragraph (a)(1)(i) of this section, subject to
certain exceptions, the election to be treated as a DISC is not valid
unless each person who is a shareholder as of the beginning of the first
taxable year for which the election is effective signs either the
statement of consent on Form 4876 or a separate statement of consent
attached to such form. A shareholder's consent is binding on such
shareholder and all transferees of his shares and may not be withdrawn
after a valid election is made by the corporation. In the case of a
corporation which files an election to become a DISC for a taxable year
beginning after December 31, 1972, if a person who is a shareholder as
of the beginning of the first taxable year for which the election is
effective does not consent by signing the statement of consent set forth
on Form 4876, such election shall be valid (except in the case of an
extension of the time for filing granted under the provisions of
subparagraph (3) of this paragraph or paragraph (c) of this section)
only if the consent of such shareholder is attached to the Form 4876
upon which such election is made.
(ii) Form of consent. A consent other than the statement of consent
set forth on Form 4876 shall be in the form of a statement which is
signed by the shareholder and which sets forth (a) the name and address
of the corporation and of the shareholder and (b) the number of shares
held by each such shareholder as of the time the consent is made and (if
the consent is made after the beginning of the corporation's taxable
year for which the election is effective) as of the beginning of such
year. If the consent is made by a recipient of transferred shares
pursuant to paragraph (c) of this section, the statement of consent
shall also set forth the name and address of the person who held such
shares as of the beginning of such taxable year and the number of such
shares. Consent shall be made in the following form: ''I (insert name
of shareholder), a shareholder of (insert name of corporation seeking to
make the election) consent to the election of (insert name of
corporation seeking to make the election) to be treated as a DISC under
section 992(b) of the Internal Revenue Code. The consent so made by me
is irrevocable and is binding upon all transferees of my shares in
(insert name of corporation seeking to make the election).'' The
consents of all shareholders may be incorporated in one statement.
(iii) Who may consent. Where stock of the corporation is owned by a
husband and wife as community property (or the income from such stock is
community property), or is owned by tenants in common, joint tenants, or
tenants by the entirety, each person having a community interest in such
stock or the income therefrom and each tenant in common, joint tenant,
and tenant by the entirety must consent to the election. The consent of
a minor shall be made by his legal guardian or by his natural guardian
if no legal guardian has been appointed. The consent of an estate shall
be made by the executor or administrator thereof. The consent of a
trust shall be made by the trustee thereof. The consent of an estate or
trust having more than one executor, administrator, or trustee, may be
made by any executor, administrator, or trustee, authorized to make a
return of such estate or trust pursuant to section 6012(b)(5). The
consent of a corporation or partnership shall be made by an officer or
partner authorized pursuant to section 6062 or 6063, as the case may be,
to sign the return of such corporation or partnership. In the case of a
foreign person, the consent may be signed by any individual (whether or
not a U.S. person) who would be authorized under sections 6061 through
6063 to sign the return of such foreign person if he were a U.S. person.
(2) Transitional rule for corporations electing during 1972. In the
case of a corporation which files an election to be treated as a DISC
for a taxable year beginning after December 31, 1971, and on or before
December 31, 1972, such election shall be valid only if the consent of
each person who is a shareholder as of the beginning of the first
taxable year for which such election is effective is filed with the
service center with which the election was filed within 90 days after
the first day of such taxable year or within the time granted for an
extension of time for filing such consent. The form of such consent
shall be the same as that prescribed in subparagraph (1) of this
paragraph. Such consent shall be attached to the statement of election
or shall be filed separately (with such service center) with a copy of
the statement of election. An extension of time for filing a consent
may be granted in the manner, and subject to the conditions, described
in subparagraph (3) of this paragraph.
(3) Extension of time to consent. An election which is timely filed
and would be valid except for the failure to attach the consent of any
shareholder to the Form 4876 upon which the election was made or to
comply with the 90-day requirement in subparagraph (2) of this paragraph
or paragraph (c)(1) of this section, as the case may be, will not be
invalid for such reason if it is shown to the satisfaction of the
service center that there was reasonable cause for the failure to file
such consent, and if such shareholder files a proper consent to the
election within such extended period of time as may be granted by the
Internal Revenue Service. In the case of a late filing of a consent, a
copy of the Form 4876 or statement of election shall be attached to such
consent and shall be filed with the same service center as the election.
The form of such consent shall be the same as that set forth in
paragraph (b)(1)(ii) of this section. In no event can any consent be
made pursuant to this paragraph on or after the last day of the first
taxable year for which a corporation elects to be treated as a DISC.
(c) Consent by holder of transferred shares -- (1) In general. If a
shareholder of a corporation transfers --
(i) Prior to the first day of the first taxable year for which such
corporation elects to be treated as a DISC, some or all of the shares
held by him without having consented to such election, or
(ii) On or before the 90th day after the first day of the first
taxable year for which such corporation elects to be treated as a DISC,
some or all of the shares held by him as of the first day of such year
(or if later, held by him as of the time such shares are issued) without
having consented to such election, then consent may be made by any
recipient of such shares on or before the 90th day after the first day
of such first taxable year. If such recipient fails to file his consent
on or before such 90th day, an extension of time for filing such consent
may be granted in the manner, and subject to the conditions, described
in paragraph (b)(3) of this section. In addition, if the transfer
occurs more than 90 days after the first day of such taxable year, an
extension of time for filing such consent may be granted to such
recipient only if it is determined under paragraph (b)(3) of this
section that an extension of time would have been granted the transferor
for the filing of such consent if the transfer had not occurred. A
consent which is not attached to the original Form 4876 or statement of
election (as the case may be) shall be filed with the same service
center as the original Form 4876 or statement of election and shall have
attached a copy of such original form or statement of election. The
form of such consent shall be the same as that set forth in paragraph
(b)(1)(ii) of this section. For the purposes of this paragraph, a
transfer of shares includes any sale, exchange, or other disposition,
including a transfer by gift or at death.
(2) Requirement for the filing of an amended Form 4876 or statement
of election. In any case in which a consent to a corporation's election
to be treated as a DISC is made pursuant to subparagraph (1) of this
paragraph, such corporation must file an amended Form 4876 or statement
of election (as the case may be) reflecting all changes in ownership of
shares. Such form must be filed with the same service center with which
the original Form 4876 or statement of election was filed by such
corporation.
(d) Effect of election -- (1) Effect on corporation. A valid
election to be treated as a DISC remains in effect (without regard to
whether the electing corporation qualifies as a DISC for a particular
year) until terminated by any of the methods provided in paragraph (e)
of this section. While such election is in effect, the electing
corporation is subject to sections 991 through 997 and other provisions
of the Code applicable to DISC's for any taxable year for which it
qualifies as a DISC (or is treated as qualifying as a DISC pursuant to
1.992-1(g)). Such corporation is also subject to such provisions for any
taxable year for which it is treated as a former DISC as a result of
qualifying or being treated as a DISC for any taxable year for which
such election was in effect.
(2) Effect on shareholders. A valid election by a corporation to be
treated as a DISC subjects the shareholders of such corporation to the
provisions of section 995 (relating to the taxation of the shareholders
of a DISC or former DISC) and to all other provisions of the Code
relating to the shareholders of a DISC or former DISC. Such provisions
of the Code apply to any person who is a shareholder of a DISC or former
DISC whether or not such person was a shareholder at the time the
corporation elected to become a DISC.
(e) Termination of election -- (1) In general. An election to be
treated as a DISC is terminated only as provided in subparagraph (2) or
(3) of this paragraph.
(2) Revocation of election -- (i) Manner of revocation. An election
by a corporation to be treated as a DISC may be revoked by the
corporation for any taxable year of the corporation after the first
taxable year for which the election is effective. Such revocation shall
be made by the corporation filing a statement that the corporation
revokes its election under section 992(b) to be treated as a DISC. Such
statement shall indicate the corporation's name, address, employer
identification number, and the first taxable year of the corporation for
which the revocation is to be effective. The statement shall be signed
by any person authorized to sign a corporation return under section
6062. Such revocation shall be filed with the service center with which
the corporation filed its election, except that, if it filed an annual
information return under section 6011(e)(2), the revocation shall be
filed with the service center with which it filed its last such return.
(ii) Years for which revocation is effective. If a corporation files
a statement revoking its election to be treated as a DISC during the
first 90 days of a taxable year (other than the first taxable year for
which such election is effective), such revocation will be effective for
such taxable year and all taxable years thereafter. If the corporation
files a statement revoking its election to be treated as a DISC after
the first 90 days of a taxable year, the revocation will be effective
for all taxable years following such taxable year.
(3) Continued failure to be a DISC. If a corporation which has
elected to be treated as a DISC does not qualify as a DISC (and is not
treated as a DISC pursuant to 1.992-1(g)) for each of any 5 consecutive
taxable years, such election terminates and will not be effective for
any taxable year after such fifth taxable year. Such termination will
be effective automatically, without notice to such corporation or to the
Internal Revenue Service. If, during any 5-year period for which an
election is effective, the corporation should qualify as a DISC (or be
treated as a DISC pursuant to 1.992-1(g)) for a taxable year, a new
5-year period shall automatically start at the beginning of the
following taxable year.
(4) Election after termination. If a corporation has made a valid
election to be treated as a DISC and such election terminates in either
manner described in subparagraph (2) or (3) of this paragraph, such
corporation is eligible to reelect to be treated as a DISC at any time
by following the procedures described in paragraphs (a) through (c) of
this section. If a corporation terminates its election and subsequently
reelects to be treated as a DISC, the corporation and its shareholders
continue to be subject to sections 995 and 996 with respect to the
period during which its first election was in effect. Thus, for
example, distributions upon disqualification includible in the gross
incomes of shareholders of a corporation pursuant to section 995(b)(2)
continue to be so includible for taxable years for which a second
election of such corporation is in effect without regard to the second
election.
(T.D. 7323, 39 FR 34405, Sept. 25, 1974, as amended by T.D. 7420, 41
FR 20655, May 20, 1976)
26 CFR 1.992-3 Deficiency distributions to meet qualification
requirements.
(a) In general. A corporation which meets the requirements described
in 1.992-1 for treatment as a DISC for a taxable year, other than the
95 percent of gross receipts test described in 1.992-1(b) or the
95-percent assets test described in 1.992-1(c), or both tests, may
nevertheless qualify as a DISC for such year by making deficiency
distributions (attributable to its gross receipts other than qualified
export receipts and its assets other than qualified export assets) if
all of the following requirements are satisfied:
(1) The corporation distributes the amount determined under paragraph
(b) of this section as a deficiency distribution. The amount of a
deficiency distribution is determined without regard to the amount by
which the corporation fails to meet either test.
(2) The reasonable cause requirements prescribed in paragraph (c)(1)
of this section are satisfied with respect to both the corporation's
failure to meet either test and its failure to make a deficiency
distribution prior to the time the distribution is made.
(3) The corporation makes such deficiency distribution pro rata to
all its shareholders.
(4) The corporation designates the distribution, at the time of the
distribution, as a deficiency distribution, pursuant to section 992(c),
to meet the qualification requirements to be a DISC. Such designation
shall be in the form of a communication sent at the time of such
distribution to each shareholder and to the service center with which
the corporation has filed or will file its return for the taxable year
to which the distribution relates. A corporation may not retroactively
designate a prior distribution as a deficiency distribution to meet
qualification requirements. Subject to the limitation described in
paragraph (c)(3) of this section, a corporation may make a deficiency
distribution with respect to a taxable year at any time after the close
of such taxable year or, in the case of a deficiency distribution made
on or before September 29, 1975, at any time during or after such
taxable year.
See sections 246(d), 904(f), 995, and 996 for rules regarding the
treatment of a deficiency distribution to meet qualification
requirements by the shareholders and the corporation.
(b) Amount of deficiency distribution -- (1) In general. In order to
meet the requirements of paragraph (a) of this section, the amount of a
deficiency distribution must be, if the corporation fails to meet --
(i) The 95 percent of gross receipts test, the amount determined in
subparagraph (2) of this paragraph,
(ii) The 95-percent assets test, the amount determined in
subparagraph (3) of this paragraph, and
(iii) Both such tests, except as provided in subparagraph (4) of this
paragraph, the sum of the amounts determined in subparagraphs (2) and
(3) of this paragraph.
(2) Computation of deficiency distribution to meet 95 percent of
gross receipts test -- (i) In general. If a corporation fails to meet
the 95 percent of gross receipts test described in 1.992-1(b) for its
taxable year, the amount of the deficiency distribution required by this
subparagraph is an amount equal to the sum of its taxable income (if
any) from each transaction giving rise to gross receipts (as defined in
1.993-6) which are not qualified export receipts (as defined in
1.993-1). A corporation's taxable income from a transaction shall be the
amount of such gross receipts from such transaction reduced only by (a)
its cost of goods sold attributable to such gross receipts, and by (b)
its expenses, losses, and other deductions properly apportioned or
allocated thereto in a manner consistent with the rules set forth in
1.861-8. For purposes of this subdivision, however, any expenses,
losses, or other deductions which cannot definitely be allocated to some
item or class of gross income in such manner shall not reduce such gross
receipts. If the corporation is a commission agent for a principal in a
transaction, the corporation's taxable income is the amount of the
commission from such transaction reduced only by the amounts described
in (b) of this subdivision.
(ii) Example. The provisions of this subparagraph may be illustrated
by the following example:
Example. (a) X and Y are calendar year taxpayers. X, a domestic
manufacturing company, owns all the stock of Y, which seeks to qualify
as a DISC for 1973. During 1973, X manufactures a machine which is
eligible to be export property as defined in 1.993-3. Y is made a
commission agent with respect to exporting such machine. Thereafter,
during 1973 Y is considered to receive gross receipts of $100,000, as
determined under section 993(f), attributable to X's sale of the machine
in a manner which causes the gross receipts to be excluded receipts
pursuant to section 993(a)(2) and, therefore, not qualified export
receipts. Y's total gross receipts for 1973 are $1 million of which
$900,000 (i.e., 90 percent) are qualified export receipts. Therefore, Y
does not satisfy the 95 percent of gross receipts test for 1973 because
less than 95 percent of its gross receipts are qualified export
receipts. Y has $9,000 of expenses properly apportioned or allocated to
its gross income from such sale and $1,000 of other expenses which
cannot definitely be allocated to some item or class of gross income,
determined in a manner consistent with the rules set forth in 1.861-8.
In order to satisfy the 95 percent of gross receipts test for 1973, if
the commission due from X to Y were $15,000, Y must make a deficiency
distribution of $6,000 computed as follows:
(b) If the commission due from X to Y were $9,400, resulting in a net
loss of $600 to Y ($9,400 to $10,000), Y must make a deficiency
distribution of $400 computed as follows:
(c) If the commission due from X to Y were $8,500, Y would not be
required to make a deficiency distribution since, under this
subparagraph, there would be no taxable income attributable to gross
receipts from the sale.
(3) Computation of deficiency distribution to meet 95 percent assets
test -- (i) In general. If a corporation fails to meet the 95 percent
assets test described in 1.992-1(c) for its taxable year, the amount of
the deficiency distribution required by this subparagraph is an amount
equal to the fair market value as of the last day of such taxable year
of the assets which are not qualified export assets held by such
corporation on such last day.
(ii) Asset held for more than 1 year. In the case of a corporation
which holds continuously an asset which is not a qualified export asset
at the close of more than 1 taxable year, it must distribute an amount
equal to its fair market value (or, if greater, the amount determined
under subparagraph (4) of this paragraph) only once if, at the close of
the first such taxable year, such corporation reasonably believed that
such asset was a qualified export asset. This subdivision shall not
apply for any taxable year beginning after the date the corporation
knows (or a reasonable man would have known) that an asset is not a
qualified export asset and in order to qualify for each such year, the
corporation must distribute the fair market value of such asset for each
such year.
(4) Computation in the case of a failure to meet both tests as a
result of a single transaction. If a corporation fails to meet both the
95 percent of gross receipts test and the 95 percent assets test for a
taxable year, and if the corporation holds at the end of such year
assets (other than cash or qualified export assets) which were received
as proceeds of a sale or exchange during such year which resulted in
gross receipts other than qualified export receipts, then the amount of
the deficiency distribution required by this paragraph with respect to
such sale or exchange and assets held is the larger of the amount
required by subparagraph (2) of this paragraph with respect to the sale
or exchange or the amount required by subparagraph (3) of this paragraph
with respect to such assets held. Thus, for example, if a corporation
sells property which is not a qualified export asset for $100, receives
$85 in cash and a note for $15, and derives $25 of taxable income from
the sale as determined under subparagraph (2) of this paragraph, it must
distribute $25. If the provisions of this subparagraph are applied with
respect to assets of a DISC (other than qualified export assets), such
provisions do not apply to any property received as proceeds from a sale
or exchange of such assets.
(c) Reasonable cause for failure -- (1) In general. If for a taxable
year, a corporation has failed to meet the 95 percent of gross receipts
test, the 95 percent assets test, or both tests, such corporation may
satisfy any such test for such year by means of a deficiency
distribution in the amount determined under paragraph (b) of this
section only if the reasonable cause requirements of this subparagraph
are satisfied. Such reasonable cause requirements are satisfied if --
(i) There is reasonable cause (as determined in accordance with
subparagraph (2) of this paragraph) for such corporation's failure to
satisfy such test and to make such distribution prior to the date on
which it was made, the time limit in subparagraph (3) of this paragraph
for making the distribution is satisfied, and interest (if required) is
paid in the amount and in the manner prescribed by subparagraph (4) of
this paragraph, or
(ii) The time and ''70-percent'' requirements of the reasonable cause
test of paragraph (d) of this section are satisfied.
(2) Determination of reasonable cause. In general, whether a
corporation's failure to meet the 95 percent of gross receipts test, the
95 percent assets test, or both tests for a taxable year and its failure
to make a pro rata distribution prior to the date on which it was made
will be considered for reasonable cause where the action or inaction
which resulted in such failure occurred in good faith, such as failure
to meet the 95 percent assets test resulting from blocked currency or
expropriation, or failure to meet either test because of reasonable
uncertainty as to what constitutes a qualified export receipt or a
qualified export asset. For further examples, if a corporation's
reasonable determination of the percentage of its total gross receipts
that are qualified export receipts is subsequently redetermined to be
less than 95 percent as a result of a price adjustment by the Internal
Revenue Service under section 482, or if the corporation has a casualty
loss for which it receives an unanticipated insurance recovery which
causes its qualified export receipts to be less than 95 percent of its
total gross receipts, then the failure to satisfy the 95 percent of
gross receipts test is considered to be due to reasonable cause.
(3) Time limit for deficiency distribution. Except as otherwise
provided in this subparagraph, the time limit prescribed by this
subparagraph for making a deficiency distribution is satisfied if the
amount of the distribution required by paragraph (b) of this section is
made within 90 days from the date of the first written notification to
the corporation by the Internal Revenue Service that it had not
satisfied the 95 percent of gross receipts test or the 95 percent assets
test or both tests, for a taxable year. Upon a showing by the
corporation that an extension of the 90-day time limit is reasonable and
necessary, the Commissioner may grant such extension of such time limit.
In any case in which a corporation contests the decision of the
Internal Revenue Service that such corporation has not met the 95
percent of gross receipts test, the 95 percent assets test, or both
tests, an extension of the 90-day time limit will be allowed until 30
days after the final determination of such contest. The date of the
final determination of such contest shall, for purposes of section
992(c), be established in the manner specified in subdivisions (i)
through (iv) of this subparagraph:
(i) The date of final determination by a decision of the United
States Tax Court is the date upon which such decision becomes final, as
prescribed in section 7481.
(ii) The date of final determination in a case which is contested in
a court (and upon which there is a judgment) other than the Tax Court is
the date upon which the judgment becomes final and will be determined on
the basis of the facts and circumstances of each particular case. For
example, ordinarily a judgment of a United States district court becomes
final upon the expiration of the time allowed for taking an appeal, if
no such appeal is duly taken within such time; and a judgment of the
United States Court of Claims becomes final upon the expiration of the
time allowed for filing a petition for certiorari if no such petition is
duly filed within such time.
(iii) The date of a final determination by a closing agreement, made
under section 7121, is the date such agreement is approved by the
Commissioner.
(iv) A final determination under section 992(c) may be made by an
agreement signed by the district director or director of the service
center with which the corporation files its annual return or by such
other official to which authority to sign has been delegated, and by or
on behalf of the taxpayer. The agreement shall set forth the total
amount of the deficiency distribution to be paid to the shareholders of
the DISC for the taxable year or years. An agreement under this
subdivision shall be sent to the taxpayer at his last known address by
either registered or certified mail. If registered mail is used for
such purpose, the date of registration is considered the date of final
determination; if certified mail is used for such purpose, the date of
postmark on the sender's receipt for such mail is considered the date of
final determination. If the corporation makes a deficiency distribution
before such registration or postmark date but on or after the date the
district director or director of the service center or other official
has signed the agreement, the date of signature by the district director
or director of the service center or other official is considered the
date of final determination. If the corporation makes a deficiency
distribution before the district director or director of the service
center or other official signs the agreement, the date of final
determination is considered to be the date of the making of the
deficiency distribution. During any extension of time the interest
charge provided in subparagraph (4) of this paragraph will continue to
accrue at the rate provided for in such subparagraph.
(4) Payment of interest for delayed distribution -- (i) In general.
If a corporation makes a deficiency distribution after the 15th day of
the ninth month after the close of the taxable year with respect to
which such distribution is made, such distribution will not be deemed to
satisfy the 95 percent of gross receipts test or the 95 percent assets
test for such year unless such corporation pays to the Internal Revenue
Service a charge determined by multiplying (a) an amount equal to 4 1/2
percent of such distribution by (b) the number of its taxable years
which begin (1) after the taxable year with respect to which the
distribution is made and (2) before such distribution is made. Such
charge must be paid, within the 30-day period beginning with the day on
which such distribution is made, to the service center with which the
corporation files its annual information return for its taxable year in
which the distribution is made. For purposes of the Internal Revenue
Code, such charge is considered interest.
(ii) Example. The provisions of subdivision (i) of this subparagraph
may be illustrated by the following example:
Example. X corporation, which uses the calendar year as its taxable
year, meets the 95 percent assets test but fails to meet the 95 percent
of gross receipts test for 1972 and does not by September 15, 1973, make
the deficiency distribution required by reason of its failure to meet
such test. Assume that reasonable cause exists for the corporation's
failure to meet the 95 percent of gross receipts test and failure to
make the required deficiency distribution. If X makes the required
deficiency distribution, in the amount of $10,000, on April 1, 1976, X
must pay on or before April 30, 1976, to the service center with which
it files its annual information return a charge of $1,800, computed as
follows:
(d) Certain distributions deemed for reasonable cause. If a
corporation makes a distribution in the amount required by paragraph (b)
of this section with respect to a taxable year on or before the 15th day
of the ninth month after the close of such year, it will be deemed to
have acted with reasonable cause with respect to its failure to satisfy
the 95 percent of gross receipts test, the 95 percent assets test, or
both tests, for such year and its failure to make such distribution
prior to the date on which the distribution was made if --
(1) At least 70 percent of the gross receipts of such corporation for
such taxable year consist of qualified export receipts, and
(2) The sum of the adjusted bases of the qualified export assets held
by such corporation on the last day of each month of the taxable year
equals or exceeds 70 percent of the sum of the adjusted bases of all
assets held by the corporation on each such day.
(T.D. 7323, 39 FR 34407, Sept. 25, 1974; 39 FR 36009, Oct. 7, 1974,
as amended by T.D. 7420, 41 FR 20655, May 20, 1976; T.D. 7854, 47 FR
51739, Nov. 17, 1982)
26 CFR 1.992-4 Coordination with personal holding company provisions in
case of certain produced film rents.
(a) In general. Section 992(d)(2) provides that a personal holding
company is not eligible to be treated as a DISC. Section 543(a)(5)(B)
provides that, for purposes of section 543, the term ''produced film
rents'' means payments received with respect to an interest in a film
for the use of, or the right to use, such film, but only to the extent
that such interest was acquired before substantial completion of
production of such film. Under section 992(e), if such produced film
rents are included in the ordinary gross income (as defined in section
543(b)(1)) of a qualified subsidiary for a taxable year of such
subsidiary, and such interest was acquired by such subsidiary from its
parent, such interest is deemed (for purposes of the application of
sections 541, 543(b)(1), and 992(d)(2), and 1.992-1(f) for such taxable
year) to have been acquired by such subsidiary at the time such interest
was acquired by such parent. Thus, for example, if a parent acquires an
interest in a film before it is substantially completed, then
substantially completes such film prior to transferring an interest in
such motion picture to a qualified subsidiary, the qualified subsidiary
is considered as having acquired such interest prior to substantial
completion of such motion picture for purposes of determining whether
payments from the rental of such motion picture will be classified as
produced film rents of such subsidiary. The provisions of section
992(e) and this section are not applicable in determining whether
payments received with respect to an interest in a film are included in
the ordinary gross income of a parent or a qualified subsidiary. Thus,
even though a qualified subsidiary is treated pursuant to this section
as having acquired an interest in a film at the time such interest was
acquired by such subsidiary's parent, payments received by such parent
with respect to such interest prior to the transfer of such interest to
such subsidiary are includible in the ordinary gross income of such
parent and not includible in the ordinary gross income of such
subsidiary.
(b) Definitions -- (1) ''Qualified subsidiary''. For purposes of
this section, a corporation is a qualified subsidiary for a taxable year
if --
(i) Such corporation was established for the purpose of becoming a
DISC,
(ii) Such corporation would qualify (or be treated) as a DISC for
such taxable year if it is not a personal holding company, and
(iii) On every day of such taxable year on which shares of such
corporation are outstanding, at least 80 percent of such shares are held
directly by a second corporation.
(2) ''Parent''. For purposes of this section, the term ''parent''
means a second corporation referred to in subparagraph (1)(iii) of this
paragraph.
(T.D. 7323, 39 FR 34409, Sept. 25, 1974)
26 CFR 1.993-1 Definition of qualified export receipts.
(a) In general. For a corporation to qualify as a DISC, at least 95
percent of its gross receipts for a taxable year must consist of
qualified export receipts. Under section 993(a), the term ''qualified
export receipts'' means any of the eight amounts described in paragraphs
(b) through (i) of this section, except to the extent that any of the
eight amounts is an excluded receipt within the meaning of paragraph (j)
of this section. For purposes of this section and 1.993-2 through
1.993-6 --
(1) DISC. All references to a DISC mean a DISC, except when the
context indicates that such term means a corporation in the process of
meeting the conditions necessary for that corporation to become a DISC,
or a corporation being tested as to whether it qualifies as a DISC.
(2) Sale, lease, and license. The term ''sale'' includes an exchange
or other disposition and the term ''lease'' includes a rental or a
sublease. The term ''license'' includes a sublicense. All rules under
this section and 1.993-2 through 1.993-6 applicable to leases of
export property apply in the same manner to licenses of export property.
See 1.993-3(f)(3) for a description of intangible property which
cannot be export property.
(3) Gross receipts. The term ''gross receipts'' is defined by
section 993(f) and 1.993-6.
(4) Qualified export assets. The term ''qualified export assests''
is defined by section 993(b) and 1.993-2.
(5) Export property. The term ''export property'' is defined by
section 993(c) and 1.993-3.
(6) Related person. The term ''related person'' means a person who
is related to another person if either immediately before or after a
transaction --
(i) The relationship between such persons would result in a
disallowance of losses under section 267 (relating to disallowance of
losses, etc., between related taxpayers), or section 707(b) (relating to
losses disallowed, etc., between partners and controlled partnerships),
and the regulations thereunder, or
(ii) Such persons are members of the same controlled group of
corporations, as defined in section 1563(a) (relating to definition of
controlled group of corporations), except that (a) ''more than 50
percent'' shall be substituted for ''at least 80 percent'' each place it
appears in section 1563(a) and the regulations thereunder, and (b) the
provisions of section 1563(b) shall not apply in determining whether
such persons are members of the same controlled group.
(7) Related supplier. The term ''related supplier'' is defined by
1.994-1(a)(3)(ii).
(8) Controlled group. The term ''controlled group'' is defined by
paragraph (k) of this section.
(b) Sales of export property. Qualified export receipts of a DISC
include gross receipts from the sale of export property by such DISC, or
by any principal for whom such DISC acts as a commission agent (whether
or not such principal is a related supplier), pursuant to the terms of a
contract entered into with a purchaser by such DISC or by such principal
at any time or by any other person and assigned to such DISC or such
principal at any time prior to the shipment of such property to the
purchaser. Any agreement, oral or written, which constitutes a contract
at law, satisfies the contractual requirement of this paragraph. Gross
receipts from the sale of export property, whenever received, do not
constitute qualified export receipts unless the seller (or the
corporation acting as commission agent for the seller) is a DISC at the
time of the shipment of such property to the purchaser. For example, if
a corporation which sells export property under the installment method
is not a DISC for the taxable year in which the property is shipped to
the purchaser, gross receipts from such sale do not constitute qualified
export receipts for any taxable year of the corporation.
(c) Leases of export property -- (1) In general. Qualified export
receipts of a DISC include gross receipts from the lease of export
property provided that --
(i) Such property is held by such DISC (or by a principal for whom
such DISC acts as commission agent with respect to the lease) either as
an owner or lessee at the beginning of the term of such lease, and
(ii) Such DISC qualified (or was treated) as a DISC for its taxable
year in which the term of such lease began.
(2) Prepayment of lease receipts. If part or all of the gross
receipts from a lease of property are prepaid, then --
(i) All such prepaid gross receipts are qualified export receipts of
a DISC if it is reasonably expected at the time of such prepayment that
throughout the term of such lease they would be qualified export
receipts if received not as a prepayment; or
(ii) If it is reasonably expected at the time of such prepayment that
throughout the term of such lease they would not be qualified export
receipts if received not as a prepayment, then only those prepaid
receipts, for the taxable years of the DISC for which they would be
qualified export receipts, are qualified export receipts.
Thus, for example, if a lessee makes a prepayment of the first and
last years' rent, and it is reasonably expected that the leased property
will be export property for the first half of the lease period but not
the second half of such period, the amount of the prepayment which
represents the first year's rent will be considered qualified export
receipts if it would otherwise qualify, whereas the amount of the
prepayment which represents the last year's rent will not be considered
qualified export receipts.
(d) Related and subsidiary services -- (1) In general. Qualified
export receipts of a DISC include gross receipts from services furnished
by such DISC which are related and subsidiary to any sale or lease (as
described in paragraph (b) or (c) of this section) of export property by
such DISC or with respect to which such DISC acts as a commission agent,
provided that such DISC derives qualified export receipts from such sale
or lease. Such services may be performed within or without the United
States.
(2) Services furnished by DISC. Services are considered to be
furnished by a DISC for purposes of this paragraph if such services are
provided by --
(i) The person who sold or lease the export property to which such
services are related and subsidiary, provided that the DISC acts as a
commission agent with respect to the sale or lease of such property and
with respect to such services,
(ii) The DISC as principal, or any other person pursuant to a
contract between such person and such DISC, provided the DISC acted as
principal or commission agent with respect to the sale or lease of such
property, or
(iii) A member of the same controlled group as the DISC where the
sale or lease of the export property is made by another member of such
controlled group provided, however, that the DISC act as principal or
commission agent with respect to such sale or lease and as commission
agent with respect to such services.
(3) Related services. A service is related to a sale or lease of
export property if --
(i) Such service is of the type customarily and usually furnished
with the type of transaction in the trade or business in which such sale
or lease arose and
(ii) The contract to furnish such service --
(a) Is expressly provided for in or is provided for by implied
warranty under the contract of sale or lease,
(b) Is entered into on or before the date which is 2 years after the
date on which the contract under which such sale or lease was entered
into, provided that the person described in subparagraph (2) of this
paragraph which is to furnish such service delivers to the purchaser or
lessor a written offer or option to furnish such services on or before
the date on which the first shipment of goods with respect to which the
service is to be performed is delivered, or
(c) Is a renewal of the services contract described in (a) or (b) of
this subdivision. Services which may be related to a sale or lease of
export property include but are not limited to warranty service,
maintenance service, repair service, and installation service.
Transportation (including insurance related to such transportation) may
be related to a sale or lease of export property, provided that the cost
of such transportation is included in the sale price or rental of the
property or, if such cost is separately stated, is paid by the DISC (or
its principal) which sold or leased the property to the person
furnishing the transportation service. Financing or the obtaining of
financing for a sale or lease is not a related service for purposes of
this paragraph.
(4) Subsidiary services -- (i) In general. Services related to a
sale or lease of export property are subsidiary to such sale or lease
only if it is reasonably expected at the time of such sale or lease that
the gross receipts from all related services furnished by the DISC (as
defined in subparagraphs (2) and (3) of this paragraph) will not exceed
50 percent of the sum of (a) the gross receipts from such sale or lease
and (b) the gross receipts from related services furnished by the DISC
(as described in subparagraph (2) of this paragraph). In the case of a
sale, reasonable expectations at the time of the sale are based on the
gross receipts from all related services which may reasonably be
expected to be performed at any time before the end of the 10-year
period following the date of such-sale. In the case of a lease,
reasonable expectations at the time of the lease are based on the gross
receipts from all related services which may reasonably be expected to
be performed at any time before the end of the term of such lease
(determined without regard to renewal options).
(ii) Allocation of gross receipts from services. In determining
whether the services related to a sale or lease of export property are
subsidiary to such sale or lease, the gross receipts to be treated as
derived from the furnishing of services may not be less than the amount
of gross receipts reasonably allocated to such services as determined
under the facts and circumstances of each case without regard to whether
--
(a) Such services are furnished under a separate contract or under
the same contract pursuant to which such sale or lease occurs or
(b) The cost of such services is specified in the contract of sale or
lease.
(iii) Transactions involving more than one item of export property.
If more than one item of export property is sold or leased in a single
transaction pursuant to one contract, the total gross receipts from such
transaction and the total gross receipts from all services related to
such transaction are each taken into account in determining whether such
services are subsidiary to such transaction. However, the provisions of
this subdivision apply only if such items could be included in the same
product line, as determined under 1.994-1(c)(7).
(iv) Renewed service contracts. If under the terms of a contract for
related services, such contract is renewable within 10 years after a
sale of export property, or during the term of a lease of export
property, related services to be performed under the renewed contract
are subsidiary to such sale or lease if it is reasonably expected at the
time of such renewal that the gross receipts from all related services
which have been and which are to be furnished by the DISC (as described
in subparagraph (2) of this paragraph) will not exceed 50 percent of the
sum of (a) the gross receipts from such sale or lease and (b) the gross
receipts from related services furnished by the DISC (as so described).
Reasonable expectations are determined as provided in subdivision (i) of
this subparagraph.
(v) Parts used in services. In a services contract described in
subparagraph (3) of this paragraph provides for the furnishing of parts
in connection with the furnishing of related services, gross receipts
from the furnishing of such parts are not taken into account in
determining whether under this subparagraph the services are subsidiary.
See paragraph (b) or (c) of this section to determine whether the gross
receipts from the furnishing of parts consitute qualified export
receipts. See 1.993-3(c)(2)(iv) and (e)(3) for rules regarding the
treatment of such parts with respect to the manufacture of export
property and the foreign content of such property, respectively.
(5) Relation to leases. If the gross receipts for services which are
related and subsidiary to a lease of property have been prepaid at any
time for all such services which are to be performed before the end of
the term of such lease, then as of the time of the prepayment the rules
in paragraph (c)(2) of this section (relating to prepayment of lease
receipts) will determine whether prepaid services under this subdivision
are qualified export receipts. Thus, for example if it is reasonably
expected that leased property will be export property for the first year
of the term of the lease but will not be export property for the second
year of the term, prepaid gross receipts for related and subsidiary
services to be furnished in the first year may be qualified export
receipts. However, any prepaid gross receipts for such services to be
furnished in the second year cannot be qualified export receipts.
(6) Relation with export property determination. The determination
as to whether gross receipts from the sale or lease of export property
constitute qualified export receipts does not depend upon whether
services connected with such sale or lease are related and subsidiary to
such sale or lease. Thus, for example, assume that a DISC receives
gross receipts of $1,000 from the sale of export property and gross,
receipts of $1,100 from installation and maintenance services which are
to be furnished by such DISC within 10 years after the sale and which
are related to such sale. The $1,100 which the DISC receives for such
services would not be qualified export receipts since the gross receipts
from the services exceed 50 percent of the sum of the gross receipts
from the sale and the gross receipts from the related services furnished
by such DISC. The $1,000 which the DISC receives from the sale of
export property would, however, be a qualified export receipt if the
sale met the requirements of paragraph (b) of this section.
(e) Gains from sales of certain qualified export assets. Qualified
export receipts of a DISC include gross receipts from the sale by such
DISC of any assets (wherever located) which, as of the date of such
sale, are qualified export assets as defined in 1.993-2 even though
such assets are not export property (as defined in 1.993-3). Gross
receipts are derived from the sale of such assets only where such sale
results in recognized gain (see 1.993-6(a)). For purposes of this
paragraph, losses from the sale of such qualified export assets shall
not be taken into account for purposes of determining the DISC's
qualified export receipts.
(f) Dividends. Qualified export receipts of a DISC for a taxable
year include all dividends includible in the gross income of such DISC
for such taxable year with respect to the stock of related foreign
export corporations (as defined in 1.993-5) and all amounts includible
in the gross income of such DISC with respect to such corporations
pursuant to section 951 (relating to amounts included in the gross
income of U.S. shareholders of controlled foreign corporations).
(g) Interest on obligations which are qualified export assets.
Qualified export receipts of a DISC include interest on any obligation
which is a qualified export asset of such DISC, including any amount
includible in gross income as interest (such as, for example, an amount
treated as original issue discount pursuant to section 1232) or as
imputed interest under section 483. Gain from the sale of obligations
described in this paragraph is treated (to the extent such gain is not
treated as interest on such obligations) as qualified export receipts
pursuant to paragraph (e) of this section.
(h) Engineering and architectural services -- (1) In general.
Qualified export receipts of a DISC include gross receipts from
engineering services (as described in subparagraph (5) of this
paragraph) or architectural services (as described in subparagraph (5)
of this paragraph) or architectural services (as described in
subparagraph (6) of this paragraph) furnished by such DISC (as described
in subparagraph (7) of this paragraph) for a construction project (as
defined in subparagraph (8) of this paragraph) located, or proposed for
location, outside the United States. Such services may be performed
within or without the United States.
(2) Services included. Engineering and architectural services
include feasibility studies for a proposed construction project whether
or not such project is ultimately initiated.
(3) Excluded services. Engineering and architectural services do not
include --
(i) Services connected with the exploration for minerals or
(ii) Technical assistance or knowhow.
For purposes of this paragraph, the term ''technical assistance or
knowhow'' includes activities or programs designed to enable business,
commerce, industrial establishments, and governmental organizations to
acquire or use scientific, architectural, or engineering information.
(4) Other services. Receipts from the performance of construction
activities other than engineering and architectural services constitute
qualified export receipts to the extent that such activities are related
and subsidiary services (within the meaning of paragraph (d) of this
section) with respect to a sale or lease of export property.
(5) Engineering services. For purposes of this paragraph,
engineering services in connection with any construction project (within
the meaning of subparagraph (8) of this paragraph) include any
professional services requiring engineering education, training, and
experience and the application of special knowledge of the mathematical,
physical, or engineering sciences to such professional services as
consultation, investigation, evaluation, planning, design, or
responsible supervision of construction for the purpose of assuring
compliance with plans, specifications, and design.
(6) Architectural services. For purposes of this paragraph,
architectural services include the offering or furnishing of any
professional services such as consultation, planning, aesthetic, and
structural design, drawings and specifications, or responsible
supervision of construction (for the purpose of assuring compliance with
plans, specifications, and design) or erection, in connection with any
construction project (within the meaning of subparagraph (8) of this
paragraph).
(7) Definition of ''furnished by such DISC''. For purposes of this
paragraph, architectural and engineering services are considered
furnished by a DISC if such services are provided --
(i) By the DISC,
(ii) By another person (whether or not a United States person)
pursuant to a contract entered into by such person with the DISC at any
time prior to the furnishing of such services, provided that the DISC
acts as principal with respect to the furnishing of such services, or
(iii) By another person (whether or not a United States person)
pursuant to a contract for the furnishing of such services entered into
at any time prior to the furnishing of such services provided that the
DISC acts as commission agent with respect to such services.
(8) Definition of ''construction project''. For purposes of this
paragraph, the term ''construction project'' includes the erection,
expansion, or repair (but not including minor remodeling or minor
repairs) of new or existing buildings or other physical facilities
including, for example, roads, dams, canals, bridges, tunnels, railroad,
tracks, and pipelines. The term also includes site grading and
improvement and installation of equipment necessary for the
construction. Gross receipts from the sale or lease of construction
equipment are not qualified export receipts unless such equipment is
export property (as defined in 1.993-3).
(i) Managerial services -- (1) In general. Qualified export receipts
of a first DISC for its taxable year include gross receipts from the
furnishing of managerial services provided for another DISC, which is
not a related person, to aid such unrelated DISC in deriving qualified
export receipts, provided that at least 50 percent of the gross receipts
of the first DISC for such year consists of qualified export receipts
derived from the sale or lease of export property and the furnishing of
related and subsidiary services, as described in paragraph (b), (c), and
(d) of this section, respectively.
For purposes of this paragraph, managerial services are considered
furnished by a DISC if such services are provided --
(i) By the first DISC,
(ii) By another person (whether or not a United States person)
pursuant to a contract entered into by such person with the first DISC
at any time prior to the furnishing of such services, provided that the
first DISC acts as principal with respect to the furnishing of such
services, or
(iii) By another person (whether or not a United States person)
pursuant to a contract for the furnishing of such services entered into
at any time prior to the furnishing of such services provided that the
DISC acts as commission agent with respect to such services.
(2) Definition of ''managerial services.'' The term ''managerial
services'' as used in this paragraph means activities relating to the
operation of another unrelated DISC which derives qualified export
receipts from the sale or lease of export property and from the
furnishing of services related and subsidiary to such sales or leases.
Such term includes staffing and operational services necessary to
operate such other DISC, but does not include legal, accounting,
scientific, or technical services. Examples of managerial services are:
(i) Export market studies, (ii) making shipping arrangements, and (iii)
contracting potential foreign purchasers.
(3) Status of recipient of managerial services -- (i) In general.
Qualified export receipts of a first DISC include receipts from the
furnishing of managerial services during any taxable year of a recipient
if such recipient qualifies as a DISC (within the meaning of 1.992-1(a)
for such taxable year.
(ii) Recipient deemed to qualify as a DISC. For purposes of
subdivision (i) of this subparagraph, a recipient is deemed to qualify
as a DISC for its taxable year if the first DISC obtains from such
recipient a copy of such recipient's election to be treated as a DISC as
described in 1.992-2(a) together with such recipient's sworn statement
that such election has been filed with the Internal Revenue Service
Center. The recipient may mark out the names of its shareholders on a
copy of its election to be treated as a DISC before submitting it to the
first DISC. The copy of the election and the sworn statement of such
recipient must be received by the first DISC within 6 months after the
beginning of the first taxable year of the recipient during which such
first DISC furnishes managerial services for such recipient. The copy
of the election and the sworn statement of the recipient need not be
obtained by the first DISC for subsequent taxable years of the
recipient.
(iii) Recipient not treated as a DISC. For purposes of subdivision
(i) of this subparagraph, a recipient of managerial services is not
treated as a DISC with respect to such services performed during a
taxable year for which such recipient does not qualify as a DISC if the
DISC performing such services does not believe or if a reasonable person
would not believe (taking into account the furnishing DISC's managerial
relationship with such recipient DISC) at the beginning of such taxable
year that the recipient will qualify as a DISC for such taxable year.
(j) Excluded receipts -- (1) In general. Notwithstanding the
provisions of paragraphs (b) through (i) of this section, qualified
export receipts of a DISC do not include any of the five amounts
described in subparagraphs (2) through (6) of this paragraph.
(2) Sales and leases of property for ultimate use in the United
States. Property which is sold or leased for ultimate use in the United
States does not constitute export property. See 1.993-3(d)(4)
(relating to determination of where the ultimate use of the property
occurs). Thus, qualified export receipts of a DISC described in
paragraph (b) or (c) of this section do not include gross receipts of
the DISC from the sale or lease of such property.
(3) Sales of export property accomplished by subsidy. Qualified
export receipts of a DISC do not include gross receipts described in
paragraph (b) of this section if the sale of export property (whether or
not such property consists of agricultural products) is pursuant to any
of the following:
(i) The development loan program, or grants under the technical
cooperation and development grants program of the Agency for
International Development, or grants under the military assistance
program administered by the Department of Defense, pursuant to the
Foreign Assistance Act of 1961, as amended (22 U.S.C. 2151), unless the
DISC shows to the satisfaction of the district director that, under the
conditions existing at the time of the sale, the purchaser had a
reasonable opportunity to purchase, on competitive terms and from a
seller who was not a U.S. person, goods which were substantially
identical to such property and which were not manufactured, produced,
grown, or extracted (as described in 1.993-3(c)) in the United States,
(ii) The Pub. L. 480 program authorized under Title I of the
Agricultural Trade Development and Assistance Act of 1954, as amended (7
U.S.C. 1691, 1701-1710),
(iii) For taxable years ending before January 1, 1974, the Barter
program of the Commodity Credit Corporation authorized by section 4(h)
of the Commodity Credit Corporation Charter Act, as amended (15 U.S.C.
714b(h)), and section 303 of the Agricultural Trade Development and
Assistance Act of 1954, as amended (7 U.S.C. 1692) but only if the
taxpayer treats such sales as sales giving rise to excluded receipts,
(iv) The Export Payment program of the Commodity Credit Corporation
authorized by sections 5(d) and (f) of the Commodity Credit Corporation
Charter Act, as amended (15 U.S.C. 714c (d) and (f)),
(v) The section 32 export payment programs authorized by section 32
of the Act of August 24, 1935, as amended (7 U.S.C. 612c), and
(vi) For taxable years beginning after November 3, 1972, the Export
Sales program of the Commodity Credit Corporation authorized by sections
5 (d) and (f) of the Commodity Credit Corporation Charter Act, as
amended (15 U.S.C. 714c (d) and (f)), other than the GSM-4 program
provided under 7 CFR part 1488, and section 407 of the Agricultural Act
of 1949, as amended (7 U.S.C. 1427), for the purpose of disposing of
surplus agricultural commodities and exporting or causing to be exported
agricultural commodities, except that for taxable years beginning on or
before November 3, 1972, the taxpayer may treat such sales as sales
giving rise to excluded receipts.
(4) Sales or lease of export property and furnishing of engineering
or architectural services for use by the United States -- (i) In
general. Qualified export receipts of a DISC do not include gross
receipts described in paragraph (b), (c), or (h) of this section if a
sale or lease of export property, or the furnishing of engineering or
architectural services, is for use by the United States or an
instrumentality thereof in any case in which any law or regulation
requires in any manner the purchase or lease of property manufactured,
produced, grown, or extracted in the United States or requires the use
of engineering or architectural services performed by a U.S. person. For
example, a sale by a DISC of export property to the Department of
Defense for use outside the United States would not produce qualified
export receipts for such DISC if the Department of Defense purchased
such property from appropriated funds subject to any provisions of the
Armed Services Procurement Regulations (32 CFR subchapter A, part 6,
subpart A) or any appropriations act for the Department of Defense for
the applicable year which restricts the availability of such
appropriated funds to the procurement of items which are grown,
reprocessed, reused, or produced in the United States.
(ii) Direct or indirect sales or leases. Any sale or lease of export
property is for use by the United States or an instrumentality thereof
is such property is sold or leased by a DISC (or by a principal for whom
such DISC acts as commission agent) to --
(a) A person who is a related person with respect to such DISC or
such principal and who sells or leases such property for use by the
United States or an instrumentality thereof or
(b) A person who is not a related person with repect to such DISC or
such principal if, at the time af such sale or lease, there is an
agreement or understanding that such property will be sold or leased for
use by the United States or an instrumentality thereof (or if a
reasonable person would have known at the time of such sale or lease
that such property would be sold or leased for use by the United States
or an instrumentality thereof) within 3 years after such sale or lease.
(iii) Excluded programs. The provisions of subdivisions (i) and (ii)
of this subparagraph do not apply in the case of a purchase by the
United States or an instrumentality thereof if such purchase is pursuant
to --
(a) The Foreign Military Sales Act, as amended (22 U.S.C. 2751 et
seq.), or a program under which the U.S. Government purchases property
for resale, on commercial terms, to a foreign government or agency or
instrumentality thereof, or
(b) A program (whether bilateral or multilateral) under which sales
to the U.S. Government are open to international competitive bidding.
(5) Services. Qualified export receipts of a DISC do not include
gross receipts described in paragraph (d) of this section (concerning
related and subsidiary services) if the services from which such gross
receipts are derived are related and subsidiary to the sale or lease of
property which results in excluded receipts pursuant to this paragraph.
(6) Receipts within controlled group -- (i) In general. Gross
receipts of a corporation do not constitute qualified export receipts
for any taxable year of such corporation if --
(a) At the time of the sale, lease, or other transaction resulting in
such gross receipts, such corporation and the person from whom such
receipts are directly or indirectly derived (whether or not such
corporation and such person are the same person) are members of the same
controlled group (as defined in paragraph (k) of this section) and
(b) Such corporation and such person each qualifies (or is treated
under section 992(a)(2)) as a DISC for its taxable year in which its
receipts arise.
Thus, for example, assume that R, S, X, and Y are members of the same
controlled group and that X and Y are DISC's. If R sells property to S
and pays X a commission relating to that sale and if S sells the same
property to an unrelated foreign party and pays Y a commission relating
to that sale, the receipts received by X from the sale of such property
by R to S will be considered to be derived from Y, a DISC which is a
member of the same controlled group as X, and thus will not result in
qualified export receipts to X. The receipts received by Y from the
sale to an unrelated foreign party may, however, result in qualified
export receipts to Y. For another example, if R and S both assign the
commissions to X, receipts derived from the sale from R to S will be
considered to be derived from X acting as commission agent for S and
will not result in qualified export receipts to X. Receipts derived by
X from the sale of property by S to an unrelated foreign party, may,
however, constitute qualified export receipts.
(ii) Leased property. See 1.993-3(f)(2) regarding property not
constituting export property in certain cases where such property is
leased to any corporation which is a member of the same controlled group
as the lessor.
(k) Definition of ''controlled group''. For purposes of sections 991
through 996 and the regulations thereunder, the term ''controlled
group'' has the same meaning as is assigned to the term ''controlled
group of corporations'' by section 1563(a), except that (1) the phrase
''more than 50 percent'' is substituted for the phrase ''at least 80
percent'' each place the latter phrase appears in section 1563(a), and
(2) section 1563(b) shall not apply. Thus, for example, a foreign
corporation subject to tax under section 881 may be a member of a
controlled group. Furthermore, two or more corporations (including a
foreign corporation) are members of a controlled group at any time such
corporations meet the requirements of section 1563(a) (as modified by
this paragraph).
(l) DISC's entitlement to income -- (1) Application of section 994.
A corporation which meets the requirements of 1.992-1(a) to be treated
as a DISC for a taxable year is entitled to income, and the intercompany
pricing rules of section 994(a)(1) or (2) apply, in the case of any
transactions described in 1.994-1(b) between such DISC and its related
supplier (as defined in 1.994-1(a)(3)). For purposes of this
subparagraph, such DISC need not have employees or perform any specific
function.
(2) Other transactions. In the case of a transaction to which the
provisions of subparagraph (1) of this paragraph do not apply but from
which a DISC derives gross receipts, the income to which the DISC is
entitled as a result of the transaction is determined pursuant to the
terms of the contract for such transaction and, if applicable, section
482 and the regulations thereunder.
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. P Corporation forms S Corporation as a wholly-owned
subsidiary. S qualifies as a DISC for its taxable year. S has no
employees on its payroll. S is granted a franchise with respect to
specified exports of P. P will sell such exports to S for resale by S.
Such exports are of a type which produce qualified export receipts as
defined in paragraph (b) of this section. P's sales force will solicit
orders in the name of S using S's order forms. S places orders with P
only when S itself has received orders. No inventory is maintained by
S. P makes shipments directly to customers of S. Employees of P will
act for S and billings and collections will be handled by P in the name
of S. Under these facts, the income derived by S for such taxable year
from the purchase and resale of the specified export is treated for
Federal income tax purposes as the income of S, and the amount of income
allocable to S will be determined under section 994 of the Code.
Example 2. P Corporation forms S Corporation as a wholly-owned
subsidiary. S qualifies as a DISC for its taxable year. S has no
employees on its payroll. S is granted a sales franchise with respect
to specified exports of P and will receive commissions with respect to
such exports. Such exports are of a type which will produce gross
receipts for S which are qualified export receipts as defined in
paragraph (b) of this section. P's sales force will solicit orders in
the name of P. Billings and collections are handled directly by P.
Under these facts, the commissions paid to S for such taxable year with
respect to the specified exports shall be treated for Federal income tax
purposes as the income of S, and the amount of income allocable to S is
determined under section 994 of the Code.
(T.D. 7514, 42 FR 55454, Oct. 15, 1977; 42 FR 60910, Nov. 30, 1977;
T.D. 7854, 47 FR 51739, Nov. 17, 1982)
26 CFR 1.993-2 Definition of qualified export assets.
(a) In general. For a corporation to qualify as a DISC, at the close
of its taxable year it must have qualified export assets with adjusted
bases equal to at least 95 percent of the sum of the adjusted bases of
all its assets. An asset which is a qualified export asset under more
than one paragraph of this section shall be taken into account only once
in determining the sum of the adjusted bases of all qualified export
assets. Under section 993(b), the qualified export assets held by a
corporation are --
(1) Export property as defined in 1.993-3 (see paragraph (b) of this
section),
(2) Business assets described in paragraph (c) of this section,
(3) Trade receivables described in paragraph (d) of this section,
(4) Temporary investments to the extent described in paragraph (e) of
this section,
(5) Producer's loans as defined in 1.993-4 (see paragraph (f) of
this section),
(6) Stock or securities (described in paragraph (g) of this section)
of related foreign export corporations as defined in 1.993-5,
(7) Export-Import Bank and other obligations described in paragraph
(h) of this section,
(8) Financing obligations described in paragraph (i) of this section,
and
(9) Funds awaiting investment described in paragraph (j) of this
section.
(b) Export property. In general, export property is certain property
held for sale or lease which meets the requirements of 1.993-3.
(c) Business assets. For purposes of this section, business assets
are assets used by a DISC (other than as a lessor) primarily in
connection with --
(1) The sale, lease, storage, handling, transportation, packaging,
assembly, or servicing of export property, or
(2) The performance of engineering or architectural services
(described in 1.993-1(h)) or managerial services (described in
1.993-1(i)) in furtherance of the production of qualified export
receipts.
Assets used primarily in the manufacture, production, growth, or
extraction (within the meaning of 1.993-3(c)) of property are not
business assets.
(d) Trade receivables -- (1) In general. For purposes of this
section, trade receivables are accounts receivable and evidences of
indebtedness which arise by reason of transactions of such corporation
or of another corporation which is a DISC and which is a member of a
controlled group which includes such corporation described in
subparagraph (A), (B), (C), (D), (G), or (H), of section 993(a)(1) and
which are due the DISC (or, if it acts as an agent, due its principal)
and held by the DISC.
(2) Trade receivables representing commissions. If a DISC acts as
commission agent for a principal in a transaction described in 1.993-1
(b), (c), (d), (e), (h), or (i) which results in qualified export
receipts for the DISC, and if an account receivable or evidence of
indebtedness held by the DISC and representing the commission payable to
the DISC as a result of the transaction arises (and, in the case of an
evidence of indebtedness, designated on its face as representing such
commission), such account receivable or evidence of indebtedness shall
be treated as a trade receiveable. If, however, the principal is a
related supplier (as defined in 1.994-1(a)(3)) with respect to the
DISC, such account receivable or evidence of indebtedness will not be
treated as a trade receivable unless it is payable and paid in a time
and manner which satisfy the requirements of 1.994-1(e) (3) or (5)
(relating to initial payment of transfer price or commission and
procedure for adjustments to transfer price or commission,
respectively), as the case may be. However, see subparagraph (3) of
this paragraph for rules regarding certain accounts receivable
representing commissions payable to a DISC by its related supplier.
(3) Indebtedness arising under 1.994-1(e). An indebtedness arising
under 1.994-1(e)(3)(iii) (relating to initial payment of transfer price
or commission) in favor of a Disc is not a qualified export asset. An
indebtedness arising under 1.994-1(e)(5)(i) (relating to procedure for
adjustments to transfer price or commission) in favor of a DISC is a
trade receivable if it is paid in the time and manner described in
1.994-1(e)(5)(i) and (ii) and if it otherwise satisfies the requirements
of subparagraph (2) of this paragraph. If such an indebtedness is not
paid in the time and manner described in 1.994-1(e)(5) (i) and (ii), it
is not a qualified export asset.
(e) Temporary investments -- (1) In general. For purposes of this
section, temporary investments are money, bank deposits (not including
time deposits of more than 1 year), and other similar temporary
investments to the extent maintained by a DISC as reasonably necessary
to meet its requirements for working capital. For purposes of this
paragraph, a temporary investment is an obligation, including an
evidence of indebtedness as defined in paragraph (d)(1) of this section,
which is a demand obligation or has a period remaining to maturity of
not more than 1 year at the date it is acquired by the DISC. A
temporary investment does not include trade receivables.
(2) Determination of amount of working capital maintained. For
purposes of this paragraph --
(i) The working capital of a DISC is the excess of its current assets
over current liabilities.
(ii) Current assets are cash and other assets (other than trade
receivables) which may reasonably be expected to be converted into cash
or sold or consumed during the current normal operating cycle of the
DISC's trade or business.
(iii) Current liabilities are obligations (or portions of
obligations) due within the current normal operating cycle of the trade
or business of the DISC whose satisfaction when due is reasonably
expected to require the use of current assets.
(iv) Generally accepted financial accounting treatments will be
accepted, and
(v) Current assets (other than temporary investments) are taken into
account before temporary investments, and trade receivables are never
taken into account, in determining whether such temporary investments
are maintained by the DISC as reasonably necessary to meet his current
liabilities and its requirements for working capital.
(3) Determination of amount of working capital reasonably required.
For purposes of this paragraph, a determination of the amount of money,
bank deposits, and other similar temporary investments reasonably
necessary to meet the requirements of the DISC for working capital will
depend upon the nature and volume of the activities of the DISC existing
at the end of the DISC's taxable year for which such determination is
made, such as, for example --
(i) In the case of a DISC which purchases and sells inventory, the
amount of working capital reasonably required is limited to an amount
reasonably necessary to meet the ordinary operating expenses during the
current normal operating cycle of the trade or business of the DISC, an
amount reasonably needed to meet specific and definite plans for
expansion and any amounts necessary for reasonably anticipated
extraordinary business expenses.
(ii) In the case of a DISC which actively conducts a trade or
business (including the employment of a sales force) and receives
commissions in respect of goods to which such DISC does not have title,
the amount of working capital required will depend upon the nature and
volume of the activities of the DISC which produce such income as they
exist on the applicable determination date. In determining the amount
of working capital which is reasonably required for the production of
such income, the anticipated future needs of the business will be taken
into account to the extent that such needs relate to the year of the
DISC following the applicable determination date. Anticipated future
needs relating to a later period will not be taken into account unless
it is clearly established that such needs are reasonably related to the
production of such income as of the applicable determination date.
(iii) In the case of a DISC which does not actively conduct a trade
or business, and which receives commissions solely by reason of section
994(a)(1), (a)(2), or (b) with respect to goods to which such DISC does
not have title, no working capital would be required beyond a de minimis
amount unless it appears from the facts and circumstances that
additional working capital will be required.
(iv) In the case of a DISC deriving income from the leasing of
property, the amount of working capital required will be determined on
the basis of the facts and circumstances in such case.
(4) Relationship of working capital to other qualified export assets.
If a temporary investment is a qualified export asset under any
provision of this section (other than this paragraph), this paragraph
shall not affect its status as a qualified export asset. However, any
such temporary investment is taken into account before other temporary
investments in determining whether such other temporary investments are
maintained by a DISC as reasonably necessary to meet its requirements
for working capital. Current assets (other than temporary investments)
are taken into account before temporary investments, and trade
receivables are never taken into account, in determining whether such
temporary investments are maintained by the DISC as reasonably necessary
requirements for working capital. An obligation issued or incurred by a
member of a controlled group (as defined in 1.993-1(k)) of which the
DISC is a member is not a qualified export asset under this paragraph.
For rules regarding working capital as of the end of each month of a
taxable year for purposes of the 70-percent reasonableness standard with
respect to certain deficiency distributions, see paragraph (j)(3) of
this section.
(f) Producer's loans. For purposes of this section, a producer's
loan is an evidence of indebtedness arising in connection with
producer's loans which are made by a DISC and which meet the
requirements of 1.993-4. If a producer's loan is a qualified export
asset, interest accrued with respect to the producer's loan will also be
treated as a qualified export asset provided that payment is made in the
form of money, property (valued at its fair market value on its date of
transfer and including accounts receivable for sales by or through a
DISC), a written obligation which qualifies as a debt under the safe
harbor rule of 1.992-1(d)(2)(ii), or an accounting entry offsetting the
account receivable against an existing debt owed by the person in whose
favor the account receivable was established to the person with whom it
engaged in the transaction and that payment is made no later than 60
days following the close of the taxable year of accrual of the interest.
This paragraph (f) is effective for taxable years beginning after
January 10, 1985 except that the taxpayer may at its option apply the
provisions of this paragraph to taxable years ending after December 31,
1971.
(g) Stock or securities of related foreign corporations. For
purposes of this section, the term ''stock or securities'', with respect
to a related foreign export corporation (as defined in 1.993-5), has
the same meaning as such term has as used in section 351 (relating to
transfers to controlled corporations), except that the term
''securities'' does not include obligations which are repaid, in whole
or in part, at any time during the taxable year of the DISC following
the taxable year of the DISC during which such obligations were acquired
by the DISC or were issued, unless the DISC demonstrates to the
satisfaction of the district director that the repayment was for bona
fide business purposes and not for the purpose of avoidance of Federal
income taxes.
(h) Export-Import Bank obligations. For purposes of this section,
the term ''Export-Import Bank obligations'' means obligations issued,
guaranteed, insured, or reinsured (in whole or in part) by the
Export-Import Bank of the United States or by the Foreign Credit
Insurance Association, but only if such obligations are acquired by the
DISC --
(1) From the Export-Import Bank of the United States,
(2) From the Foreign Credit Insurance Association, or
(3) From the person selling or purchasing the goods or services by
reason of which such obligations arose, or from any corporation which is
a member of the same controlled group (as defined in 1.993-1(k)) as
such person.
For purposes of this paragraph, obligations issued by a person
described in subparagraphs (1), (2), and (3) of this paragraph are
treated as acquired from such person by the DISC if acquired from any
person not more than 90 days after the date of original issue (as
defined in 1.1232-3(b)(3)). Examples of specific types of Export-Import
Bank obligations include debentures issued by such bank and certificates
of loan participation.
(i) Financing obligations. For purposes of this section, financing
obligations are obligations (held by a DISC) of a domestic corporation
organized solely for the purpose of financing sales of export property
pursuant to an agreement with the Export-Import Bank of the United
States under which such corporation makes export loans guaranteed by
such Bank.
(j) Funds awaiting investment -- (1) In general. For purposes of
this section, subject to the limitation descibed in subparagraph (2) of
this paragraph, if, at the close of a DISC's taxable year, the sum of
the DISC's money, bank deposits, and other similar temporary investments
is determined under paragraph (e) of this section to exceed an amount
reasonably necessary to meet the DISC's requirements for working
capital, the amount of the DISC's bank deposits in the United States to
the extent of the amount of this excess are funds awaiting investment at
the close of such taxable year.
(2) Limitation. Bank deposits described in subparagraph (1) of this
paragraph are funds awaiting investment only if, by the last day of each
of the sixth, seventh, and eighth months after the close of such taxable
year, the sum of the adjusted bases of the qualified export assets of
the DISC (other than such bank deposits) equals or exceeds 95 percent of
the sum of the adjusted bases of all assets of the DISC (including such
bank deposits) it held on the last day of such taxable year. For
purposes of this subparagraph, the adjusted bases of assets of a DISC
are determined as of the end of each of the months referred to in this
subparagraph. Funds awaiting investment as described in this paragraph
need not be traceable to any of the qualified export assets held by the
DISC at the end of any of the months referred to in this subparagraph.
(3) Coordination with certain deficiency distribution provisions.
Under section 992(c)(3) and 1.992-3(d) a deficiency distribution made
on or before the 15th day of the ninth month after the end of a
corporation's taxable year is deemed to be for reasonable cause if
certain requirements are met, including the requirement (described in
section 992(c)(3)(B) and 1.992-3(d)(2)) that the sum of the adjusted
bases of the qualified export assets held by the corporation on the last
day of each month of such year equals or exceeds 70 percent of the sum
of the adjusted bases of all assets held by the corporation on each such
last day. If, on any such last day, the sum or a DISC's money, bank
deposits, and other similar temporary investments is determined under
paragraph (e) of this section to exceed an amount reasonably necessary
to meet the DISC's requirements for working capital, the amount of the
DISC's bank deposits to the extent of the amount of this excess are
funds awaiting investment on such last day, if either --
(i) The requirements of subparagraph (2) of this paragraph are
satisfied with respect to the taxable year of the DISC which includes
such month or
(ii) At the close of such taxable year the sum of the DISC's money,
bank deposits, and other similar temporary investments is determined
under paragraph (e) of this section not to exceed an amount reasonably
necessary to meet the DISC's requirements for working capital.
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal
Revenue Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10);
90 Stat. 1659, 26 U.S.C. 995(g); and 68A Stat 917, 26 U.S.C. 7805))
(T.D. 7514, 42 FR 55459, Oct. 17, 1977; 42 FR 60910, Nov. 30, 1977;
T.D. 7854, 47 FR 51740, Nov. 17, 1982, as amended by T.D. 7984, 49 FR
40018, Oct. 12, 1984)
26 CFR 1.993-3 Definition of export property.
(a) General rule. Under section 993(c), except as otherwise provided
with respect to excluded property in paragraph (f) of this section and
with respect to certain short supply property in paragraph (i) of this
section, export property is property in the hands of any person (whether
or not a DISC) --
(1) Manufactured, produced, grown, or extracted in the United States
by any person or persons other than a DISC (see paragraph (c) of this
section),
(2) Held primarily for sale or lease in the ordinary course of a
trade or business to any person for direct use, consumption, or
disposition outside the United States (see paragraph (d) of this
section),
(3) Not more than 50 percent of the fair market value of which is
attributable to articles imported into the United States (see paragraph
(e) of this section), and
(4) Which is not sold or leased by a DISC, or with a DISC as
commission agent, to another DISC which is a member of the same
controlled group (as defined in 1.993-1(k)) as the DISC.
(b) Services. For purposes of this section, services (including the
written communication of services in any form) are not export property.
Whether an item is property or services shall be determined on the basis
of the facts and circumstances attending the development and disposition
of the item. Thus, for example, the preparation of a map of a
particular construction site would constitute services and not export
property, but standard maps prepared for sale to customers generally
would not constitute services and would be export property if the
requirements of this section were otherwise met.
(c) Manufacture, production, growth, or extraction of property -- (1)
By a person other than a DISC. Export property may be manufactured,
produced, grown, or extracted in the United States by any person,
provided that such person does not qualify (and is not treated) as a
DISC. Property held by a DISC which was manufactured, produced, grown,
or extracted by it at a time when it did not qualify (and was not
treated) as a DISC is not export property of the DISC. Property which
sustains further manufacture or production outside the United States
prior to sale or lease by a person but after manufacture or production
in the United States will not be considered as manufactured, produced,
grown, or extracted in the United States by such person.
(2) Manufactured or produced -- (i) In general. For purposes of this
section, property which is sold or leased by a person is considered to
be manufactured or produced by such person if such property is
manufactured or produced (within the meaning of either subdivision (ii),
(iii), or (iv) of this subparagraph) by such person or by another person
pursuant to a contract with such person. Except as provided in
subdivision (iv) of this subparagraph, manufacture or production of
property does not include assembly or packaging operations with respect
to property.
(ii) Substantial transformation. Property is manufactured or
produced by a person if such property is substantially transformed by
such person. Examples of substantial transformation of property would
include the conversion of woodpulp to paper, steel rods to screws and
bolts, and the canning of fish.
(iii) Operations generally considered to constitute manufacturing.
Property is manufactured or produced by a person if the operations
performed by such person in connection with such property are
substantial in nature and are generally considered to constitute the
manfacture or production of property.
(iv) Value added to property. Property is manufactured or produced
by a person if with respect to such property conversion costs (direct
labor and factory burden including packaging or assembly) of such person
account for 20 percent of more of --
(a) The cost of goods sold or inventory amount of such person for
such property is such property is sold or held for sale, or
(b) The adjusted basis of such person for such property, as
determined in accordance, with the provisions of section 1011, if such
property is held for lease or leased.
The value of parts provided pursuant to a services contract, as
described in 1.993-1 (d) (4) (v), is not taken into account in applying
this subdivision.
(d) Primary purpose of which property is held -- (1) In general --
(i) General rule. Under paragraph (a) (2) of this section, export
property (a) must be held primarily for the purpose of sale or lease in
the ordinary course of trade or business to a DISC, or to any other
person, and (b) such sale or lease must be for direct use, consumption,
or disposition outside the United States. Thus, property cannot qualify
as export property unless it is sold or leased for direct use,
consumption or disposition outside the United States. Property is sold
or leased for direct use, consumption, or disposition outside the United
States if such sale or lease satisfies the destination test described in
subparagraph (2) of this paragraph, the proof of compliance requirements
described in subparagraph (3) of this paragraph, and the use outside the
United States test described in subparagraph (4) of this paragraph.
(ii) Factors not taken into account. In determining whether property
which is sold or leased to a DISC is sold or leased for direct use
consumption, or disposition outside the United States, the fact that the
acquiring DISC holds the property in inventory or for lease prior to the
time it sells or leases it for direct use, consumption, or disposition
outside the United States will not affect the characterization of the
property as export property. Export property need not be physically
segregated from other property
(2) Destination test. (i) For purposes of subparagraph (1) of this
paragraph the destination test in this subparagraph is satisfied with
respect to property sold or leased by a seller or lessor only if it is
delivered by such seller or lessor (or an agent of such seller or
lessor) regardless of the F.O.B. point or the place at which title
passes or risk of loss shifts from the seller or lessor --
(a) Within the United States to a carrier or freight forwarder for
ultimate delivery outside the United States to a purchaser or lessee (or
to a subsequent purchaser or sublessee)
(b) Within the United States to a purchaser or lessee, if such
property is ultimately delivered, directly used, or directly consumed
outside the United States (including delivery to a carrier or freight
forwarder for delivery outside the United States) by the purchaser or
lessee (or a subsequent purchaser or sublessee) within 1 year after such
sale or lease,
(c) Within or outside the United States to a purchaser or lessee
which, at the time of the sale or lease, is a DISC and is not a member
of the same controlled group (as defined in 1.993-1(k)) as the seller
or lessor.
(d) From the United States to the purchaser or lessee (or a
subsequent purchaser or sublessee) at a point outside the United States
by means of a ship, aircraft, or other delivery vehicle, owned, leased,
or chartered by the seller or lessor.
(e) Outside the United States to a purchaser or lessee from a
warehouse, a storage facility, or assembly site located outside the
United States, if such property was previously shipped by such seller or
lessor from the United States, or
(f) Outside the United States to a purchaser or lessee if such
property was previously shipped by such seller or lessor from the United
States and if such property is located outside the United States
pursuant to a prior lease by the seller or lessor, and either (1) such
prior lease terminated at the expiration of its term (or by the action
of the prior lessee acting alone), (2) the sale occurred or the term of
the subsequent lease began after the time at which the term of the prior
lease would have expired, or (3) the lessee under the subsequent lease
is not a related person (as defined in 1.993-1(a)(6)) with respect to
the lessor and the prior lease was terminated by the action of the
lessor (acting alone or together with the lessee).
(ii) For purposes of this subparagraph (other than (c) and (f) (3) of
subdivision (i) thereof), any relationship between the seller or lessor
and any purchaser, subsequent purchaser, lessee, or sublessee is
immaterial.
(iii) In no event is the destination test of this subparagraph
satisfied with respect to property which is subject to any use (other
than a resale or sublease), manufacture, assembly, or other processing
(other than packaging) by any person between the time of the sale or
lease by such seller or lessor and the delivery or ultimate delivery
outside the United States described in this subparagraph.
(iv) If property is located outside the United States at the time it
is purchased by a person or leased by a person as lessee, such property
may be export property in the hands of such purchaser or lessee only if
it is imported into the United States prior to its further sale or lease
(including a sublease) outside the United States. Paragraphs (a)(3) and
(e) of this section (relating to 50 percent foreign content test) are
applicable in determining whether such property is export property.
Thus, for example, if such property is not subjected to manufacturing or
production (as defined in paragraph (c) of this section) within the
United States after such importation, it does not qualify as export
property.
(3) Proof of compliance with destination test -- (i) Delivery outside
the United States. For purposes of subparagraph (2) of this paragraph
(other than subdivision (i)(c) thereof), a seller or lessor shall
establish ultimate delivery, use, or consumption of property outside the
United States by providing --
(a) A facsimile or carbon copy of the export bill of lading issued by
the carrier who delivers the property,
(b) A certificate of an agent or representative of the carrier
disclosing delivery of the property outside the United States,
(c) A facsimile or carbon copy of the certificate of lading for the
property executed by a customs officer of the country to which the
property is delivered.
(d) If such country has no customs administration, a written
statement by the person to whom delivery outside the United States was
made,
(e) A facsimile or carbon copy of the shipper's export declaration, a
monthly shipper's summary declaration filed with the Bureau of Customs,
or a magnetic tape filed in lieu of the Shipper's Export Declaration,
covering the property,
(f) Any other proof (including evidence as to the nature of the
property or the nature of the transaction) which establishes to the
satisfaction of the Commissioner that the property was ultimately
delivered, or directly sold, or directly consumed outside the United
States within 1 year after the sale or lease.
(ii) The requirements of subdivision (i) (a), (b), (c), or (e) of
this subparagraph will be considered satisfied even though the name of
the ultimate consignee and the price paid for the goods is marked out
provided that, in the case of a Shipper's Export Declaration or other
document listed in such subdivision (e) or a document such as an export
bill of lading such document still indicates the country in which
delivery to the ultimate consignee is to be made and, in the case of a
certificate of an agent or representative of the carrier, that such
document indicates that the property was delivered outside the United
States.
(iii) A seller or lessor shall also establish the meeting of the
requirement of subparagraph (2)(i) of this paragraph (other than
subdivision (c) thereof), that the property was delivered outside the
United States without further use, manufacture, assembly, or other
processing within the United States.
(iv) Sale or lease to an unrelated DISC. For purposes of
subparagraph (2)(i)(c) of this paragraph, a purchaser or lessee of
property is deemed to qualify as a DISC for its taxable year if the
seller or lessor obtains from such purchaser or lessee a copy of such
purchaser's or lessee's election to be treated as a DISC as described in
1.992-2(a) together with such purchaser's or lessee's sworn statement
that such election has been filed with the Internal Revenue Service
Center. The copy of the election and the sworn statement of such
purchaser or lessee must be received by the seller or lessor within 6
months after the sale or lease. A purchaser or lessee is not treated as
a DISC with respect to a sale or lease during a taxable year for which
such purchaser or lessee does not qualify as a DISC if the seller or
lessor does not believe or if a reasonable person would not believe at
the time such sale or lease is made that the purchaser or lessee will
qualify as a DISC for such taxable year.
(v) Failure of proof. If a seller or lessor fails to provide proof
of compliance with the destination test as required by this
subparagraph, the property sold or leased is not export property.
(4) Sales and leases of property for ultimate use in the United
States -- (i) In general. For purposes of subparagraph (1) of this
paragraph, the use test in this subparagraph is satisfied with respect
to property which --
(a) Under subdivisions (ii) through (iv) of this subparagraph is not
sold for ultimate use in the United States or
(b) Under subdivision (v) of this subparagraph is leased for ultimate
use outside the United States.
(ii) Sales of property for ultimate use in the United States. For
purposes of subdivision (i) of this subparagraph, a purchaser of
property (including components, as defined in subdivision (vii) of this
subparagraph) is deemed to use such property ultimately in the United
States if any of the following conditions exists:
(a) Such purchaser is a related person (as defined in 1.993-1(a)(6))
with respect to the seller and such purchaser ultimately uses such
property, or a second product into which such property is incorporated
as a component, in the United States.
(b) At the time of the sale, there is an agreement or understanding
that such property, or a second product into which such property is
incorporated as a component, will be ultimately used by the purchaser in
the United States.
(c) At the time of the sale, a reasonable person would have believed
that such property or such second product would be ultimately used by
such purchaser in the United States unless, in the case of a sale of
components, the fair market value of such components at the time of
delivery to the purchaser constitutes less than 20 percent of the fair
market value of the second product into which such components are
incorporated (determined at the time of completion of the production,
manufacture or assembly of such second product).
For purposes of (b) of this subdivision, there is an agreement or
understanding that property will ultimately be used in the United States
if, for example, a component is sold abroad under an express agreement
with the foreign purchaser that the component is to be incorporated into
a product to be sold back to the United States. As a further example
there would also be such an agreement or understanding if the foreign
purchaser indicated at the time of the sale or previously that the
component is to be incorporated into a product which is designed
principally for the United States market. However, such an agreement or
understanding does not result from the mere fact that a second product,
into which components exported from the United States have been
incorporated and which is sold on the world market, is sold in
substantial quantities in the United States.
(iii) Use in the United States. For purposes of subdivision (ii) of
this subparagraph, property (including components incorporated into a
second product) is or would be ultimately used in the United States by
such purchaser if, at any time within 3 years after the purchase of such
property or components, either such property or components (or the
second product into which such components are incorporated) is resold by
such purchaser for use by a subsequent purchaser within the United
States or such purchaser or subsequent purchaser fails, for any period
of 365 consecutive days, to use such property or second product
predominantly outside the United States as defined in subdivision (vi)
of this subparagraph).
(iv) Sales to retailers. For purposes of subdivision (ii)(c) of this
subparagraph property sold to any person whose principal business
consists of selling from inventory to retail customers at retail outlets
ouside the United States will be considered as property for ultimate use
outside the United States.
(v) Leases of property for ultimate use outside the United States.
For purposes of subdivision (i) of this subparagraph a lessee of
property is deemed to use such property ultimately outside the United
States during a taxable year of the lessor if such property is used
predominantly outside the United States (as defined in subdivision (vi)
of this subparagraph) by the lessee during the portion of the lessor's
taxable year which is included within the term of the lease. A
determination as to whether the ultimate use of leased property
satisfies the requirements of this subdivision is made for each taxable
year of the lessor. Thus, leased property may be used predominantly
outside the United States for a taxable year of the lessor (and thus,
constitute export property if the remaining requirements of this section
are met) even if the property is not used predominantly outside the
United States in earlier taxable years or later taxable years of the
lessor.
(vi) Predominant use outside the United States. For purposes of this
subparagraph, property is used predominantly outside the United States
for any period if, during such period, such property is located outside
the United States more than 50 percent of the time. An aircraft,
railroad rolling stock, vessel, motor vehicle, container, or other
property used for transportation purposes in deemed to be used
predominantly outside the United States for any period if, during such
period, either such property is located outside the United States more
than 50 percent of the time or more than 50 percent of the miles
traversed in the use of such property are traversed in outside the
United States. However, any such property is deemed to be within the
United States at all times during which it is engaged in transport
between any two points within the United States, except where such
transport constitutes uninterrupted international air transportation
within the meaning of section 4262(c)(3) and the regulations thereunder
(relating to tax on air transportation of persons). For purposes of
applying section 4262(c)(3) to this subdivision, the term ''United
States'' has the same meaning as in 1.993-7.
(vii) Component. For purposes of this subparagraph, a component is
property which is (or is reasonably expected to be) incorporated into a
second product by the purchaser of such component by means of
production, manufacture, or assembly.
(e) Foreign content of property -- (1) The 50 percent test. Under
paragraph (a)(3) of this section, no more than 50 percent of the fair
market value of export property may be attributable to the fair market
value of articles which were imported into the United States. For
purposes of this paragraph, articles imported into the United States are
referred to as ''foreign content''. The fair market value of the
foreign content of export property is computed in accordance with
subparagraph (4) of this paragraph. The fair market value of export
property which is sold to a person who is not a related person with
respect to the seller is the sale price for such property (not including
interest finance or carrying charges, or similar charges)
(2) Application of 50 percent test. The 50 percent test described in
subparagraph (1) of this paragraph is applied on an item-by-item basis
If, however, a person sells or leases a substantial volume of
substantially identical export property in a taxable year and if all of
such property contains substantially identical foreigh content is
substantially the same proportion, such person may determine the protion
of foreign content contained in such property on an aggregate basis.
(3) Parts and services. If, at the time property is sold or leased
the seller or lessor agrees to furnish parts pursuant to a services
contract (as provided in 1.993-1(d)(4)(v)) and the price for the parts
is not separately stated, the 50 percent test described in subparagraph
(1) of this paragraph is applied on an aggregate basis to the property
and parts. If the price for the parts is described in subparagraph (1)
of this paragraph is applied separately to the property and to the
parts.
(4) Computation of foreign content -- (i) Valuation. For purposes of
applying the 50 percent test described in subparagraph (1) of this
paragraph, it is necessary to determine the fair market value of all
articles which constitute foreign content of the property being tested
to determine if it is export property. The fair market value of such
imported articles is determined as of the time such articles are
imported into the United States. With respect to articles imported into
the United States before July 1, 1980, the fair market value of such
articles is their appraised value as determined under section 402 or
402a of the Tariff Act of 1930 (19 U.S.C. 1401a or 1402) in connection
with their importation. With respect to articles imported into the
United States on or after July 1, 1980, the fair market value of such
articles is their appraised value as determined under section 402 of the
Tariff Act of 1930 (19 U.S.C. 1401a) in connection with their
importation. The appraised value of such articles is the full dutiable
value of such articles, determined, however, without regard to any
special provision in the United States tariff laws which would result in
a lower dutiable value. Thus, an article which is imported into the
United States is treated as entirely imported even if all or a portion
of such article was originally manufactured, produced, grown, or
extracted in the United States.
(ii) Evidence of fair market value. For purposes of subdivision (i)
of this subparagraph, the fair market value of imported articles
constituting foreign content may be evidenced by the customs invoice
issued on the importation of such articles into the United States. If
the holder of such articles is not the importer (or a related person
with respect to the importer), the fair market value of such articles
may be evidenced by a certificate based upon information contained in
the customs invoice and furnished to the holder by the person from whom
such articles (or property incorporating such articles) were purchased.
If a customs invoice or certificate described in the preceding sentence
is not available to a person purchasing property, such person shall
establish that no more than 50 percent of the fair market value of such
property is attributable to the fair market value of articles which were
imported into the United States.
(iii) Interchangeable component articles. (a) Where identical or
similar component articles can be incorporated interchangeably into
property and a person acquires some such component articles that are
imported into the United States and other such component articles that
are not imported into the United States, the determination whether
imported component articles were incorporated in such property as is
exported from the United States shall be made on a substitution basis as
in the case of the rules relating to drawback accounts under the customs
laws. See section 313(b) of the Tariff Act of 1930, as amended (19
U.S.C. 1313(b)).
(b) The provisions of (a) of this subdivision may be illustrated by
the following example:
Example. Assume that a manufacturer produces a total of 20,000
electronic devices. The manufacturer exports 5,000 of the devices and
subsequently sells 11,000 of the devices to a DISC which exports the
11,000 devices. The major single component article in each device is a
tube which represents 60 percent of the fair market value of the device
at the time the device is sold by the manufacturer. The manufacturer
imports 8,000 of the tubes and produces the remaining 12,000 tubes. For
purposes of this subdivision, in accordance with the substitution
principle used in the customs drawback laws, the 5,000 devices exported
by the manufacturer are each treated as containing an imported tube
because the devices were exported prior to the sale to the DISC. The
remaining 3,000 imported tubes are treated as being contained in the
first 3,000 devices purchased and exported by the DISC. Thus, since the
50 percent test is not met with respect to the first 3,000 devices
purchased and exported by the DISC, those devices are not export
property. The remaining 8,000 devices purchased and exported by the
DISC are treated as containing tubes produced in United States, and
those devices are export property (if they otherwise meet the
requirements of this section).
(f) Excluded property -- (1) In general. Notwithstanding any other
provision of this section, the following property is not export property
--
(i) Property described in subparagraph (2) of this paragraph
(relating to property leased to a member of a controlled group),
(ii) Property described in subparagraph (3) of this paragraph
(relating to certain types of intangible property),
(iii) Products described in paragraph (g) of this section (relating
to depletable products), and
(iv) Products described in paragraph (h) of this section (relating to
certain export controlled products).
(2) Property leased to member of controlled group -- (i) In general.
Property leased to a person (whether or not a DISC) which is a member of
the same controlled group (as defined in 1.993-1(k)) as the lessor
constitutes export property for any period of time only if during the
period --
(a) Such property is held for sublease, or is subleased, by such
person to a third person for the ultimate use of such third person;
(b) Such third person is not a member of the same controlled group;
and
(c) Such property is used predominantly outside the United States by
such third person.
(ii) Predominant use. The provisions of paragraph (d)(4)(vi) of this
section apply in determining under subdivision (i)(c) of this
subparagraph whether such property is used predominently outside the
United States by such third person.
(iii) Leasing rule. For purposes of this subparagraph, leased
property is deemed to be ultimately used by a member of the same
controlled group as the lessor if such property is leased to a person
which is not a member of such controlled group but which subleases such
property to a person which is a member of such controlled group. Thus,
for example, if X, a DISC for the taxable year, leases a movie film to
Y, a foreign corporation which is not a member of the same controlled
group as X, and Y then subleases the film to persons which are members
of such group for showing to the general public, the film is not export
property. On the other hand, if X, a DISC for the taxable year, leases
a movie film to Z, a foreign corporation which is a member of the same
controlled group as X, and Z then subleases the film to Y, another
foreign corporation, which is not a member of the same controlled group
for showing to the general public, the film is not disqualified under
this subparagraph from being export property.
(iv) Certain copyrights. With respect to a copyright which is not
excluded by subparagraph (3) of this paragraph from being export
property, the ultimate use of such property is the sale or exhibition of
such property to the general public. Thus, if A, a DISC for the taxable
year, leases recording tapes to B, a foreign corporation which is a
member of the same controlled group as A, and if B makes records from
the recording tape and sells the records to C, another foreign
corporation, which is not a member of the same controlled group, for
sale by C to the general public, the recording tape is not disqualified
under this subparagraph from being export property, notwithstanding the
leasing of the recording tape by A to a member of the same controlled
group, since the ultimate use of the tape is the sale of the records
(i.e., property produced from the recording tape).
(3) Intangible property. Export property does not include any
patent, invention, model, design, formula, or process, whether or not
patented, or any copyright (other than films, tapes, records, or similar
reproductions, for commercial or home use), goodwill, trademark,
tradebrand, franchise, or other like property. Although a copyright
such as a copyright on a book does not constitute export property, a
copyrighted article (such as a book) if not accompanied by a right to
reproduce it is export property if the requirements of this section are
otherwise satisfied. However, a license of a master recording tape for
reproduction outside the United States is not disqualified under this
subparagraph from being export property.
(g) Depletable products -- (1) In general. Under section
993(c)(2)(C), a product or commodity which is a depletable product (as
defined in subparagraph (2) of this paragraph) or contains a depletable
product is not export property if --
(i) It is a primary product from oil, gas, coal, or uranium (as
described in subparagraph (3) of this paragraph), or
(ii) It does not qualify as a 50-percent manufactured or processed
product (as described in subparagraph (4) of this paragraph).
(2) Definition of ''depletable product''. For purposes of this
paragraph, the term ''depletable product'' means any product or
commodity of a character with respect to which a deduction for depletion
is allowable under section 613 or 613A. Thus, the term depletable
product includes any mineral extracted from a mine, an oil or gas well,
or any other natural deposit, whether or not the DISC or related
supplier is allowed a deduction, or is eligible to take a deduction, for
depletion with respect to the mineral in computing its taxable income.
Thus, for example, iron ore purchased by a DISC from a broker is a
depletable product in the hands of the DISC for purposes of this
paragraph even though the DISC is not eligible to take a deduction for
depletion under section 613 or 613A.
(3) Primary product from oil, gas, coal, or uranium. A primary
product from oil, gas, coal, or uranium is not export property. For
purposes of this paragraph --
(i) Primary product from oil. The term ''primary product from oil''
means crude oil and all products derived from the destructive
distillation of crude oil, including --
(a) Volatile products,
(b) Light oils such as motor fuel and kerosene,
(c) Distillates such as naphtha,
(d) Lubricating oils,
(e) Greases and waxes, and
(f) Residues such as fuel oil.
For purposes of this paragraph, a product or commodity derived from
shale oil which would be a primary product from oil if derived from
crude oil is considered a primary product from oil.
(ii) Primary product from gas. The term ''primary product from gas''
means all gas and associated hydrocarbon components from gas wells or
oil wells, whether recovered at the lease or upon further processing,
including --
(a) Natural gas,
(b) Condensates,
(c) Liquefied petroleum gases such as ethane, propane, and butane,
and
(d) Liquid products such as natural gasoline.
(iii) Primary product from coal. The term ''primary product from
coal'' means coal and all products recovered from the carbonization of
coal including --
(a) Coke,
(b) Coke-oven gas,
(c) Gas liquor,
(d) Crude light oil, and
(e) Coal tar.
(iv) Primary product from uranium. The term ''primary product from
uranium'' means uranium ore and uranium concentrates (known in the
industry as ''yellow cake''), and nuclear fuel materials derived from
the refining of uranium ore and uranium concentrates, or produced in a
nuclear reaction, including --
(a) Uranium hexafluoride,
(b) Enriched uranium hexafluoride,
(c) Uranium metal,
(d) Uranium compounds, such as uranium carbide,
(e) Uranium dioxide, and
(f) Plutonium fuels.
(v) Primary products and changing technology. The primary products
from oil, gas, coal, or uranium described in subdivisions (i) through
(iv) of this subparagraph and the processes described in those
subdivisions are not intended to represent either the only primary
products from oil, gas, coal, or uranium, or the only processes from
which primary products may be derived under existing and future
technologies, such as the gasification and liquefaction of coal.
(vi) Petrochemicals. For purposes of this paragraph, petrochemicals
are not considered primary products from oil, gas, or coal.
(4) 50-percent manufactured or processed product -- (i) In general.
A product or commodity (other than a primary product from oil, gas,
coal, or uranium) which is or contains a depletable product is not
excluded from the term ''export property'' by reason of section
993(c)(2)(C) if it is a 50-percent manufactured or processed product.
Such a product or commodity is a ''50-percent manufactured or processed
product'' if, after the cutoff point of the depletable product, it is
manufactured or processed (as defined in subdivision (ii) of this
subparagraph) and either the cost test described in subdivision (iv) of
this subparagraph or the fair market value test described in subdivision
(v) of this subparagraph is satisfied. To determine cutoff point, see
subdivisions (vi) and (vii) of this subparagraph.
(ii) Manufactured or processed. A product is manufactured or
processed if it is manufactured or produced within the meaning of
paragraph (c)(2) of this section, except that for purposes of this
subdivision the term manufacturing or processing does not include any
excluded process (as defined in subdivision (iii) of this subparagraph)
and the term conversion costs (as used in subdivision (iv) of such
paragraph (c)(2)) does not include any costs attributable to any
excluded process.
(iii) Excluded processes. For purposes of this paragraph, excluded
processes are extracting (i.e., all processes which are applied before
the cutoff point of the mineral to which such processes are applied),
and handling, packing, packaging, grading, storing, and transporting.
(iv) Cost test. A product or commodity will qualify as a 50-percent
manufactured or processed product if --
(a) Its manufacturing and processing costs (that is, the portion of
the cost of goods sold or inventory amount of the product or commodity
attributable to the aggregate cost of manufacturing or processing each
mineral contained therein) equal or exceed --
(b) An amount equal to either of the following:
(1) 50 percent of its cost of goods sold or inventory amount
(decreased, at the DISC's option, by the portion of such cost or amount
the DISC establishes is allocable to the difference between each prior
owner's selling price for each depletable product contained in such
product or commodity and such prior owner's cost of goods sold with
respect thereto).
(2) The aggregate of the cost at the cutoff point (see subdivisions
(vi) and (vii) of this subparagraph) properly attributable to each
mineral contained in such product or commodity. However, if this
subdivision (2) is applied, then the amount in (a) of this subparagraph
(iv) shall be decreased and the amount in this subdivision (2) shall be
increased, by so much of the cost of goods sold or inventory amount of
the product or commodity as is properly allocable to any process other
than transportation applied after the cutoff point of such mineral which
would be a mining process (within the meaning of 1.613-4) were it
applied before such point.
(v) Fair market value test. A product or commodity will qualify as a
50-percent manufactured or processed product if --
(a) The excess of its fair market value on the date it is sold,
exchanged, or otherwise disposed of (or, if not sold, exchanged, or
otherwise disposed of, the last day of the DISC's taxable year) over the
portion thereof properly allocable to excluded processes other than
extracting is equal to or greater than
(b) Twice the aggregate of the fair market value at the cutoff point
for each mineral contained in such product or commodity.
For purposes of this subdivision (v), the fair market value of a
product or commodity on the date it is sold, exchanged, or otherwise
disposed of is the price at which it is disposed of, subject to any
adjustment that may be required under the arm's length standard of
section 482 and the regulations thereunder. If such product or
commodity is not sold, exchanged, or otherwise disposed of, then, for
purposes of section 992(a)(1)(B) (relating to the 95-percent test with
respect to qualified export assets), the fair market value of a product
or commodity on the last day of the DISC's taxable year is the arm's
length price at which such product or commodity would have been sold on
such date, determined by applying the principles of section 482 and the
regulations thereunder.
(vi) Cutoff point of a mineral. For purposes of this subparagraph:
(a) The cutoff point is the point at which gross income from the
property (within the meaning of section 613(a)) was in fact determined.
(b) The cost at the cutoff point is deemed to be the amount of the
gross income from the property of the taxpayer eligible for a depletion
deduction with respect to the mineral.
(c) The fair market value at the cutoff point is deemed to be the
amount of the gross income from the property of the taxpayer eligible
for a depletion deduction with respect to the mineral, except that, if
(1) the fair market value of a product or commodity on the date
specified in subdivision (v)(a) of this subparagraph exceeds the
aggregate of the fair market value at the cutoff point for each mineral
contained therein and (2) 10 percent or more of such excess is
attributable to a net increase in the fair market values of such
minerals by reason of factors other than manufacturing or processing or
the application of excluded processes (such as, for example, increases
in the fair market values of some minerals by reason of inflation or
speculation exceed decreases in such values of other minerals by reason
of deflation or speculation), then the aggregate of the fair market
value at the cutoff point for each such mineral shall be increased to
reflect the net excess so attributable.
(d) The provisions of this subdivision (vi) are illustrated by the
following example.
Example. An integrated manufacturer, X, on February 1, 1976, had
gross income from the property (within the meaning of section 613(a)) of
$50 with respect to a specified volume of a mineral. Thus, the cost at
the cutoff point of the mineral was $50. X converted the mineral into a
product which it sold on July 15, 1976, for $75. Of the $25 excess of
the selling price over the gross income from the property, $23 was
attributable to manufacturing, processing, and the application or
excluded processes, and $2 was attributable to an increase in the fair
market value of the mineral due to inflation between February 1 and July
15, 1976. Since only 8 percent of such excess ($2/$25) was attributable
to factors other than manufacturing, processing, and the application of
excluded processes, the fair market value at the cutoff point of the
mineral is $50. However, had $3 of the $25 excess, or 12 percent, been
attributable to an incease in the fair market value of the mineral due
to inflation, then the fair market value at the cutoff point of the
mineral would be $53.
(vii) (Reserved)
(viii) Special rule for certain used products and scrap products. If
a product or commodity is a used 50-percent manufactured or processed
product, or is recovered as scrap from a 50-percent manufactured or
processed product, such product or commodity will be treated as a
50-percent manufactured or processed product.
(ix) Special rule for byproducts and waste products. For purposes of
applying the cost test or fair market value test of subdivision (iv) or
(v) of this subparagraph if a depletable product is recovered from a
manufacturing process as a byproduct or waste product, then the cost and
fair market value at the cutoff point are each deemed to be the lesser
of --
(a) The fair market value of the waste product or byproduct
containing the depletable product, determined as of the date the
byproduct or waste product is recovered, or
(b) The amount the cost at the cut-off point would be for a
depletable product of like kind and grade which is extracted, determined
as of the date the byproduct or waste product is recovered.
For purposes of (b) of this subdivision the cutoff point for the
depletable product of like kind and grade is deemed to be the point at
which gross income from the property would be determined if such
depletable product were sold by the taxpayer eligible to take a
deduction for depletion after the completion of all mining processes
applied to the depletable product and before the application of any
nonmining process.
(x) Proof of satisfaction of 50-percent manufactured or processed
test. (a) No substantiation is required to establish that either the
cost test or the fair market value test of subdivisions (iv) or (v) of
this subparagraph is satisfied or that a product or commodity qualifies
under (viii) of this subdivision as either a used 50-percent
manufactured or processed product or as scrap from a 50-percent
manufactured or processed product as long as it is reasonably obvious,
on the basis of all relevant facts and circumstances, that either the
cost test or fair market value test is satisfied, or that the product or
commodity qualifies as either as used 50-percent manufactured or
processed product or as scrap from a 50-percent manufactured or
processed product. Thus, for example, in the case of a DISC exporting a
high precision lens at least 50 percent of the fair market value of
which is obviously attributable to grinding, no substantiation of gross
income from the property properly allocable to the depletable products
contained in the lens, cost, or fair market values will be required.
(b) In cases in which satisfaction of either the cost test or the
fairmarket value test is not reasonably obvious, a DISC will be required
to substantiate the gross income from the property properly allocable to
each depletable product in a product or commodity and either all costs
or fair market values relied upon the DISC.
(c) For purposes of substantiating (1) gross income from the property
properly allocable to a depletable product, (2) costs, and (3) fair
market values, the DISC and related supplier shall each identify items
in (or that were in) inventory in the same manner each used to identify
items in inventory for purposes of computing Federal income tax.
(xi) Application of 50-percent test. The 50-percent test described
in this subparagraph is applied on an item-by-item basis. If, however,
a DISC sells a substantial volume of substantially identical products or
commodities and if all or a group of such products or commodities
contain substantially identical depletable products in substantially the
same proportions and have cost or fair market value relationships (as
the case may be) that are in substantially the same proportions, such
DISC may apply the 50-percent test on an aggregate basis with respect to
all such products or commodities, or group, as the case may be.
(5) Effective dates. Except as provided in subparagraph (6) of this
paragraph, section 993(c)(2)(C) applies --
(i) With respect to any product or commodity not owned by a DISC, to
sales, exchanges, or other dispositions made after March 18, 1975, with
respect to which the DISC derives gross receipts.
(ii) With respect to any product or commodity acquired by a DISC
after March 18, 1975.
(iii) With respect to any product or commodity owned by a DISC on
March 18, 1975, to sales, exchanges, or other dispositions made after
March 18, 1976, and to owning such product or commodity after such date.
For purposes of this paragraph and subparagraph (6) of this
paragraph, the date of a sale, exchange, or other disposition of a
product or commodity is the date as of which title to such product or
commodity passes. The accounting method of a person is not
determinative of the date of a sale, exchange, or other disposition.
(6) Fixed contracts. Section 1101(f) of the Tax Reform Act of 1976
provides an exception to the effective date rules in this paragraph and
in paragraph (h) of this section. Section 1101(f)(2) of the Act
provides that section 993)c)(2) (C) and (D) shall not apply to sales,
exchanges, and other dispositions made after March 18, 1975, but before
March 19, 1980, if they are made pursuant to a fixed contract. Section
1101(f)(2) also defines fixed contract. Under that definition, if the
seller can vary the price of the product for unspecified cost increases
(which could include tax cost increases), or if the quantity of products
or commodities to be sold can be increased or decreased under the
contract by the seller without penalty, the contract is not to be
considered a fixed contract with respect to the amount over which the
seller has discretion. For example, if a contract calls for a minimum
delivery of x amount of a product but allows the seller to refuse to
deliver goods beyond that minimum amount (or allows a renegotiation of
the sales price of goods beyond that amount), then with respect to the
amount above the minimum the contract is not a fixed quantity contract.
(h) Export controlled products -- (1) In general. An export
controlled product is not export property. A product or commodity may
be an export controlled product at one time but not an export controlled
product at another time. For purposes of this paragraph, a product or
commodity is an ''export controlled product'' at a particular time if at
that time the export of such product or commodity is prohibited or
curtailed under section 4(b) of the Export Administration Act of 1969 or
section 7(a) of the Export Administration Act of 1979, to effectuate the
policy relating to the protection of the domestic economy set forth in
such Acts (paragraph (2)(A) of section 3 of the Export Administration
Act of 1969 and paragraph (2)(C) of section 3 of the Export
Administration Act of 1979). Such policy is to use export controls to
the extent necessary ''to protect the domestic economy from the
excessive drain of scarce materials and to reduce the serious
inflationary impact of foreign demand.''
(2) Products considered export controlled products -- (i) In general.
For purposes of this paragraph, an export controlled product is a
product or commodity which is subject to short supply export controls
under 15 CFR part 377. A product or commodity is considered an export
controlled product for the duration of each control period which applies
to such product or commodity. A control period of a product or
commodity begins on and includes the initial control date (as defined in
subdivision (ii) of this subparagraph) and ends on and includes the
final control date (as defined in subdivision (iii) of this
subparagraph).
(ii) Initial control date. The initial control date of a product or
commodity which was subject to short supply export controls on March 19,
1975, is March 19, 1975. The initial control date of a product or
commodity which is subject to short supply export controls after March
19, 1975, is the effective date stated in the regulations to 15 CFR part
377 which subjects such product or commodity to short supply export
controls. If there is no effective date stated in such regulations, the
initial control date of such product or commodity is the date on which
such regulations are filed for publications in the Federal Register.
(iii) Final control date. The final control date of a product or
commodity is the effective date stated in the regulations to 15 CFR part
377 which removes such product or commodity from short supply export
controls. If there is no effective date stated in such regulations, the
final control date of such product or commodity is the date on which
such regulations are filed for publication in the Federal Register.
(iv) Expiration of Export Administration Act. An initial control
date and a final control date cannot occur after the expiration date of
the Export Administration Act under the authority of which the short
supply export controls were issued.
(3) Effective dates -- (i) Products controlled on March 19, 1975.
Except as provided in paragraph (g)(6) of this section, if a product or
commodity was subject to short supply export controls on March 19, 1975,
this paragraph applies --
(a) With respect to any such product or commodity not owned by a
DISC, to sales, exchanges, other dispositions, or leases made after
March 18, 1975, with respect to which the DISC derives gross receipts.
(b) With respect to any such product or commodity acquired by a DISC
after March 18, 1975, and
(c) With respect to any such product or commodity owned by a DISC on
March 18, 1975, to sales, exchanges, other dispositions, and leases made
after March 18, 1976, and to owning such product or commodity after such
date.
(ii) Products first controlled after March 19, 1975. If a product or
commodity becomes subject to short supply export controls after March
19, 1975, this paragraph applies to sales, exchanges, other
dispositions, or leases of such product or commodity made on or after
the initial control date of such product or commodity, and to owning
such product or commodity on or after such date.
(iii) Date of sale, exchange, lease, or other disposition. For
purposes of this subparagraph, the date of sale, exchange, or other
disposition of a product or commodity is the date as of which title to
such product or commodity passes. The date of a lease is the date as of
which the lessee takes possession of a product or commodity. The
accounting method of a person is not determinative of the date of sale,
exchange, other disposition, or lease.
(iv) Property in short supply. If the President determines that the
supply of any property which is otherwise export property as defined in
this section is insufficient to meet the requirements of the domestic
economy, he may by Executive order designate such property as in short
supply. Any property so designated will be treated as property which is
not export property during the period beginning with the date specified
in such Executive order and ending with the date specified in an
Executive order setting forth the President's determination that such
property is no longer in short supply.
(T.D. 7514, 42 FR 55461, Oct. 17, 1977, as amended by T.D. 7513, 42
FR 57309, Nov. 2, 1977; T.D. 7854, 47 FR 51740, Nov. 17, 1982)
26 CFR 1.993-4 Definition of producer's loans.
(a) General rule -- (1) Definition. Under section 993(d), a loan
made by a DISC to a person, referred to in this section as the
''borrower,'' is a producer's loan if --
(i) The loan is made out of accumulated DISC income within the
meaning of subparagraph (3) of this paragraph.
(ii) The loan is evidenced by an obligation described in subparagraph
(4) of this paragraph.
(iii) The requirement as to the trade or business of the borrower
described in subparagraph (5) of this paragraph is satisfied.
(iv) At the time the loan is made, the obligation referred to in
subdivision (ii) of this subparagraph bears a legend stating ''This
Obligation Is Designated A Producer's Loan Within The Meaning of section
993(d) of the Internal Revenue Code'' or words of substantially the same
meaning.
(v) The limitation as to the export-related assets of the borrower
described in paragraph (b) of this section is satisfied.
(vi) The requirement as to the increased investment of the borrower
in export-related assets described in paragraph (c) of this section is
satisfied, and
(vii) The requirement of paragraph (d) of this section as to proof of
compliance with paragraphs (b) and (c) of this section is satisfied.
(2) Application of this section -- (i) In general. A loan which is a
producer's loan is a qualified export asset of the DISC (see
1.993-2(a)(5) and (F)). The interest on a producer's loan is a
qualified export receipt of the DISC (see 1.993-1(g)). A producer's
loan is not a dividend to a borrower which is also a shareholder of the
DISC making the loan. For rules with respect to deemed distributions by
reason of the amount of foreign investment attributable to producer's
loans, see section 995(b)(1)(G) and (d) and the regulations thereunder.
(ii) No tracing of loan proceeds. For purposes of applying this
section, in order to qualify as a producer's loan, the proceeds of the
loan need not be traced to an investment in any specific asset.
(iii) Unrelated borrower. For purposes of applying this section, it
is not necessary for a borrower to be a related person with respect to
the DISC from which it receives a producer's loan, or a member of the
same controlled group as the DISC.
(iv) Unpaid balance of producer's loans. For purposes of applying
this section, the unpaid balance of producer's loans does not include
the unpaid balance of any producer's loan to the extent the loan has
been deducted or charged off by the DISC as totally or partially
worthless under section 165 or 166.
(v) Refinancing, renewal, and extension. For purposes of applying
this section, the refinancing, renewal, or extension of a producer's
loan shall be treated as the making of a new loan which may qualify as a
producer's loan only if the requirements of subparagraph (1) of this
paragraph are met.
(vi) Events subsequent to time loan is made. The determination as to
whether a loan qualifies as a producer's loan is made on the basis of
the relevant facts taken into account for purposes of determining
whether the loan was a producer's loan when made. Thus, for example, if
the accumulated DISC income of the lender is later reduced below the
unpaid balance of all producer's loans previously made by the DISC, such
subsequent decrease in the amount of accumulated DISC income will not
result in later disqualification of such loan (or part thereof) as a
producer's loan. Similarly, if a loan (or part of a loan) does not
qualify as a producer's loan because of an insufficient amount of
accumulated DISC income at the time the loan is made, a subsequent
increase in the amount of accumulated DISC income will not result in
later qualification of such loan (or part thereof) as a producer's loan.
As a further example, for purposes of applying the borrower's export
related assets limitation described in paragraph (b) of this section, a
loan which qualifies as a producer's loan when made will not later be
disqualified if property, the gross receipts from the sale or lease of
which were includible in the numerator of the fraction described in
paragraph (b)(3)(i) of this section at the time of sale or lease by the
borrower, is later characterized as excluded property (as defined in
1.993-3(f)).
(vii) Application of tests under paragraphs (b) and (c) on controlled
group bases. If the borrower is a member of a controlled group (as
defined in 1.993-1(k)) at the time a loan is made, all amounts that
must be determined for purposes of applying the limitation and increased
investment requirement with respect to the export-related assets of the
borrower (described in paragraphs (b) and (c), respectively, of this
section) may be determined at the election of the borrower by
aggregating such amounts for all members of the controlled group,
determined for the taxable year of each member of the controlled group
during which the loan is made, excluding only such members of the group
as are DISC's or foreign corporations for such year. However, such
amounts may be included only to the extent that such amounts have not
already been taken into account in applying the limitation and increased
investment requirement with respect to any other borrower. Amounts to
be aggregated for all such members if such election is made include, for
example, gross receipts (described in paragraphs (b)(3) (i) and (ii) of
this section) and export-related assets (described in paragraph (b)(2)
of this section). The borrower may make such election by causing its
written statement of election to be attached to the lending DISC's
return under section 6011(e)(2) for the first taxable year of the
lending DISC within which or with which the borrower's taxable year for
which the election is to apply ends. An election once made is binding
on all members of the controlled group which includes the borrower with
respect to all taxable years of the borrower beginning with its first
taxable year for which the election is made. A borrower who makes such
election may revoke it only if it secures the consent of the
Commissioner to such revocation upon application made through the
lending DISC.
(3) Loan out of accumulated DISC income -- (i) In general. A loan is
a producer's loan only to the extent that it is made out of accumulated
DISC income. A loan is made out of accumulated DISC income only if the
amount of the loan, when added to the unpaid balance at the time such
loan is made of all other producer's loans made by a DISC, does not
exceed the amount of accumulated DISC income of the DISC at the
beginning of the month in which the loan is made. The amount of
accumulated DISC income at the beginning of any month is determined as
if the DISC's taxable year closed at the end of the immediately
preceding month.
(ii) Presumption. A loan made during a taxable year shall be deemed
under subdivision (i) of this subparagraph to have been made out of
accumulated DISC income if the balance of producer's loans at the
beginning of the year and those made during the year do not exceed
accumulated DISC income at the end of the year.
(iii) Deemed distributions. For purposes of this subparagraph,
accumulated DISC income as of the end of any taxable year (or month)
shall be determined without regard to deemed distributions under section
995(b) (1)(G) for the amount of foreign investment attributable to
producer's loans for such year (or for the taxable year for which such
month is a part) but actual distributions shall be taken into account.
(4) Evidence and terms of obligation. A loan is a producer's loan
only if the loan is evidenced by a note or other evidence of
indebtedness which is made by the borrower and which has a stated
maturity date not more than 5 years from the date the loan is made.
Accordingly, a loan which does not have a stated maturity date or which
has a stated maturity date more than 5 years from the date such loan is
made can never meet the 5-year requirement of this subparagraph. Thus,
for example, even if there is a period of less than 5 years remaining to
the stated maturity date of a loan, the loan can never be a producer's
loan if it had a stated maturity date more than 5 years from the date it
was made. For a further example, if a loan having a period remaining to
maturity of 2 years is extended for a further period of 3 years (making
a total of 5 years to maturity from the date of the extension), the
extension of the loan would under subparagraph (2)(v) of this paragraph
constitute the making of a new producer's loan and the original
producer's loan would terminate. If, however, a loan having a period
remaining to maturity of 2 years is extended for a further period of 4
years (making a total of 6 years to maturity from the date of the
extension), the original producer's loan will terminate and the new loan
will not be a producer's loan. If a producer's loan is not paid in full
at its maturity date and is not formally refinanced, renewed, or
extended, such loan shall be deemed to be a new loan which does not have
a stated maturity date and, thus, will not be a producer's loan. For
purposes of this subparagraph, an evidence of indebtedness is a written
instrument of indebtedness. Section 482 and the regulations thereunder
are applicable to determine, in the case of a loan by the DISC to a
borrower which is owned or controlled directly or indirectly by the same
interests as the DISC within the meaning of section 482, whether the
interest charged on such loan is at an arm's length rate.
(5) Borrower's trade or business. A loan is a producer's loan only
if the loan is made to a person engaged in the United States in the
manufacture, production, growth, or extraction (within the meaning of
1.993-3(c)) of export property determined without regard to
1.993-3(f)(1) (iii) and (iv). The borrower may also be engaged in other
trades or businesses and the loan need not be traceable to specific
investments in export property.
(b) Borrower's export related assets limitation -- (1) General rule.
A loan to a borrower is a producer's loan only to the extent that the
amount of the loan, when added to the unpaid balance of all other
producer's loans made by all DISC's to the borrower which are
outstanding at the time the loan is made, does not exceed an amount
equal to the amount of the borrower's export-related assets (determined
under subparagraph (2) of this paragraph) multiplied by the fraction set
forth in subparagraph (3) of this paragraph.
(2) Amount of export-related assets -- (i) In general. For purposes
of subparagraph (1) of this paragraph, the amount of the borrower's
export-related assets is the sum of the amounts described in
subdivisions (ii), (iii), and (iv) of this subparagraph.
(ii) Borrower's plant and equipment. The amount described in this
subdivision is the sum of the borrower's adjusted bases (determined as
of the beginning of the borrower's taxable year in which a loan is made
to it) for plant, machinery, equipment, and supporting production
facilities, which are located in the United States. Supporting
production facilities are all property used primarily in connection with
the manufacture, production, growth, or extraction (within the meaning
of 1.993-3(c)) or storage, handling, transportation, or assembly of
property by the borrower.
(iii) Borrower's property held primarily for sale or lease. The
amount described in this subdivision is the amount of the borrower's
property (at the beginning of the taxable year of the borrower in which
a loan is made to it) held primarily for sale or lease to customers in
the ordinary course of its trade or business. The amount of such
property held for sale is determined under the methods of identifying
and valuing inventory normally used by the borrower. The amount of such
property held for lease or leased is the borrower's adjusted bases,
determined under section 1011, for such property.
(iv) Borrower's research and experimental expenditures. The amount
described in this subdivision is the aggregate amount, whether or not
charged to capital account, of research and experimental expenditures
(within the meaning of section 174) incurred in the United States by the
borrower during each of its taxable years which begin after December 31,
1971, and precede the taxable year in which the loan is made to the
borrower. Such research and experimental expenditures need bear no
relationship to export property (as defined in 1.993-3) of the
borrower. The aggregate amount of all such expenditures for each of
such preceding taxable years is taken into account for purposes of this
subparagraph, regardless of whether all or any portion of the aggregate
amount has been taken into account with respect to producer's loans made
to the borrower by any DISC in preceding taxable years. The aggregate
amount of all such expenditures shall include such expenditures of a
corporation, the assets of which were acquired by the borrower in a
distribution or a transfer described in section 381(a) (1) or (2)
(relating to carryovers in certain corporate acquisitions).
(3) Fraction referred to in subparagraph (1) of this paragraph -- (i)
Numerator of fraction. The numerator of the fraction set forth in this
subparagraph is the sum of the borrower's gross receipts for each of its
3 taxable years immediately preceding the taxable year in which the loan
is made (but not including any taxable year beginning before January 1,
1972) from the sale or lease of export property (determined without
regard to 1.993-3(f)(1) (iii) and (iv)) which is manufactured,
produced, grown, or extracted (within the meaning of 1.993-3(c)) by the
borrower whether or not sold or leased directly or through a related
domestic person (notwithstanding 1.993-3(a)(4) and (f)(2)). For
purposes of the preceding sentence, with respect to a sale or lease to a
related DISC in which the transfer price is determined under section
994(a) (1) or (2), the rules under 1.994-1(c)(5) (relating to
incomplete transactions) shall be applied, and with respect to all other
sales and leases the rules under 1.994-1(c)(5) other than subdivision
(i)(d) thereof shall be applied.
(ii) Denominator of fraction. The denominator of the fraction set
forth in this subparagraph is the sum of the amount included in the
numerator and all other gross receipts of the borrower, for each of its
taxable years for which gross receipts are included in the numerator of
the fraction, from all sales or leases of all property held by the
borrower primarily for sale or lease to customers in the ordinary course
of its trade or business. For purposes of subdivision (i) of this
subparagraph and this subdivision, if such property is sold or leased to
a domestic related person which resells or subleases such property, the
borrower's gross receipts shall be the gross receipts derived by the
domestic related person from the resale or sublease of the export
property.
(iii) Taxable years. If the borrower has not engaged in the sale or
lease of property (as described in this subparagraph) for the 3
immediately preceding taxable years, or if 3 taxable years beginning
after December 31, 1971, have not elapsed, the fraction will be computed
on the basis of such gross receipts for its taxable years immediately
preceding the loan and beginning after December 31, 1971, during which
the borrower has so engaged. No producer's loans can be made to a
borrower until after the end of the first taxable year of the borrower
beginning after December 31, 1971.
(c) Requirement for increased investment in export-related assets --
(1) In general. A loan to a borrower is a producer's loan only to the
extent that the amount of the loan, when added to the unpaid balance of
all other producer's loans made by all DISC's to the borrower during the
borrower's taxable year during which such loan is made, does not exceed
the amount of the borrower's increase for the year in investment in
export-related assets. Such increase for any taxable year is the sum of
--
(i) The increase (if any) in the borrowers adjusted basis of certain
types of assets as determined under subparagraph (2) of this paragraph
and
(ii) The amount (if any) during the year of its research and
experimental expenditures as determined under paragraph (b)(2)(iv) of
this section.
(2) Increase in adjusted basis. The amount under this subparagraph
is the amount (not less than zero) by which --
(i) The borrower's adjusted basis (determined as of the end of its
taxable year in which the producer's loan is made) in all of its
property which is described in paragraph (b)(2)(ii) (plant and
equipment), and (iii) (property held primarily for sale or lease) of
this section, including any such property acquired by it during such
taxable year, exceeds
(ii) Its adjusted bases in all such property (determined as of the
beginning of such year).
(3) Ordering rule. If during the borrower's taxable year the amount
of increase in investment in export-related assets determined under this
subparagraph is exceeded by amounts loaned to the borrower during such
year that would otherwise qualify as producer's loans, such loans shall
be applied in the order made against the amount of such increase in
order to determine which loans qualify as producer's loans.
(d) Proof of borrower's compliance with paragraphs (b) and (c) of
this section. For purposes of paragraphs (b) and (c) of this section, a
DISC shall be prepared to establish initially the compliance of the
borrower with the requirements of such paragraphs by providing the
written statement of the borrower, certified by a certified public
accountant, stating that the borrower has complied with the limitation
and increased investment requirement in section 993(d) (2) and (3) of
the Internal Revenue Code of 1954. In lieu of certification by a
certified public accountant, the DISC may attach to its return a
statement signed by the borrower under penalties of perjury on a form
provided by the Internal Revenue Service certifying that the borrower
has complied with the limitation and increased investment requirement in
section 993(d) (2) and (3) of the Internal Revenue Code of 1954. For
taxable years ending after October 17, 1977, the DISC must attach either
the certification by the certified public accountant or the
certification by the borrower to its return. Additional full
substantiation of the borrower's compliance with the requirements of
such paragraphs may be required by the district director. If full
substantiation of such compliance is not provided by the DISC (or the
borrower) when required, the loan shall be deemed not to be a producer's
loan.
(e) Special limitation in the case of domestic film maker -- (1)
General rule. The limitation of paragraph (b) of this section as to the
export-related assets of the borrower will be considered satisfied if
the DISC --
(i) Is engaged in the trade or business of selling or leasing films
which are export property, or is acting as a commission agent for a
person who is so engaged,
(ii) Makes a loan to a borrower which is a domestic film maker (as
defined in subparagraph (5) of this paragraph) for the purpose of making
a film, and
(iii) The amount of such loan, when added to the unpaid balance of
all other producer's loans made by all DISC's to the borrower which are
outstanding at the time the loan is made, does not exceed an amount
determined by multiplying --
(a) The sum of (1) the amount of the export-related assets of the
borrower (determined under paragraph (b)(2)(i) of this section as of the
beginning of the borrower's taxable year in which the loan is made),
plus (2) the amount of a reasonable estimate of the amount of such
export related assets obtained or to be obtained by the borrower during
such year and subsequent years with respect to films as to which filming
begins within such year by
(b) The percentage which, based on the experience of other film
makers of similar films for the 5 calendar years preceding the calendar
year in which the loan is made, the annual gross receipts (as described
in 1.993-6(a)(1), whether or not such films constitute property
described therein) of such other film makers from the sale or lease of
such films outside the United States is of the annual gross receipts of
such other film makers from all sales or leases of such films.
(2) Purpose of loan. A loan by a DISC will be deemed to be for the
making of a film if there exists a written agreement between the DISC
and the borrower, executed at or before the time the loan is made,
stating that the loan is made or to be made to enable the borrower to
make such film.
(3) Reasonable estimate of amounts. For purposes of subparagraph
(1)(iii)(a)(2) of this paragraph, a reasonable estimate shall be based
on the conditions known by the DISC and borrower to exist at the time a
loan is made (or which the DISC and borrower have reason to know to
exist at such time).
(4) Experience of film makers. For purposes of subparagraph
(1)(iii)(b) of this paragraph, the experience of other film makers of
similar films for the 5 calendar years preceding the calendar year in
which the loan is made shall be derived from such records and statistics
as are acknowledged in the trade as reasonably reliable.
(5) Domestic film maker. For purposes of this section, a borrower is
a domestic film maker with respect to a film if --
(i) The borrower is a U.S. person within the meaning of section
7701(a)(30), except that (a) with respect to a partnership all of the
partners must be U.S. persons and (b) with respect to a corporation all
of its officers and at least a majority of its directors must be U.S.
persons,
(ii) The borrower is engaged in the trade or business of making the
film with respect to which the loan is made,
(iii) Each studio, if any, used or to be used for filming or for
recording sound incorporated into such film is located in the United
States (as defined in section 7701(a)(9)),
(iv) At least 80 percent of the aggregate playing time of the film is
or will be photographed within the United States (as defined in section
7701(a)(9)), and
(v) At least 80 percent of the total amount (not including any amount
which is contingent upon receipts or profits of such film and which is
fully taxable by the United States) paid or to be paid for services
performed in the making of the film is either paid or to be paid to
persons who are U.S. persons at the time such services are performed or
consists of amounts which are fully taxable by the United States.
(6) Amounts as fully taxable. For purposes of subparagraph (5)(v) of
this paragraph, an amount is considered fully taxable by the United
States if the entire amount is included in gross income under section 61
or is subject to withholding under any provision of U.S. law or treaty
to which the U.S. is a party and is not exempt from taxation under any
provision of such law or treaty. Where a nonresident alien individual
is engaged for the making of a film or where a foreign corporation is
engaged to furnish the services of one of its officers or employees for
the making of a film, the amount paid such individual or corporation
will be considered as fully taxable by the United States only if it
meets the test of this subparagraph.
(T.D. 7514, 42 FR 55464, Oct. 17, 1977, as amended by T.D. 7513, 42
FR 57311, Nov. 2, 1977; T.D. 7514, 42 FR 60910, Nov. 30, 1977; T.D.
7854, 47 FR 51741, Nov. 17, 1982)
26 CFR 1.993-5 Definition of related foreign export corporation.
(a) General rule -- (1) Definition. Under section 993(e), a foreign
corporation is a related foreign export corporation with respect to a
DISC if --
(i) It is a foreign international sales corporation described in
paragraph (b) of this section,
(ii) It is a real property holding company described in paragraph (c)
of this section, or
(iii) It is an associated foreign corporation described in paragraph
(d) of this section.
(2) Application of this section. It is necessary to determine
whether a foreign corporation is a related foreign export corporation
with respect to a DISC for the following two purposes:
(i) Qualified export assets. Under 1.993-2(g), the stock or
securities of a related foreign export corporation held by the DISC are
qualified export assets.
(ii) Qualified export receipts. Under 1.993-1 (e), (f), and (g),
certain receipts of the DISC with respect to stock or securities of a
related foreign export corporation held by the DISC are qualified export
receipts.
(b) Foreign international sales corporation -- (1) In general. A
foreign corporation is a foreign international sales corporation with
respect to a taxable year of a DISC if --
(i) On each day during such taxable year of the DISC on which the
foreign corporation has stock issued and outstanding, the DISC owns
directly stock of the foreign corporation possessing more than 50
percent of the total combined voting power of all classes of stock of
the foreign corporation entitled to vote as determined under the
principles of 1.957-1(b) (relating to definition of controlled foreign
corporation),
(ii) 95 percent or more of such foreign corporation's gross receipts
(as defined in 1.993-6) for its taxable year ending with or within such
taxable year of the DISC consists of qualified export receipts described
in 1.993-1 (b) through (e) or interest described in 1.993-1(g) derived
from any obligations described in 1.993-2 (d) or (e), and
(iii) The sum of the adjusted bases of the assets of the foreign
corporation which are qualified export assets described in 1.993-2 (b)
through (e) and which are held by the foreign corporation at the close
of its taxable year which ends with or within such taxable year of the
DISC equals or exceeds 95 percent of the sum of the adjusted bases of
all assets held by the foreign corporation at the close of such taxable
year.
(2) Certain determinations. The determinations as to whether gross
receipts are qualified export receipts described in subparagraph (1)(ii)
of this paragraph and as to whether assets are qualified export assets
described in subparagraph (1)(iii) of this paragraph are made by
applying the requirements of 1.993-1 and 1.993-2 to the foreign
corporation as if it were a domestic corporation being tested to
determine whether it is a DISC. For purposes of making either of such
determinations, the principles of accounting applicable for purposes of
computing earnings and profits under 1.964-1 (relating to a controlled
foreign corporation's earnings and profits) shall apply.
(c) Real property holding company -- (1) In general. A foreign
corporation is a real property holding company with respect to a taxable
year of a DISC if --
(i) On each day during such taxable year of the DISC on which the
foreign corporation has stock issued and outstanding, the DISC owns
directly stock of the foreign corporation possessing more than 50
percent of the total combined voting power of all classes of stock of
the foreign corporation entitled to vote as determined under the
principles of 1.957-1(b) and
(ii) The sole function of the foreign corporation is to hold title to
real property situated outside the United States for the exclusive use
of the DISC, title to which may not be held by the DISC (and, if the
DISC subleases such property to a related supplier, as described in
subparagraph (3) of this paragraph, by such related supplier) under the
law of the country in which such property is situated.
(2) Activities of the foreign corporation. For purposes of
subparagraph (1)(ii) of this paragraph, a foreign corporation which
holds title to real property situated outside the United States may also
perform activities with respect to such property (such as management,
maintenance, and payment of taxes) which are ancillary to its function
of holding title to such property.
(3) Exclusive use by the DISC. Real property held by the foreign
corporation must be used exclusively by the DISC whether under a lease
or any other arrangement. Real property is not so used by the DISC if
the DISC subleases such property to any other person. If, however,
during a taxable year of the DISC --
(i) 90 percent or more of the qualified export receipts of the DISC
for such year are derived from transactions with respect to which it is
a commission agent for a related supplier (as defined in
1.994-1(a)(3)(ii)), and
(ii) The DISC subleases such property to such related supplier
then such property will be considered as used exclusively by the DISC
during such year if such related supplier does not sublease such
property.
(d) Associated foreign corporation -- (1) In general. A foreign
corporation is an associated foreign corporation with respect to a
taxable year of the DISC if --
(i) On each day during such taxable year of the DISC on which the
foreign corporation has stock issued and outstanding, the DISC, or one
or more members of the same controlled group of corporations (as defined
in subparagraph (2) of this paragraph) as the DISC, owns (within the
meaning of section 1563 (d) and (e)) stock of the foreign corporation
possessing less than 10 percent of the total combined voting power of
all classes of stock of the foreign corporation entitled to vote, as
determined under the principles of 1.957-1(b), or owns no stock of such
corporation, and
(ii) The ownership of stock, or of securities (as defined in
1.993-2(g)), of the foreign corporation by the DISC or by one or more
members of such controlled group of corporations reasonably furthers a
transaction or transactions giving rise to qualified export receipts for
the DISC.
(2) Controlled group of corporations. For purposes of this
paragraph, the term ''controlled group of corporations'' has the same
meaning assigned to the term in section 1563(a) and not section
993(a)(3) and 1.993-1(k). Thus, for purposes of this paragraph, the
test of control is 80 percent control and, since the rules of section
1563(b) apply, only domestic members are considered to be members of the
controlled group.
(3) Furtherance of qualified export receipts. Ownership of stock or
securities of a foreign corporation will be considered as reasonably
furthering a transaction or transactions giving rise to qualified export
receipts for a DISC if --
(i) The ownership is necessary to obtain or maintain the foreign
corporation as a customer of the DISC or of a related supplier, as
defined in 1.994-1(a)(3)(ii) of the DISC or to aid the sales
distribution system of the DISC or of such related supplier, and
(ii) The amount of the investment in the foreign corporation bears a
reasonable relationship to the amount of the DISC's annual net profit
from transactions in its trade or business which it may reasonably
expect to derive on account of such ownership.
In determining whether the amount of the investment is reasonable,
there shall be taken into account any stock or securities of the foreign
corporation owned by any other foreign corporation which, if it were a
domestic corporation, would be a member of the same controlled group of
corporations as the DISC.
(T.D. 7514, 42 FR 55467, Oct. 17, 1977; 42 FR 60910, Nov. 30, 1977)
26 CFR 1.993-6 Definition of gross receipts.
(a) General rule. Under section 993(f), for purposes of sections 991
through 996, the gross receipts of a person for a taxable year are --
(1) The total amounts received or accrued by the person from the sale
or lease of property held primarily for sale or lease in the ordinary
course of a trade or business, and
(2) Gross income recognized from all other sources, such as, for
example, from --
(i) The furnishing of services (whether or not related to the sale or
lease of property described in subparagraph (1) of this paragraph),
(ii) Dividends and interest,
(iii) The sale at a gain of any property not described in
subparagraph (1) of this paragraph, and
(iv) Commission transactions as and to the extent described in
paragraph (e) of this section.
(b) Nongross receipts items. For purposes of paragraph (a) of this
section, gross receipts do not include amounts received or accrued by a
person from --
(1) The proceeds of a loan or of the repayment of a loan, or
(2) A receipt of property in a transaction to which section 118
(relating to contribution to capital) or 1032 (relating to exchange of
stock for property) applies.
(c) Nonreduction of total amounts. For purposes of paragraph (a) of
this section, the total amounts received or accrued by a person are not
reduced by returns and allowances, costs of goods sold, expenses,
losses, a deduction for dividends received under section 243, or any
other deductible amounts.
(d) Method of accounting. For purposes of paragraph (a) of this
section, the total amounts received or accrued by a person shall be
determined under the method of accounting used in computing its taxable
income. If, for example, a DISC receives advance or installment
payments for the sale or lease of property described in paragraph (a)(1)
of this section, for the furnishing of services, or which represent
recognized gain from the sale of property not described in paragraph
(a)(1) of this section, any amount of such advance payments is
considered to be gross receipts of the DISC for the taxable year for
which such amount is included in the gross income of the DISC.
(e) Commission transactions. (1) In the case of transactions which
give rise to a commission on the sale or lease of property or the
furnishing of services by a principal, the amount recognized by the
commission agent as gross income from all such transactions shall be the
gross receipts derived by the principal from the sale or lease of the
property, or the gross income derived by the principal from the
furnishing of services, with respect to which the commissions are
derived. In the case of a commission agent for a related supplier (as
defined in 1.994-1(a)(3)(ii)), the gross receipts or gross income of
such agent shall be determined as if it used the same method of
accounting as its related supplier. In the case of a commission agent
for a principal other than a related supplier, the gross receipts or
gross income of such principal shall be determined as if such principal
used the same method of accounting as its agent.
(2) If the commission arrangement provides that the commission agent
will receive a commission only with respect to sales or leases of export
property, or the furnishing of services, which result in qualified
export receipts, the commission agent will not take into account the
gross receipts or gross income, as the case may be, derived by the
principal from any transaction for which the commission agent would not
be entitled to a commission under the commission arrangement.
(f) Example. The provisions of this section may be illustrated by
the following example:
Example. During 1973, M, a related supplier (as defined in
1.994-1(a)(3)(ii)) of N, is engaged in the manufacture of machines in
the United States. N, a calendar year taxpayer, is engaged in the sale
and lease of such machines in foreign countries. N furnishes services
which are related and subsidiary to its sale and lease of such machines.
N also acts as a commission agent in foreign countries for Z, an
unrelated supplier, with respect to Z's sale of products. N receives
dividends on stock owned by it in a related foreign export corporation
(as defined in 1.993-5), interest on producer's loans made to M, and
proceeds from sales of business assets located outside the United States
resulting in a recognized gains and losses. N's gross receipts for 1973
are $3,550, computed on the basis of the additional facts assumed in the
table below:
(T.D. 7514, 42 FR 55468, Oct. 17, 1977)
26 CFR 1.993-7 Definition of United States.
Under section 993(g), the term ''United States'' includes the States,
the District of Columbia, the Commonwealth of Puerto Rico, and
possessions of the United States. For the requirement that a DISC must
be incorporated and existing under the laws of a State or the District
of Columbia, see 1.992-1(a)(1).
(T.D. 7514, 42 FR 55468, Oct. 17, 1977)
26 CFR 1.994-1 Inter-company pricing rules for DISC's.
(a) In general -- (1) Scope. In the case of a transaction described
in paragraph (b) of this section, section 994 permits a person related
to a DISC to determine the allowable transfer price charged the DISC (or
commission paid the DISC) by its choice of three methods described in
paragraph (c) (2), (3), and (4) of this section: The ''4 percent''
gross receipts method, the ''50-50'' combined taxable income method, and
the section 482 method. Under the first two methods, the DISC is
entitled to 10 percent of its export promotion expenses as additional
taxable income. When the gross receipts method or combined taxable
income method is applied to a transaction, the Commissioner may not make
distributions, apportionments, or allocations as provided by section 482
and the regulations thereunder. For rules as to certain ''incomplete
transactions'' and for computing combined taxable income, see paragraph
(c) (5) and (6) of this section. Grouping of transactions for purposes
of applying the method chosen is provided by paragraph (c)(7) of this
section. The rules in paragraph (c) of this section are directly
applicable only in the case of sales or exchanges of export property to
a DISC for resale, and are applicable by analogy to leases, commissions,
and services as provided in paragraph (d) of this section. For rules
limiting the application of the gross receipts method and combined
taxable income method so that the supplier related to the DISC will not
incur a loss on transactions, see paragraph (e)(1) of this section.
Paragraph (e)(2) of this section provides for the applicability of
section 482 to resales by the DISC to related persons. Paragraph (e)(3)
of this section provides for the time by which a reasonable estimate of
the transfer price (including commissions and other payments) should be
paid. The subsequent determination and further adjustments to transfer
prices are set forth in paragraph (e)(4) of this section. Export
promotion expenses are defined in paragraph (f) of this section.
Paragraph (g) of this section has several examples illustrating the
provisions of this section. Section 1.994-2 prescribes the marginal
costing rules authorized by section 994(b)(2).
(2) Performance of substantial economic functions. The application
of section 994(a)(1) or (2) does not depend on the extent to which the
DISC performs substantial economic functions (except with respect to
export promotion expenses). See paragraph (l) of 1.993-1.
(3) Related party and related supplier. For the purposes of this
section --
(i) The term ''related party'' means a person which is owned or
controlled directly or indirectly by the same interests as the DISC
within the meaning of section 482 and 1.482-1(a).
(ii) The term ''related supplier'' means a related party which singly
engages in a transaction directly with the DISC which is subject to the
rules of section 994 and this section. However, a DISC may have
different related suppliers with respect to different transactions. If,
for example, X owns all the stock of Y, a corporation, and of Z, a DISC,
and sells a product to Y which is resold to Z, only Y is the related
supplier of Z, and, thus, only the resale from Y to Z is subject to
section 994 and this section. If, however, X sells directly to Z and Y
also sells directly to Z, then, as to the transactions involving direct
sales to Z, each of X and Y is a related supplier of Z.
(b) Transactions to which section 994 applies. Section 994(a)(3) may
be applied, as described in paragraph (a) of this section, to any
transaction between a related supplier and a DISC. Section 994(a) (1)
or (2) may be applied, as described in paragraph (a) of this section, to
a transaction between a related supplier and a DISC only in the
following cases:
(1) Where the related supplier sells export property to the DISC for
resale or where the DISC is commission agent for the related supplier on
sales by the related supplier of export property to third parties
whether or not related parties. For purposes of this section,
references to sales include exchanges.
(2) Where the related supplier leases export property to the DISC for
sublease for a comparable period with comparable terms of payment or
where the DISC is commission agent for the related supplier on leases by
the related supplier of export property to third parties whether or not
related parties.
(3) Where services are furnished by a related supplier which are
related and subsidiary to any sale or lease by the DISC, acting as
principal or commission agent, of export property under subparagraph (1)
or (2) of this paragraph.
(4) Where engineering or architectural services for construction
projects located (or proposed for location) outside of the United States
are furnished by a related supplier where the DISC is acting as
principal or commission agent with respect to the furnishing of such
services to a third party whether or not a related party.
(5) Where the related supplier furnishes managerial services in
furtherance of the production of qualified export receipts of an
unrelated DISC where the related DISC is acting as principal or
commission agent with respect to the furnishing of such services to an
unrelated DISC.
Transactions are included, for purposes of this paragraph, only if
they give rise to qualified export receipts (within the meaning of
section 993(a)) in the hands of the related DISC. If a transaction is
not included in subparagraph (1), (2), (3), (4), or (5) of this
paragraph, the rules of section 994(a) (1) or (2) do not apply. Thus,
for example, the rules of sectoin 994(a) (1) or (2) would not apply if a
DISC purchased export property from its related supplier and leased such
property to a third party.
(c) Transfer price for sales of export property -- (1) In general.
Under this paragraph, rules are prescribed for computing the allowable
price for a transfer from a related supplier to a DISC in the case of a
sale of export property described in paragraph (b)(1) of this section.
(2) The ''4-percent'' gross receipts method. Under the gross
receipts method of pricing, the transfer price for a sale by the related
supplier to the DISC is the price as a result of which the taxable
income derived by the DISC from the sale will not exceed the sum of (i)
4 percent of the qualified export receipts of the DISC derived from the
sale of the export property (as defined in section 993 (c)) and (ii) 10
percent of the export promotion expenses (as defined in paragraph (f) of
this section) of the DISC attributable to such qualified export
receipts.
(3) The ''50-50'' combined taxable income method. Under the combined
taxable income method of pricing, the transfer price for a sale by the
related supplier to the DISC is the price as a result of which the
taxable income derived by the DISC from the sale will not exceed the sum
of (i) 50 percent of the combined taxable income (as defined in
subparagraph (6) of this paragraph) of the DISC and its related supplier
attributable to the qualified export receipts from such sale and (ii) 10
percent of the export promotion expenses (as defined in paragraph (f) of
this section) of the DISC attributable to such qualified export
receipts.
(4) Section 482 method. If the rules of subparagraphs (2) and (3) of
this paragraph are inapplicable to a sale or a taxpayer does not choose
to use them, the transfer price for a sale by the related supplier to
the DISC is to be determined on the basis of the sale price actually
charged but subject to the rules provided by section 482 and the
regulations thereunder.
(5) Incomplete transactions. (i) For purposes of the gross receipts
and combined taxable income methods, where property (encompassed within
a transaction or group chosen under subparagraph (7) of this paragraph)
is transferred by a related supplier to a DISC during a taxable year of
either the DISC or related supplier, but some or all of such property is
not sold by the DISC during such year --
(a) The transfer price of such property sold by the DISC during such
year shall be computed separately from the transfer price of the
property not sold by the DISC during such year,
(b) With respect to such property not sold by the DISC during such
year, the transfer price paid by the DISC for such year shall be the
related supplier's cost of goods sold (see subparagraph (6)(ii) of this
paragraph) with respect to the property, except that, with respect to
such taxable years ending on or before August 15, 1975, the transfer
price paid by the DISC shall be at least (but need not exceed) the
related supplier's cost of goods sold with respect to the property.
(c) For the subsequent taxable year during which such property is
resold by the DISC, an additional amount shall be paid by the DISC (to
be treated as income for such year by the related supplier) equal to the
excess of the amount which would have been the transfer price under this
section had the transfer to the DISC by the related supplier and the
resale by the DISC taken place during the taxable year of the DISC
during which it resold the property over the amount already paid under
(b) of this subdivision.
(d) The time and manner of payment of transfer prices required by (b)
and (c) of this subdivision shall be determined under paragraph (e) (3),
(4), and (5) of this section.
(ii) For purposes of this paragraph, a DISC may determine the year in
which it receives property from a related supplier and the year in which
it sells property in accordance with the method of identifying goods in
its inventory properly used under section 471 or 472 (relating
respectively to general rule for inventories and to LIFO inventories).
Transportation expense of the related supplier in connection with a
transaction to which this subparagraph applies shall be treated as an
item of cost of goods sold with respect to the property if the related
supplier includes the cost of intracompany transportation between its
branches, divisions, plants, or other units in its cost of goods sold
(see subparagraph (6)(ii) of this paragraph).
(6) Combined taxable income. For purposes of this section, the
combined taxable income of a DISC and its related supplier from a sale
of export property is the excess of the gross receipts (as defined in
section 993(f)) of the DISC from such sale over the total costs of the
DISC and related supplier which relate to such gross receipts. Gross
receipts from a sale do not include interest with respect to the sale.
Combined taxable income under this paragraph shall be determined after
taking into account under paragraph (e)(2) of this section all
adjustments required by section 482 with respect to transactions to
which such section is applicable. In determining the gross receipts of
the DISC and the total costs of the DISC and related supplier which
relate to such gross receipts, the following rules shall be applied:
(i) Subject to subdivisions (ii) through (v) of this subparagraph,
the taxpayer's method of accounting used in computing taxable income
will be accepted for purposes of determining amounts and the taxable
year for which items of income and expense (including depreciation) are
taken into account. See 1.991-1(b)(2) with respect to the method of
accounting which may be used by a DISC.
(ii) Cost of goods sold shall be determined in accordance with the
provisions of 1.61-3. See sections 471 and 472 and the regulations
thereunder with respect to inventories. With respect to property to
which an election under section 631 applies (relating to cutting of
timber considered as a sale or exchange), cost of goods sold shall be
determined by applying 1.631-1 (d)(3) and (e) (relating to fair market
value as of the beginning of the taxable year of the standing timber cut
during the year considered as its cost).
(iii) Costs (other than cost of goods sold) which shall be treated as
relating to gross receipts from sales of export property are (a) the
expenses, losses, and other deductions definitely related, and therefore
allocated and apportioned, thereto, and (b) a ratable part of any other
expenses, losses, or other deductions which are not definitely related
to a class of gross income, determined in a manner consistent with the
rules set forth in 1.861-8.
(iv) The taxpayer's choice in accordance with subparagraph (7) of
this paragraph as to the grouping of transactions shall be controlling,
and costs deductible in a taxable year shall be allocated and
apportioned to the items or classes of gross income of such taxable year
resulting from such grouping.
(v) If an account receivable arising with respect to a sale of export
property is transferred by the related supplier to a DISC which is a
member of the same controlled group within the meaning of 1.993-1(k)
for an amount reflecting a discount from the selling price taken into
account in computing (without regard to this subdivision) combined
taxable income of the DISC and its related supplier, then the combined
taxable income from such sale shall be reduced by the amount of the
discount.
(7) Grouping transactions. (i) Generally, the determinations under
this section are to be made on a transaction-by-transaction basis.
However, at the annual choice of the taxpayer some or all of these
determinations may be made on the basis of groups consisting of products
or product lines.
(ii) A determination by a taxpayer as to a product or a product line
will be accepted by a district director if such determination conforms
to any one of the following standards: (a) A recognized industry or
trade usage, or (b) the 2-digit major groups (or any inferior
classifications or combinations thereof, within a major group) of the
Standard Industrial Classification as prepared by the Statistical Policy
Division of the Office of Management and Budget, Executive Office of the
President.
(iii) A choice by the taxpayer to group transactions for a taxable
year on a product or product line basis shall apply to all transactions
with respect to that product or product line consummated during the
taxable year. However, the choice of a product or product line grouping
applies only to transactions covered by the grouping and, as to
transactions not encompassed by the grouping, the determinations are
made on a transaction-by-transaction basis. For example, the taxpayer
may choose a product grouping with respect to one product and use the
transaction-by-transaction method for another product within the same
taxable year.
(iv) For rules as to grouping certain related and subsidiary
services, see paragraph (d)(3)(ii) of this section.
(d) Rules under section 994(a) (1) and (2) for transactions other
than sales. The following rules are prescribed for purposes of applying
the gross receipts method or combined taxable income method to
transactions other than sales:
(1) Leases. In the case of a lease of export property by a related
supplier to a DISC for sublease by the DISC to produce gross receipts,
for any taxable year the amount of rent the DISC must pay to the related
supplier shall be determined under the DISC's lease with its related
supplier but must be computed in a manner consistent with the rules in
paragraph (c) of this section for computing the transfer price in the
case of sales and resales of export property under the gross receipts
method or combined taxable income method. For purposes of applying this
subparagraph, transactions may not be so grouped on a product or product
line basis under the rules of paragraph (c)(7) of this section as to
combine in any one group of transactions both lease transactions and
sale transactions involving the same product or product line.
(2) Commissions. If any transaction to which section 994 applies is
handled on a commission basis for a related supplier by a DISC and such
commissions give rise to qualified export receipts under section 993(a)
--
(i) The amount of the income that may be earned by the DISC in any
year is the amount, computed in a manner consistent with paragraph (c)
of this section, which the DISC would have been permitted to earn under
the gross receipts method, the combined taxable income method, or
section 482 method if the related supplier had sold (or leased) the
property or service to the DISC and the DISC in turn sold (or subleased)
to a third party, whether or not a related party, and
(ii) The maximum commission the DISC may charge the related supplier
is the sum of the amount of income determined under subdivision (i) of
this subparagraph plus the DISC's total costs for the transaction as
determined under paragraph (c)(6) of this section.
(3) Receipts from services -- (i) Related and subsidiary services
attributable to the year of the export transaction. The gross receipts
for related and subsidiary services described in paragraph (b)(3) of
this section shall be treated as part of the receipts from the export
transaction to which such services are related and subsidiary, but only
if, under the arrangement between the DISC and its related supplier and
the accounting method otherwise employed by the DISC, the income from
such services is includible for the same taxable year as income from
such export transaction.
(ii) Other services. In the case of related and subsidiary services
to which subdivision (i) of this subparagraph does not apply and other
services described in paragraph (b) (4) or (5) of this section performed
by a related supplier (relating respectively to engineering and
architectural services and certain managerial services), the amount of
taxable income which the DISC may derive for any taxable year shall be
determined under the arrangement between the DISC and its related
supplier and shall be computed in a manner consistent with the rules in
paragraph (c) of this section for computing the transfer price in the
case of sales for resale of export property under the gross receipts
method or combined taxable income method. Related and subsidiary
services to which subdivision (i) of this subparagraph does not apply
may be grouped, under the rules for grouping of transactions in
paragraph (c)(7) of this section, with the products or product lines to
which they are related and subsidiary, so long as the grouping of
services chosen is consistent with the grouping of products or product
lines chosen for the taxable year in which either the product or product
lines were sold or in which payment for such services is received or
accrued. The rules for grouping of transactions in paragraph (c)(7) of
this section shall not apply with respect to the determination of
taxable income which the DISC may derive from other services described
in paragraph (b) (4) or (5) of this section performed by a related
supplier or commissions on such services, and such determination shall
be made only on a transaction-by-transaction basis.
(e) Methods of applying paragraphs (c) and (d) of this section -- (1)
Limitation on DISC income (''no loss'' rule) -- (i) In general. Except
as otherwise provided in this subparagraph, neither the gross receipts
method nor the combined taxable income method may be applied to cause in
any taxable year a loss to the related supplier, but either method may
be applied to the extent it does not cause a loss. A loss to a related
supplier would result if the taxable income of the DISC would exceed the
combined taxable income of the related supplier and the DISC. If,
however, there is no combined taxable income of the DISC and the related
supplier (because, for example, a combined loss is incurred), a transfer
price (or commission) will not be deemed to cause a loss to the related
supplier if it allows the DISC to recover an amount not in excess of its
costs (if any).
(ii) Special rule for applying ''4 percent'' gross receipts method to
sales. A transfer price or commission, determined under the ''4
percent'' gross receipts method (determined without regard to
subdivision (i) of this subparagraph), for a sale of export property
referred to in paragraph (b)(1) of this section, will not be considered
to cause a loss for the related supplier if for the DISC's taxable year,
the ratio that (a) the taxable income of the DISC derived from such sale
by using such price or commission bears to (b) the DISC's gross receipts
from such sale is not greater than the ratio that (c) all of the taxable
income of the related supplier and the DISC from all sales of the same
product or product line (domestic and foreign) to third parties whether
or not related parties bears to (d) the total gross receipts of the
related supplier and the DISC from such sales. For purposes of the
preceding sentence, sales between the DISC and its related suppliers
shall not be taken into account under (c) or (d) of this subdivision.
For example, assume that for a taxable year of a DISC the total costs of
the related supplier and the DISC with respect to all sales ($150 for
domestic and $44 for foreign) of a product line are $194 and the total
gross receipts of the related supplier and the DISC with respect to such
sales are $200 so that the total taxable income of the related supplier
and the DISC with respect to such sales is $6. The parties would thus
be entitled to compute a transfer price determined under the gross
receipts method on any given sale of product A of such product line by
the related supplier to the DISC which would allocate to the DISC
taxable income equal to not more than 3 percent (i.e., $6/$200) of its
gross receipts derived from its resale of such product. If the DISC
were to resell an item of product A for $10, the transfer price paid by
the DISC to the related supplier determined under the gross receipts
method could be as low as $9.70.
(iii) Grouping transactions. For purposes of subdivision (i) of this
subparagraph, the basis for grouping transactions chosen by the taxpayer
under paragraph (c)(7) of this section for the taxable year shall be
applied. For purposes of making the computations of subdivision (ii)
(c) and (d) of this subparagraph, however, the taxpayer may choose any
basis for grouping transactions permissible under paragraph (c)(7) of
this section, even though it may not be the same basis as that already
chosen under paragraph (c)(7) of this section for computing transfer
prices or commissions to a DISC. If, for example, the taxpayer has
chosen to group transactions on a product basis for computing transfer
prices or commissions to a DISC for a taxable year, the taxpayer may
still group transactions on a product line basis for purposes of
computing taxable income and total gross receipts under subdivision (ii)
(c) and (d) of this subparagraph. For a further example, if the
taxpayer computes taxable income for one group of transactions under the
gross receipts method and computes taxable income for a second group of
transactions under the combined taxable income method, the taxpayer may
aggregate these transactions for purposes of computing taxable income
and total gross receipts under subdivision (ii) (c) and (d) of this
subparagraph.
(2) Relationship to section 482. In applying the rules under section
994, it may be necessary to first take into account the price of a
transfer (or other transaction) between the DISC (or related supplier)
and a related party which is subject to the arm's length standard of
section 482. Thus, for example, where a related supplier sells export
property to a DISC which the related supplier purchased from related
parties, the costs taken into account in computing the combined taxable
income of the DISC and the related supplier are determined after any
necessary adjustment under section 482 of the price paid by the related
supplier to the related parties. In applying section 482 to a transfer
by a DISC, however, the DISC and its related supplier are treated as if
they were a single entity carrying on all the functions performed by the
DISC and the related supplier with respect to the transaction and the
DISC shall be allowed to receive under the section 482 standard the
amount the related supplier would have received had there been no DISC.
(3) Initial payment of transfer price or commission. (i) The amount
of a transfer price (or reasonable estimate thereof) actually charged by
a related supplier to a DISC, or a sales commission (or reasonable
estimate thereof) actually charged by a DISC to a related supplier, in a
transaction to which section 994 applies must be paid no later than 60
days following the close of the taxable year of the DISC during which
the transaction occurred.
(ii) Payment must be in the form of money, property (including
accounts receivable from sales by or through the DISC), a written
obligation which qualifies as debt under the safe harbor rule of
1.992-1(d)(2)(ii), or an accounting entry offsetting the account
receivable against an existing debt owed by the person in whose favor
the account receivable was established to the person with whom it
engaged in the transaction. The form of the payment to a DISC need not
be a qualified export asset under 1.993-2. However, for the requirement
that the adjusted basis of the qualified export assets of the DISC at
the close of its taxable year must equal or exceed 95 percent of the sum
of the adjusted bases of all assets of the DISC at the close of its
taxable year, see section 992(a)(1)(B).
(iii) If the district director can demonstrate, based upon the data
available as of the 60th day after the close of such taxable year, that
the amount actually paid did not represent a reasonable estimate of the
transfer price or commission (as the case may be) to be determined under
section 994 and this section, an indebtedness will be deemed to arise,
from the person required to make the payment in favor of the person to
whom the payment is required to be made, in an amount equal to the
difference between the amount of the transfer price or commission
determined under section 994 and this section and the amount (if any)
actually paid and received. Such indebtedness will be deemed to arise
as of the date the transaction occurred which gave rise to the
indebtedness, except that, if such transaction occurred in a taxable
year of the DISC ending on or before August 15, 1975, at the taxpayer's
option, the indebtedness will be deemed to arise as of the date by which
payment was required under subdivision (i) of this paragraph (e)(3).
Such indebtedness owed to a DISC shall be treated as an asset but shall
not be treated as a trade receivable or other qualified export asset
(see 1.993-2(d)(3)) as of the end of the taxable year of the DISC in
which the indebtedness is deemed to arise.
(iv)(a) Except with respect to incomplete transactions to which
paragraph (c)(5)(i)(b) of this section applies, if the amount actually
paid results in the DISC realizing at least 50 percent of the DISC's
taxable income from the transaction as reported in its tax return for
the taxable year the transaction is completed, then the amount actually
paid shall be deemed to be a reasonable estimate of such transfer price
or commission.
(b) With respect to incomplete transactions to which paragraph
(c)(5)(i)(b) of this section applies and which were initiated during a
taxable year ending after August 15, 1975, the amount actually paid
shall be deemed to be a reasonable estimate of such transfer price if
any one of the following three tests is met:
(1) The amount actually paid by the DISC to the related supplier in
respect of the property does not exceed the related supplier's cost of
goods sold (see paragraph (c)(6)(ii) of this section) with respect to
the property.
(2) If the transaction is completed by the date on which the DISC's
return is required to be filed for the year in which the transaction was
initiated, the amount actually paid by the DISC to the related supplier
in respect of the property results in the DISC realizing at least 50
percent of the DISC's taxable income from the transaction when
completed.
(3) The percentage that (i) an amount equal to (a) the amount
actually paid by the DISC to the related supplier in respect of the
property minus (b) the related supplier's cost of goods sold with
respect to the property, bears to (ii) the related supplier's cost of
goods sold in respect of the property, is not greater than 50 percent of
the percentage that (iii) the combined taxable income for completed
transactions of the same group as the property during the DISC's taxable
year in which the incomplete transaction was initiated, bears to (iv)
the cost of goods sold of the related supplier and DISC with respect to
such transactions.
(c) For purposes of this subdivision (iv), whether the transfer price
or commission actually paid is deemed a reasonable estimate may be
determined on the basis for grouping transactions chosen by the taxpayer
under paragraph (c) (5) and (7) of this section.
(v) An indebtedness arising under subdivision (iii) of this
subparagraph shall bear interest at an arm's length rate, computed in
the manner provided by 1.482-2(a)(2) from the 61st day after the close
of the DISC's taxable year in which the transaction occurred which gave
rise to the indebtedness to the date of payment. The interest so
computed shall be accrued and included in the taxable income of the
person to whom the indebtedness is owed for each taxable year during
which the indebtedness is unpaid.
(4) Subsequent determination of transfer price or commission. The
DISC and its related supplier would ordinarily determine under section
994 and this section the transfer price payable by the DISC (or the
commission payable to the DISC) for a transaction before the DISC files
its return for the taxable year of the transaction. After the DISC has
filed its return, a redetermination of the transfer price (or
commission) may only be made if permitted by the Code and the
regulations thereunder. Such a redetermination would include a
redetermination by reason of an adjustment under section 482 and the
regulations thereunder or section 861 and 1.861-8 which affects the
amounts which entered into the determination of the transfer price or
commission.
(5) Procedure for adjustments to transfer price or commission.
(i)(a) If the transfer price (or commission) for a transaction
determined under section 994 is different from the price (or commission)
actually charged, the person who received too small a transfer price (or
commission) or paid too large a transfer price (or commission) shall
establish (or be deemed to have established), at the date of the
determination or redetermination under subparagraph (4) of this
paragraph of the transfer price (or commission) under section 994, an
account receivable due the DISC from the person with whom it engaged in
the transaction equal to the difference in amount between the transfer
price (or commission) so determined and the transfer price (or
commission) previously paid and received. If the account receivable is
paid within 90 days after the date it is established (or deemed
established), then as of the end of the taxable year of the DISC in
which the transaction occurred which gave rise to the indebtedness, the
account receivable shall be treated as an asset and, under
1.993-2(d)(3) as a trade receivable, and thus as a qualified export
asset.
(b) If, for example, during 1972, a DISC which uses the calendar year
as its taxable year sold a product which it purchased that year from its
related supplier and paid a price of $10,000 which price is a reasonable
estimate under subparagraph (3)(iii) of this paragraph but is later
determined under section 994 to be $8,000 immediately before the DISC
filed its return for 1972, the DISC must be paid $2,000 (i.e.,
$10,000^$8,000) by its related supplier or establish an account
receivable from its related supplier of $2,000. The account receivable
may be paid without tax consequences, provided that such account
receivable is paid within 90 days after the date it is established (or
deemed established). Such account receivable paid within such 90 days
will be considered to relate to the taxable year in which the
transaction occurred which gave rise thereto rather than the taxable
year during which it is established or paid.
(ii) Payment must be in a form specified in subparagraph (3) of this
paragraph.
(iii) If an account receivable of a DISC described in subdivision (i)
of this paragraph (e)(5) is not paid within 90 days of the date it is
established (or deemed established), then, as of the end of the taxable
year of the DISC in which the transaction occurred which gives rise to
the indebtedness, the account receivable shall be treated as an asset
except that, if the account receivable is established (or deemed
established) in a taxable year of the DISC ending on or before August
15, 1975, at the taxpayer's option, the account receivable shall be
treated as an asset as of the end of such taxable year. However, under
1.993-2(d)(3), an account receivable referred to in the preceding
sentence shall not be treated as a trade receivable or other qualified
export asset.
(iv) An account receivable established in accordance with subdivision
(i) of this subparagraph shall bear interest at an arm's length rate,
computed in the manner provided by 1.482-2(a)(2) from the day after the
date the account receivable is deemed established to the date of
payment. The interest so computed shall be accrued and included in the
taxpayer's taxable income for each taxable year during which the account
receivable is outstanding.
(v) (a) In lieu of establishing an account receivable in accordance
with subdivision (i) of this subparagraph for all or part of an amount
due a related supplier, the related supplier and DISC are permitted to
treat all or part of any distribution which was made by the DISC out of
its previously taxed income with respect to the year to which the
determination or redetermination relates as an additional payment of
transfer price or repayment of commission (and not as a distribution)
made as of the date the distribution was made. Any additional amount
arising on the determination or redetermination due the related supplier
after this treatment shall be represented by an account receivable
established under subdivision (i) of this subparagraph. To the extent
that a distribution is so treated under this subdivision (v), it shall
cease to qualify as distribution for any Federal income tax purpose, and
the DISC's account for previously taxed income shall be adjusted
accordingly. If all or part of any distribution made to a shareholder
other than the related supplier is recharacterized under this
subdivision (v), the related supplier shall establish an account
receivable from that shareholder for the amount so recharacterized.
Such account receivable shall be paid in the time and manner set forth
in this paragraph (e)(5). In order to obtain the relief provided by
this subdivision (v), the conditions and procedures prescribed by
Revenue Procedure 84-3 must be met. The provisions of this paragraph
(e)(5)(v) shall apply to all open taxable years ending after December
31, 1971.
(b) If, for example, during 1982, a DISC commission from a related
supplier with respect to a transaction completed in 1980 was
redetermined to be $1,000 less than the commission actually charged by,
and paid to, the DISC, the amount of any distribution previously made by
the DISC from its 1980 previously taxed income to the related supplies
as a shareholder may, to the extent of $1,000, be treated not as a
distribution but as a repayment of the commission.
(vi) The procedure for adjustments to transfer price provided by this
subparagraph does not apply to incomplete transactions described in
paragraph (c)(5)(i)(b) of this section. Such procedure will, however,
be applied to any such transaction with respect to the taxable year in
which the transaction is completed.
(6) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. (i) During 1975, a DISC which uses the calendar year as
its taxable year purchased a product from its related supplier and made
an initial payment of $8,500. If $8,500 were determined to be the
transfer price under section 994, the DISC's taxable income from the
transaction would be $1,000. Immediately before the DISC filed its
return for 1975, under section 994 it is determined that the transfer
price is $8,000 and the DISC's taxable income is $1,500. Thus, the
requirement of a reasonable estimate under subparagraph (3) of this
paragraph was met because the amount ($8,500) actually paid resulted in
the DISC realizing taxable income of $1,000 which is not less than 50
percent of the DISC's taxable income ($1,500) from the transaction as
determined under section 994.
(ii) Pursuant to subparagraph (5) of this paragraph, an account
receivable due the DISC for $500, i.e., $8,500^$8,000, is established on
September 15, 1976, the date the DISC files its return for 1975, and is
paid on December 1, 1976. The account receivable for $500 will be
considered to relate to the taxable year (1975) in which the transaction
occurred which gave rise thereto and will be a qualified export asset
under 1.993-2(d)(3) for the last day of such year.
Example 2. Assume the same facts as in example 1 except that the
account receivable for $500 is paid on January 1, 1977. The account
receivable for $500 will still be considered to relate to the taxable
year (1975) in which the transaction occurred which gave rise thereto.
However, such account receivable will be treated as an asset which is
not a qualified export asset under 1.993-2(d)(3) for the last day of
such year.
(f) Export promotion expenses -- (1) Purpose of expense. (i) In
order for an expense or cost of a type described in subparagraph (2) of
this paragraph to be an export promotion expense, the expense or cost
must be incurred or treated as incurred by the DISC (under subparagraph
(7) of this paragraph) to advance the sale, lease, or other distribution
of export property for use, consumption, or distribution outside the
United States. Costs of services in performing installation (but not
assembly) on the site and for meeting warranty commitments if such
services are related and subsidiary (within the meaning of 1.993-1(d))
to any qualified sale, lease, or other distribution of export property
by the DISC (or with respect to which the DISC received a commission)
will be considered to advance the sale, lease, or other distribution of
export property. General and administrative expenses attributable to
billing customers, other clerical functions of the DISC, or generally
operating the DISC, will also be considered to advance the sale, lease,
or other distribution of export property. (ii) Where an expense or cost
incurred or treated as incurred by the DISC qualifies only in part as an
export promotion expense, such expense or cost must be allocated between
the qualified portion and such other portion on a reasonable basis. See
1.994-2(b)(2) for the option of the related supplier not to claim
expenses as export promotion expenses.
(2) Types of expenses. The only expenses or costs which may be
export promotion expenses are those expenses or costs meeting the test
of subparagraph (1) of this paragraph which constitute --
(i) Ordinary and necessary expenses of the DISC paid or incurred
during the DISC's taxable year in carrying on any trade or business,
allowable as deductions under section 162, such as expenses for market
studies, advertising, salaries and wages (including contributions or
compensations deductible under section 404) of sales, clerical, and
other personnel, rentals on property, sales commissions, warehousing,
and other selling expenses,
(ii) A reasonable allowance under section 167 for exhaustion, wear
and tear, or obsolescence of the property of the DISC,
(iii) Costs of freight (subject to the limitations of subparagraph
(4) of this paragraph),
(iv) Costs of packaging for export (as defined in subparagraph (5) of
this paragraph), or
(v) Costs of designing and labeling packages exclusively for export
markets (under subparagraph (6) of this paragraph).
(3) Ineligible expenses. Items ineligible to be export promotion
expenses include, for example, interest expenses, bad debt expenses,
freight insurance, State and local income and franchise taxes, the cost
of manufacture or assembly operations, and items of cost of goods sold
(except as otherwise provided in this paragraph in the case of certain
freight, packaging, and designing and labeling expenses). Income or
similar taxes eligible for a foreign tax credit under sections 901 and
903 are also not eligible to be export promotion expenses.
(4) Freight expenses -- (i) In general. Export promotion expenses
include one-half of the freight expense (not including insurance) for
shipping export property aboard a U.S.-flag carrier in those cases where
law or regulation of the United States or of any State or political
subdivision thereof or of any agency or instrumentality of any of these
does not require that the export property be shipped aboard a U.S.-flag
carrier. For purposes of this paragraph, the term ''freight expense''
includes charges paid for c.o.d. service, miscellaneous ground charges,
such as charges incurred for services normally performed by U.S.-flag
carriers, charges for services of loading aboard U.S.-flag carriers
normally performed by such carriers, freight forwarders, or independent
contractors engaged in loading property, and charges attributable to a
freight consolidation function normally performed by freight forwarders.
In order for one-half of freight expenses paid to the owner (or the
agent of the owner) of a U.S.-flag carrier to be claimed as an export
promotion expense, the DISC must obtain a written statement (such as,
for example, a bill of lading) from the owner (or the agent) disclosing
that the export property was shipped aboard the owner's U.S.-flag
carrier or another U.S.-flag carrier, and the DISC must have no
reasonable basis for disbelieving such statement of the owner (or the
agent). For the requirement of a written statement from a freight
forwarder, see subdivision (iv) of this subparagraph.
(ii) U.S.-flag carrier defined. For purposes of this paragraph, the
term ''U.S.-flag carrier'' is an airplane owned and operated by a U.S.
person or persons (as defined in section 7701(a)(30)) or a ship
documented under the laws of the United States. Shipment initiated by
delivery to the U.S. Postal Service shall be considered shipment aboard
a U.S.-flag carrier, but not if shipped to a place to which mail
shipments from the United States are ordinarily accomplished by land
transportation, such as to Canada or Mexico, unless airmail is
specified.
(iii) Shipment pursuant to law or regulation. Shipment pursuant to
law or regulation includes instances where a U.S.-flag carrier must be
used in order to obtain permission from the Government to make the
export. If the law or regulation requires a fixed portion of the export
property to be shipped aboard a U.S.-flag carrier, the freight expense
on that portion of such export property that was so shipped in order to
satisfy such requirement cannot qualify as an export promotion expense.
(iv) Freight forwarders. A payment to a freight forwarder shall be
considered freight expense within the meaning of this paragraph to the
extent the forwarder utilizes a U.S.-flag carrier. For purposes of this
paragraph, the term ''freight forwarder'' includes air freight
consolidators and carriers owned and operated by U.S. persons utilizing
U.S.- flag carriers such as non-vessel-owning common carriers. In order
for one-half of freight expenses paid to a freight forwarder to be
claimed as export promotion expenses, the DISC must obtain a written
statement (such as, for example, a bill of lading) from the freight
forwarder disclosing that the export property was shipped aboard a
U.S.-flag carrier, and the DISC must have no reasonable basis for
disbelieving such statement of the freight forwarder.
(v) Freight within the United States. A DISC may not claim as export
promotion expense any amount that is attributable to carriage of export
property between points within the United States. If, however, export
property is carried from the United States to a foreign country on a
through shipment pursuant to a single bill of lading or similar document
aboard one or more U.S.-flag carriers, the freight expense of such
carriage shall not be apportioned between the domestic and foreign
portions of such carriage, even though a carrier may stop en route
within the United States or the export property may be shifted from one
carrier to another, and one-half of such freight expense may be claimed
as an export promotion expense. Freight expense does not include the
cost of transporting the export property to the depot of the U.S.-flag
carrier or freight forwarder for shipment abroad. The expense of
shipment of export property initiated by delivery to the U.S. Postal
Service for ultimate delivery outside the United States shall be
considered as attributable entirely to carriage of such property outside
the United States.
(5) Packaging for export. (i) Export promotion expenses include the
direct and indirect cost of packaging export property (including the
cost of the package) for export whether or not the packaging is the same
as domestic packaging. Such packaging costs do not include costs of
manufacturing (as defined in the regulations under section 993) and
assembly. Thus, if a DISC buys and packages export property for resale,
its costs of packaging the export property are export promotion
expenses. If, however, the process of such packaging by the DISC is
physically integrated with the process of manufacturing the export
property by the related supplier, the costs of such packaging are not
export promotion expenses.
(ii) The cost of containers leased from a shipping company to which
the DISC also pays freight for the property packaged is not a cost of
packaging. However, in such circumstances, one-half of the rental
charge may be allowable as a freight expense if permitted under
subparagraph (4) of this paragraph.
(6) Designing and labeling packages. Export promotion expenses
include the direct and indirect costs of designing and labeling
packages, including bottles, cans, jars, boxes, cartons, or containers,
to the extent incurred for export markets. Thus, for example, to the
extent incurred for supplying export markets, the cost of designing
labels in a foreign language and the cost of printing such labels are
export promotion expenses.
(7) DISC must incur export promotion expenses -- (i) In general. In
order for an expense to be an export promotion expense it must be
incurred or treated as incurred under this subparagraph by the DISC.
For example, an expense is incurred by a DISC if the expense results
from (a) the DISC incurring an obligation to pay compensation to its
employees, (b) depreciation of property owned by the DISC and used by
its employees, (c) the DISC incurring an obligation to pay for office
supplies used by its employees, (d) the DISC incurring an obligation to
pay space costs for use by its employees, or (e) the DISC incurring an
obligation to pay other costs supporting efforts by its employees.
(ii) Payments to independent contractors. A payment to an
independent contractor, directly or indirectly, is treated as incurred
by the DISC if the cost of performing the function performed by the
independent contractor would be considered an export promotion expense
described in subparagraphs (1) and (2) of this paragraph if performed by
the DISC, and if, in a case where the services of the independent
contractor were engaged by a party related to the DISC, such related
party and such DISC agreed in writing before the contract was entered
into that a specified portion or all of the contract was for the benefit
of the DISC and that all of the expenses of the contract (eligible to be
considered as export promotion expenses) with respect to such portion
would be borne by the DISC.
(iii) Expenses incurred by related parties. Reimbursements or other
payments by a DISC to a related party are export promotion expenses only
if the expenses of the related party for which reimbursement is made are
for space in a building actually used by employees of the DISC or for
export property owned by the DISC. Except as otherwise provided in the
preceding sentence, expenses incurred by a foreign international sales
corporation (FISC) or a real property holding company (as defined in
section 993(e)(1) and (2), respectively) shall not be treated as export
promotion expenses of its DISC.
(iv) Selling commissions paid by a DISC. A commission paid by a DISC
to a person other than a related person, with respect to a transaction
which gives rise to qualified export receipts of the DISC, is an export
promotion expense of the DISC. A commission paid by a DISC to a related
person is not an export promotion expense.
(v) Sales of promotional material. If a DISC sells promotional
material to a buyer of export property from the DISC at a price which is
greater than the costs of the DISC for such material, such costs are not
export promotion expenses. If, however, the DISC sells promotional
material at a price which is less than its costs for such material, the
excess of such costs over such price is an export promotion expense.
For rules relating to the status of promotional material as qualified
export assets and export property, see 1.993-2 and 1.993-3,
respectively.
(vi) An expense may be incurred by the DISC under subdivisions (i)
through (v) of this subparagraph even if the accounting for and payment
of such expense is handled by a related party and the DISC reimburses
the related party for such expenses.
(8) Incomplete transactions. Expenses eligible to be treated as
export promotion expenses which are attributable to the sale, lease, or
other distribution of export property and which are incurred prior to
the taxable year of sale, lease, or other distribution by the DISC are
not treated as export promotion expenses until the taxable year of sale,
lease, or other distribution or until the taxable year in which it is
first determined that no transaction is reasonably expected to result
from the expense incurred (whether or not a transaction subsequently
results). Thus, for example, if a DISC incurs a packaging cost which is
otherwise eligible to be treated as an export promotion expense, the
DISC may not include such charge as an export promotion expense until
the year in which the export property with respect to which the
packaging cost was incurred is actually sold by the DISC. If no
transaction is reasonably expected to result from the packaging cost,
such cost should be allocated as an export promotion expense to the
group of transactions to which such cost is most closely related.
(g) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. J and K are calendar year taxpayers. J, a domestic
manufacturing company, owns all the stock of K, a DISC for the taxable
year. During 1972, J manufactures only 100 units of a product (which is
eligible to be export property as defined in section 993(c)). J enters
into a written agreement with K whereby K is granted a sales franchise
with respect to exporting such property and K will receive commissions
with respect to such exports equal to the maximum amount permitted to be
received under the intercompany pricing rules of section 994.
Thereafter, the 100 units are sold for $1,000. J's cost of goods sold
attributable to the 100 units is $650. J's direct selling expenses so
attributable are $100. Although J has other deductible expenses, for
purposes of this example assume that J has no other deductible expenses.
K pays $230 to independent contractors which qualify as export
promotion expenses under paragraph (f)(7)(ii) of this section. K does
not perform functions substantial enough to entitle it to an allocation
of income which meets the arm's length standard of section 482. The
income which K may earn under section 994 under the franchise is $20,
computed as follows:
Since combined taxable income ($20) is lower than both K's profit
under the combined taxable income method ($33) and under the gross
receipts method ($63), the maximum income K may earn is $20.
Accordingly, the commissions K may receive from J are $250, i.e., K's
expenses ($230) plus K's profit ($20).
Example 2. M and N are calendar year taxpayers. M, a domestic
manufacturing company, owns all the stock of N, a DISC for the taxable
year. During 1972, M produces and sells a particular product line of
export property to N for $75, a price which can be justified as
satisfying the standard of arm's length price of section 482. N
performs substantial functions with respect to the transaction and
resells the export property for $100. M's cost of goods sold
attributable to the export property is $60. M's direct selling expenses
so attributable (relating to advertising of the product line in foreign
markets) are $12. Although M has other deductible expenses, for
purposes of this example, assume that M has no other deductible
expenses. N's expenses attributable to resale of the export property
are $22 of which $20 are export promotion expenses. The maximum profit
which N may earn with respect to the product line is $6, computed as
follows:
Since the gross receipts method results in greater profit to N ($6)
than does the combined taxable income method ($5) or section 482 method
($3), and does not exceed combined taxable income ($6), N may earn a
maximum profit of $6. Accordingly, the transfer price from M to N may
be readjusted as long as the transfer price is not readjusted below $72,
computed as follows:
Example 3. Q and R are calendar year taxpayers. Q, a domestic
manufacturing company, owns all the stock of R, a DISC for the taxable
year. During 1972, Q produces and sells a product line of export
property to R for $170, a price which can be justified as satisfying the
standards of arm's length price of section 482, and R resells the export
property for $200. Q's cost of goods sold attributable to the export
property is $115 so that the combined gross income from the sale of the
export property is $85 (i.e., $200 minus $115). Q's expenses incurred
in connection with the property sold are $35. Q's deductible overhead
and other supportive expenses allocable to all gross income are $6.
Apportionment of these supportive expenses on the basis of gross income
does not result in a material distortion of income and is a reasonable
method of apportionment. Q's gross income from sources other than the
transaction is $170 making total gross income of Q and R (excluding the
transfer price paid by R) $255 (i.e., $85 plus $170). R's expenses
attributable to resale of the export property are $20, all of which are
export promotion expenses. The maximum profit which R may earn with
respect to the product line is $16, computed as follows:
Since the combined taxable income method results in greater profit to
R ($16) than does the gross receipts method ($10) or section 482 method
($10), and does not exceed combined taxable income ($28), R may earn a
maximum profit of $16. Accordingly, the transfer price from Q to R may
be readjusted as long as the transfer price is not readjusted below $164
computed as follows:
Example 4. S and T are calendar year taxpayers. S, a domestic
manufacturing company, owns all the stock of T, a DISC for the taxable
year. During 1972, S produces and sells 100 units of a particular
product to T under a written agreement which provides that the transfer
price between S and T shall be that price which allocates to T the
maximum permitted to be received under the intercompany pricing rules of
section 994. Thereafter, the 100 units are sold by T for $950. S's
cost of goods sold attributable to the 100 units is $650. S's other
deductible expenses so attributable are $300. Although S has other
deductible expenses, for purposes of this example, assume that S has no
deductible expenses not definitely allocable to any item of gross
income. T's expenses attributable to the resale of the 100 units are
$50. S chooses not to apply the section 482 method. T may not earn any
income under the gross receipts or combined taxable income method with
respect to resale of the 100 units because combined taxable income is a
negative figure, computed as follows:
Under paragraph (e)(1)(i) of this section, T is permitted to recover
its expenses attributable to the 100 units ($50) even though such
recovery results in a loss or increased loss to the related supplier.
Accordingly, the transfer price from S to T may be readjusted as long as
the transfer price is not readjusted below $900, computed as follows:
Example 5. Assume the same facts as in example 4 except that S
chooses to apply the section 482 method and that under arm's length
dealings T would have derived $10 of income. Accordingly, the transfer
price from S to T may be set at an amount not less than $890, computed
as follows:
Example 6. X and Y are calendar year taxpayers. X, a domestic
manufacturing company, owns all the stock of Y, a DISC for the taxable
year. During March 1972, X manufactures a particular product of export
property which it leases on April 1, 1972, to Y for a term of 1 year at
a monthly rental of $1,000, a rent which satisfies the standard of arm's
length rental under section 482. Y subleases the product on April 1,
1972, for a term of 1 year at a monthly rental of $1,200. X's cost for
the product leased is $40,000. X's other deductible expenses
attributable to the product are $900, all of which are incurred in 1972.
Although X has other deductible expenses, for purposes of this example,
assume that X has no other deductible expenses. Y's expenses
attributable to sublease of the export property are $450, all of which
are incurred in 1972 and are export promotion expenses. X depreciates
the property on a straight line basis without the use of an averaging
convention, assuming a useful life of 8 years and no salvage value. The
profit which Y may earn with respect to the transaction is $2,895 for
1972 and $1,175 for 1973, computed as follows:
Since the combined taxable income method results in greater profit to
Y ($2,895) than does the gross receipts method ($477) or section 482
method ($1,350), Y may earn a profit of $2,895 for 1972. Accordingly,
the monthly rental payable by Y to X for 1972 may be readjusted as long
as the monthly rental payable is not readjusted below $828.33, computed
as follows:
Since the combined taxable income method results in greater profit to
Y ($1,175) than does the gross receipts method ($144) or section 482
method ($600), Y may earn a profit of $1,175 for 1973. Accordingly, the
monthly rental payable by Y to X for 1973 may be readjusted as long as
the monthly rental payable is not readjusted below $808.33, computed as
follows:
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal
Revenue Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10);
90 Stat. 1659, 26 U.S.C. 995(g); and 68A Stat 917, 26 U.S.C. 7805))
(T.D. 7364, 40 FR 29827, July 16, 1975, as amended by T.D. 7435, 41
FR 43142, Sept. 30, 1976; T.D. 7854, 47 FR 51741, Nov. 17, 1982; T.D.
7984, 49 FR 40018, Oct. 12, 1984)
26 CFR 1.994-2 Marginal costing rules.
(a) In general. This section prescribes the marginal costing rules
authorized by section 994(b)(2). If under paragraph (c)(1) of this
section a DISC is treated for its taxable year as seeking to establish
or maintain a foreign market for sales of an item, product, or product
line of export property (as defined in 1.993-3) from which qualified
export receipts are derived, the marginal costing rules prescribed in
paragraph (b) of this section may be applied to allocate costs between
gross receipts derived from such sales and other gross receipts for
purposes of computing, under the ''50-50'' combined taxable income
method of 1.994-1(c)(3), the combined taxable income of the DISC and
related supplier derived from such sales. Such marginal costing rules
may be applied whether or not the related supplier manufactures,
produces, grows, or extracts (within the meaning of 1.993-3(c)) the
export property sold. Such marginal costing rules do not apply to sales
of export property which in the hands of a purchaser related under
section 954(d)(3) to the seller give rise to foreign base company sales
income as described in section 954(d) unless, for the purchaser's year
in which it resells the export property, section 954(b)(3)(A) is
applicable or such income is under the exceptions in section 954(b)(4).
Such marginal costing rules do not apply to leases of property or the
performance of any services whether or not related and subsidiary
services (as defined in 1.994-1(b)(3).
(b) Marginal costing rules for allocations of costs -- (1) In
general. Marginal costing is a method under which only marginal or
variable costs of producing and selling a particular item, product, or
product line are taken into account for purposes of section 994. Where
this section is applicable, costs attributable to deriving qualified
export receipts for the DISC's taxable year from sales of an item,
product, or product line may be determined in any manner the related
supplier (as defined in 1.994-1(a)(3)(ii)) chooses, provided that the
requirements of both subparagraphs (2) and (3) of this paragraph are
met.
(2) Variable costs taken into account. There are taken into account
in computing the combined taxable income of the DISC and its related
supplier from sales of an item, product, or product line the following
costs: (i) Direct production costs (as defined in 1.471-11(b)(2)(i))
and (ii) costs which are export promotion expenses, but only if they are
claimed as export promotion expenses in determining taxable income
derived by the DISC under the combined taxable income method of
1.994-1(c)(3). At the taxpayer's option, all, a part, or none of the
costs which qualify as export promotion expenses may be so claimed as
export promotion expenses.
(3) Overall profit percentage limitation. As a result of such
determination of costs attributable to such qualified export receipts
for the DISC's taxable year, the combined taxable income of the DISC and
its related supplier from sales of such item, product, or product line
for the DISC's taxable year does not exceed gross receipts (determined
under 1.993-6) of the DISC derived from such sales, multiplied by the
overall profit percentage (determined under paragraph (c)(2) of this
section).
(c) Definitions -- (1) Establishing or maintaining a foreign market.
A DISC shall be treated for its taxable year as seeking to establish or
maintain a foreign market with respect to sales of an item, product, or
product line of export property from which qualified export receipts are
derived if the combined taxable income computed under paragraph (b) of
this section is greater than the combined taxable income computed under
1.994-1(c)(6).
(2) Overall profit percentage. (i) For purposes of this section, the
overall profit percentage for a taxable year of the DISC for a product
or product line is the percentage which --
(a) The combined taxable income of the DISC and its related supplier
plus all other taxable income of its related supplier from all sales
(domestic and foreign) of such product or product line during the DISC's
taxable year, computed under the full costing method, is of
(b) The total gross receipts (determined under 1.993-6) from all
such sales.
(ii) At the annual option of the related supplier, the overall profit
percentage for the DISC's taxable year for all products and product
lines may be determined by aggregating the amounts described in
subdivision (i) (a) and (b) of this subparagraph of the DISC, and all
domestic members of the controlled group (as defined in 1.993-1(k)) of
which the DISC is a member, for the DISC's taxable year and for taxable
years of such members ending with or within the DISC's taxable year.
(iii) For purposes of determining the amounts in subdivisions (i) (b)
and (ii) of this subparagraph, a sale of property between a DISC and its
related supplier or between domestic members of the controlled group
shall be taken into account only during the DISC's taxable year (or
taxable year of the member ending within the DISC's taxable year) during
which the property is ultimately sold to a person which is neither the
DISC nor such a domestic member.
(3) Grouping of transactions. (i) In general, for purposes of this
section, an item, product, or product line is the item or group
consisting of the product or product line pursuant to 1.994-1(c)(7)
used by the taxpayer for purposes of applying the intercompany pricing
rules of 1.994-1.
(ii) However, for purposes of determining the overall profit
percentage under subparagraph (2) of this paragraph, any product or
product line grouping permissible under 1.994-1(c)(7) may be used at
the annual choice of the taxpayer, even though it may not be the same
item or grouping referred to in subdivision (i) of this subparagraph, as
long as the grouping chosen for determining the overall profit
percentage is at least as broad as the grouping referred to in such
subdivision (i).
(4) Full costing method. For purposes of this section, the term
''full costing method'' is the method for determining combined taxable
income set forth in 1.994-1(c)(6).
(d) Application of limitation on DISC income (''no loss'' rule). If
the marginal costing rules of this section are applied, the combined
taxable income method of 1.994-1(c)(3) may not be applied to cause in
any taxable year a loss to the related supplier, but such method may be
applied to the extent it does not cause a loss. For purposes of the
preceding sentence, a loss to a related supplier would result if the
taxable income of the DISC would exceed the combined taxable income of
the related supplier and the DISC determined in accordance with
paragraph (b) of this section. If, however, there is no combined
taxable income (so determined), see the last sentence of
1.994-1(e)(1)(i).
(e) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. X and Y are calendar year taxpayers. X, a domestic
manufacturing company, owns all the stock of Y, a DISC for the taxable
year. During 1973, X manufactures a product line which is eligible to
be export property (as defined in 1.993-3). X enters into a written
agreement with Y whereby Y is granted a sales franchise with respect to
exporting such product line from which qualified export receipts will be
derived and Y will receive commissions with respect to such exports
equal to the maximum amount permitted to be received under the
intercompany pricing rules of section 994. Commissions are computed
using the combined taxable income method under 1.994-1(c)(3). For
purposes of applying the combined taxable income method, X and Y compute
their combined taxable income attributable to the product line of export
property under the marginal costing rules in accordance with the
additional facts assumed in the table below:
Since the overall profit percentage limitation under line (2)(g)
($28.50) is less than maximum combined taxable income under line (1)(c)
($30), combined taxable income under marginal costing is limited to
$28.50. Since under the franchise agreement Y is to earn the maximum
commission permitted under the intercompany pricing rules of section
994, combined taxable income on the transactions is $28.50.
Accordingly, the costs attributable to export sales (other than for
direct material, direct labor, and export promotion expenses) are $1.50,
i.e., line (1)(c) ($30) minus line (2)(g) ($28.50). Under the combined
taxable income method of 1.994-1 (c)(3), Y will have taxable income
attributable to the sales of $14.75, i.e., the sum of 1/2 of combined
taxable income (1/2 of $28.50) and 10 percent of Y's export promotion
expenses claimed in determining Y's taxable income (10 percent of $5).
Accordingly, the commissions Y receives from X are $22.75, i.e., Y's
costs ($8, see line (2)(b)(iii)) plus Y's profit ($14.75).
Example 2. (1) Assume the same facts as in example 1, except that
gross receipts from export sales are only $85 and gross receipts from
all sales remain at $400. For purposes of applying the combined taxable
income method, X and Y may compute their combined taxable income
attributable to the product line of export property under the marginal
costing rules as follows:
Since maximum combined taxable income under line (1)(c) ($20) is less
than the overall profit percentage limitation under line (2)(c)
($25.50), combined taxable income under marginal costing is limited to
$20. Since under the franchise agreement Y is to earn the maximum
commission permitted under the intercompany pricing rules of section
994, combined taxable income on the transactions is $20. Accordingly,
no costs (other than for direct material, direct labor, and export
promotion expenses) will be attributed to export sales. Under the
combined taxable income method of 1.994-1(c)(3), Y will have taxable
income attributable to the sales of $10.50, i.e., the sum of 1/2 of
combined taxable income (1/2 of $20) and 10 percent of Y's export
promotion expenses claimed in determining Y's taxable income (10 percent
of $5). Accordingly, the Commissions Y receives from X are $18.50,
i.e., Y's costs ($8, see line (2)(b)(iii) of example 1) plus Y's profit
($10.50).
(2) If export promotion expenses are not claimed in determining
taxable income of Y under the combined taxable income method, the
taxable income of Y would be increased to $12.50 and commissions payable
to Y would be increased to $20.50, computed as follows:
Since maximum combined taxable income under line (3)(c) ($25) is less
than the overall profit percentage under line (4) ($25.50), combined
taxable income under marginal costing is limited to $25. Since under
the franchise agreement Y is to earn the maximum commission permitted
under the intercompany pricing rules of section 994, combined taxable
income on the transactions is $25. Accordingly, no costs (other than
for direct material and direct labor) will be attributed to export
sales. Under the combined taxable income method of 1.994-1(c)(3), Y
will have taxable income attributable to the sales of $12.50, i.e., 1/2
of combined taxable income (1/2 of $25). Accordingly, the commissions Y
receives from X are $20.50, i.e., Y's costs ($8, see line (2)(b)(iii) of
example 1) plus Y's profit ($12.50).
Example 3. (1) Assume the same facts as in example 1, except that
gross receipts from export sales are only $85, gross receipts from all
sales remain at $400, and Y has costs of $40 consisting of Y's export
promotion expenses of $35 and costs of $5 other than for direct
material, direct labor, or export promotion expenses. For purposes of
applying the combined taxable income method, X and Y may compute their
combined taxable income attributable to the product line of export
property under the marginal costing rules as follows:
Since maximum combined taxable income under line (1)(c) (which is a
loss of $10) is less than the overall profit percentage limitation under
line (2)(c) ($25.50), combined taxable income under marginal costing is
a loss of $10 and, under the combined taxable income method of
1.994-1(c)(3), Y will have no taxable income or loss attributable to the
sales. Accordingly, the commissions Y receives from X are $40, i.e.,
Y's costs ($40).
(2) If export promotion expenses are not claimed in determining Y's
taxable income under the combined taxable income method, the taxable
income of Y would be increased to $12.50 and commissions payable to Y
would be increased to $52.50 computed as follows:
The results would be the same as in part (2) of example 2, except
that the commissions Y receives from X are $52.50, i.e., Y's costs ($40)
plus Y's profit ($12.50).
(T.D. 7364, 40 FR 29836, July 16, 1975; 40 FR 33972, Aug. 13, 1975)
26 CFR 1.995-1 Taxation of DISC income to shareholders.
(a) In general. (1) Under 1.991-1(a), a corporation which is a DISC
for a taxable year is not subject to any tax imposed by subtitle A of
the Code (sections 1 through 1564) for the taxable year, except for the
tax imposed by chapter 5 thereof (sections 1491 through 1494) on certain
transfers to avoid tax.
(2) Under section 995(a), the shareholders of a DISC, or a former
DISC, are subject to taxation on the earnings and profits of the DISC in
accordance with the provisions of chapter 1 of the Code generally
applicable to shareholders, but subject to the modifications provided in
sections 995, 996, and 997.
(3) Under 1.996-3, three divisions of earnings and profits of a
DISC, or former DISC, are defined: ''accumulated DISC income'',
''previously taxed income'', and ''other earnings and profits''. Under
1.995-2, certain amounts of the DISC's earnings and profits are deemed
to be distributed as dividends to shareholders of the DISC at the close
of the DISC's taxable year in which such earnings were derived. Such
deemed distributions do not cause a reduction in the DISC's earnings and
profits, but are taken into account in 1.996-3(c) as an increase in
previously taxed income. To the extent the DISC's earnings and profits
are paid out in a subsequent distribution which is, under 1.996-1,
treated as made out of such ''previously taxed income,'' they will not
be taxable to the shareholders a second time.
(4) In general, ''accumulated DISC income'' is the earnings and
profits of the DISC which have not been deemed distributed and which may
be deferred from taxation so long as they are not actually distributed
with respect to its stock. However, deferral of taxation on
''accumulated DISC income'' may be terminated, in whole or in part, in
the event of: (i) Certain foreign investment attributable to producer's
loans (see 1.995-2(a)(5) and 1.995-5); (ii) revocation of the
election to be treated as a DISC or other disqualification (see
1.995-3); and (iii) certain dispositions of DISC stock in which gain is
realized (see 1.995-4).
(5) Since a DISC is not taxed on its taxable income, section 246(d)
and 1.246-4 provide that the deduction otherwise allowed under section
243 shall not be allowed with respect to a dividend from a DISC, or
former DISC, paid or treated as paid out of accumulated DISC income or
previously taxed income or with respect to a deemed distribution in a
qualified year under 1.995-2(a).
(b) Amounts and character of amounts includible in shareholder's
gross income. Each shareholder of a corporation which is a DISC, or
former DISC, shall include in his gross income --
(1) Amounts actually distributed to him that are includible in his
gross income in accordance with paragraph (c) of this section.
(2) Amounts which, pursuant to 1.995-2, he is deemed to receive as a
distribution taxable as a dividend on the last day of each of the
corporation's taxable years for which it qualifies as a DISC,
(3) Amounts which, pursuant to 1.995-3, he is deemed to receive as a
distribution taxable as a dividend in the event the corporation revokes
its election to be treated as a DISC or otherwise is disqualified as a
DISC, and
(4) Gain realized on certain dispositions of stock in the corporation
which, under 1.995-4, is includible in his gross income as a dividend.
(c) Treatment of actual distributions. (1) Except as provided in
subparagraph (3) of this paragraph, amounts actually distributed to a
shareholder of a DISC, or former DISC, with respect to his stock are
includible in his gross income in accordance with section 301.
(2) Since a deemed distribution does not reduce the earnings and
profits of a DISC, it does not affect the determination as to whether a
subsequent actual distribution is a ''dividend'' under section 316(a).
Since, however, the amount of a deemed distribution increases
''previously taxed income'', it does affect the determination as to
whether a subsequent actual distribution is excluded (as described in
subparagraph (3) of this paragraph) from gross income.
(3) Under 1.996-1(c), the amount of any actual distribution
(including a deficiency distribution made pursuant to 1.992-3), with
respect to stock in a DISC, or former DISC, which is treated under
1.996-1 as made out of previously taxed income, is excluded by the
distributee from gross income, but only to the extent that such amount
does not exceed the adjusted basis of the distributee's stock. Under
1.996-5(b), that portion of any actual distribution which is treated as
made out of previously taxed income shall be applied against and reduce
the adjusted basis of the stock and, to the extent that it exceeds the
adjusted basis of the stock, it shall be treated as gain from the sale
or exchange of property.
(4) A deficiency distribution pursuant to 1.992-3 may be made after
the close of the DISC's taxable year with respect to which it is made.
The determinations as to whether such deficiency distribution is a
dividend under section 301 and as to which division of earnings and
profits is the source thereof depend upon the status of the DISC's
earnings and profits account and divisions thereof at the time the
distribution is actually made. See 1.996-1(d) for the priority of such
deficiency distribution over other actual distributions made during the
same taxable year.
(d) Personal holding company income. (1) Any amount includible in a
shareholder's gross income as a dividend with respect to the stock of a
DISC, or former DISC, pursuant to paragraph (b) of this section shall be
treated as a dividend for all purposes of the Code, except that for
purposes of determining whether such shareholder is a personal holding
company within the meaning of section 542 any amount deemed distributed
for qualified years under 1.995-2 or upon disqualification under
1.995-3, any amount of gain on certain dispositions of DISC stock to
which 1.995-4 applies, and any amount treated under 1.996-1 as
distributed out of accumulated DISC income or previously taxed income
shall not be treated as a dividend or any other kind of income described
in section 543(a).
(2) Notwithstanding subparagraph (1) of this paragraph, the
shareholder may treat as an item of income described under section 543
(for example, rents) any amount to which the exception in such
subparagraph (1) applies, if it establishes to the satisfaction of the
district director that such amount is attributable to earnings and
profits derived from such item of income.
(T.D. 7324, 39 FR 35109, Sept. 30, 1974)
26 CFR 1.995-2 Deemed distributions in qualified years.
(a) General rule. Under section 995 (b) (1), each shareholder of a
DISC shall be treated as having received a distribution taxable as a
dividend with respect to his stock on the last day of each taxable year
of the DISC, in an amount which is equal to his pro rata share of the
sum (as limited by paragraph (b) of this section), of the following
seven items:
(1) An amount equal to the gross interest derived by the DISC during
such year from producer's loans (as defined in 1.993-4).
(2) An amount equal to the lower of --
(i) Any gain recognized by the DISC during such year on the sale or
exchange of property (other than property which in the hands of the DISC
is a qualified export asset) which was previously transferred to it in a
transaction in which the transferor realized gain which was not
recognized in whole or in part, or
(ii) The amount of the transferor's gain which was not recognized on
the previous transfer of the property to the DISC.
For purposes of this subparagraph, each item of property shall be
considered separately. See paragraph (d) of this section for special
rules with respect to certain tax-free acquisitions of property by the
DISC.
(3) An amount equal to the lower of --
(i) Any gain recognized by the DISC during such year on the sale or
exchange of property which in the hands of the DISC is a qualified
export asset (other than stock in trade or property described in section
1221(1)) and which was previously transferred to the DISC in a
transaction in which the transferor realized gain which was not
recognized in whole or in part, or
(ii) The amount of the transferor's gain which was not recognized on
the previous transfer of the property to the DISC and which would have
been includible in the transferor's gross income as ordinary income if
its entire realized gain had been recognized upon the transfer.
For purposes of this subparagraph, each item of property shall be
considered separately. See paragraph (d) of this section for special
rules with respect to certain tax-free acquisitions of property by the
DISC.
(4) For taxable years beginning after December 31, 1975, an amount
equal to 50 percent of the taxable income of the DISC for the taxable
years attributable to military property (as defined in 1.995-6).
(5) For taxable years beginning after December 31, 1975, the taxable
income for the taxable year attributable to base period export gross
receipts (as defined in 1.995-7).
(6) The sum of --
(i)(A) In the case of a corporate share holder, an amount equal to
57.5 percent of the excess (if any) (one-half for DISCs' taxable years
beginning before January 1, 1983) of the taxable income of the DISC for
such year (computed as provided in 1.991-1(b)(1)) over the sum of the
amounts deemed distributed for the taxable year in accordance with
subparagraphs (1), (2), (3), (4) and (5) of this paragraph, or
(B) in the case of a non-corporate share holder, an amount equal to
one-half of the excess (if any) of the taxable income of the DISC for
such year (computed as provided in 1.991-1(b)(1)) over the sum of the
amounts deemed distributed for the taxable year in accordance with
subparagraphs (1), (2), (3), (4), and (5) of this paragraph.
(ii) (A) An amount equal to the amount under subdivision (i) of
paragraph (a) (6) of this section multiplied by the international
boycott factor as determined under section 999 (c) (1) , or
(B) In lieu of the amount determined under subdivision (ii) (A) of
paragraph (a) (6) of this section, the amount described under section
999 (c) (2) of such international boycott income, and
(iii) An amount equal to the sum of any illegal bribes, kickbacks, or
other payments paid by or on behalf of the DISC directly or indirectly
to an official, employee, or agent in fact of a government. An amount
is paid by a DISC where it is paid by any officer, director, employee,
shareholder, or agent of the DISC for the benefit of such DISC. For
purposes of this section, the principles of section 162 (c) and the
regulations thereunder shall apply. The fair market value of an illegal
payment made in the form of property or services shall be considered the
amount of such illegal payment.
(7) The amount of foreign investment attributable to producer's loans
of the DISC, as of the close of the ''group taxable year'' ending with
such taxable year of the DISC, determined in accordance with 1.995-5.
The amount of such foreign investment attributable to producer's loans
so determined for any taxable year of a former DISC shall be deemed
distributed as a dividend to the shareholders of such former DISC on the
last day of such taxable year. See 1.995-3(e) for the effect that such
deemed distribution has on scheduled installments of deemed
distributions of accumulated DISC income under 1.995-3(a) upon
disqualification.
(b) Limitation on amount of deemed distributions under section
995(b)(1). (1) The sum of the amounts described in paragraph (a)(1)
through (a)(6) of this section which is deemed distributed pro rata to
the DISC's shareholders a dividend for any taxable year of the
corporation shall not exceed the DISC's earnings and profits for such
year.
(2) The amount of foreign investment attributable to producer's loans
of the DISC (as described in paragraph (a)(7) of this section) which is
deemed to be distributed pro rata to the DISC's shareholders as
dividends for any taxable year of the corporation shall not exceed the
lower of the corporation's accumulated DISC income at the beginning of
such year or the corporation's accumulated earnings and profits at the
beginning of such year (but not less than zero) --
(i) Increased by any DISC income of the corporation for such year as
defined in 1.996-3(b)(2) (i.e., any excess of the DISC's earnings and
profits for such year over the sum of the amounts described in paragraph
(a)(1) through (a)(6) of this section), or
(ii) Decreased by any deficit in the corporation's earnings and
profits for such year.
Thus, for example, if a DISC has a deficit in accumulated earnings
and profits at the binning of a taxable year of $10,000, current
earnings and profits of $12,000, no amounts described in paragraphs
(a)(1) through (a)(6) of this section for the year, and foreign
investment attributable to producer's loans for the taxable year of
$5,000, the DISC would have a deemed distribution described in paragraph
(a)(7) of this section of $5,000 for the taxable year. On the other
hand, suppose the DISC had accumulated earnings and profits of $13,000
at the beginning of the taxable year, accumulated DISC income of $10,000
at the beginning of the taxable year, a deficit in earnings and profits
for the taxable year of $12,000, no amounts described in paragraphs
(a)(1) through (a)(6) of this section for the taxable year, and foreign
investment attributable to producer's loans for the taxable year of
$5,000. Under these facts the DISC would have no deemed distribution
described in paragraph (a)(7) of this section because the corporation
had no DISC income for the taxable year and the current year's deficit
in earnings and profits subtracted from the DISC's accumulated DISC
income at the beginning of the year produces a negative amount. For
rules relating to the carryover to a subsequent year of the $5,000 of
foreign investment attributable to producer's loans, see 1.995-5(a)(6).
(3) If, by reason of the limitation in subparagraph (1) of this
paragraph, less than the sum of the amounts described in paragraphs
(a)(1) through (a)(6) of this section is deemed distributed, then the
portion of such sum which is deemed distributed shall be attributed
first to the amount described in subparagraph (1) of such paragraph, to
the extent thereof; second to the amount described in subparagraph (2)
of such paragraph, to the extent thereof; third to the amount described
in subparagraph (3) of such paragraph, to the extent thereof; and so
forth, and finally to the amount described in paragraph (b)(6) of this
paragraph.
(c) Examples. Paragraphs (a) and (b) of this section may be
illustrated by the following examples:
Example 1. Y is a corporation which uses the calendar year as its
taxable year and which elects to be treated as a DISC beginning with
1972. X is its sole shareholder. In 1972, X transfers certain property
to Y in exchange for Y's stock in a transaction in which X does not
recognize gain or loss by reason of the application of section 351(a).
Included in the property transferred to Y is depreciable property
described in paragraph (a)(3) of this section on which X realizes, but
does not recognize by reason of the application of section 1245(b)(3), a
gain of $20,000. If X had sold such property for cash, the $20,000 gain
would have been recognized as ordinary income under section 1245. Also
included in the transfer to Y is 100 shares of stock in a third
corporation (which is not a related foreign export corporation) on which
X realizes, but does not recognize, a gain of $5,000. In 1973, Y sells
such property and recognizes a gain of $25,000 on the depreciable
property and $8,000 on the 100 shares of stock. Y has accumulated
earnings and profits at the beginning of 1973 of $5,000, earnings and
profits for 1973 of $72,000, and taxable income for 1973 of $100,000.
At the beginning of 1973, Y has $6,000 of accumulated DISC income, no
previously taxed income, and a deficit of $1,000 of other earnings and
profits. Under these facts and the additional facts assumed in the
table below, X is treated as having received a deemed distribution
taxable as a dividend of $76,000 on December 31, 1973, determined as
follows:
Example 2. Assume the facts are the same as in example 1, except
that earnings and profits for 1973 amount to only $60,000. Under these
facts, X is treated as receiving a deemed distribution taxable as a
dividend of $65,000 on December 31, 1973, determined as follows:
Example 3. Assume the facts are the same as in example 1, except
that Y has a deficit in accumulated earnings and profits at the
beginning of 1973 of $4,000. Such deficit is comprised of accumulated
DISC income of $1,000, no previously taxed income, and a deficit in
other earnings and profits of $5,000. Under these facts, X is treated
as receiving a deemed distribution taxable as a dividend in the amount
of $72,000 on December 31, 1973, determined as follows:
(d) Special rules for certain tax-free acquisitions of property by
the DISC. (1) For purposes of paragraph (a)(2)(i) and (3)(i) of this
section, if --
(i) A DISC acquires property in a first transaction and in a second
transaction it disposes of such property in exchange for other property,
and
(ii) By reason of the application of section 1031 (relating to
like-kind exchanges) or section 1033 (relating to involuntary
conversions), the basis in the DISC's hands of the other property
acquired in such second transaction is determined in whole or in part
with reference to the basis of the property acquired in the first
transaction,
then upon a disposition of such other property in a third transaction
by the DISC such other property shall be treated as though it had been
transferred to the DISC in the first transaction. Thus, if the first
transaction is a purchase of the property for cash, then paragraphs (a)
(2) and (3) of this section will not apply to a sale by the DISC of the
other property acquired in the second transaction.
(2) For purposes of paragraphs (a) (2)(i) and (3)(i) of this section,
if a DISC acquires property in a first transaction and it transfers such
property to a transferee DISC in a second transaction in which the
transferor DISC's gain is not recognized in whole or in part, then such
property shall be treated as though it had been transferred to the
transferee DISC in the same manner in which it was acquired in the first
transaction by the transferor DISC. For example, if X and Y both
qualify as DISC's and X transfers property to Y in a second transaction
in which gain or loss is not recognized, paragraph (a) (2) or (3) of
this section does not apply to a sale of such property by Y in a third
transaction if X had acquired the property in a first transaction by a
purchase for cash. If, however, X acquired the property from a
transferor other than a DISC in the first transaction in which the
transferor's realized gain was not recognized, then paragraph (a) (2) or
(3) of this section may apply to the sale by Y if the other conditions
of such paragraph (a) (2) or (3) are met.
(3) If a DISC acquires property in a second transaction described in
subparagraph (1) or (2) of this paragraph in which it (or, in the case
of a second transaction described in subparagraph (2) of this paragraph,
the transferor DISC) recognizes a portion (but not all) of the realized
gain, then the amount described in paragraph (a)(2)(ii) or (a)(3)(ii) of
this section with respect to a disposition by the DISC of such acquired
property in a third transaction shall not exceed the transferor's gain
which was not recognized on the first transaction minus the amount of
gain recognized by the DISC (or transferor DISC) on the second
transaction.
(4) The provisions of this paragraph may be illustrated by the
following examples:
Example 1. X and Y are corporations each of which qualifies as a
DISC and uses the calendar year as its taxable year. In 1972, X
acquires section 1245 property in a first transaction in which the
transferor's entire realized gain of $17 is not recognized. In 1973, X
transfers such property to Y in a second transaction in which X realizes
a gain of $20 of which only $4 is recognized. (On December 31, 1973,
X's shareholders are treated as having received a deemed distribution of
a dividend which includes such $4 under paragraph (a)(3) of this
section, provided the limitation in paragraph (b) of this section is
met.) In a third transaction in 1974, Y sells such property and
recognizes a gain of $25. With respect to Y's shareholders on December
31, 1974, the amount described in paragraph (a)(3)(ii) of this section
would be limited to $13, which is the amount of the transferor's gain
which was not recognized on the first transaction ($17) minus the amount
of gain recognized by X on the second transaction ($4).
Example 2. Z is a DISC using the calendar year as its taxable year.
In a first transaction in 1972, in exchange for its stock, Z acquires
section 1245 property from A, an individual who is its sole shareholder,
in a transaction in which A's realized gain of $30 is not recognized by
reason of the application of section 351(a). In a second transaction in
1973, Z exchanges such property for other property in a like-kind
exchange to which section 1031(b) applies and recognizes $10 of a
realized gain of $35. (On December 31, 1973, A is treated as having
received a deemed distribution of a dividend which includes such $10
under paragraph (a)(3) of this section, provided the limitation in
paragraph (b) of this section is met.) In a third transaction in 1974, Z
sells the property acquired in the like-kind exchange and recognizes a
gain of $25. With respect to A on December 31, 1974, the amount
described in paragraph (a)(3)(ii) of this section is limited to $20,
which is the amount of A's gain which was not recognized on the first
transaction ($30) minus the amount of gain recognized by Z on the second
transaction ($10).
(e) Carry back of net operating loss and capital loss to prior DISC
taxable year. For purposes of sections 991, 995, and 996, the amount of
the deduction for the taxable year under section 172 for a net operating
loss carryback or carryover or under section 1212 for a capital loss
carryback or carryover shall be determined in the same manner as if the
DISC were a domestic corporation which had not elected to be treated as
a DISC. Thus, the amount of the deduction will be the same whether or
not the corporation was a DISC in the year of the loss or in the year to
which the loss is carried. For provisions setting forth adjustments to
the DISC's, or former DISC's, deemed distributions, adjustments to its
divisions of earnings and profits, and other tax consequences arising
from such carrybacks, see 1.996-8.
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal
Revenue Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10);
90 Stat. 1659, 26 U.S.C. 995(g); and 68A Stat 917, 26 U.S.C. 7805))
(T.D. 7324, 39 FR 35110, Sept. 30, 1974, as amended by T.D. 7862, 47
FR 56492, Dec. 17, 1982; T.D. 7984, 49 FR 40018, Oct. 12, 1984)
26 CFR 1.995-3 Distributions upon disqualification.
(a) General rule. Under section 995 (b)(2), a shareholder of a
corporation which is disqualified from being a DISC, either because
pursuant to 1.992-2(e)(2) it revoked its election to be treated as a
DISC or because it has failed to satisfy the requirements as set forth
in 1.992-1 to be a DISC for a taxable year, shall be deemed to have
received (at the times specified in paragraph (b) of this section)
distributions taxable as dividends aggregating an amount equal to his
pro rata share of the accumulated DISC income (as defined in
1.996-3(b)) of such corporation which was accumulated during the
immediately preceding consecutive taxable years for which the
corporation was a DISC. The pro rata share referred to in the preceding
sentence shall be determined as of the close of the last of such
consecutive taxable years for which the corporation was a DISC. See
1.996-7(c) for rules relating to the carryover of, and maintaining a
separate account for, such accumulated DISC income in certain
reorganizations.
(b) Time of receipt of deemed distributions. Distributions described
in paragraph (a) of this section shall be deemed to be received in equal
installments on the last day of each of the 10 taxable years of the
corporation following the year of the disqualification described in
paragraph (a) of this section, except that in no case may the number of
equal installments exceed the number of the immediately preceding
consecutive taxable years for which the corporation was a DISC.
(c) Transfer of shares. Deemed distributions are includible under
paragraphs (a) and (b) of this section in a shareholder's gross income
as a dividend only so long as he continues to hold the shares with
respect to which the distribution is deemed made. Thus, the transferee
of such shareholder will include in his gross income under paragraphs
(a) and (b) of this section the remaining installments of the deemed
distribution which the transferor would have included in his gross
income as a dividend had he not transferred the shares. However, if the
transferee acquires the shares in a transaction in which the
transferor's gain is treated under 1.995-4 in whole or in part as a
dividend, then under 1.996-4(a) such transferee does not include
subsequent installments in his gross income to the extent that the
transferee treats such subsequent installments as made out of previously
taxed income.
(d) Effect of requalification. Deemed distributions under paragraphs
(a) and (b) of this section continue and are includible in gross income
as dividends by the shareholders whether or not the corporation
subsequently requalifies and is treated as a DISC.
(e) Effect of actual distributions and deemed distributions under
section 995(b)(1)(G). If, during the period a shareholder of a DISC, or
former DISC, is taking into account deemed distributions under
paragraphs (a) and (b) of this section, an actual distribution is made
to him out of accumulated DISC income or a deemed distribution because
of foreign investment attributable to producer's loans is made under
1.995-2(a)(5) out of accumulated DISC income, such actual or deemed
distribution shall first reduce the last installment of the deemed
distributions scheduled to be included in the shareholder's gross income
as a dividend, and then the preceding scheduled installments in reverse
order. If deemed distributions are scheduled to be included in gross
income for two or more disqualifications, an actual distribution or a
deemed distribution under 1.995-2 (a)(5) which is treated as made out
of accumulated DISC income reduces the deemed distributions resulting
from the earlier disqualification first.
(f) Examples. This section may be illustrated by the following
examples:
Example 1. X Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1972. X
qualifies as a DISC for taxable years 1972 through 1975, but, pursuant
to 1.992-2(e)(2), revokes its election as of January 1, 1976, and is
disqualified as a DISC. On that date, X has $24,000 of accumulated DISC
income. X's shareholders will be deemed to receive $6,000 in
distributions taxable as a dividend on the last day of each of X's four
succeeding taxable years (1977, 1978, 1979, and 1980).
Example 2. Assume the same facts as in example 1, except that in
1978 X makes an actual distribution of $22,000 to its shareholders of
which $10,000 is treated under 1.996-1 as made out of accumulated DISC
income. (The remaining $12,000 of such distribution is treated as made
out of previously taxed income.) The actual distribution would first
reduce the $6,000 deemed distribution scheduled for 1980 to zero and
then reduce the $6,000 deemed distribution scheduled for 1979 to $2,000.
Thus, X's shareholders include in 1978 $16,000 is gross income as
dividends ($10,000 of actual distributions and the $6,000 deemed
distribution scheduled for that year) and $2,000 as a dividend in 1979.
Example 3. Assume the same facts as in example 2, except that X
requalifies as a DISC for taxable year 1977 during which it derives
$7,000 of DISC income (computed after taking into account a deemed
distribution under 1.995-2(a)(4) of $7,000), but is again disqualified
in 1978. In addition X makes an actual distribution in 1977 equal to
the deemed distribution of $7,000. Such actual distribution is excluded
from gross income under 1.996-1(c). In 1977. X's shareholders include
in gross income as dividends the $6,000 deemed distribution upon
disqualification (in addition to the deemed distributions of $7,000
under 1.995-2 for 1977 when it was treated as a DISC). The actual
distribution in 1978 still reduces the installments resulting from the
earlier disqualification. Thus, in 1978, X's shareholders include
$16,000 in gross income as dividends. In 1979, X's shareholders include
$9,000 in gross income as dividends (the final installment of $2,000
from the earlier disqualification plus the single deemed distribution of
$7,000 resulting from the later disqualification).
(T.D. 7324, 39 FR 35112, Sept. 30, 1974, as amended by T.D. 7854, 47
FR 51741, Nov. 17, 1982)
26 CFR 1.995-4 Gain on disposition of stock in a DISC.
(a) Disposition in which gain is recognized -- (1) In general. If a
shareholder disposes, or is treated as disposing, of stock in a DISC, or
former DISC, then any gain recognized on such disposition shall be
included in the shareholder's gross income as a dividend,
notwithstanding any other provision of the Code, to the extent of the
accumulated DISC income amount (described in paragraph (d) of this
section). To the extent the recognized gain exceeds the accumulated
DISC income amount, it is taxable as gain from the sale or exchange of
the stock.
(2) Nonapplication of subparagraph (1). The provisions of
subparagraph (1) of this paragraph do not apply (i) to the extent gain
is not recognized (such as, for example, in the case of a gift or an
exchange of stock to which section 354 applies) and (ii) to the amount
of any recognized gain which is taxable as a dividend (such as, for
example, under section 301 or 356(a)(2)) or as gain from the sale or
exchange of property which is not a capital asset. The amount taxable
as a dividend under section 301 or 356(a)(2) is subject to the rules
provided in 1.995-1(c) for the treatment of actual distributions by a
DISC.
(b) Disposition in which separate corporate existence of DISC is
terminated -- (1) General. If stock in a corporation that is a DISC, or
former DISC, is disposed of in a transaction in which its separate
corporate existence as a DISC, or former DISC, is terminated, then,
notwithstanding any other provision of the Code, an amount of realized
gain shall be recognized and included in the transferor's gross income
as a dividend. The realized gain shall be recognized to the extent that
such gain --
(i) Would not have been recognized but for the provisions of this
paragraph, and
(ii) Does not exceed the accumulated DISC income amount (described in
paragraph (d) of this section).
(2) Cessation of separate corporate existence as a DISC, or former
DISC. For purposes of subparagraph (1) of this paragraph, separate
corporate existence as a DISC, or former DISC, will be treated as having
ceased if, as a result of the transaction, there is no separate entity
which is a DISC and to which is carried over the accumulated DISC income
and other tax attributes of the DISC, or former DISC, the stock of which
is disposed of. Thus, for example, if stock in a DISC, or former DISC,
is exchanged in a transaction described in section 381(a) (relating to
carryovers in certain corporate acquisitions), the gain realized on the
transfer of such stock will not be recognized under subparagraph (1) of
this paragraph if the assets of such DISC, or former DISC, are acquired
by a corporation which immediately after the acquisition qualifies as a
DISC. For a further example, if a DISC, or former DISC, is liquidated
in a transaction to which section 332 (relating to complete liquidations
of subsidiaries) applies, the transaction will be subject to
subparagraph (1) of this paragraph if the basis to the transferee
corporation of the assets acquired on the liquidation is determined
under section 334(b)(2) (as in effect prior to amendment by the Tax
Equity and Fiscal Responsibility Act of 1982) or if immediately after
such liquidation the transferee of such assets does not qualify as a
DISC. However, separate corporate existence as a DISC, or former DISC,
will not be treated as having ceased in the case of a mere change in
place of organization, however effected. See 1.996-7 for rules for the
carryover of the divisions of a DISC's earnings and profits to one or
more DISC's.
(c) Disposition to which section 311, 336, or 337 applies -- (1) In
general. If, after December 31, 1976, a shareholder distributes, sells,
or exchanges stock in a DISC, or former DISC, in a transaction to which
section 311, 336, or 337 applies, then an amount equal to the excess of
the fair market value of such stock over its adjusted basis in the hands
of the shareholder shall, notwithstanding any other provision of the
Code, be included in gross income of the shareholder as a dividend to
the extent of the accumulated DISC income amount (described in paragraph
(d) of this section).
(2) Nonapplication of subparagraph (1). Subparagraph (1) shall not
apply if the person receiving the stock in the disposition has a holding
period for the stock which includes the period for which the stock was
held by the shareholder disposing of such stock.
(d) Accumulated DISC income amount -- (1) General. For purposes of
this section, the accumulated DISC income amount is the accumulated DISC
income of the DISC or former DISC which is attributable to the stock
disposed of and which was accumulated in taxable years of such DISC or
former DISC during the period or periods such stock was held by the
shareholder who disposed of such stock.
(2) Period during which a shareholder has held stock. For purposes
of this section, the period during which a shareholder has held stock
includes the period he is considered to have held it by reason of the
application of section 1223 and, if his basis is determined in whole or
in part under the provisions of section 1014(d) (relating to special
rule for DISC stock acquired from decedent), the holding period of the
decedent. Such holding period is to exclude the day of acquisition but
include the day of disposition. Thus, for example, if A purchases stock
in a DISC on December 31, 1972, and makes a gift of such stock to B on
June 30, 1973, then on December 31, 1974, B will be treated as having
held the stock for 2 full years. If the basis of the stock in C's hands
is determined under section 1014(d) upon a transfer from B's estate on
December 31, 1976, by reason of B's death on June 30, 1974, then on
December 31, 1976, C will be treated as having held the stock for 4 full
years.
(e) Accumulated DISC income allocable to shareholder under section
995(c)(2) -- (1) In general. Under this paragraph, rules are prescribed
for purposes of paragraph (d) of this section as to the manner of
determining, with respect to the stock of a DISC, or former DISC,
disposed of, the amount of accumulated DISC income which is attributable
to such stock and which was accumulated in taxable years of the
corporation during the period or periods the stock disposed of was held
or treated under paragraph (d)(2) of this section as held by the
transferor. Subparagraphs (2), (3), and (4) of this paragraph set forth
a method of computation which may be employed to determine such amount.
Any other method may be employed so long as the result obtained would be
the same as the result obtained under such method.
(2) Step 1. Determine the increase (or decrease) in accumulated DISC
income for each taxable year of the DISC, or former DISC, by subtracting
from the amount of accumulated DISC income (as defined in 1.996-3(b))
at the close of each taxable year the amount thereof as of the close of
the immediately preceding taxable year.
(3) Step 2. (i) Determine for each taxable year of the DISC, or
former DISC, the increase (or decrease) in accumulated DISC income per
share by dividing such increase (or decrease) for the year by the number
of shares outstanding or deemed outstanding on each day of such year.
(ii) If the number of shares of stock in the corporation outstanding
on each day of a taxable year of the DISC, or former DISC, is not
constant, then the number of such shares deemed outstanding on each day
of such year shall be the sum of the fractional amounts in respect of
each share which was outstanding on any day of the taxable year. The
fractional amount in respect of a share shall be determined by dividing
the number of days in the taxable year on which such share was
outstanding (excluding the day the share became outstanding, but
including the day the share ceased to be outstanding), by the total
number of days in such taxable year.
(iii) If for any taxable year of a DISC, or former DISC, the share
disposed of was not held (or treated under paragraph (d)(2) of this
section as held) by the disposing shareholder for the entire year, then
the amount of increase (or decrease) in accumulated DISC income
attributable to such share for such year is the amount determined as if
he held the share until the end of such year multiplied by a fraction
the numerator of which is the number of days in the taxable year on
which the shareholder held (or under paragraph (d) (2) of this section
is treated as having held) such share and the denominator of which is
the total number of days in the taxable year.
(4) Step 3. Add the amounts computed in step 2 for each taxable year
of the DISC, or former DISC, in which the shareholder held such share of
stock.
(5) Examples. This paragraph may be illustrated by the following
examples:
Example 1. X Corporation uses the calendar year as its taxable year
and elects to be a DISC for the first time for 1973. On January 1,
1973, X has 20 shares issued and outstanding. A and B each own 10
shares. On July 1, 1976, X issues 10 shares to C. On December 31,
1977, A sells his 10 shares to D and recognizes a gain of $120. Under
these facts and other facts assumed in the table below, A includes in
his gross income for 1977 a dividend under paragraph (b) of this section
of $61.30 and long-term capital gain of $58.70.
Example 2. Assume the same facts as in example 1, except that A
sells his 10 shares to D on July 1, 1977. Under subparagraph (3)(iii)
of this paragraph, the amount of increase in accumulated DISC income for
1977 which is attributable to each share disposed of is limited to $.67,
i.e., $1.33 multiplied by 182 days/365 days. Therefore, the sum of the
yearly increases (and decreases) in accumulated DISC income for each
share is reduced by $.66 (i.e., $1.33 minus $.67). The total increase in
accumulated DISC income for each share disposed of is $5.47 (i.e., $6.13
minus $.66). Under these facts, A would include in his gross income for
1977 a dividend of $54.70 and long-term capital gain of $65.30
determined as follows:
(T.D. 7324, 39 FR 35112, Sept. 30, 1974, as amended by T.D. 7854, 47
FR 51741, Nov. 17, 1982)
26 CFR 1.995-5 Foreign investment attributable to producer's loans.
(a) In general -- (1) Limitation. Under section 995(d), the amount
as of the close of a ''group taxable year'' (as defined in subparagraph
(3) of this paragraph) of foreign investment attributable to producer's
loans of a DISC for purposes of section 995(b)(1)(G) shall be the excess
(as of the close of such year) of --
(i) The smallest of --
(a) The amount of the net increase in foreign assets (as defined in
paragraph (b) of this section) by domestic and foreign members of the
controlled group which includes the DISC,
(b) The amount of the actual foreign investment by the domestic
members of such group (as determined under paragraph (c) of this
section), or
(c) The amount of outstanding producer's loans (as determined under
1.993-4) by such DISC to members of such controlled group, over
(ii) The amount (determined under 1.995-2 (a)(5) and (b)(2)) of
foreign investment attributable to producer's loans treated under
section 995(b)(1)(G) as deemed distributions by the particular DISC
taxable as dividends for prior taxable years of that particular DISC.
Thus, for example, if the shareholders of a DISC which uses the
calendar year as its taxable year (and which is a member of a controlled
group in which all of the members use the calendar year as their taxable
year) are treated under section 995(b)(1)(G) as receiving foreign
investment attributable to producer's loans of a DISC of $0 in 1972, $10
in 1973, and $30 in 1974, or a total of $40, and if the smallest of the
amounts described in subdivision (i) of this subparagraph at the end of
1975 is $90, then the amount of the foreign investment attributable to
producer's loans of a DISC at the end of 1975 is $50, i.e., the excess
(as of the close of 1975) of the smallest of the amounts described in
subdivision (i) of this subparagraph ($90) over the sum of the amounts
of foreign investment attributable to producer's loans treated under
section 995(b)(1)(G) as deemed distributions by the DISC taxable as
dividends for prior taxable years of the DISC ($40). If the separate
corporate existence of the DISC as to which the amount described in
subdivision (ii) of this subparagraph relates ceases to exist within the
meaning of 1.995-4(c)(2), then such amount shall no longer be taken
into account by the group for any purpose. For inclusion of amounts
because of certain corporate acquisitions, see paragraph (d) of this
section.
(2) Controlled group; domestic and foreign member. For purposes of
this section --
(i) The term ''controlled group'' has the meaning assigned to such
term by 1.993-1(k).
(ii) The term domestic member means a domestic corporation which is a
member of a controlled group, and the term foreign member means a
foreign corporation which is a member of a controlled group.
(3) Group taxable year. (i) The term group taxable year refers
collectively to the taxable year of the DISC and to the taxable year of
each corporation in the controlled group which includes the DISC ending
with or within the taxable year of the DISC. Thus, for example, if a
corporation has a subsidiary which uses the calendar year as its taxable
year and which elects to be treated as a DISC, and if the parent has a
taxable year ending on October 31, the ''group taxable year'' for 1973
would refer to calendar year 1973 for the DISC and to the parent's
taxable year ending October 31, 1973.
(ii) In cases in which the DISC makes a return for a short taxable
year, that is, for a taxable year consisting of a period of less than 12
months, pursuant to section 443 and the regulations thereunder, or
1.991-1(b)(3), the following rules shall apply --
(a) In the case of a change in the annual accounting period of the
DISC resulting in a short taxable year, the group taxable year refers
collectively to the short taxable year and to the taxable year of each
corporation in the controlled group which includes the DISC ending with
or within the short taxable year.
(b) In the case of a DISC which is in existence during only part of
what would otherwise be its taxable year, the group taxable year refers
collectively to the short period during which the DISC was in existence
and to the taxable year of each corporation in the controlled group
which includes the DISC ending with or within the 12-month period ending
on the last day of the short period.
(iii) With respect to periods prior to the first taxable year for
which a member of the group qualified (or is treated) as a DISC, each
group taxable year shall be determined under subdivision (i) of this
subparagraph as if such member was in existence, it qualified as a DISC,
and its taxable year ended on that date corresponding to the date such
member's first taxable year ended after it qualified (or is treated) as
a DISC whether or not the corporation which qualifies (or is treated) as
a DISC used the same taxable year before it so qualified (or is so
treated). Thus, for example, if a corporation which is organized on
March 3, 1975, uses the calendar year as its taxable year, and is a
member of a controlled group which does not include a DISC, first
qualifies (or is treated) as a DISC for calendar year 1975, then the
term ''group taxable year'' with respect to years prior to 1975 refers
collectively to such prior calendar years and to the taxable year of
each corporation in the group ending with or within such prior calendar
years.
(iv) For special rules in the case of a group which includes more
than one DISC, see paragraph (g) of this section.
(4) Amounts determined for prior years. Unless the 3-year limitation
is properly elected under subparagraph (5) of this paragraph, the
amounts described in paragraphs (b) (relating to net increase in foreign
assets) and (c) (relating to actual foreign investments by domestic
members) of this section reflect, as of the close of a group taxable
year, amounts for all taxable years of members of the group beginning
after December 31, 1971 (and amounts arising after December 31, 1971, or
such other date prescribed in paragraph (b)(7) of this section),
provided that such amounts relate to such group taxable year and
preceding group taxable years. Thus, for example, if all members of a
controlled group use the calendar year as the taxable year, and 1980 is
the first taxable year for which any member of the group qualifies (or
is treated) as a DISC, then, unless the 3-year limitation is elected
under subparagraph (5) of this paragraph, the amounts described in
paragraphs (b) and (c) of this section will be taken into account
beginning with the dates specified in the preceding sentence. For rules
as to carryovers on certain corporate acquisitions and reorganizations,
see paragraph (d) of this section.
(5) Three-year elective limitation. (i) A DISC may elect to take
into account only amounts described in paragraphs (b) (relating to net
increase in foreign assets) and (c) (relating to actual foreign
investment by domestic members) of this section for the 3 taxable years
of each member immediately preceding its taxable year included in that
first group taxable year which includes a member's first taxable year
during which it qualifies (or is treated) as a DISC. For purposes of
the preceding sentence, determinations shall be made by reference to the
taxable year of the issuer or transferor (as the case may be). If an
election is made under this subdivision, the offset for uncommitted
transitional funds under paragraph (b)(7) of this section is not
allowed. If an election is made under this subdivision, the 3-year
limitation applies to amounts described in paragraphs (b)(4) and (c) (1)
and (2) of this section.
(ii) An election under subdivision (i) of this subparagraph shall not
apply with respect to amounts which must be carried over under paragraph
(d) of this section in the case of certain corporate acquisitions and
reorganizations.
(iii) An election under subdivision (i) of this subparagraph shall be
made by the DISC attaching to its first return, filed under section
6011(e)(2), a statement to the effect that the 3-year limitation is
being elected under 1.995-5(a)(5)(i).
(6) Cumulative basis. Pursuant to section 995(d)(5), all
determinations of amounts specified in this section are to be made on a
cumulative basis from the 1st year (or date) provided for in this
section. Thus, each such determination shall take into account a net
increase or a net decrease during the year, as the case may be.
However, if the 3-year limitation is elected under subparagraph (5) of
this paragraph, then only amounts with respect to periods specified in
such subparagraph (5) are amounts taken into account for years before a
member of the group qualifies (or is treated) as a DISC. The
computations described in this section may be made in any way chosen by
the DISC (including a corporation being tested as to whether it
qualifies as a DISC), provided such method results in the amount
prescribed by this section.
(7) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. X Corporation, which uses the calendar year as its taxable
year, is a member of a controlled group (within the meaning of
subparagraph (2) of this paragraph). X elects to be treated as a DISC
beginning with 1972. The amount of foreign investment attributable to
X's producer's loans treated under section 995(b)(1)(G) as a
distribution taxable as a dividend as of the close of each group taxable
year with respect to each taxable year of X from 1972 through 1975 are
set forth in the table below, computed on the basis of the facts assumed
(the amounts on lines (1), (2), (3), and (5) being running balances):
(b) Net increase in foreign assets -- (1) In general. (i) The term
net increase in foreign assets when used in this section means the
excess for the controlled group (as of the close of the group taxable
year) of (a) the investment in foreign assets to be taken into account
under subparagraph (2) of this paragraph over (b) the aggregate of the
five offsets allowed by subparagraphs (3) through (7) of this paragraph.
(ii) No amount described in this paragraph (other than amounts
described in subparagraphs (4) and (7) of this paragraph) with respect
to a member of the group (or foreign branch of a member) shall be taken
into account unless it is attributable to a taxable year of such member
beginning after December 31, 1971. For a 3-year elective limitation
with respect to the first taxable year for which a member qualifies (or
is treated) as a DISC, see paragraph (a)(5) of this section. For manner
of determining amounts on a cumulative basis, see paragraph (a)(6) of
this section.
(2) Investments made in foreign assets. (i) For purposes of
subparagraph (1) of this paragraph, there shall be taken into account as
investment in foreign assets the aggregate of the amounts expended
(within the meaning of subdivision (ii) of this subparagraph) during the
period described in subparagraph (1)(ii) of this paragraph by all
members of the controlled group which includes the DISC to acquire
assets described in section 1231(b) (determined without regard to any
holding period therein provided) which are located outside the United
States (as defined in 1.993-7) reduced by the aggregate of the amounts
received by all such members of the controlled group from the sale,
exchange, or involuntary conversion of such assets described in section
1231(b) which are located outside the United States. For purposes of
this section, amounts expended for assets which are qualified export
assets (as defined in 1.993-2) of a DISC (or which would be qualified
export assets if owned by a DISC) shall not be taken into account.
Thus, for example, if a DISC acquires a qualified export asset located
outside the United States, the asset is not to be taken into account for
purposes of determining the net increase in foreign assets.
(ii) As used in subdivision (i) of this subparagraph, the term
amounts expended (or amounts received) means the amount of any money or
the fair market value (on the date of acquisition, sale, exchange, or
involuntary conversion) of any property (other than money) used to
acquire (or received for) the assets described in such subdivision (i).
(iii) For purposes of this subparagraph, an asset (other than an
aircraft or vessel) is considered as located outside the United States
if it was used predominantly outside the United States during the group
taxable year. The determination as to whether such an asset is used
predominantly outside the United States during the group taxable year in
which it was acquired or sold, exchanged, or involuntarily converted
shall be made by applying the rules of 1.993-3(d) except that an
aircraft described in section 48(a)(2)(B)(i) or a vessel described in
section 48(a)(2)(B)(iii) shall be considered located in the United
States and all other aircraft or vessels shall be considered located
outside the United States. Thus, for example, if a member of a
controlled group which includes a DISC acquires a vessel which is
documented under the laws of a foreign country, the amount expended to
acquire that vessel is an amount described in subdivision (i) of this
subparagraph.
(iv) Examples. The provisions of this subparagraph may be
illustrated by the following examples:
Example 1. X Corporation, which uses the calendar year as its
taxable year, is a domestic member of a controlled group (within the
meaning of paragraph (a)(2) of this section). During 1972, in a
transaction to which section 1031 applies, X acquires a warehouse
located outside the United States and having a fair market value of
$100. As consideration, X transfers $20 in cash and a warehouse located
within the United States and having a fair market value of $80. Under
these facts, $100 will be taken into account as investment in foreign
assets.
Example 2. The facts are the same as in example 1, except that the
warehouse transferred by X as consideration is located outside the
United States. Under these facts, only $20 will be taken into account
as investment in foreign assets because the amount expended for such
assets (i.e., $100) is reduced by the fair market value of any property
located outside the United States received in exchange for such assets
(i.e., $80).
(3) Depreciation with respect to all foreign assets of a controlled
group. (i) An offset allowed by this subparagraph is the depreciation
(determined under subdivision (ii) of this subparagraph) or depletion
(determined under subdivision (iii) of this subparagraph) attributable
to taxable years of the member beginning after December 31, 1971, with
respect to all of the group's foreign assets described in subparagraph
(2) of this paragraph including such assets acquired prior to the date
provided in such subparagraph (2), and without regard to whether the
3-year election in paragraph (a)(5) of this section is made. Thus, for
example, depreciation for a taxable year of a member beginning after
December 31, 1971, with respect to an asset described in section 1231(b)
which is located outside of the United States and which was acquired
during a taxable year of the member beginning before January 1, 1972, is
an offset allowed by this subparagraph. For a further example,
depreciation with respect to a qualified export asset is not such an
offset.
(ii) The depreciation taken into account under subdivision (i) of
this subparagraph shall be --
(a) In the case of an asset owned by a domestic member, only the
amount allowed under section 167(b)(1) (relating to the allowance of the
straight-line method of depreciation) and 1.162-11 (b) (relating to
amortization in lieu of depreciation), but not the amount allowed under
section 179 (relating to the additional first-year depreciation
allowance).
(b) In the case of an asset owned by a foreign member, the
depreciation and amortization (referred to in (a) of this subdivision)
allowable for purposes of computing earnings and profits under
subparagraph (5)(i) of this paragraph.
(iii) The depletion taken into account under subdivision (i) of this
subparagraph shall be limited to cost depletion computed under sections
611 and 612 and the regulations thereunder. Thus, percentage depletion
is not to be taken into account in computing the offset under this
subparagraph.
(4) Amount of outstanding stock or debt. (i) An offset allowed by
this subparagraph is the outstanding amount of stock (including treasury
stock) or debt obligations of any member of the group issued, sold, or
exchanged after December 31, 1971, by any member (whether or not the
same member) to persons who (on the date of such issuance, sale, or
exchange) were neither United States persons (within the meaning of
section 7701(a)(30)) nor members of the group: Provided, That, in the
case of a debt obligation, such obligation is not repaid within 12
months after such issuance, sale, or exchange. Thus, for example, if
stock is issued to a member of the group before January 1, 1972, and
after December 31, 1971, it is sold to a person who is neither a United
States person nor a member of the group, an offset allowed by this
subparagraph includes the outstanding amount of such stock. For
purposes of this subparagraph, foreign branches of United States banks
are not considered to be United States persons.
(ii) The outstanding amount of stock or debt obligations shall be
determined in accordance with the following provisions:
(a) The outstanding amount of stock or debt obligations described in
subdivision (i) of this subparagraph is equal to the net amount
described in (b) of this subdivision reduced (but not below zero) by the
amount described in (c) of this subdivision.
(b) The net amount described in this subdivision (b) is the excess of
(1) the aggregate of the amount of money and the fair market value of
property (other than money) transferred by persons who are not members
of the group and who are not U.S. persons as consideration for such
stock and debt obligations over (2) fees and commission expenses borne
by the issuer or transferror with respect to their issuance, sale, or
exchange.
(c) The amount described in this subdivision (c) is the aggregate
amount of money and fair market value of property (other than money)
distributed to such persons on distributions in respect of such stock
from other than earnings and profits or on distributions in redemption
of such stock and the amount of principal paid pursuant to such debt
obligations.
(d) For purposes of this subdivision (ii), in the case of a
redemption, the stock or debt redeemed shall be charged against the
earliest of such stock or debt issued, sold, or exchanged in order to
determine the amount by which the balance of outstanding stock or debt
is to be reduced. For purposes of this subparagraph, the fair market
value of property received as consideration shall be determined as of
the date the transaction occurs, and a contribution to capital within
the meaning of section 118 shall be treated as the issuance of stock.
(iii) The provisions of subdivision (i) of this subparagraph apply
regardless of the treatment under the Code of the transaction in which
the stock or debt was issued, sold, or exchanged. Thus, for example, if
X Corporation, a member of a controlled group which includes a DISC,
acquires from a nonresident alien individual in exchange solely for X's
voting stock all of the stock of Y Corporation pursuant to a
reorganization as defined in section 368(a)(1)(B), the fair market value
of the Y stock on the date of the exchange would be an offset allowed by
this subparagraph.
(iv) The provisions of this subparagraph may be illustrated by the
following example:
Example. X Corporation is a member of a controlled group (within a
meaning of paragraph (a)(2) of this section) every member of which uses
the calendar year as its taxable year. On January 1, 1972, X issues in
a public offering its stock to persons described in subdivision (i) of
this subparagraph who, in the aggregate, pay $1,000 as consideration. X
pays $100 in underwriting fees. On the same date, X receives $425 upon
issuing a $500 debt obligation to such persons at a discount of $75 and
pays $25 in underwriting fees. On December 31, 1972, the offset allowed
under this subparagraph is $1,300, i.e., ($1,000 minus $100) plus ($425
minus $25). If, during 1973, X makes a distribution of $150 (not in
redemption) from other than earnings and profits with respect to such
stock, then the offset is reduced to $1,150.
(5) Earnings and profits. (i) An offset allowed by this subparagraph
is one-half the aggregate of the earnings and profits accumulated for
all taxable years beginning after December 31, 1971, computed (without
regard to any distributions from earnings and profits by a foreign
corporation to a domestic corporation in accordance with 1.964-1
(relating to a controlled foreign corporation's earnings and profits),
of each foreign member of the group which is controlled directly or
indirectly (as determined under the principles of section 958 and the
regulations thereunder) by a domestic member of the group and each
foreign branch of a domestic member of the group (computed as if the
branch were a foreign corporation). The DISC is bound by any action on
behalf of a foreign member that was taken pursuant to 1.964-1(c)(3) or
by any failure to take action by or on behalf of a foreign member within
the time specified in 1.964-1(c)(6). With respect to a foreign member
for which action was not previously required under 1.964-1(c)(6) to be
taken, the DISC may take action on behalf of such member by attaching a
statement to that effect to the return of the DISC under section
6011(e)(2) for the first taxable year during which it qualifies (or is
treated) as a DISC and there is outstanding a producer's loan made by
such DISC to a member of the controlled group which includes the DISC.
(ii) If the aggregate of the accumulated earnings and profits
described in subdivision (i) of this subparagraph is a deficit, the
amount allowable as an offset under this subparagraph is zero.
(6) Royalties and fees. An offset allowed by this subparagraph is
one-half the royalties and fees paid by foreign members of the group to
domestic members of the group and by foreign branches of domestic
members of the group to domestic members of the group during the taxable
years of such members beginning after December 31, 1971.
(7) Uncommitted transitional funds. (i) An offset allowed by this
subparagraph for the uncommitted transitional funds of the group is the
sum described in subdivision (ii) of this subparagraph of the amount of
certain capital raised under the foreign direct investment program and
the amounts described in subdivision (iv) of this subparagraph of
certain foreign excess working capital held on October 31, 1971.
(ii) The amount described in this subdivision of certain capital
raised under the foreign direct investment program is the excess (if
any) of --
(a) The amount of the offset allowed by subparagraph (4) of this
paragraph, determined, however, with respect to the stock and debt
obligations of domestic members of the group outstanding on December 31,
1971 (including amounts treated as stock outstanding by reason of a
contribution to capital), whether or not outstanding after such date,
which were issued, sold, or exchanged on or after January 1, 1968, by
any member (whether or not the same member) to persons who (on the date
of such issuance, sale, or exchange) were neither United States persons
(within the meaning of section 7701(a)(30)) nor members of the group,
but only to the extent the taxpayer establishes that such amount
constitutes a long-term borrowing (see 15 CFR 1000.324 /1/ ) for
purposes of the foreign direct investment program (see 15 CFR part 1000
/1/ ), over
(b) The amount (determined under paragraph (c) of this section) of
actual foreign investment by the domestic members of the group during
the portion of the period such stock or debt obligations have been
outstanding prior to January 1, 1972, such determination to be made by
substituting January 1, 1968, for the December 31, 1971, date specified
in such paragraph (c) and by not taking into account the earnings and
profits described in paragraph (c)(3) of this section.
For purposes of this subparagraph, foreign branches of United States
banks are not considered to be United States persons.
(iii) (a) A taxpayer may establish that an amount under subdivision
(ii) (a) of this subparagraph constitutes a long-term borrowing for
purposes of the foreign direct investment program by keeping records
sufficient to demonstrate that appropriate reports were filed with the
Office of Foreign Direct Investment of the Department of Commerce with
respect to the foreign borrowing or by any other method satisfactory to
the district director.
(b) The amounts described in subdivision (ii) (a) of this
subparagraph include amounts with respect to which an election under
section 4912(c), to subject certain obligations of a United States
person to the interest equalization tax, has been made: Provided, That
the obligations to which such amounts relate were issued by an
''overseas financing subsidiary'' described in 15 CFR part 1000 /1/ and
were assumed by a United States person from such overseas financing
subsidiary. Thus, for example, if an overseas financing subsidiary
issues its notes to a foreign person in 1968, and such notes are assumed
by its United States parent in 1973, which parent elects under section
4912(c) to have the notes subject to the interest equalization tax, then
the amount of money received by the subsidiary is an amount described in
subdivision (ii)(a) of this subparagraph.
(iv) The amount described in this subdivision of foreign excess
working capital is the amount of liquid assets held by the foreign
members of such group and foreign branches of domestic members of such
group on October 31, 1971 (whether or not so held after such date) in
excess of their reasonable working capital needs (as defined in 1.993-2
(e)) on that date, but only to the extent not included in subdivision
(ii) of this subparagraph. For purposes of this subdivision, the term
liquid assets means money, bank deposits (not including time deposits),
and indebtedness of any kind (including time deposits) which on the day
acquired had a maturity of 2 years or less.
(8) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. X Corporation, which uses the calendar year as its taxable
year is a member of a controlled group (within the meaning of paragraph
(a)(2) of this section). X elects to be treated as a DISC beginning
with 1972. The amount of net increase in foreign assets of the group at
the close of each group taxable year with respect to each taxable year
of X from 1972 through 1975 are set forth in the table below, computed
on the basis of the facts assumed (the amounts on each line being
running balances):
(c) Actual foreign investment by domestic members. For purposes of
determining the limitation in paragraph (a) of this section, the amount
of the actual foreign investment by domestic members of a controlled
group is the sum (as of the close of the group taxable year) determined
on a cumulative basis (see paragraph (a)(6) of this section) of --
(1) Outstanding stock or debt (including contributions to capital).
The outstanding amount (determined in accordance with the principles of
paragraph (b)(4)(ii) of this section, applied with respect to stock or
debt obligations described in this subparagraph) of stock (including
treasury stock) or debt obligations (other than normal trade
indebtedness) of foreign members of the group issued, sold, or exchanged
after December 31, 1971, by any person (whether or not a member) which
is not a domestic member to domestic members of the group: Provided,
That the outstanding amount of debt obligations of any foreign member
shall be the greater of such amount outstanding at the close of the
taxable year of such member or the highest such amount outstanding at
any time during the immediately preceding 90 days,
(2) Transfers to foreign branches. The amount of money or the fair
market value of property (other than money) transferred by domestic
members of the group after December 31, 1971, to foreign branches of
such members in transactions which would, if the branch were a
corporation, be in consideration for the sale of stock or debt
obligations of (or a contribution of capital to) such foreign branches
(as determined under subparagraph (1) of this paragraph), and
(3) Earnings and profits of foreign members. One-half of the
earnings and profits (computed in accordance with paragraph (b)(5) of
this section for purposes of computing net increase in foreign assets)
of foreign members of the group which are controlled directly or
indirectly (as determined under the principles of section 958 and the
regulations thereunder) by a domestic member of the group and foreign
branches (treated for this purpose as a corporation) of domestic members
of the group accumulated during the taxable years of such foreign
members (or branches) beginning after December 31, 1971, or, if later,
the taxable year referred to in paragraph (a)(5)(i) of this section if
the 3-year election provided for in such paragraph (a)(5)(i) is made.
(d) Carryovers on certain corporate acquisitions and reorganizations
-- (1) Certain corporate acquisitions. (i) If --
(a) A member of a controlled group (''first controlled group'')
acquires in a transaction to which section 381 applies the assets of a
corporation which is a member of a second controlled group or acquires
stock in such a corporation pursuant to a reorganization as defined in
section 368(a)(1)(B) to which section 361 applies, or
(b) A member or combination of members of the first controlled group
acquire in a transaction not described in (a) of this subdivision a
majority interest (as defined in paragraph (e)(2) of this section) in
the stock of a corporation which is a member of a second controlled
group which includes a DISC so that such DISC after the acquisition is a
member of the new controlled group,
then, for purposes of computing foreign investment attributable to
producer's loans with respect to the new controlled group as constituted
after such acquisition, all amounts described in paragraphs (a) through
(c) of this section, including the amount specified in paragraph
(a)(1)(ii) of this section (relating to amounts treated under section
995(b)(1)(G) as deemed distributions by the DISC taxable as dividends
for prior taxable years of the DISC), with respect to members of the
second controlled group which become members of the new controlled group
shall carry over to such new controlled group. For purposes of this
subdivision (i), a controlled group may consist of only one member.
With respect to certain transactions involving foreign corporations, see
section 367.
(ii) If a member or combination of members of a controlled group,
immediately after an acquisition of stock to which subdivision (i) of
this subparagraph applies, do not control the total combined voting
power (determined under 1.957-1(b)) of the corporation whose stock was
acquired, proper apportionment consistent with the principles of
paragraph (e)(5) of this section shall be made with respect to amounts
to which paragraphs (a) through (c) of this section apply.
(iii) (a) If subdivision (i) of this subparagraph applies, then for
purposes of determining the application of the 3-year elective
limitation provided for in paragraph (a)(5) of this section, the rules
in (b), (c), and (d) of this subdivision (iii) apply.
(b) If both the ''first controlled group'' and the ''second
controlled group'' (as those terms are defined in subdivision (i) of
this subparagraph) include a DISC, and a DISC in either group has
elected the 3-year limitation provided in paragraph (a)(5) of this
section, then only those amounts taken into account under such paragraph
(a)(5) by the electing DISC or DISC's shall be taken into account.
(c) If one of the groups includes a DISC and the other does not, and
if the DISC has elected the 3-year limitation provided in paragraph
(a)(5) of this section, then, for purposes of computing foreign
investment attributable to producer's loans with respect to the new
controlled group as constituted after the acquisition, all amounts
described in paragraphs (a) through (c) of this section with respect to
members of the controlled group which did not include the DISC shall
carry over to such new controlled group, but only to the extent provided
in such paragraph (a)(5), computed as if the group taxable year in which
the acquisition occurred was the first group taxable year which includes
a member's first taxable year during which it qualifies (or is treated)
as a DISC.
(d) If (c) of this subdivision (iii) applies, except that the DISC
has not elected the 3-year limitation provided in paragraph (a)(5) of
this section, then the DISC in the new controlled group as constituted
after the acquisition may, with respect to members of the controlled
group which did not include the DISC, make the election provided in such
paragraph (a)(5), and treat the year in which the acquisition occurred
as if it were the first group taxable year which includes a member's
first taxable year during which it qualifies (or is treated) as a DISC.
(iv) If a majority interest, or an interest in addition to a majority
interest, is acquired in a transaction other than a transaction
described in subdivision (i) of this subparagraph, then the rules in
paragraph (e) of this section (relating to the acquisition of the
foreign assets of a corporation) apply.
(2) Corporation ceasing to be a member. As of the date a corporation
which is a member of a controlled group ceases to be a member of such
group, the amounts of such group described in paragraphs (a) through (c)
of this section will be reduced by such amounts which are attributable
to the corporation which is no longer a member of the group.
(e) Acquisition of a majority interest in a corporation -- (1) In
general. If paragraph (d)(1)(i) of this section (relating to certain
corporate acquisitions in which all amounts described in paragraphs (a)
through (c) of this section carry over) does not apply, then, for
purposes of determining under paragraph (b)(2) of this section the
investments made in foreign assets by a controlled group, the
acquisition of a majority interest (as defined in subparagraph (2) of
this paragraph) or an interest in addition to a majority interest in a
corporation by any member or combination of members of the controlled
group is considered an acquisition of the assets (to the extent provided
in subparagraph (5) of this paragraph) of the acquired corporation by
the group, including the assets of any foreign corporation in which the
acquired corporation owns a majority interest (to the extent provided in
subparagraph (5) of this paragraph). For the rules concerning the date
upon which an acquisition of a majority interest is considered to have
occurred, see subparagraph (3) of this paragraph.
(2) Majority interest. For purposes of this section, a majority
interest is more than 50 percent of the total combined voting power of
all classes of a corporation's stock entitled to vote, as determined
under 1.957-1(b).
(3) Acquisition date. For purposes of this paragraph, an acquisition
of a majority interest shall be considered to have occurred on the day
on which the combined voting power of the group first reached the
percentage required in subparagraph (2) of this paragraph.
(4) Valuation of assets. For purposes of this section, the amount of
a corporation's assets deemed acquired is the fair market value of the
assets on the date a majority interest, or an interest in addition to a
previously held majority interest, is acquired.
(5) Apportionment in the case of the acquisition of less than all of
the voting stock. (i) If the acquisition described in subparagraph (1)
of this paragraph of a majority interest is of less than 100 percent of
the total combined voting power of all classes of stock of the acquired
corporation entitled to vote, then for purposes of subparagraph (1) of
this paragraph the amount of the foreign assets of the corporation
deemed acquired as of the day the majority interest is considered
acquired shall be an amount equal to the fair market value of all of the
corporation's foreign assets described in paragraph (b)(2) of this
section as of such day multiplied by the percentage of the total
combined voting power (determined under 1.957-1(b)) held by members of
the group on the day the majority interest is considered acquired.
(ii) If any member or combination of members of the controlled group
hold a majority interest in a corporation, then for purposes of
subparagraph (1) of this paragraph the acquisition of additional
combined voting power by members of the controlled group shall be
considered an acquisition of its foreign assets described in paragraph
(b)(2) of this section in an amount equal to the fair market value of
all such assets held by the foreign corporation on the date of the
acquisition, multiplied by the increase (expressed in percentage points)
in total combined voting power (as determined under 1.957-1(b)) which
occurred.
(6) Examples. The application of this paragraph may be illustrated
by the following examples:
Example 1. M Corporation uses the calendar year as its taxable year.
On November 18, 1973, M acquires from A, an individual United States
person, for $1 million cash all 10,000 shares of the voting stock of N,
a foreign corporation. N's only asset is a warehouse located in France
with a fair market value on the date of acquisition of $1 million.
Under subparagraph (1) of this paragraph, the controlled group of which
M is a member is considered to have expended $1 million for the
acquisition of foreign assets described in paragraph (b)(2) of this
section.
Example 2. The facts are the same as in example 1, except that on
November 18, 1973, M acquires only 80 percent of N's voting stock. M is
considered to have expended $800,000 for the acquisition of assets
described in paragraph (b)(2) of this section, computed as follows:
Example 3. The facts are the same as in example 2, except that
individual A is not a United States person, and M acquires the 80
percent of N voting stock in exchange for cash of $100,000 and M stock
having a fair market value on the date of the acquisition of $700,000.
M is considered to have acquired assets described in paragraph (b)(2) of
this section in the amount of $800,000 (see computations in example 2)
and to have an offset under paragraph (b)(4) of this section (relating
to outstanding stock or debt) of $700,000 (the fair market value of the
M stock transferred to A who is not a United States person). However,
the controlled group of which M is a member is not considered to have
acquired any other amounts described in paragraphs (a) through (c) of
this section with respect to N for taxable years prior to the taxable
year of N during which the acquisition occurred.
Example 4. P Corporation, which uses the calendar year as its
taxable year, is a member of a controlled group which includes a DISC.
During 1973, P acquires from B, an individual United States person, for
cash, 30 percent of the total combined voting power of all classes of
stock entitled to vote of Q, a foreign corporation. All of Q's assets
are assets described in paragraph (b)(2) of this section. No additional
interest in Q is acquired by members of the group during 1973. The
controlled group of which Q is a member is not considered to have made
any investments in foreign assets described in such paragraph (b)(2) as
of the close of 1973.
Example 5. Assume the same facts as in example 4. Assume further
that during 1974, R Corporation, a member of the controlled group which
includes P, acquires for cash 40 percent of the total combined voting
power of all classes of stock of Q entitled to vote as follows: 20
percent on July 31, and 20 percent on December 31. Thus, on December
31, 1974, members of the controlled group own 70 percent of Q's voting
power (30+20+20) and on that date are considered to have acquired a
majority interest in Q. The fair market value of Q's assets on December
31, 1974, is $5 million. The group is considered to have expended
$3,500,000 for the acquisition of assets described in paragraph (b)(2)
of this section computed as follows:
Example 6. The facts are the same as in example 5. Assume further
that on July 15, 1975, P acquires the remaining 30 percent of the total
combined voting power of all classes of Q stock entitled to vote, and on
such date the fair market value of Q's assets is $5,500,000. The group
is considered to have expended $5,150,000 for the acquisition of assets
described in paragraph (b)(2) of this section as of the close of 1975,
computed as follows:
(f) Records. A DISC shall keep or be readily able to produce such
permanent books of account or records as are sufficient to establish the
transactions and amounts described in this section. Where applicable,
such books of account or records shall be cumulative and shall show
transactions and amounts of the members of the controlled group which
includes the DISC which occurred prior to the date the DISC qualified
(or is treated) as a DISC.
(g) Multiple DISC's -- (1) Allocation among DISC's. In the case of a
controlled group which includes more than one DISC, the amounts
described in paragraphs (b) and (c) of this section shall be allocated
among the DISC's in order to determine the limitation in paragraph (a)
of this section. Each DISC's allocable portion of these amounts shall
be equal to the total of such amounts multiplied by a fraction the
numerator of which is the individual DISC's outstanding producer's loans
to members of the group, and the denominator of which is the aggregate
amounts of outstanding producer's loans to members of the group by all
DISC's which are members of the group.
(2) Different taxable years. If all of the DISC's which are members
of the controlled group do not have the same taxable year, then one such
DISC shall on behalf of all such DISC's elect to make all computations
under section 995(d) as if all DISC's that are members of the group use
the same taxable year as the actual taxable year of any one of the
DISC's. The election as to which DISC's taxable year is to be used
shall be made by the electing DISC attaching to its first return, filed
under section 6011(e)(2), a statement indicating which such taxable year
will be used. Once such an election is made it may not be revoked until
such time as all of the DISC's which are members of the group use the
same taxable year. If this subparagraph applies, books and records must
be kept by the group which are adequate to show the necessary
computations under section 995(d).
(3) This paragraph may be illustrated by the following example:
Example. Corporation X and corporation Y are members of the same
controlled group and each has elected to be treated as a DISC. X uses a
taxable year ending March 31, and Y uses a taxable year ending November
30. Notwithstanding the fact that all other members of the group use
the calendar year as their taxable year, all computations for purposes
of determining the amount of foreign investment attributable to
producer's loans under section 995(d) must be made as if both DISC's use
a taxable year ending either March 31 (X's taxable year) or November 30
(Y's taxable year).
(T.D. 7324, 39 FR 35114, Sept. 30, 1974, as amended by T.D. 7420, 41
FR 20655, May 20, 1976; T.D. 7854, 47 FR 51742, Nov. 17, 1982)
/1/ Editorial Note: 15 CFR part 1000 was removed at 39 FR 30481,
Aug. 23, 1974.
26 CFR 1.995-6 Taxable income attributable to military property.
(a) Gross income attributable to military property. For purposes of
section 995(b)(3)(A)(i), the term ''gross income which is attributable
to military property'' includes income from the sale, exchange, lease,
or rental of military property (as described in paragraph (c) of this
section). The term also includes gross income from the performance of
services which are related and subsidiary (as defined in 1.993-1(d)) to
any qualified sale, exchange, lease, or rental of military property.
Where gross income cannot be determined on an item by item basis, the
gross income with respect to those items not so determinable shall be
apportioned. Such apportionment shall be accomplished using appropriate
facts and circumstances, so that the gross income apportioned to sale of
military property bears a reasonably close factual relationship to the
actual gross income earned on such sales. The apportionment shall be
based on methods which include the fair market value of property sold or
exchanged, the fair rental value of any leaseholds granted, the fair
market value of any related or subsidiary services performed in
connection with such sale or leases or methods based on gross receipts
or costs of goods sold, where appropriate.
(b) Deductions. For purposes of section 995(b)(3)(A)(ii), deductions
shall be properly allocated and apportioned to gross income, described
in paragraph (a) of this section, in accordance with the rules of
1.861-8. These deductions include all applicable deductions from gross
income provided under part VI of subchapter B of chapter 1 of the Code.
(c) Military property. For purposes of this section, the term
military property means any property which is an arm, ammunition, or
implement of war designated in the munitions list published pursuant to
section 38 of the International Security Assistance and Arms Export
Control Act of 1976 (22 U.S.C. 2778 which superseded 22 U.S.C. 1934) and
the regulations thereunder (22 CFR 121.01).
(d) Illustration. The principles of this section may be illustrated
by the following example:
Example. X Corporation elects to be a DISC for the first time in
1976. X has taxable income of $50,000, of which $30,000 is attributable
to military property and $10,000 to interest on producer's loans. The
total deemed distributions with respect to X are as follows:
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal
Revenue Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10);
90 Stat. 1659, 26 U.S.C. 995(g); and 68A Stat 917, 26 U.S.C. 7805))
(T.D. 7984, 49 FR 40019, Oct. 12, 1984)
26 CFR 1.995-7 Taxable income attributable to base period export gross
receipts.
(a) General rule. This section provides rules for the computation of
taxable income attributable to base period export gross receipts.
Section 995(b)(1)(E) treats taxable income attributable to base period
export gross receipts as a deemed distribution to a shareholder of a
DISC for taxable years of a DISC beginning after December 31, 1975. The
amount attributable to base period export gross receipts that must be
included in income of a shareholder will be referred to as the
nonincremental distribution. The nonincremental distribution must be
computed for each taxable year of a DISC. Such year will be referred to
as the computation year.
(b) Nonincremental distribution -- (1) General rule. The
nonincremental distribution for a computation year of a DISC is computed
by multiplying the adjusted taxable income of the DISC by a fraction.
The numerator of the fraction is the amount of the adjusted base period
export gross receipts and the denominator is the amount of the export
gross receipts of the DISC for the computation year.
(2) Adjusted taxable income. The adjusted taxable income is the
taxable income of a DISC for the computation year reduced by the amounts
described under section 995(b)(1) (A) through (D) and the regulations
thereunder.
(3) Export gross receipts. The export gross receipts is the
qualified export gross receipts described in section 993(a)(1) (A), (B),
(C), (G), and (H) of a DISC for a taxable year reduced by 50 percent of
those receipts which are attributable to military property (as defined
under 1.995-6). For purposes of determining the denominator described
in this paragraph (b), if the computation year is a short taxable year,
the amount of export gross receipts for that year is multiplied by a
fraction. The numerator of the fraction is the number of days which
would have been in the taxable year of the taxpayer if there had been a
full taxable year and the denominator is the number of days in the short
taxable year.
(4) Adjusted base period export gross receipts. The amount of
adjusted base export gross receipts is 67 percent of the average of the
base period export gross receipts.
(c) Average base period export gross receipts -- (1) Base period of
48 months or less. If a DISC has a base period of 48 months or less,
the amount of average base period export gross receipts is determined by
dividing the base period export gross receipts by number four (4).
(2) Base period or more than 48 months. If a DISC has a base period
of more than 48 months, the amount of average base period export gross
receipts is determined by multiplying the base period export gross
receipts by a fraction. The numerator of the fraction is the number
365.25 and the denominator is the total number of days in the base
period.
(3) Change of accounting period. Notwithstanding paragraph (c)(1) of
this section, if a corporation that is a DISC changes its annual
accounting period (other than during the first taxable year of its
existence), and the effect of such a change creates a base period of
less than 48 months, the average base period export gross receipts are
determined under paragraph (c)(2) of this section. This paragraph
(c)(3) applies with respect to changes of accounting period permitted
under 1.995-7(d)(5).
(4) Base period export gross receipts. Base period export gross
receipts means the aggregate export gross receipts of a DISC for all
taxable years beginning during the base period reduced by the base
period export gross receipts attributable to property that is excluded
from export gross receipts during the computation year. Excluded
property is property described in section 993(c)(2) (C) or (D) without
regard to the fixed contract exception under 1.993-3(g)(6). When the
fixed contract exception applies, the amount of excluded property is
multiplied by a fraction. The numerator of the fraction is the amount
of the gross receipts in the computation year attributable to excluded
property less the amount of the export gross receipts by reason of the
fixed contract exception under 1.993-3(g)(6). The denominator of the
fraction is the total amount of gross receipts in the computation year
attributable to excluded property. For taxable years of a DISC ending
before November 15, 1982, base period export gross receipts do not
include receipts attributable to property sold or leased to a WHTC or
receipts which arose in the absence of a written supplier's agreement
unless the receipts were treated as qualified export by the taxpayers.
(5) Illustration. The following example illustrates the application
of paragraph (c)(4) of this section:
Example. X Corporation, a DISC since 1972, derived $2000 from sales
of coal and $3000 from sales of foodstuffs in 1976. In 1975 gross
receipts from the sale of agricultural products were $1000 and from the
sale of coal were $3000. One thousand dollars of the $3000 was derived
from sales prior to March 19, 1975, and $2000 from sales made after
March 18, 1975, of which $500 of the latter sales were pursuant to a
fixed contract. Assume that all gross receipts are qualified export
receipts (and, therefore, export gross receipts as provided in paragraph
(b)(3) of 1.995-7)
except to the extent that section 993 (c)(2)(C) (which treats natural
resources such as coal as excluded property) is applicable. Assume
further that the gross receipts for 1972, 1973, and 1974 were each $500,
all derived entirely from the sale of foodstuffs and all qualifying as
export gross receipts. Under these facts the adjusted base period
export gross receipts are determined as follows:
(6) Base years. The base period is a 4-year period attributable to a
computation year. For computation years of a DISC beginning before
January 1, 1980, the base period calendar years are 1972, 1973, 1974,
and 1975. For other computation years, the base period calendar years
are the fourth, fifth, sixth and seventh calendar years preceding the
calendar year in which the computation year begins. If a DISC has
taxable years beginning in every base period calendar year, the base
period is the period which begins on the first day of the first taxable
year beginning in the earliest base period calendar year and ends on the
last day of the last taxable year beginning in the latest base period
calendar year. A corporation that revoked its election to be treated as
a DISC or failed to satisfy the conditions of section 992(a)(1) for a
taxable year to be a DISC will, for purposes of computing its base
period export gross receipts, be treated as a DISC newly established in
such subsequent taxable year. However, see paragraph (e)(3) of this
section, which treats a disqualification as a separation. This
paragraph (c)(6) applies whether or not the DISC qualified (or was
treated) as a DISC (within the meaning of section 992(a)(1) and
1.992-1) for all taxable years beginning in the base period calendar
years. If a DISC does not have a taxable year beginning in every base
period calendar year, the base period is the period which begins on the
the date during the earliest base period calendar year that corresponds
to the date on which the first taxable year of the DISC begins, and ends
on the last day of the last taxable year of the DISC beginning in the
latest base period calendar year.
(7) Illustrations. The following examples illustrate the application
of this paragraph (c):
Example 1. X Corporation, a DISC, was organized on March 1, 1972,
and adopted a taxable year beginning on March 1. With respect to the
computation year beginning on March 1, 1976, X's base period calendar
years are 1972, 1973, 1974, and 1975. The base period is the period
which begins on March 1, 1972, and ends on February 29, 1976.
Example 2. Y Corporation, a DISC, was organized on March 15, 1974,
and adopted a taxable year beginning on October 1. With respect to the
computation year beginning on October 1, 1977, Y's base period is the
period which begins on March 15, 1972, and ends on September 30, 1976.
Example 3. Z Corporation, a DISC, was organized on December 10,
1974, and adopted a taxable year beginning on February 1. With respect
to the computation year beginning on February 1, 1980, Z's base period
calendar years are 1973, 1974, 1975, and 1976. The base period is the
period which begins on December 10, 1973, and ends on January 31, 1977.
(d) Controlled group -- (1) General rule. Where more than one member
of a controlled group of corporations (as defined in section 993(a)(3)
and 1.993-1(k)) qualifies or is treated as a DISC, special rules are
used to calculate the nonincremental distribution. In such a case, the
fraction described in paragraph (d)(2) of this section to compute the
nonincremental distribution is the aggregate of the adjusted base period
export gross receipts over the aggregate of the computation year export
gross receipts for the computation year of every member DISC within the
controlled group. This fraction is multiplied by the aggregate adjusted
taxable income of each member DISC within the controlled group. The
computation of the nonincremental distribution described in this
paragraph applies to shareholders of a DISC that is a member of a
controlled group even though such shareholder is not a related person
within the meaning of 1.993-1(a)(6).
(2) Aggregate adjusted base period export gross receipts. If any
DISC that is a member of the controlled group uses a taxable year that
is different from another DISC that is a member of the same controlled
group, the aggregate of the adjusted base period export gross receipts
consists of the sum of the adjusted base period export gross receipts of
each of the following DISCs:
(i) The DISC (primary DISC) with respect to which the nonincremental
distribution is being determined; and
(ii) All other DISCs (secondary DISCs) that are members of the same
controlled group (as defined in section 993(a)(3)) as the primary DISC
and whose computation years end with or within the computation year of
the primary DISC.
For purposes of this paragraph (d)(2), the base period calendar years
of any secondary DISC is the base period calendar years of the primary
DISC.
(3) Aggregate current year export gross receipts. If paragraph
(d)(2) of this section applies, the aggregate of the export gross
receipts for the computation year consists of the sum of the export
gross receipts of the primary DISC and the export gross receipts of all
secondary DISCs for their computation years described in paragraph
(d)(2)(ii) of this section.
(4) Illustrations. The following examples illustrate the application
of this paragraph (d):
Example 1. P Corporation owns all of the stock of V and X
Corporations. V owns all of the stock of Y Corporation, a DISC. X owns
all of the stock of Z Corporation, a DISC. P, V, X, Y, and Z are
members of the same controlled group for all periods involved. V uses a
fiscal year ending June 30 as its taxable year. X uses the calendar
year as its taxable year. Y and Z both use the calendar year as their
taxable years. For the computation year ending in 1980, Y has adjusted
taxable income (as defined under paragraph (b)(2) of this section) of
$3,000, adjusted base period export gross receipts (as defined under
paragraph (b)(4) of this section) of $2,000, and export gross receipts
(as defined under paragraph (b)(3) of this section) of $5,000. For the
same year, Z has adjusted taxable income of $4,000, adjusted base period
export gross receipts of $6,000 and export gross receipts of $5,000.
The numerator of the fraction to determine the nonincremental
distribution is $8,000, the aggregate of the adjusted base period export
gross receipts of Y and Z. The denominator of the fraction is $10,000,
the aggregate of the export gross receipts of Y and Z. The
nonincremental distribution under paragraph (b)(1) of this section with
respect to Y is $2,400 ($3,000 8/10), and with respect to Z is $3,200
($4,000 8/10).
Example 2. The facts are the same as in example 1 except that Y uses
a fiscal year ending January 31 as its taxable year and the computation
year ends in 1980. In computing the nonincremental distribution with
respect to Z, a calendar year DISC, Z is the primary DISC described in
paragraph (d)(2)(i) of this section. In computing the adjusted base
period export gross receipts of Y, Y's base period is the same as that
of Z even though Y's computation year begins in the calendar year 1979.
The adjusted taxable income and current year export gross receipts of Z
are for the calendar year beginning January 1, 1980, and the current
year export gross receipts of Y are for Y's fiscal year ending January
31, 1980.
(5) Change of annual accounting period. Where more than one member
of a controlled group of corporations (as defined in section 993(a)(3)
and 1.993-1(k)) qualifies or is treated as a DISC and where any two or
more of the member DISCs have different annual accounting periods, the
annual accounting periods of the member DISCs may be changed without the
approval of the Secretary if, and only if
(i) All member DISCs have the same annual accounting period after the
change; and
(ii) The period chosen is the annual accounting period of one of the
member DISCs.
In the case of an existing controlled group with member DISCs having
different annual accounting periods, the change may be made within one
year after (the date of adoption of the regulations as a Treasury
decision); and in the case of a newly acquired DISC, the accounting
period of such DISC may be changed by adopting the period of any
existing DISC within one year after acquisition.
(e) Separation of DISC and trade or business -- (1) General rule.
If, at any time after the beginning of the base period of a DISC, there
has been a separation of the ownership of the stock in that DISC from
the ownership of a trade or business that produced export gross receipts
of the DISC, the persons who own the trade or business during the
taxable year are treated as having in any DISC in which they have (or
acquire) a direct or indirect interest additional export gross receipts
attributable to the trade or business for purposes of computing base
period export gross receipts. Notwithstanding the separation, the base
period export gross receipts remain with the DISC after separation and
are taken into account by shareholders of the DISC (whether or not there
are new shareholders of the DISC as a result of the separation) in
computing the adjusted base period export gross receipts of the DISC for
taxable years beginning prior to the year in which the separation
occurs.
(2) Ownership. A person will be treated as an owner of a trade or
business which produced export gross receipts of a DISC if the person
owns stock, directly or indirectly, in a corporation that conducts the
trade or business. A person will also be treated as an owner of a trade
or business if that person is, for example, a partner in a partnership
that either conducts the business or owns stock, directly or indirectly,
in a corporation that conducts it, a lessee of substantially all the
assets of a trade or business, or a licensee of a patent, copyright,
trademark, or similar property essential to the conduct of a trade or
business. For purposes of this paragraph (e)(2), a person who owns
indirectly less than 5 percent of the entity conducting the trade or
business shall not be treated as the owner of the trade or business.
For purposes of this paragraph (e)(2), stock owned, directly, or
indirectly, by or for a corporation, partnership, trust, or estate shall
be considered as being owned proportionately by its shareholders,
partners, or beneficiaries. Stock considered to be owned by a person by
reason of the application of the preceding sentence may be treated as
actually owned by such person.
(3) Separation. A separation occurs if the ratio of a person's
percentage ownership interest in a DISC to his percentage ownership in
the trade or business which produced export gross receipts of the DISC
changes at any time during the year. Thus, if A Corporation owns all
the stock of B, C, and D Corporations, and D is a DISC and B and C
produced export gross receipts for D, the transfer of the stock of B and
C will result in a separation. Similarly, the transfer of the stock of
C and the stock of D will result in a separation as will the liquidation
of D by A. The disqualification of a DISC by revocation of the election
or by failing to satisfy the conditions of section 992(a)(1) for a
taxable year shall be treated as a separation, and the export gross
receipts produced prior to the disqualification will be attributed to
the separated trade or business. A requalified DISC will be treated as
having additional export gross receipts attributable to the separated
trade or business. For purposes of this paragraph (e)(3), members of
the same controlled group (as defined in section 993(a)(3)) will be
treated as one person.
(4) Amount of attribution. If a separation described in paragraph
(e)(3) of this section occurs, the additional amount referred to in
paragraph (e)(1) of this section is the amount of the export gross
receipts attributable to the separated trade or business.
(5) Recapture of accumulated DISC income. If a shareholder of a DISC
recaptures accumulated DISC income (as defined in section 996(f)(1)) as
a result of a disposition (as described in section 995(c)) of stock in a
DISC or a disqualification which results in a separation, the base
period export gross receipts of the DISC for base period years prior to
the disposition are reduced on a pro rata basis to the extent of the
recapture in the taxable year. This reduction does not apply for
purposes of determining the amount described in paragraph (e) (1) and
(4) of this section which is attributable to the owner of a trade or
business after the separation.
(6) Illustrations. The principles of this paragraph (e) are
illustrated by the following examples:
Example 1. A Corporation owns all the stock of B, C and D
Corporations. D is a DISC and B and C each produced $5,000 of the
export gross receipts of D. A sells the stock of B to Z, an unrelated
party, which organizes P Corporation, a DISC, for which B produces
export gross receipts. Under paragraph (e)(3) of 1.995-7, the sale of
the stock of B constitutes a separation and under paragraph (e) (1) and
(4), $5,000 of export gross receipts is attributable to P. Under
paragraph (e)(1) the export gross receipts of D are $10,000 unchanged by
the separation. If D is liquidated by A and F Corporation a new DISC is
organized, F will have export gross receipts of $5,000. Under paragraph
(3)(5), the export gross receipts of D are eliminated. However,
paragraph (e)(5) does not apply to amounts attributable to the owner of
the trade or business after the separation under paragraph (e)(4).
Therefore, $5,000 is attributable to P (by B) and $5,000 is attributable
to F (by C).
Example 2. G Corporation owns all the stock of H and I Corporations
and H Corporation owns all the stock of J Corporation, a DISC. During
the base period H produces all the export gross receipts of J, which
amounts to $25,000. The sale of the stock of H to B does not constitute
a separation within the meaning of paragraph (e)(3). If J is
liquidated, there will be attributed to any future DISC organized with
respect to H the export gross receipts attributable to the separate
trade or business. Although the liquidation will result in a recapture
of accumulated DISC income, paragraph (e)(5) does not apply for purposes
of determining the amount attributable to the owner of the trade or
business after the separation, and under paragraph (e)(1) such amount is
attributed to any future DISC for which H produces export gross
receipts.
Example 3. P Corporation owns several corporations including R
Corporation, a DISC, and M Corporation, which has produced export gross
receipts for R. P also owns several other DISC's. The stock of M is
sold to W Corporation. Assuming that M produced $100,000 of export
gross receipts during the base period and that those receipts were the
only receipts produced with respect to R, there is a separation under
paragraph (e)(3) and under paragraph (e)(1) $100,000 in export gross
receipts will be attributable to any DISC that W organizes with respect
to M. In addition, under paragraph (e)(1) the export gross receipts of
R are unreduced and taken into account in computing base period export
gross receipts under the controlled group rules of paragraph (d). If R
is liquidated there will be a recapture of accumulated DISC income and
under paragraph (e)(5) a reduction of the export gross receipts of R,
but no reduction with respect to any DISC that W organizes with respect
to M.
(f) DISC base period attributed through shareholders -- (1) In
general. If --
(i) Any person owns 5 percent or more of the stock of a DISC
(referred to as the ''first DISC''), and
(ii) That person at any time during the base period of the first DISC
owned 5 percent or more of the stock of a second DISC, and
(iii) Both DISCs derived export gross receipts from the sale of the
same or similar property, or from the performance of the same or similar
services,
then the base period export gross receipts of the first DISC are
increased by the shareholder's pro rata portion of the base period
export gross receipts of the second DISC.
(2) Exception. Paragraph (f)(1) of this section does not apply to
the extent paragraph (d) or (e) of this section apply.
(3) Ownership of stock. For purposes of this paragraph (f), the
ownership of stock is determined under section 318.
(4) Recapture of accumulated DISC income. The rules with respect to
recapture of accumulated DISC income described in paragraph (e)(5) of
this section apply with respect to base period attribution under this
paragraph.
(5) Illustration. The following example illustrates the application
of this paragraph.
Example. A Corporation owns all the stock of B and C Corporations and
B owns all the stock of D Corporation, a DISC. B produced $10,000 of
export gross receipts of D for the base period 1972-1975. On January 1,
1976, A sells all the stock of C to X Corporation, an unrelated
corporation. Subsequently A purchases 50 percent of the stock of F
Corporation, another DISC, and B conducts all of its export business
through F with B as the related supplier. Neither the sale of C by A
nor the purchase of F result in a separation with respect to A under
paragraph (e) of this section. In addition, D and F are not members of
the same controlled group within the meaning of section 993(a)(3), and
paragraph (d) of this section does not apply. However, under paragraph
(f)(1) of this section, the base period export gross receipts of F are
increased by $10,000.
(g) Small DISC exception -- (1) Adjusted taxable income of $100,000
or less. Except as provided in paragraph (g)(4) of this section, if a
DISC has adjusted taxable income of $100,000 or less for the taxable
year, section 995(b)(1)(E) and this section do not apply for that year.
(2) Partial exception. If, for a taxable year, a DISC has adjusted
taxable income of more than $100,000 but less than $150,000, the
nonincremental distribution under paragraph (b)(1) of this section is
reduced (but not below zero) by an amount equal to twice the excess of
$150,000 over the adjusted taxable income.
(3) Short taxable year. In computing a DISC's adjusted taxable
income for purposes of this paragraph (g), when the current taxable year
is a short taxable year, the adjusted taxable income for the year is
multiplied by a fraction. The numerator of the fraction is the number
of days in the full taxable year and the denominator is the number of
days in the short taxable year.
(4) Controlled groups. If more than one member of a controlled group
(as defined in section 993(a)(3)) qualifies, or is treated, as a DISC
for the current taxable year, the adjusted taxable income of each member
of the group is aggregated for purposes of determining the application
of paragraph (g) (1) or (2) of this section. The adjusted taxable
income of any DISC for purposes of this aggregation may not be less than
zero.
The aggregation is made in the same manner and with respect to those
DISCs described in paragraph (d)(2) of this section. If the adjusted
taxable income of the member DISCs is more than $100,000, but less than
$150,000, the nonincremental distribution under paragraph (b)(1) of this
section is determined in accordance with paragraph (d) of this section.
The reduction determined under paragraph (g)(2) of this section is
apportioned among the DISCs described in paragraph (d)(2) of this
section in accordance with the ratio which the adjusted taxable income
of each member DISC for the year bears to the total adjusted taxable
income of all member DISCs for the year. This paragraph (g)(4) applies
to a shareholder of a DISC even though the shareholder is not a related
person as defined in 1.993-1(a)(6).
(h) Certain transfer of DISC assets --
(1) In general. If --
(i) A corporation owns all the stock of a subsidiary and a DISC,
(ii) The corporation transfers (within the meaning of paragraph
(h)(4) of this section) all the stock of the subsidiary,
(iii) The subsidiary has been engaged in the active conduct of a
trade or business (within the meaning of section 355(b) and regulations
thereunder) throughout the 5-year period ending on the date of the
transfer, and continues to be so engaged thereafter,
(iv) During the taxable year of the subsidiary in which its stock is
transferred, and its preceding taxable year, the trade or business
produced qualified export receipts with respect to the subsidiary and
the DISC,
(v) The DISC transfers all of its assets related to the conduct of
the trade or business to a new DISC in exchange for all the stock of the
new DISC, the DISC distributes the stock in the new DISC to the
corporation and the corporation transfers the stock in the new DISC to
the subsidiary, and
(vi) The transfers described in paragraph (h)(1)(v) of this section
are undertaken for the sole purpose of avoiding the application of
section 995(e)(9) and paragraph (e) of this section, and, therefore,
preventing double attribution under paragraph (e)(1),
then notwithstanding any other rule or regulation to the contrary,
the transfer described in paragraph (h)(1)(v) will be a reorganization
within the meaning of section 368(a)(1)(D) to which section 355 applies
and an exchange of stock of the new DISC by the corporation for stock of
the subsidiary to which section 351 applies.
(2) Special rule. If --
(i) A corporation owns, directly or indirectly, all the stock of a
subsidiary and a DISC,
(ii) A transfer or transfers described in this paragraph (h)(2) of
the stock or assets of the subsidiary and the DISC are for the purpose
described in paragraph (h)(1)(vi) of this section, and
(iii) The transfer or transfers occur in a transaction other than one
described in paragraph (h)(1)(v) of this section but which satisfies the
requirements of paragraphs (h)(1) (iii) and (iv) of this section,
then the transfer or transfers described in this paragraph
(h)(2)(iii) will be a reorganization within the meaning of section 368,
a transaction to which section 355 applies, an exchange of stock to
which section 351 applies, or a combination of these, as the case may
be, provided the transfer or transfers are consistent with the purpose
and effect of those described in paragraph (h)(1)(v) of this section.
(3) Ownership. Stock owned, directly or indirectly, by a corporation
shall be considered as owned proportionately by its shareholders.
(4) Transfer. The term transfer includes a sale, exchange, or other
disposition of property.
(5) Illustrations. The following examples illustrate the application
of this paragraph (h):
Example 1. P Corporation, which was organized on January 1, 1966,
owns all the stock of X and Y Corporations, both also organized on
January, 1 1966. X has been engaged in the manufacture of shoes. Y has
been engaged in the manufacture of recreational equipment. On January
1, 1972, P organizes Z Corporation, a DISC. X and Y serve as the
related suppliers of Z. On January 1, 1977, U Corporation offers to buy
the stock of X. As part of an overall plan to avoid the application of
section 995(e)(9), Z transfers all the export assets that relate to the
trade or business conducted by X to V Corporation in exchange for all of
the stock of V. Z then distributes all the stock of V to P, which
transfers all the V stock to X. Immediately after this series of
transactions, P sells all of the X stock to U Corporation. Under
paragraph (h)(1) of this section, the transfer and distribution by Z
constitute a reorganization under section 368(a)(1)(D) to which section
355 applies, and the exchange by P constitutes and exchange to which
section 351 applies. The result would be the same even if P sold less
than all of the stock in X.
Example 2. The facts are the same as in example 1, except that Y
organizes and owns all the stock of Z. Accordingly, after the transfer
by Z, Z distributes the stock of V to Y, which in turn distributes the
stock to P. P transfers all the V stock to X. Under paragraph (h)(2)
of this section, the transfers by Z to Y, and Y to P constitute a
reorganization described in section 368(a)(1)(D) to which section 355
applies. The transfer by P to X constitutes an exchange to which
section 351 applies.
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal
Revenue Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10);
90 Stat. 1659, 26 U.S.C. 995(g); and 68A Stat. 917, 26 U.S.C. 7805))
(T.D. 7984, 49 FR 40019, Oct. 12, 1984)
26 CFR 1.996-1 Rules for actual distributions and certain deemed
distributions.
(a) General rule. Under section 996(a)(1), any actual distribution
(other than a distribution described in paragraph (b) of this section or
to which 1.995-4 applies) to a shareholder by a DISC, or former DISC,
which is made out of earnings and profits shall be treated as made --
(1) First, out of ''previously taxed income'' (as defined in
1.996-3(c)) to the extent thereof,
(2) Second, out of ''accumulated DISC income'' (as defined in
1.996-3(b)) to the extent thereof, and
(3) Third, out of ''other earnings and profits'' (as defined in
1.996-3(d)) to the extent thereof.
(b) Rules for qualifying distributions and deemed distributions under
section 995(b)(1)(G) -- (1) In general. Except as provided in
subparagraph (2), any actual distribution to meet qualification
requirements made pursuant to 1.992-3 and any deemed distribution
pursuant to 1.995-2(a)(5) (relating to foreign investment attributable
to producer's loans) which is made out of earnings and profits shall be
treated as made --
(i) First, out of ''accumulated DISC income'' (as defined in
1.996-3(b)) to the extent thereof.
(ii) Second, out of ''other earnings and profits'' (as defined in
1.996-3(d)) to the extent thereof, and
(iii) Third, out of ''previously taxed income'' (as defined in
1.996-3(c)) to the extent thereof.
(2) Special rule. For taxable years beginning after December 31,
1975, paragraph (b)(1) of this section shall apply to one-half of the
amount of an actual distribution made pursuant to 1.992-3 to satisfy
the condition of 1.992-1(b) (the gross receipts test) and paragraph (a)
of this section shall apply to the remaining one-half of such amount.
(c) Exclusion from gross income. Under section 996(a)(3), amounts
distributed out of previously taxed income shall be excluded by the
distributee from gross income. However, see 1.996-5(b) for treatment
as gain from the sale or exchange of property of the portion of an
actual distribution out of previously taxed income to the extent it
exceeds the adjusted basis of the stock with respect to which the
distribution is made.
(d) Priority of distributions. Under section 996(c), for purposes of
determining their treatment under paragraphs (a), (b), and (c) of this
section, distributions made during a taxable year shall be treated as
being made in the following order --
(1) Deemed distributions under 1.995-2 and 1.995-3.
(2) Actual distributions to meet qualification requirements made
pursuant to 1.992-3 in the order in which they are made, and
(3) Other actual distributions in the order in which they are made.
Thus, the treatment of any distribution shall be determined after the
divisions of earnings and profits have been properly adjusted by taking
into account distributions of higher priority which are made or deemed
made during the same taxable year.
(e) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. Y Corporation, which uses the calendar year as its
taxable year elects to be treated as a DISC beginning with 1972. During
1973, Y makes a cash distribution of $100 to X Corporation, Y's sole
shareholder. For 1973, Y has no earnings and profits. As of the
beginning of 1973, Y has $300 of accumulated earnings and profits, which
consist of $70 of accumulated DISC income, $40 of previously taxed
income, and $190 of other earnings and profits. The entire $100
distribution is a dividend under section 316. However, $40 thereof is
treated as made out of previously taxed income and is thus excluded from
gross income. Accordingly, only $60 is treated as distributed out of
accumulated DISC income and includible in gross income. See 1.246-4
for the inapplicability of the dividend received deduction with respect
to the entire distribution of $100.
Example 2. Assume the same facts as in example 1, except that the
cash distribution is designated as a distribution to meet qualification
requirements made pursuant to 1.992-3. Under these facts, X includes
the entire distribution in its gross income as a dividend. Of the $100
distributed, $70 is treated as made out of accumulated DISC income and
the remaining $30 is treated as made out of other earnings and profits.
The dividend received deduction under section 243 is available only with
respect to such $30.
Example 3. Y Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1972. As of
the end of 1975, Y had failed to meet the gross receipts test for that
year. In 1975 Y had $100 of taxable income, $80 of which was
attributable to qualified export receipts and $20 of which was
attributable to receipts that did not qualify as qualified export
receipts. As of the beginning of 1976, Y had $300 of accumulated
earnings and profits, which consisted of $70 of accumulated DISC income,
$40 of previously taxed income, and $190 of other earnings and profits.
In 1976 Y makes a cash distribution of $20 pursuant to 1.992-3 in order
to satisfy the gross receipts test for 1975. For 1976 Y has no earnings
and profits and no deemed distributions. The entire $20 distribution is
a dividend under section 316. Under 1.996-1(b)(2), half of the $20
cash distribution is treated pursuant to 1.996-1(b)(1) and half is
treated pursuant to 1.996-1(a). Thus, $10 is treated as distributed out
of accumulated DISC income and is includible in gross income. The other
$10 is treated as made out of previously taxed income and is thus
excluded from gross income. As of the beginning of 1977, Y has $280 of
accumulated earnings and profits, which consists of $60 of accumulated
DISC income, $30 of previously taxed income, and $190 of other earnings
and profits.
(T.D. 7324, 39 FR 35120, Sept. 30, 1974, as amended by T.D. 7854, 47
FR 51742, Nov. 17, 1982)
26 CFR 1.996-2 Ordering rules for losses.
(a) In general. Under section 996(b), if for any taxable year a
DISC, or a former DISC, incurs a deficit in earnings and profits, such
deficit shall be charged --
(1) First, to other earnings and profits (as defined in 1.996-3(d))
to the extent thereof,
(2) Second, to accumulated DISC income (as defined in 1.996-3(b)) to
the extent thereof, subject to the special rule in paragraph (b) of this
section,
(3) Third, to previously taxed income (as defined in 1.996-3(c)) to
the extent thereof, and
(4) To the extent that the amount of such deficit exceeds the sum of
the amounts charged in accordance with subparagraphs (1), (2), and (3)
of this paragraph, to other earnings and profits (as defined in
1.996-3(d)).
Thus, the excess deficit charged to other earnings and profits under
subparagraph (4) of this paragraph will create a deficit therein in the
amount of such excess. To determine the amount of any division of
earnings and profits for the purpose of determining under 1.996-1 the
treatment of any actual and certain deemed distributions, the portion of
a deficit in earnings and profits chargeable under this paragraph to
such division prior to such distribution shall be determined in a manner
consistent with the rules in 1.316-2(b) for determining the amount of
earnings and profits available on the date of any distribution.
(b) Deficits subsequent to a disqualification. A deficit in earnings
and profits of a DISC, or former DISC, shall not be charged to
accumulated DISC income which has been determined is to be deemed
distributed to the shareholders pursuant to 1.995-3 as a result of a
revocation of election or other disqualification. Thus, in accordance
with paragraph (a) of this section as modified by this paragraph, a
deficit incurred by a former DISC following such a revocation or
disqualification shall be charged first to other earnings and profits
and then to previously taxed income with any balance being charged to
other earnings and profits and creating a deficit therein. The
preceding sentence shall also apply in the case of a deficit incurred by
a DISC which has no accumulated DISC income accumulated during its
current taxable year and all immediately preceding consecutive taxable
years for which it was a DISC. If as a result of the application of
this paragraph the amount of a deficit in other earnings and profits
exceeds the amount of a deficit in accumulated earnings and profits,
then upon any subsequent actual distribution the deficit in other
earnings and profits shall be reduced by the lower of (1) the amount of
such actual distribution chargeable to accumulated DISC income or
previously taxed income or (2) the amount of such excess.
(c) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. X Corporation, which uses the calendar year as its
taxable year, becomes a DISC beginning with 1976. In addition to other
facts assumed in the table below, X incurs a deficit in earnings and
profits for 1979 of $70. Such deficit is charged to the divisions of
X's earnings and profits pursuant to paragraph (a) of this section in
the manner set forth in such table.
Example 2. Assume the same facts as in example 1, except that
effective for taxable years beginning with 1979, X revokes its election
to be treated as a DISC. Under 1.995-3, X has $30 of accumulated DISC
income which is to be deemed distributed $10 per year in 1980, 1981, and
1982. The deficit in earnings and profits for 1979 is charged to the
divisions of X's earnings and profits pursuant to paragraph (b) of this
section in the manner set forth in the table below:
Example 3. Assume the same facts as in example 2, except that the
deficit in earnings and profits for 1979 is $120. Assume further that
for 1980, 1981, and 1982, during which years X's shareholders are
receiving scheduled installments of the deemed distributions of
accumulated DISC income under 1.995-3, X, a former DISC, has neither
earnings and profits nor a deficit in earnings and profits. The $120
deficit for 1979 is charged to the divisions of X's earnings and profits
pursuant to paragraph (b) of this section in the manner set forth in the
table below:
Example 4. Assume the same facts as in example 3, except that on
December 31, 1980, X makes an actual distribution of $10 out of
previously taxed income. On January 1, 1981, X has $20 of accumulated
DISC income, no previously taxed income, and a deficit of $36 in other
earnings and profits. The deficit of $16 in accumulated earnings and
profits remains the same.
(T.D. 7324, 39 FR 35120, Sept. 30, 1974)
26 CFR 1.996-3 Divisions of earnings and profits.
(a) In general. For purposes of sections 991 through 997, the
earnings and profits of a DISC, or former DISC, shall be treated as
composed of the following three divisions:
(1) Accumulated DISC income (as defined in paragraph (b) of this
section),
(2) Previously taxed income (as defined in paragraph (c) of this
section), and
(3) Other earnings and profits (as defined in paragraph (d) of this
section),
(b) Accumulated DISC income defined. (1) Accumulated DISC income is
that portion of a corporation's earnings and profits which were derived
during taxable years for which it qualified as a DISC and which were
deferred from taxation. Accumulated DISC income as of the close of each
taxable year of the corporation is --
(i) The amount of accumulated DISC income as of the close of the
immediately preceding taxable year increased by,
(ii) The amount of DISC income for the year (as determined in
subparagraph (2) of this paragraph) and reduced (but not below zero) by,
(iii) The items enumerated in subparagraph (3) of this paragraph.
(2) Under section 996(f)(1), DISC income is (i) the earnings and
profits derived by the corporation during a taxable year for which such
corporation is a DISC minus (ii) amounts deemed distributed under
1.995-2 other than the amount of foreign investment attributable to
producer's loans described in 1.995-2(a)(5). For example, the earnings
and profits of a DISC for a taxable year include any amounts includible
in such DISC's gross income pursuant to section 951(a) (relating to
controlled foreign corporations). Deemed distributions under
1.995-2(a)(5) are taken into account under subparagraph (3) of this
paragraph as a reduction in computing accumulated DISC income.
(3) The accumulated DISC income (as increased by DISC income for the
year determined under subparagraph (2) of this paragraph) is reduced by
each of the following items in the following order:
(i) Any amount deemed distributed for such year under 1.995-3
(relating to deemed distributions upon disqualification),
(ii) Any amount of foreign investment attributable to producer's
loans deemed distributed for such year under 1.995-2(a)(5) to the
extent it is charged to accumulated DISC income under 1.996-1(b)(1)(i),
(iii) The amount of any adjustment to accumulated DISC income for
such year under 1.966-4(b)(1), and
(iv) To the extent they are treated, under 1.996-1 (a) or (b)
(relating to ordering rules for distributions), as made out of
accumulated DISC income, the amounts of any actual qualifying
distributions pursuant to 1.992-3 in the order in which they are made,
and thereafter by the amounts of any other actual distributions in the
order in which they are made, except that, prior to each actual
distribution, accumulated DISC income shall be reduced by the portion of
any deficit in earnings and profits for the taxable year chargeable at
that time under 1.996-2(a)(2) to accumulated DISC income.
(4) Every distribution or other reduction in accumulated DISC income
pursuant to subparagraph (3) of this paragraph shall be charged to the
most recently accumulated DISC income.
(c) Previously taxed income. Under section 996(f)(2), previously
taxed income as of the close of each taxable year of the corporation is
an amount equal to --
(1) The sum of --
(i) The amount of previously taxed income as of the close of the
immediately preceding taxable year,
(ii) Amounts deemed distributed for the current year under 1.995-2
(relating to deemed distributions in qualified years),
(iii) Amounts deemed distributed for the current year under 1.995-3
(relating to deemed distributions upon disqualification),
(iv) With respect to a distribution in redemption to which
1.996-4(b)(1) applies, an amount equal to the excess (if any) of (a) the
amount of the reduction under 1.996-4(b)(1) in accumulated DISC income
over (b) the reduction in the corporation's earnings and profits (see
section 312(e)), and
(v) Any amount by which accumulated DISC income is reduced under
paragraph (b)(3)(ii) of this section by reason of a deemed distribution
as a dividend, under 1.995-2(a)(5), of an amount of foreign investment
attributable to producer's loans,
(2) Decreased (but not below zero), to the extent they are treated,
under 1.996-1 (a) or (b) (relating to ordering rules for
distributions), as made out of previously taxed income, by the amounts
of any actual qualifying distributions pursuant to 1.992-3 in the order
in which they are made, and thereafter by the amounts of any other
actual distributions in the order in which they are made, except that,
prior to any actual distribution, previously taxed income shall be
reduced by the portion of any deficit in earnings and profits for the
taxable year chargeable at that time under 1.996-2(a)(3) to previously
taxed income.
(d) Other earnings and profits. Under section 996(f)(3), other
earnings and profits consist of earnings and profits other than
accumulated DISC income and previously taxed income described
respectively in paragraphs (b) and (c) of this section. Other earnings
and profits as of the close of each taxable year of the corporation is
(subject to paragraph (e) of this section) an amount equal to the amount
of other earnings and profits as of the close of the immediately
preceding taxable year decreased (if necessary, below zero) in the
following order by --
(1) To the extent they are treated, under 1.996-1 (a) or (b)
(relating to ordering rules for distributions), as made out of other
earnings and profits, the amounts of any actual qualifying distributions
pursuant to 1.992-3 in the order in which they are made, and thereafter
the amounts of any other actual distributions in the order in which they
are made, except that, prior to any actual distribution, other earnings
and profits shall be reduced by the portion of any deficit in earnings
and profits for the taxable year chargeable at that time under
1.996-2(a)(1) to other earnings and profits, and
(2) With respect to a distribution in redemption to which
1.996-4(b)(1) applies, an amount equal to the excess (if any) of (a) the
reduction in the corporation's earnings and profits (see section 312(e))
over (b) the amount of the reduction under 1.996-4(b)(1) in accumulated
DISC income.
(e) Distributions in kind. (1) For purposes of determining, under
paragraphs (b), (c), and (d) of this section, the amount by which any
division of earnings and profits is reduced by reason of a distribution
of property (other than money or the DISC's, or former DISC's, own
obligations), the amount of such distribution is the fair market value
of such property at the time of the distribution.
(2) For any taxable year in which the DISC makes a distribution of
such property, the amount of other earnings and profits determined under
paragraph (d) of this section (without regard to this subparagraph)
shall be --
(i) Increased by the excess (if any) of the amount of such
distribution treated as a dividend under section 316(a) over the
adjusted basis of such property, and
(ii) Decreased by the excess (if any) of the adjusted basis of such
property over the amount of such distribution treated as a dividend
under section 316 (a).
Each item of property shall be considered separately for purposes of
making the adjustment under this subparagraph.
(f) Examples. The provisions of 1.996-1, 1.996-2, and this section
may be illustrated by the following examples:
Example 1. M Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1974.
During 1975, M derives no earnings and profits and makes no deemed or
actual distributions, except that on December 31, 1975, M's shareholders
are treated as having received a dividend distribution of $100 under
1.995-2 (a)(5) (relating to foreign investment attributable to
producer's loans). M's earnings and profits are adjusted as shown on
line (2) of the table below on the basis of facts assumed therein.
Example 2. N Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1972.
During 1973, N derives no earnings and profits for the year and makes no
deemed or actual distributions, except that A, a shareholder, realized
$200 of gain upon receiving an actual cash distribution of $300 in
redemption of N stock having an adjusted basis of $100 in his hands.
The redemption is treated as an exchange under section 302(a) but, under
section 995(c), A includes the $200 of gain in his gross income as a
dividend. Assuming that, under section 312(e), $240 is properly
chargeable to capital account of N and that, under 1.996-4(b),
accumulated DISC income is reduced by $200, N's accounts are adjusted on
line (2) of the table below on the basis of facts assumed therein.
Example 3. P Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1973.
During 1974, P derives no earnings and profits for the year and makes no
deemed or actual distributions, except for a distribution to B, its sole
shareholder, of property with a fair market value of $100 and an
adjusted basis in P's hands of $40. Under 1.996-1(a)(1), B treats the
entire amount of the distribution as being made out of previously taxed
income and, under 1.996-1(c), excludes it from his gross income. P's
earnings and profits, divisions are adjusted on lines (2) and (3) of the
table below on the basis of facts assumed therein.
Example 4. Q Corporation, which uses the calendar year as its
taxable year, elects to be treated as a DISC beginning with 1974. On
January 1, 1975, Q has accumulated earnings and profits of $1,200 and,
during 1975, Q incurs a deficit in earnings and profits of $365. The
amount of such deficit incurred as of any date before the close of 1975
cannot be shown. On July 1, 1975, Q makes a cash distribution of $650,
with respect to its stock to C, Q's sole shareholder. C subsequently
transfers by gift all of his Q stock to D. On December 31, 1975, Q
makes a cash distribution of $650, with respect to its stock, to D.
Under these facts and additional facts assumed in the table below, C is
treated as having received a dividend of $650 of which $320 is treated
as distributed out of previously taxed income and excluded from gross
income. D is treated as receiving a dividend of $186. Adjustments to
Q's earnings and profits accounts are illustrated in the table below:
Examples 5 -- (1) Facts. R Corporation, which uses the calendar year
as its taxable year elects to be treated as a DISC beginning with 1972.
X Corporation is its sole shareholder. At the beginning of 1974, R has
a deficit in earnings and profits of $60 all of which is composed of
''other earnings and profits''. For 1974, R has earnings and profits of
$80 before reduction for any distributions and taxable income of $70.
On June 15, 1974, R makes a cash distribution to X of $60, with respect
to its stock, to which section 301 applies. On August 15, 1974, R makes
a cash distribution to X of $30 designated as a distribution to meet
qualification requirements pursuant to 1.992-3. Under 1.995-2(a), X is
deemed to receive, on December 31, 1974, a distribution of a dividend of
$35, i.e., one-half of R's taxable income of $70. The tax consequences
of these facts to X and their effect on R's earnings and profits are set
forth in the subsequent subparagraphs of this example.
(2) Dividend treatment of actual distributions. Since R had $80 of
earnings and profits for 1974 and a deficit in accumulated earnings and
profits at the beginning of 1974, only $80 of the actual distributions
($90) are treated as dividends under sections 301(c)(1) and 316(a)(2).
($10 of the actual distribution, which is not treated as a dividend is
treated in the manner specified in section 301(c) (2) and (3).) Thus,
under 1.316-2(b), $26.67 of the actual qualifying distribution made on
August 15, 1974 ($30 $80/$90), and $53.33 of the actual distribution
made on June 15, 1974 ($60 $80/$90), are considered made out of earnings
and profits.
(3) Priority of distributions. Under 1.996-1(d), for purposes of
adjusting the divisions of R's earnings and profits and determining the
treatment of subsequent distributions, the sequence in which each
distribution is treated as having been made is --
(i) First, the deemed distribution of $35,
(ii) Second, the actual qualifying distribution of $30 made on August
15, 1974, pursuant to 1.992-3, and
(iii) Finally, the actual distribution of $60 made on June 15, 1974.
(4) Treatment and effect of deemed distribution. Under 1.995-2(a),
on December 31, 1974, X includes the deemed distribution of $35 in its
gross income as a dividend. Under paragraph (c)(1)(ii) of this section,
R's previously taxed income is increased by $35 as shown on line (3) of
the table in subparagraph (7) of this example. Under paragraph
(b)(1)(ii) and (2) of this section, accumulated DISC income is increased
by $45 of DISC income i.e., R's earnings and profits for 1974, $80,
minus the deemed distribution of $35, as shown on line (4) of the table.
(5) Treatment and effect of actual qualifying distribution of $30.
As indicated in subparagraph (2) of this example, $26.67 of the $30
qualifying distribution on August 15, 1974, is treated as made out of
earnings and profits for 1974. Under 1.996-1(b)(1)(i), the entire
$26.67 is treated as distributed out of accumulated DISC income. Thus,
on August 15, 1974, X includes $26.67 in its gross income as a dividend.
No deduction is allowable under section 243. Under paragraph
(b)(3)(iv) of this section, R's accumulated DISC income is reduced by
$26.67 as shown on line (6) of the table in subparagraph (7) of this
example.
(6) Treatment and effect of actual distribution of $60. As indicated
in subparagraph (2) of this example, $53.33 of the $60 distribution on
June 15, 1974, is treated as made out of earnings and profits for 1974.
Under 1.996-1(a), the $53.33 is treated as distributed out of
previously taxed income to the extent thereof, $35, and then out of
accumulated DISC income, $18.33. Thus, on June 15, 1974, X includes
$18.33 in its gross income as a dividend. Under 1.996-1(c), the
distribution of $35 out of previously taxed income is excluded from
gross income. No deduction is allowable under section 243 with respect
to the actual distribution of $53.33. Under paragraph (b)(3)(iv) of this
section, accumulated DISC income is reduced by $18.33 and, under
paragraph (c)(2) of this section, previously taxed income is reduced by
$35, as shown on line (7) of the table in subparagraph (7) of this
example.
(7) Summary. The effects on earnings and profits and the divisions
of earnings and profits are summarized in the following table:
Example 6. Assume the facts are the same as in example 5, except
that at the beginning of 1974 R's accumulated earnings and profits
amount to $60 consisting of accumulated DISC income of $20, previously
taxed income of $10, and other earnings and profits of $30. In
addition, on August 1, 1974, X transfers all R's stock to Y Corporation
in a reorganization described in section 368(a)(1)(B) in which under
section 354 X recognizes no gain or loss. Under these facts, X includes
in its gross income for 1974 a dividend of $15 which is attributable to
the actual distribution of $60 paid out of earnings and profits on June
15, 1974. X excludes from gross income the balance of the $60
distribution ($45) paid out of earnings and profits because, under
1.996-1(a), it is treated as paid out of previously taxed income. Y
includes in its gross income for 1974 a dividend of $65 of which $35 is
attributable to the deemed distribution of a dividend to Y on December
31, 1974, under 1.995-2(a) and $30 is attributable to the qualifying
distribution paid out of earnings and profits to Y on August 15, 1974.
The adjustments to R's earnings and profits are summarized in the
following table:
(g) DISCs having corporate and noncorporate shareholders. In the
case of a DISC having one or more corporate shareholders but less than
all of its shareholders subject to the special rules of section
291(a)(4), relating to certain deferred DISC income as a corporate
preference item, accumulated DISC income and previously taxed income of
the DISC are divided between the corporate shareholders, as a class, and
the other shareholders, as a class, in proportion to amounts of DISC
income not deemed distributed and amounts deemed distributed to each
class. Subsequent taxation of actual and qualifying distributions shall
be based upon this division. Thus, if a DISC is owned 50 percent by
corporate shareholders and 50 percent by individual shareholders and has
undistributed taxable income of $2,000 for its year, the division is
made as follows:
(Secs. 995(e)(7), (8) and (10), 995(g) and 7805 of the Internal
Revenue Code of 1954 (90 Stat. 1655, 26 U.S.C. 995 (e)(7), (8) and (10);
90 Stat. 1659, 26 U.S.C. 995(g); and 68A Stat 917, 26 U.S.C. 7805))
(T.D. 7324, 39 FR 35121, Sept. 30, 1974, as amended by T.D. 7854, 47
FR 51742, Nov. 17, 1982; T.D. 7984, 49 FR 40024, Oct. 12, 1984)
26 CFR 1.996-4 Subsequent effect of previous disposition of DISC stock.
(a) Shareholder adjustment for previously taxed income. (1) Under
section 996(d)(1), except as provided in subparagraph (2) of this
paragraph, if --
(i) Gain with respect to a share of stock of a DISC, or former DISC,
is treated under 1.995-4 as a dividend, and
(ii) With respect to such share, any person subsequently receives an
actual distribution made out of accumulated DISC income, or a deemed
distribution made, pursuant to 1.995-3, by reason of disqualification,
out of accumulated DISC income,
then such person shall treat such distribution in the same manner as
a distribution from previously taxed income (and thus excludable from
gross income under 1.996-1(c)) to the extent that the gain referred to
in subdivision (i) of this subparagraph exceeds the aggregate amount of
any other distributions with respect to such share which were treated
under this subparagraph as made from previously taxed income.
(2) In applying subparagraph (1) of this paragraph with respect to a
share of stock in a DISC, or former DISC, the gain referred to in
subparagraph (1)(i) of this paragraph does not include any gain to a
shareholder on a redemption of such share which qualifies as an exchange
under section 302(a) or any gain on a disposition of such share prior to
such redemption. Distributions described in subparagraph (1)(ii) of
this paragraph do not include a distribution in a redemption which
qualifies as an exchange under section 302(a). For adjustments to
accumulated DISC income by reason of dividend treatment under 1.995-4
with respect to gain upon a redemption of DISC stock to which section
302(a) applies and upon a prior disposition of such stock, see paragraph
(b) of this section.
(3) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. In 1974, under 1.995-4, A, a shareholder of a DISC, on the
sale of his DISC stock to B, is required to treat $20 of his gain as a
dividend. The DISC has no previously taxed income and $40 of
accumulated DISC income. Subsequently in the same year, B, the
purchaser of the stock, receives an actual dividend distribution of $15
with respect to such stock which, under 1.996-1(a), is treated as made
out of accumulated DISC income. The amounts of the DISC's previously
taxed income and accumulated DISC income were not adjusted by reason of
the $20 treated as a dividend on the prior sale. However, even though
the DISC had no previously taxed income, the purchaser would treat the
$15 as though it had been paid out of previously taxed income and,
therefore would not include the $15 in gross income. If in 1975, B
receives another actual distribution of $9 with respect to such stock,
$5 (i.e., $20 dividend on A's sale less the $15 distribution to B in
1974 which was treated under subparagraph (1) of this paragraph as made
from previously taxed income) is treated as made from previously taxed
income and excluded from gross income. The result would be the same if,
on January 1, 1975, B had transferred such stock to C by gift and the $9
distribution had been made to C.
(b) Corporate adjustment upon redemption. (1) Under section
996(d)(2), if by reason of 1.995-4 gain on a redemption of stock in a
DISC, or former DISC, is included in the shareholder's gross income as a
dividend, then the accumulated DISC income shall be reduced by an amount
equal to the sum of --
(i) The amount of gain on such redemption which, under 1.995-4, is
treated as a dividend, and
(ii) The amount of any gain with respect to such redeemed stock
which, under 1.995-4, was treated as a dividend on a disposition prior
to such redemption minus the amount of distributions with respect to
such stock which have been treated as made out of previously taxed
income by reason of the application of paragraph (a)(1) of this section.
(2) The provisions of this paragraph may be illustrated by the
following examples:
Example 1. The entire stock of a DISC, which uses the calendar year
as its taxable year, has been owned equally by A, B, C, and D since it
was organized. At the close of 1976, when the DISC has $100 of
accumulated DISC income, it redeems all of A's shares in a transaction
qualifying as an exchange under section 302(a) and A, under 1.995-4,
includes $25 in his gross income as a dividend. The redemption has the
effect of reducing accumulated DISC income by $25 to $75.
Example 2. Assume the same facts as in example 1 except that the
stock of the DISC has not been held equally by A, B, C, and D since its
organization. A purchased his shares from X in 1974 in a transaction in
which X, under 1.995-4, included in his gross income $30 as a dividend.
In 1975, A receives a distribution of $10 out of accumulated DISC
income which, under paragraph (a)(1) of this section, is treated as made
out of previously taxed income. Under these facts, the redemption of
A's stock in 1976 has the effect of reducing accumulated DISC income by
$45 to $55 determined as follows:
(T.D. 7324, 39 FR 35121, Sept. 30, 1974)
26 CFR 1.996-5 Adjustment to basis.
(a) Addition to basis. Under section 996(e)(1) amounts representing
deemed distributions as provided in section 995(b) shall increase the
basis of the stock with respect to which the distribution is made.
(b) Reductions of basis. Under section 996(e)(2), the portion of an
actual distribution treated as made out of previously taxed income shall
reduce the basis of the stock with respect to which it is made and, to
the extent that it exceeds the adjusted basis of such stock, shall be
treated as gain from the sale or exchange of property. In the case of
stock includible in the gross estate of a decedent for which an election
is made under section 2032 (relating to alternate valuation), this
paragraph shall not apply to any distribution made after the date of the
decendent's death and before the alternate valuation date provided by
section 2032. See section 1014(d) for a special rule for determining
the basis of stock in a DISC, or former DISC, acquired from a decedent.
(T.D. 7324, 39 FR 35124, Sept. 30, 1974)
26 CFR 1.996-6 Effectively connected income.
In the case of a shareholder who is a nonresident alien individual or
a foreign corporation, trust, or estate, amounts taxable as dividends by
reason of the application of 1.995-4 (relating to gain on disposition
of stock in a DISC), amounts treated under 1.996-1 as distributed out
of accumulated DISC income, and amounts deemed distributed under
1.995-2(a) (1) through (4) shall be treated as gains and distributions
which are effectively connected with the conduct of a trade or business
conducted through a permanent establishment of such shareholder within
the United States, and shall be subject to tax in accordance with the
provisions of section 871(b) and the regulations thereunder in the case
of nonresident alien individuals, trusts, or estates, or section 882 and
the regulations thereunder in the case of foreign corporations. In no
case, however shall other income of such shareholder be taxable as
effectively connected with the conduct of a trade or business through a
permanent establishment in the United States solely because of the
application of this section.
(T.D. 7324, 39 FR 35124, Sept. 30, 1974)
26 CFR 1.996-7 Carryover of DISC tax attributes.
(a) In general. Carryover of a DISC's divisions of earnings and
profits to acquiring corporations in nontaxable transactions shall be
subject to rules generally applicable to other corporate tax attributes.
For example, a DISC which acquires the assets of another DISC in a
transaction to which section 381(a) applies shall succeed to, and take
into account, the divisions of the earnings and profits of the
transferor DISC in accordance with section 381(c)(2).
(b) Allocation of divisions of earnings and profits in corporate
separations. (1) If one DISC transfers part of its assets to a
controlled DISC in a transaction to which section 368(a)(1)(D) applies
and immediately thereafter the stock of the controlled DISC is
distributed in a distribution or exchange to which section 355 (or so
much of section 356 as relates to section 355) applies, then --
(i) The earnings and profits of the distributing DISC immediately
before the transaction shall be allocated between the distributing DISC
and the controlled DISC in accordance with the provisions of 1.312-10.
(ii) Each of the divisions of such earnings and profits, namely
previously taxed income, accumulated DISC income, and other earnings and
profits, shall be allocated between the distributing DISC and the
controlled DISC on the same basis as the earnings and profits are
allocated.
(iii) Any assets of the distributing DISC whose status as qualified
export assets is limited by its accumulated DISC income (e.g.,
producer's loans described in 1.993-4, Export-Import Bank and other
obligations described in 1.993-2(h), and financing obligations
described in 1.993-2(i)) shall be treated as having been allocated, for
the purpose of determining the classification of such assets in the
hands of the distributing DISC or the controlled DISC, on the same basis
as the earnings and profits are allocated regardless of how such assets
are actually allocated.
(2) Example. The provisions of this paragraph may be illustrated by
the following example:
Example. On January 1, 1974, P Corporation transfers part of its
assets to S Corporation, a newly organized subsidiary of P, in a
transaction described in section 368(a)(1)(D) and distributes all the S
stock in a transaction which qualifies under section 355. Immediately
before such transfer, P had earnings and profits of $120,000 of which
$100,000 constitutes accumulated DISC income. The unpaid balance of P's
producer's loans is $80,000 all of which is retained by P. Pursuant to
1.312-10, 25 percent of P's accumulated DISC income is allocated to S
(i.e., $25,000). P's producer's loans will be treated as allocated to S
in the same proportion. Accordingly, for purposes of determining, under
1.993-4(a)(3), the amount of producer's loans which S is entitled to
make, S is treated as having an unpaid balance of producer's loans of
$20,000 (i.e., 25% $80,000) and P is treated as having an unpaid
balance of $60,000 (i.e., 75% $80,000).
(c) Accumulated DISC income accounts of separate DISC's maintained
after corporate combination. If two or more DISC's combine to form a
new DISC, or if the assets of one DISC are acquired by another DISC, in
a transaction described in section 381(a), accumulated DISC income of
the acquired DISC or DISC's shall carry over and be taken into account
by the acquiring or new DISC, except that a separate account shall be
maintained for the accumulated DISC income of any DISC scheduled to be
received as a deemed distribution by its shareholders under 1.995-3
(relating to deemed distributions upon disqualification). If, as a part
of such transaction, the stock of the DISC which has accumulated DISC
income scheduled to be deemed distributed is exchanged for stock of the
acquiring or new DISC to which such accumulated DISC income is carried
over and which maintains a separate account, then such accumulated DISC
income shall be deemed distributed pro rata to shareholders of the
acquiring or new DISC on the basis of stock ownership immediately after
the exchange.
(T.D. 7324, 39 FR 35125, Sept. 30, 1974)
26 CFR 1.996-8 Effect of carryback of capital loss or net operating
loss to prior DISC taxable year.
(a) Under 1.995-2(e), the deduction under section 172 for a net
operating loss carryback or under section 1212 for a capital loss
carryback is determined as if the DISC were a domestic corporation which
had not elected to be treated as a DISC. A carryback of a net operating
loss or of a capital loss of any corporation which reduces its taxable
income for a preceding taxable year for which it qualified as a DISC
will have the consequences enumerated in paragraphs (b) through (e) of
this section.
(b) For such preceding taxable year, the amount of a deemed
distribution of one-half of certain taxable income described in
1.995-2(a)(4) will ordinarily be reduced in effect (but not below zero)
by one-half of the sum of the amount of the deduction under section 172
for such year for net operating loss carrybacks and the amount of the
deduction under section 1212 for such year for capital loss carrybacks.
(c) The amount of reduction in the deemed distribution under
paragraph (b) of this section will have the effect of increasing the
limitation, provided in 1.995-2(b)(2), on the amount of foreign
investment attributable to producer's loans which is deemed distributed
under 1.995-2(a)(5).
(d) If the amount of a deemed distribution for a preceding taxable
year is reduced as described in paragraph (b) of this section, then for
such preceding taxable year the previously taxed income (as defined in
1.996-3(c)) shall be decreased by the amount of such reduction and the
accumulated DISC income (as defined in 1.996-3(b)) shall be increased
by the amount of such reduction. Such adjustments shall be made as of
the time the deemed distribution for such preceding taxable year is
treated as having occurred. See 1.996-1(d) for the priority of such
deemed distribution in relation to other distributions made in that
preceding taxable year.
(e) The amount and treatment of any actual distribution made in such
preceding taxable year or a year subsequent to such preceding year, and
the treatment of gain on a disposition (in any such year) of the DISC's
stock to which 1.995-4 applies, shall be properly adjusted to reflect
the adjustments to previously taxed income and accumulated DISC income
described in paragraph (d) of this section.
(T.D. 7324, 39 FR 35125, Sept. 30, 1974)
26 CFR 1.997-1 Special rules for subchapter C of the Code.
(a) For purposes of applying the provisions of sections 301 through
395 of the Code, any distribution in property to a corporation by a
DISC, or former DISC, which is made out of previously taxed income or
accumulated DISC income shall be treated as a distribution in the same
amount as if such distribution of property were made to an individual,
and have a basis, in the hands of the recipient corporation, equal to
such amount treated as having been distributed.
(b) This section may be illustrated by the following example:
Example. X Corporation is the sole shareholder of Y Corporation which
is a DISC. Y makes an actual distribution of property to X with respect
to X's stock in Y. The property has a basis of $50 and a fair market
value of $100. The distribution is treated as made out of accumulated
DISC income under section 996(a) and is taxable as a dividend under
section 301(c)(1). Even though X is a corporation, the amount of the
distribution is $100 notwithstanding the provisions of section
301(b)(1)(B) and the basis the property in X's hands is $100
notwithstanding the provisions of section 301(d)(2).
(T.D. 7324, 39 FR 35125, Sept. 30 1974)
26 CFR 1.997-1 FINDING AIDS
A list of CFR titles, subtitles, chapters, subchapters and parts and
an alphabetical list of agencies publishing in the CFR are included in
the CFR Index and Finding Aids volume to the Code of Federal Regulations
which is published separately and revised annually.
Table of CFR Titles and Chapters
Alphabetical List of Agencies Appearing in the CFR
Table of OMB Control Numbers
List of CFR Sections Affected
Chap.
26 CFR 1.997-1 Table of CFR Titles and Chapters
26 CFR 1.997-1 Title 1 -- General Provisions
I Administrative Committee of the Federal Register (Parts 1 -- 49)
II Office of the Federal Register (Parts 50 -- 299)
III Administrative Conference of the United States (Parts 300 -- 399)
IV Miscellaneous Agencies (Parts 400 -- 500)
26 CFR 1.997-1 Title 2 -- (Reserved)
26 CFR 1.997-1 Title 3 -- The President
I Executive Office of the President (Parts 100 -- 199)
26 CFR 1.997-1 Title 4 -- Accounts
I General Accounting Office (Parts 1 -- 99)
II Federal Claims Collection Standards (General Accounting Office --
Department of Justice) (Parts 100 -- 299)
III General Accounting Office (CASB) (Parts 300 -- 499)
26 CFR 1.997-1 Title 5 -- Administrative Personnel
I Office of Personnel Management (Parts 1 -- 1199)
II Merit Systems Protection Board (Parts 1200 -- 1299)
III Office of Management and Budget (Parts 1300 -- 1399)
IV Advisory Committee on Federal Pay (Parts 1400 -- 1499)
V The International Organizations Employees Loyalty Board (Parts 1500
-- 1599)
VI Federal Retirement Thrift Investment Board (Parts 1600 -- 1699)
VII Advisory Commission on Intergovernmental Relations (Parts 1700 --
1799)
VIII Office of Special Council (Parts 1800 -- 1899)
IX Appalachian Regional Commission (Parts 1900 -- 1999)
XI United States Soldiers' and Airmen's Home (Parts 2100 -- 2199)
XIV Federal Labor Relations Authority, General Counsel of the Federal
Labor Relations Authority and Federal Service Impasses Panel (Parts 2400
-- 2499)
XV Office of Administration, Executive Office of the President (Parts
2500 -- 2599)
XVI Office of Government Ethics (Parts 2600 -- 2699)
26 CFR 1.997-1 Title 6 -- Economic Stabilization (Reserved)
26 CFR 1.997-1 Title 7 -- Agriculture
Subtitle A -- Office of the Secretary of Agriculture (Parts 0 -- 26)
Subtitle B -- Regulations of the Department of Agriculture
I Agricultural Marketing Service (Standards, Inspections, Marketing
Practices), Department of Agriculture (Parts 27 -- 209)
II Food and Nutrition Service, Department of Agriculture (Parts 210
-- 299)
III Animal and Plant Health Inspection Service, Department of
Agriculture (Parts 300 -- 399)
IV Federal Crop Insurance Corporation, Department of Agriculture
(Parts 400 -- 499)
V Agricultural Research Service, Department of Agriculture (Parts 500
-- 599)
VI Soil Conservation Service, Department of Agriculture (Parts 600 --
699)
VII Agricultural Stabilization and Conservation Service (Agricultural
Adjustment), Department of Agriculture (Parts 700 -- 799)
VIII Federal Grain Inspection Service, Department of Agriculture
(Parts 800 -- 899)
IX Agricultural Marketing Service (Marketing Agreements and Orders;
Fruits, Vegetables, Nuts), Department of Agriculture (Parts 900 -- 999)
X Agricultural Marketing Service (Marketing Agreements and Orders;
Milk), Department of Agriculture (Parts 1000 -- 1199)
XI Agricultural Marketing Service (Marketing Agreements and Orders;
Miscellaneous Commodities), Department of Agriculture (Parts 1200 --
1299)
XIV Commodity Credit Corporation, Department of Agriculture (Parts
1400 -- 1499)
XV Foreign Agricultural Service, Department of Agriculture (Parts
1500 -- 1599)
XVI Rural Telephone Bank, Department of Agriculture (Parts 1600 --
1699)
XVII Rural Electrification Administration, Department of Agriculture
(Parts 1700 -- 1799)
XVIII Farmers Home Administration, Department of Agriculture (Parts
1800 -- 2099)
XXI Foreign Economic Development Service, Department of Agriculture
(Parts 2100 -- 2199)
XXII Office of International Cooperation and Development, Department
of Agriculture (Parts 2200 -- 2299)
XXV Office of the General Sales Manager, Department of Agriculture
(Parts 2500 -- 2599)
XXVI Office of Inspector General, Department of Agriculture (Parts
2600 -- 2699)
XXVII Office of Information Resources Management, Department of
Agriculture (Parts 2700 -- 2799)
XXVIII Office of Operations, Department of Agriculture (Parts 2800 --
2899)
XXIX Office of Energy, Department of Agriculture (Parts 2900 -- 2999)
XXX Office of Finance and Management, Department of Agriculture
(Parts 3000 -- 3099)
XXXI Office of Environmental Quality, Department of Agriculture
(Parts 3100 -- 3199)
XXXII Office of Grants and Program Systems, Department of Agriculture
(Parts 3200 -- 3299)
XXXIII Office of Transportation, Department of Agriculture (Parts
3300 -- 3399)
XXXIV Cooperative State Research Service, Department of Agriculture
(Parts 3400 -- 3499)
XXXVI National Agricultural Statistics Service, Department of
Agriculture (Parts 3600 -- 3699)
XXXVII Economic Research Service, Department of Agriculture (Parts
3700 -- 3799)
XXXVIII World Agricultural Outlook Board, Department of Agriculture
(Parts 3800 -- 3899)
XXXIX Economic Analysis Staff, Department of Agriculture (Parts 3900
-- 3999)
XL Economics Management Staff, Department of Agriculture (Parts 4000
-- 4099)
XLI National Agricultural Library, Department of Agriculture (Part
4100)
26 CFR 1.997-1 Title 8 -- Aliens and Nationality
I Immigration and Naturalization Service, Department of Justice
(Parts 1 -- 499)
26 CFR 1.997-1 Title 9 -- Animals and Animal Products
I Animal and Plant Health Inspection Service, Department of
Agriculture (Parts 1 -- 199)
II Packers and Stockyards Administration, Department of Agriculture
(Parts 200 -- 299)
III Food Safety and Inspection Service, Meat and Poultry Inspection,
Department of Agriculture (Parts 300 -- 399)
26 CFR 1.997-1 Title 10 -- Energy
I Nuclear Regulatory Commission (Parts 0 -- 199)
II Department of Energy (Parts 200 -- 699)
III Department of Energy (Parts 700 -- 999)
X Department of Energy (General Provisions) (Parts 1000 -- 1099)
XV Office of the Federal Inspector for the Alaska Natural Gas
Transportation System (Parts 1500 -- 1599)
XVII Defense Nuclear Facilities Safety Board (Parts 1700 -- 1799)
26 CFR 1.997-1 Title 11 -- Federal Elections
I Federal Election Commission (Parts 1 -- 9099)
26 CFR 1.997-1 Title 12 -- Banks and Banking
I Comptroller of the Currency, Department of the Treasury (Parts 1 --
199)
II Federal Reserve System (Parts 200 -- 299)
III Federal Deposit Insurance Corporation (Parts 300 -- 399)
IV Export-Import Bank of the United States (Parts 400 -- 499)
V Office of Thrift Supervision, Department of The Treasury (Parts 500
-- 599)
VI Farm Credit Administration (Parts 600 -- 699)
VII National Credit Union Administration (Parts 700 -- 799)
VIII Federal Financing Bank (Parts 800 -- 899)
IX Federal Housing Finance Board (Parts 900 -- 999)
XI Federal Financial Institutions Examination Council (Parts 1100 --
1199)
XIII Farm Credit System Assistance Board (Parts 1300 -- 1399)
XIV Farm Credit System Insurance Corporation (Parts 1400 -- 1499)
XV Thrift Depositor Protection Oversight Board (Parts 1500 -- 1599)
XVI Resolution Trust Corporation (Parts 1600 -- 1699)
26 CFR 1.997-1 Title 13 -- Business Credit and Assistance
I Small Business Administration (Parts 1 -- 199)
III Economic Development Administration, Department of Commerce
(Parts 300 -- 399)
26 CFR 1.997-1 Title 14 -- Aeronautics and Space
I Federal Aviation Administration, Department of Transportation
(Parts 1 -- 199)
II Office of the Secretary, Department of Transportation (Aviation
Proceedings) (Parts 200 -- 399)
III Office of Commercial Space Transportation, Department of
Transportation (Parts 400 -- 499)
V National Aeronautics and Space Administration (Parts 1200 -- 1299)
26 CFR 1.997-1 Title 15 -- Commerce and Foreign Trade
Subtitle A -- Office of the Secretary of Commerce (Parts 0 -- 29)
Subtitle B -- Regulations Relating to Commerce and Foreign Trade
I Bureau of the Census, Department of Commerce (Parts 30 -- 199)
II National Institute of Standards and Technology, Department of
Commerce (Parts 200 -- 299)
III International Trade Administration, Department of Commerce (Parts
300 -- 399)
IV Foreign-Trade Zones Board (Parts 400 -- 499)
VII Bureau of Export Administration, Department of Commerce (Parts
700 -- 799)
VIII Bureau of Economic Analysis, Department of Commerce (Parts 800
-- 899)
IX National Oceanic and Atmospheric Administration, Department of
Commerce (Parts 900 -- 999)
XI Technology Administration, Department of Commerce (Parts 1100 --
1199)
XII United States Travel and Tourism Administration, Department of
Commerce (Parts 1200 -- 1299)
XIII East-West Foreign Trade Board (Parts 1300 -- 1399)
XIV Minority Business Development Agency (Parts 1400 -- 1499)
Subtitle C -- Regulations Relating to Foreign Trade Agreements
XX Office of the United States Trade Representative (Parts 2000 --
2099)
Subtitle D -- Regulations Relating to Telecommunications and
Information
XXIII National Telecommunications and Information Administration,
Department of Commerce (Parts 2300 -- 2399)
26 CFR 1.997-1 Title 16 -- Commercial Practices
I Federal Trade Commission (Parts 0 -- 999)
II Consumer Product Safety Commission (Parts 1000 -- 1799)
26 CFR 1.997-1 Title 17 -- Commodity and Securities Exchanges
I Commodity Futures Trading Commission (Parts 1 -- 199)
II Securities and Exchange Commission (Parts 200 -- 399)
IV Department of the Treasury (Parts 400 -- 499)
26 CFR 1.997-1 Title 18 -- Conservation of Power and Water Resources
I Federal Energy Regulatory Commission, Department of Energy (Parts 1
-- 399)
III Delaware River Basin Commission (Parts 400 -- 499)
VI Water Resources Council (Parts 700 -- 799)
VIII Susquehanna River Basin Commission (Parts 800 -- 899)
XIII Tennessee Valley Authority (Parts 1300 -- 1399)
26 CFR 1.997-1 Title 19 -- Customs Duties
I United States Customs Service, Department of the Treasury (Parts 1
-- 199)
II United States International Trade Commission (Parts 200 -- 299)
III International Trade Administration, Department of Commerce (Parts
300 -- 399)
26 CFR 1.997-1 Title 20 -- Employees' Benefits
I Office of Workers' Compensation Programs, Department of Labor
(Parts 1 -- 199)
II Railroad Retirement Board (Parts 200 -- 399)
III Social Security Administration, Department of Health and Human
Services (Parts 400 -- 499)
IV Employees' Compensation Appeals Board, Department of Labor (Parts
500 -- 599)
V Employment and Training Administration, Department of Labor (Parts
600 -- 699)
VI Employment Standards Administration, Department of Labor (Parts
700 -- 799)
VII Benefits Review Board, Department of Labor (Parts 800 -- 899)
VIII Joint Board for the Enrollment of Actuaries (Parts 900 -- 999)
IX Office of the Assistant Secretary for Veterans' Employment and
Training, Department of Labor (Parts 1000 -- 1099)
26 CFR 1.997-1 Title 21 -- Food and Drugs
I Food and Drug Administration, Department of Health and Human
Services (Parts 1 -- 1299)
II Drug Enforcement Administration, Department of Justice (Parts 1300
-- 1399)
26 CFR 1.997-1 Title 22 -- Foreign Relations
I Department of State (Parts 1 -- 199)
II Agency for International Development, International Development
Cooperation Agency (Parts 200 -- 299)
III Peace Corps (Parts 300 -- 399)
IV International Joint Commission, United States and Canada (Parts
400 -- 499)
V United States Information Agency (Parts 500 -- 599)
VI United States Arms Control and Disarmament Agency (Parts 600 --
699)
VII Overseas Private Investment Corporation, International
Development Cooperation Agency (Parts 700 -- 799)
IX Foreign Service Grievance Board Regulations (Parts 900 -- 999)
X Inter-American Foundation (Parts 1000 -- 1099)
XI International Boundary and Water Commission, United States and
Mexico, United States Section (Parts 1100 -- 1199)
XII United States International Development Cooperation Agency (Parts
1200 -- 1299)
XIII Board for International Broadcasting (Parts 1300 -- 1399)
XIV Foreign Service Labor Relations Board; Federal Labor Relations
Authority; General Counsel of the Federal Labor Relations Authority;
and the Foreign Service Impasse Disputes Panel (Parts 1400 -- 1499)
XV African Development Foundation (Parts 1500 -- 1599)
XVI Japan-United States Friendship Commission (Parts 1600 -- 1699)
26 CFR 1.997-1 Title 23 -- Highways
I Federal Highway Administration, Department of Transportation (Parts
1 -- 999)
II National Highway Traffic Safety Administration and Federal Highway
Administration, Department of Transportation (Parts 1200 -- 1299)
III National Highway Traffic Safety Administration, Department of
Transportation (Parts 1300 -- 1399)
26 CFR 1.997-1 Title 24 -- Housing and Urban Development
Subtitle A -- Office of the Secretary, Department of Housing and
Urban Development (Parts 0 -- 99)
Subtitle B -- Regulations Relating to Housing and Urban Development
I Office of Assistant Secretary for Equal Opportunity, Department of
Housing and Urban Development (Parts 100 -- 199)
II Office of Assistant Secretary for Housing-Federal Housing
Commissioner, Department of Housing and Urban Development (Parts 200 --
299)
III Government National Mortgage Association, Department of Housing
and Urban Development (Parts 300 -- 399)
V Office of Assistant Secretary for Community Planning and
Development, Department of Housing and Urban Development (Parts 500 --
599)
VI Office of Assistant Secretary for Community Planning and
Development, Department of Housing and Urban Development (Parts 600 --
699)
VII Office of the Secretary, Department of Housing and Urban
Development (Section 8 Housing Assistance Programs and Public and Indian
Housing Programs) (Parts 700 -- 799)
VIII Office of the Assistant Secretary for Housing -- Federal Housing
Commissioner, Department of Housing and Urban Development (Section 8
Housing Assistance Programs and Section 202 Direct Loan Program) (Parts
800 -- 899)
IX Office of Assistant Secretary for Public and Indian Housing,
Department of Housing and Urban Development (Parts 900 -- 999)
X Office of Assistant Secretary for Housing -- Federal Housing
Commissioner, Department of Housing and Urban Development (Interstate
Land Sales Registration Program) (Parts 1700 -- 1799)
XI Solar Energy and Energy Conservation Bank, Department of Housing
and Urban Development (Parts 1800 -- 1899)
XII Office of Inspector General, Department of Housing and Urban
Development (Parts 2000 -- 2099)
XV Mortgage Insurance and Loan Programs under the Emergency
Homeowners' Relief Act, Department of Housing and Urban Development
(Parts 2700 -- 2799)
XX Office of Assistant Secretary for Housing -- Federal Housing
Commissioner, Department of Housing and Urban Development (Parts 3200 --
3699)
XXV Neighborhood Reinvestment Corporation (Parts 4100 -- 4199)
26 CFR 1.997-1 Title 25 -- Indians
I Bureau of Indian Affairs, Department of the Interior (Parts 1 --
299)
II Indian Arts and Crafts Board, Department of the Interior (Parts
300 -- 399)
III National Indian Gaming Commission (Parts 500 -- 599)
IV Office of Navajo and Hopi Indian Relocation (Parts 700 -- 799)
26 CFR 1.997-1 Title 26 -- Internal Revenue
I Internal Revenue Service, Department of the Treasury (Parts 1 --
799)
26 CFR 1.997-1 Title 27 -- Alcohol, Tobacco Products and Firearms
I Bureau of Alcohol, Tobacco and Firearms, Department of the Treasury
(Parts 1 -- 299)
26 CFR 1.997-1 Title 28 -- Judicial Administration
I Department of Justice (Parts 0 -- 199)
III Federal Prison Industries, Inc., Department of Justice (Parts 300
-- 399)
V Bureau of Prisons, Department of Justice (Parts 500 -- 599)
VI Offices of Independent Counsel, Department of Justice (Parts 600
-- 699)
VII Office of Independent Counsel (Parts 700 -- 799)
26 CFR 1.997-1 Title 29 -- Labor
Subtitle A -- Office of the Secretary of Labor (Parts 0 -- 99)
Subtitle B -- Regulations Relating to Labor
I National Labor Relations Board (Parts 100 -- 199)
II Bureau of Labor-Management Relations and Cooperative Programs,
Department of Labor (Parts 200 -- 299)
III National Railroad Adjustment Board (Parts 300 -- 399)
IV Office of Labor-Management Standards, Department of Labor (Parts
400 -- 499)
V Wage and Hour Division, Department of Labor (Parts 500 -- 899)
IX Construction Industry Collective Bargaining Commission (Parts 900
-- 999)
X National Mediation Board (Parts 1200 -- 1299)
XII Federal Mediation and Conciliation Service (Parts 1400 -- 1499)
XIV Equal Employment Opportunity Commission (Parts 1600 -- 1699)
XVII Occupational Safety and Health Administration, Department of
Labor (Parts 1900 -- 1999)
XX Occupational Safety and Health Review Commission (Parts 2200 --
2499)
XXV Pension and Welfare Benefits Administration, Department of Labor
(Parts 2500 -- 2599)
XXVI Pension Benefit Guaranty Corporation (Parts 2600 -- 2699)
XXVII Federal Mine Safety and Health Review Commission (Parts 2700 --
2799)
26 CFR 1.997-1 Title 30 -- Mineral Resources
I Mine Safety and Health Administration, Department of Labor (Parts 1
-- 199)
II Minerals Management Service, Department of the Interior (Parts 200
-- 299)
III Board of Surface Mining and Reclamation Appeals, Department of
the Interior (Parts 300 -- 399)
IV Geological Survey, Department of the Interior (Parts 400 -- 499)
VI Bureau of Mines, Department of the Interior (Parts 600 -- 699)
VII Office of Surface Mining Reclamation and Enforcement, Department
of the Interior (Parts 700 -- 999)
26 CFR 1.997-1 Title 31 -- Money and Finance: Treasury
Subtitle A -- Office of the Secretary of the Treasury (Parts 0 -- 50)
Subtitle B -- Regulations Relating to Money and Finance
I Monetary Offices, Department of the Treasury (Parts 51 -- 199)
II Fiscal Service, Department of the Treasury (Parts 200 -- 399)
IV Secret Service, Department of the Treasury (Parts 400 -- 499)
V Office of Foreign Assets Control, Department of the Treasury (Parts
500 -- 599)
VI Bureau of Engraving and Printing, Department of the Treasury
(Parts 600 -- 699)
VII Federal Law Enforcement Training Center, Department of the
Treasury (Parts 700 -- 799)
VIII Office of International Investment, Department of the Treasury
(Parts 800 -- 899)
26 CFR 1.997-1 Title 32 -- National Defense
Subtitle A -- Department of Defense
I Office of the Secretary of Defense (Parts 1 -- 399)
V Department of the Army (Parts 400 -- 699)
VI Department of the Navy (Parts 700 -- 799)
VII Department of the Air Force (Parts 800 -- 1099)
Subtitle B -- Other Regulations Relating to National Defense
XII Defense Logistics Agency (Parts 1200 -- 1299)
XVI Selective Service System (Parts 1600 -- 1699)
XIX Central Intelligence Agency (Parts 1900 -- 1999)
XX Information Security Oversight Office (Parts 2000 -- 2099)
XXI National Security Council (Parts 2100 -- 2199)
XXIV Office of Science and Technology Policy (Parts 2400 -- 2499)
XXVII Office for Micronesian Status Negotiations (Parts 2700 -- 2799)
XXVIII Office of the Vice President of the United States (Parts 2800
-- 2899)
26 CFR 1.997-1 Title 33 -- Navigation and Navigable Waters
I Coast Guard, Department of Transportation (Parts 1 -- 199)
II Corps of Engineers, Department of the Army (Parts 200 -- 399)
IV Saint Lawrence Seaway Development Corporation, Department of
Transportation (Parts 400 -- 499)
26 CFR 1.997-1 Title 34 -- Education
Subtitle A -- Office of the Secretary, Department of Education (Parts
1 -- 99)
Subtitle B -- Regulations of the Offices of the Department of
Education
I Office for Civil Rights, Department of Education (Parts 100 -- 199)
II Office of Elementary and Secondary Education, Department of
Education (Parts 200 -- 299)
III Office of Special Education and Rehabilitative Services,
Department of Education (Parts 300 -- 399)
IV Office of Vocational and Adult Education, Department of Education
(Parts 400 -- 499)
V Office of Bilingual Education and Minority Languages Affairs,
Department of Education (Parts 500 -- 599)
VI Office of Postsecondary Education, Department of Education (Parts
600 -- 699)
VII Office of Educational Research and Improvement, Department of
Education (Parts 700 -- 799)
26 CFR 1.997-1 Title 35 -- Panama Canal
I Panama Canal Regulations (Parts 1 -- 299)
26 CFR 1.997-1 Title 36 -- Parks, Forests, and Public Property
I National Park Service, Department of the Interior (Parts 1 -- 199)
II Forest Service, Department of Agriculture (Parts 200 -- 299)
III Corps of Engineers, Department of the Army (Parts 300 -- 399)
IV American Battle Monuments Commission (Parts 400 -- 499)
V Smithsonian Institution (Parts 500 -- 599)
VII Library of Congress (Parts 700 -- 799)
VIII Advisory Council on Historic Preservation (Parts 800 -- 899)
IX Pennsylvania Avenue Development Corporation (Parts 900 -- 999)
XI Architectural and Transportation Barriers Compliance Board (Parts
1100 -- 1199)
XII National Archives and Records Administration (Parts 1200 -- 1299)
26 CFR 1.997-1 Title 37 -- Patents, Trademarks, and Copyrights
I Patent and Trademark Office, Department of Commerce (Parts 1 --
199)
II Copyright Office, Library of Congress (Parts 200 -- 299)
III Copyright Royalty Tribunal (Parts 300 -- 399)
IV Assistant Secretary for Technology Policy, Department of Commerce
(Parts 400 -- 499)
V Under Secretary for Technology, Department of Commerce (Parts 500
-- 599)
26 CFR 1.997-1 Title 38 -- Pensions, Bonuses, and Veterans' Relief
I Department of Veterans Affairs (Parts 0 -- 99)
26 CFR 1.997-1 Title 39 -- Postal Service
I United States Postal Service (Parts 1 -- 999)
III Postal Rate Commission (Parts 3000 -- 3099)
26 CFR 1.997-1 Title 40 -- Protection of Environment
I Environmental Protection Agency (Parts 1 -- 799)
V Council on Environmental Quality (Parts 1500 -- 1599)
26 CFR 1.997-1 Title 41 -- Public Contracts and Property Management
Subtitle B -- Other Provisions Relating to Public Contracts
50 Public Contracts, Department of Labor (Parts 50-1 -- 50-999)
51 Committee for Purchase from the Blind and Other Severely
Handicapped (Parts 51-1 -- 51-99)
60 Office of Federal Contract Compliance Programs, Equal Employment
Opportunity, Department of Labor (Parts 60-1 -- 60-999)
61 Office of the Assistant Secretary for Veterans Employment and
Training, Department of Labor (Parts 61-1 -- 61-999)
Subtitle C -- Federal Property Management Regulations System
101 Federal Property Management Regulations (Parts 101-1 -- 101-99)
105 General Services Administration (Parts 105-1 -- 105-999)
109 Department of Energy Property Management Regulations (Parts 109-1
-- 109-99)
114 Department of the Interior (Parts 114-1 -- 114-99)
115 Environmental Protection Agency (Parts 115-1 -- 115-99)
128 Department of Justice (Parts 128-1 -- 128-99)
132 Department of the Air Force (Parts 132-1 -- 132-99)
Subtitle D -- Other Provisions Relating to Property Management
(Reserved)
Subtitle E -- Federal Information Resources Management Regulations
System
201 Federal Information Resources Management Regulation (Parts 201-1
-- 201-99)
Subtitle F -- Federal Travel Regulation System
301 Travel Allowances (Parts 301-1 -- 301-99)
302 Relocation Allowances (Parts 302-1 -- 302-99)
303 Payment of Expenses Connected with the Death of Certain Employees
(Parts 303-1 -- 303-2)
304 Payment from a non-Federal source for travel expenses (Parts
304-1 -- 304-99)
26 CFR 1.997-1 Title 42 -- Public Health
I Public Health Service, Department of Health and Human Services
(Parts 1 -- 199)
IV Health Care Financing Administration, Department of Health and
Human Services (Parts 400 -- 499)
V Office of Inspector General-Health Care, Department of Health and
Human Services (Parts 1000 -- 1999)
26 CFR 1.997-1 Title 43 -- Public Lands: Interior
Subtitle A -- Office of the Secretary of the Interior (Parts 1 --
199)
Subtitle B -- Regulations Relating to Public Lands
I Bureau of Reclamation, Department of the Interior (Parts 200 --
499)
II Bureau of Land Management, Department of the Interior (Parts 1000
-- 9999)
26 CFR 1.997-1 Title 44 -- Emergency Management and Assistance
I Federal Emergency Management Agency (Parts 0 -- 399)
IV Department of Commerce and Department of Transportation (Parts 400
-- 499)
26 CFR 1.997-1 Title 45 -- Public Welfare
Subtitle A -- Department of Health and Human Services, General
Administration (Parts 1 -- 199)
Subtitle B -- Regulations Relating to Public Welfare
II Office of Family Assistance (Assistance Programs), Family Support
Administration, Department of Health and Human Services (Parts 200 --
299)
III Office of Child Support Enforcement (Child Support Enforcement
Program), Family Support Administration, Department of Health and Human
Services (Parts 300 -- 399)
IV Office of Refugee Resettlement, Administration for Children and
Families Department of Health and Human Services (Parts 400 -- 499)
V Foreign Claims Settlement Commission of the United States,
Department of Justice (Parts 500 -- 599)
VI National Science Foundation (Parts 600 -- 699)
VII Commission on Civil Rights (Parts 700 -- 799)
VIII Office of Personnel Management (Parts 800 -- 899)
X Office of Community Services, Family Support Administration,
Department of Health and Human Services (Parts 1000 -- 1099)
XI National Foundation on the Arts and the Humanities (Parts 1100 --
1199)
XII ACTION (Parts 1200 -- 1299)
XIII Office of Human Development Services, Department of Health and
Human Services (Parts 1300 -- 1399)
XVI Legal Services Corporation (Parts 1600 -- 1699)
XVII National Commission on Libraries and Information Science (Parts
1700 -- 1799)
XVIII Harry S. Truman Scholarship Foundation (Parts 1800 -- 1899)
XX Commission on the Bicentennial of the United States Constitution
(Parts 2000 -- 2099)
XXI Commission on Fine Arts (Parts 2100 -- 2199)
XXII Christopher Columbus Quincentenary Jubilee Commission (Parts
2200 -- 2299)
XXIV James Madison Memorial Fellowship Foundation (Parts 2400 --
2499)
26 CFR 1.997-1 Title 46 -- Shipping
I Coast Guard, Department of Transportation (Parts 1 -- 199)
II Maritime Administration, Department of Transportation (Parts 200
-- 399)
III Coast Guard (Great Lakes Pilotage), Department of Transportation
(Parts 400 -- 499)
IV Federal Maritime Commission (Parts 500 -- 599)
26 CFR 1.997-1 Title 47 -- Telecommunication
I Federal Communications Commission (Parts 0 -- 199)
II Office of Science and Technology Policy and National Security
Council (Parts 200 -- 299)
III National Telecommunications and Information Administration,
Department of Commerce (Parts 300 -- 399)
26 CFR 1.997-1 Title 48 -- Federal Acquisition Regulations System
1 Federal Acquisition Regulation (Parts 1 -- 99)
2 Department of Defense (Parts 200 -- 299)
3 Department of Health and Human Services (Parts 300 -- 399)
4 Department of Agriculture (Parts 400 -- 499)
5 General Services Administration (Parts 500 -- 599)
6 Department of State (Parts 600 -- 699)
7 Agency for International Development (Parts 700 -- 799)
8 Department of Veterans Affairs (Parts 800 -- 899)
9 Department of Energy (Parts 900 -- 999)
10 Department of the Treasury (Parts 1000 -- 1099)
12 Department of Transportation (Parts 1200 -- 1299)
13 Department of Commerce (Parts 1300 -- 1399)
14 Department of the Interior (Parts 1400 -- 1499)
15 Environmental Protection Agency (Parts 1500 -- 1599)
16 Office of Personnel Management Federal Employees Health Benefits
Acquisition Regulation (Parts 1600 -- 1699)
17 Office of Personnel Management (Parts 1700 -- 1799)
18 National Aeronautics and Space Administration (Parts 1800 -- 1899)
19 United States Information Agency (Parts 1900 -- 1999)
22 Small Business Administration (Parts 2200 -- 2299)
24 Department of Housing and Urban Development (Parts 2400 -- 2499)
25 National Science Foundation (Parts 2500 -- 2599)
28 Department of Justice (Parts 2800 -- 2899)
29 Department of Labor (Parts 2900 -- 2999)
34 Department of Education Acquisition Regulation (Parts 3400 --
3499)
35 Panama Canal Commission (Parts 3500 -- 3599)
44 Federal Emergency Management Agency (Parts 4400 -- 4499)
51 Department of the Army Acquisition Regulations (Parts 5100 --
5199)
52 Department of the Navy Acquisition Regulations (Parts 5200 --
5299)
53 Department of the Air Force Federal Acquisition Regulation
Supplement (Parts 5300 -- 5399)
57 African Development Foundation (Parts 5700 -- 5799)
61 General Services Administration Board of Contract Appeals (Parts
6100 -- 6199)
63 Department of Transportation Board of Contract Appeals (Parts 6300
-- 6399)
99 Cost Accounting Standards Board, Office of Federal Procurement
Policy, Office of Management and Budget (Parts 9900 -- 9999)
26 CFR 1.997-1 Title 49 -- Transportation
Subtitle A -- Office of the Secretary of Transportation (Parts 1 --
99)
Subtitle B -- Other Regulations Relating to Transportation
I Research and Special Programs Administration, Department of
Transportation (Parts 100 -- 199)
II Federal Railroad Administration, Department of Transportation
(Parts 200 -- 299)
III Federal Highway Administration, Department of Transportation
(Parts 300 -- 399)
IV Coast Guard, Department of Transportation (Parts 400 -- 499)
V National Highway Traffic Safety Administration, Department of
Transportation (Parts 500 -- 599)
VI Urban Mass Transportation Administration, Department of
Transportation (Parts 600 -- 699)
VII National Railroad Passenger Corporation (AMTRAK) (Parts 700 --
799)
VIII National Transportation Safety Board (Parts 800 -- 899)
X Interstate Commerce Commission (Parts 1000 -- 1399)
26 CFR 1.997-1 Title 50 -- Wildlife and Fisheries
I United States Fish and Wildlife Service, Department of the Interior
(Parts 1 -- 199)
II National Marine Fisheries Service, National Oceanic and
Atmospheric Administration, Department of Commerce (Parts 200 -- 299)
III International Regulatory Agencies (Fishing and Whaling) (Parts
300 -- 399)
IV Joint Regulations (United States Fish and Wildlife Service,
Department of the Interior and National Marine Fisheries Service,
National Oceanic and Atmospheric Administration, Department of
Commerce); Endangered Species Committee Regulations (Parts 400 -- 499)
V Marine Mammal Commission (Parts 500 -- 599)
VI Fishery Conservation and Management, National Oceanic and
Atmospheric Administration, Department of Commerce (Parts 600 -- 699)
26 CFR 1.997-1 CFR Index and Finding Aids Subject/Agency Index
List of Agency Prepared Indexes Parallel Table of Statutory Authorities
and Rules Acts Requiring Publication in the Federal Register List of CFR
Titles, Chapters, Subchapters, and Parts
26 CFR 1.997-1 Alphabetical List of Agencies Appearing in the CFR
CFR Title, Subtitle or
Agency
Chapter
ACTION 45, XII
Administrative Committee of the Federal Register 1, I
Administrative Conference of the United States 1, III
Advisory Commission on Intergovernmental Relations 5, VII
Advisory Committee on Federal Pay 5, IV
Advisory Council on Historic Preservation 36, VIII
African Development Foundation 22, XV; 48, 57
Agency for International Development 22, II; 48, 7
Agricultural Marketing Service 7, I, IX, X, XI
Agricultural Research Service 7, V
Agricultural Stabilization and Conservation Service 7, VII
Agriculture Department
Agricultural Marketing Service 7, I, IX, X, XI
Agricultural Research Service 7, V
Agricultural Stabilization and Conservation Service 7, VII
Animal and Plant Health Inspection Service 7, III; 9, I
Commodity Credit Corporation 7, XIV
Cooperative State Research Service 7, XXXIV
Economic Analysis Staff 7, XXXIX
Economic Research Service 7, XXXVII
Economics Management Staff 7, XL
Energy, Office of 7, XXIX
Environmental Quality, Office of 7, XXXI
Farmers Home Administration 7, XVIII
Federal Acquisition Regulation 48, 4
Federal Crop Insurance Corporation 7, IV
Federal Grain Inspection Service 7, VIII
Finance and Management, Office of 7, XXX
Food and Nutrition Service 7, II
Food Safety and Inspection Service 9, III
Foreign Agricultural Service 7, XV
Foreign Economic Development Service 7, XXI
Forest Service 36, II
General Sales Manager, Office of 7, XXV
Grants and Program Systems, Office of 7, XXXII
Information Resources Management, Office of 7, XXVII
Inspector General, Office of 7, XXVI
International Cooperation and Development Office 7, XXII
National Agricultural Library 7, XLI
National Agricultural Statistics Service 7, XXXVI
Operations Office 7, XXVIII
Packers and Stockyards Administration 9, II
Rural Electrification Administration 7, XVII
Rural Telephone Bank 7, XVI
Secretary of Agriculture, Office of 7, Subtitle A
Soil Conservation Service 7, VI
Transportation, Office of 7, XXXIII
World Agriculture Outlook Board 7, XXXVIII
Air Force Department 32, VII; 41, Subtitle C, Ch. 132
Federal Acquisition Regulation Supplement 48, 53
Alaska Natural Gas Transportation System, Office of the Federal
Inspector 10, XV
Alcohol, Tobacco and Firearms, Bureau of 27, I
AMTRAK 49, VII
American Battle Monuments Commission 36, IV
Animal and Plant Health Inspection Service 7, III; 9, I
Appalachian Regional Commission 5, IX
Architectural and Transportation Barriers Compliance Board 36, XI
Arms Control and Disarmament Agency, U.S. 22, VI
Army Department 32, V
Engineers, Corps of 33, II; 36, III
Federal Acquisition Regulation 48, 51
Assistant Secretary for Technology Policy, Department of Commerce 37,
IV
Benefits Review Board 20, VII
Bicentennial of the United States Constitution, Commission on the 45,
XX
Bilingual Education and Minority Languages Affairs, Office of 34, V
Blind and Other Severely Handicapped, Committee for Purchase from 41,
51
Board for International Broadcasting 22, XIII
Budget, Office of Management and 5, III
Census Bureau 15, I
Central Intelligence Agency 32, XIX
Child Support Enforcement, Office of 45, III
Christopher Columbus Quincentenary Jubilee Commission 45, XXII
Civil Rights Commission 45, VII
Civil Rights, Office for (Education Department) 34, I
Claims Collection Standards, Federal 4, II
Coast Guard 33, I; 46, I, III; 49, IV
Commerce Department 44, IV
Census Bureau 15, I
Assistant Secretary for Technology Policy 37, IV
Economic Affairs, Under Secretary 37, V
Economic Analysis, Bureau of 15, VIII
Economic Development Administration 13, III
Endangered Species Committee 50, IV
Export Administration Bureau 15, VII
Federal Acquisition Regulation 48, 13
Fishery Conservation and Management 50, VI
International Trade Administration 15, III; 19, III
National Institute of Standards and Technology 15, II
National Marine Fisheries Service 50, II, IV
National Oceanic and Atmospheric Administration 15, IX; 50, II, III,
IV, VI
National Telecommunications and Information Administration 15, XXIII;
47, III
Patent and Trademark Office 37, I
Productivity, Technology and Innovation, Assistant Secretary for 37,
IV
Secretary of Commerce, Office of 15, Subtitle A
Technology Administration 15, XI
Under Secretary for Technology 37, V
United States Travel and Tourism Administration 15, XII
Commercial Space Transportation, Office of, Department of
Transportation 14, III
Commission on the Bicentennial of the United States Constitution 45,
XX
Committee for Purchase from the Blind and Other Severely Handicapped
41, 51
Commodity Credit Corporation 7, XIV
Commodity Futures Trading Commission 17, I
Community Planning and Development, Office of Assistant Secretary for
24, V, VI
Community Services, Office of 45, X
Comptroller of the Currency 12, I
Construction Industry Collective Bargaining Commission 29, IX
Consumer Product Safety Commission 16, II
Cooperative State Research Service 7, XXXIV
Copyright Office 37, II
Copyright Royalty Tribunal 37, III
Cost Accounting Standards Board, Office of Federal Procurement Policy
48, 99
Council on Environmental Quality 40, V
Customs Service, United States 19, I
Defense Department 32, Subtitle A
Air Force Department 32, VII; 41, Subtitle C, Ch. 132
Army Department 32, V; 33, II; 36, III, 48, 51
Engineers, Corps of 33, II; 36, III
Federal Acquisition Regulation 48, 2
Navy Department 32, VI; 48, 52
Secretary of Defense, Office of 32, I
Defense Logistics Agency 32, XII
Defense Nuclear Facilities Safety Board 10, XVII
Delaware River Basin Commission 18, III
Drug Enforcement Administration 21, II
East-West Foreign Trade Board 15, XIII
Economic Affairs, Under Secretary (Commerce) 37, V
Economic Analysis, Bureau of 15, VIII
Economic Analysis Staff, Department of Agriculture 7, XXXIX
Economic Development Administration 13, III
Economics Management Staff 7, XL
Economic Research Service 7, XXXVII
Education, Department of
Bilingual Education and Minority Languages Affairs, Office of 34, V
Civil Rights, Office for 34, I
Educational Research and Improvement, Office of 34, VII
Elementary and Secondary Education, Office of 34, II
Federal Acquisition Regulation 48, 34
Postsecondary Education, Office of 34, VI
Secretary of Education, Office of 34, Subtitle A
Special Education and Rehabilitative Services, Office of 34, III
Vocational and Adult Education, Office of 34, IV
Educational Research and Improvement, Office of 34, VII
Elementary and Secondary Education, Office of 34, II
Employees' Compensation Appeals Board 20, IV
Employees Loyalty Board, International Organizations 5, V
Employment and Training Administration 20, V
Employment Standards Administration 20, VI
Endangered Species Committee 50, IV
Energy, Department of 10, II, III, X; 41, 109
Federal Acquisition Regulation 48, 9
Federal Energy Regulatory Commission 18, I
Energy, Office of, Department of Agriculture 7, XXIX
Engineers, Corps of 33, II; 36, III
Engraving and Printing, Bureau of 31, VI
Environmental Protection Agency 40, I; 41, 115; 48, 15
Environmental Quality, Office of (Agriculture Department) 7, XXXI
Equal Employment Opportunity Commission 29, XIV
Equal Opportunity, Office of Assistant Secretary for 24, I
Executive Office of the President 3, I
Administration, Office of 5, XV
Export Administration Bureau 15, VII
Export-Import Bank of the United States 12, IV
Family Assistance, Office of 45, II
Family Support Administration 45, II, III, IV, X
Farm Credit Administration 12, VI
Farm Credit System Assistance Board 12, XIII
Farm Credit System Insurance Corporation 12, XIV
Farmers Home Administration 7, XVIII
Federal Acquisition Regulation 48, 1
Federal Aviation Administration 14, I
Federal Claims Collection Standards 4, II
Federal Communications Commission 47, I
Federal Contract Compliance Programs, Office of 41, 60
Federal Crop Insurance Corporation 7, IV
Federal Deposit Insurance Corporation 12, III
Federal Election Commission 11, I
Federal Emergency Management Agency 44, I; 48, 44
Federal Energy Regulatory Commission 18, I
Federal Financial Institutions Examination Council 12, XI
Federal Financing Bank 12, VIII
Federal Grain Inspection Service 7, VIII
Federal Highway Administration 23, I, II; 49, III
Federal Home Loan Mortgage Corporation 1, IV
Federal Housing Finance Board 12, IX
Federal Information Resources Management Regulations 41, Subtitle E,
Ch. 201
Federal Inspector for the Alaska Natural Gas Transportation System,
Office of 10, XV
Federal Labor Relations Authority, and General Counsel of the Federal
Labor Relations Authority 5, XIV; 22, XIV
Federal Law Enforcement Training Center 31, VII
Federal Maritime Commission 46, IV
Federal Mediation and Conciliation Service 29, XII
Federal Mine Safety and Health Review Commission 29, XXVII
Federal Pay, Advisory Committee on 5, IV
Federal Prison Industries, Inc. 28, III
Federal Procurement Policy Office 48, 99
Federal Property Management Regulations 41, 101
Federal Property Management Regulations System 41, Subtitle C
Federal Railroad Administration 49, II
Federal Register, Administrative Committee of 1, I
Federal Register, Office of 1, II
Federal Reserve System 12, II
Federal Retirement Thrift Investment Board 5, VI
Federal Service Impasses Panel 5, XIV
Federal Trade Commission 16, I
Federal Travel Regulation System 41, Subtitle F
Finance and Management, Department of Agriculture 7, XXX
Fine Arts Commission 45, XXI
Fiscal Service 31, II
Fish and Wildlife Service, United States 50, I, IV
Fishery Conservation and Management 50, VI
Fishing and Whaling, International Regulatory Agencies 50, III
Food and Drug Administration 21, I
Food and Nutrition Service 7, II
Food Safety and Inspection Service 9, III
Foreign Agricultural Service 7, XV
Foreign Assets Control, Office of 31, V
Foreign Claims Settlement Commission of United States 45, V
Foreign Economic Development Service 7, XXI
Foreign Service Grievance Board 22, IX
Foreign Service Impasse Disputes Panel 22, XIV
Foreign Service Labor Relations Board 22, XIV
Foreign-Trade Zones Board 15, IV
Forest Service 36, II
General Accounting Office 4, I, II, III
General Sales Manager, Office of 7, XXV
General Services Administration
Contract Appeals Board 48, 61
Federal Acquisition Regulation 48, 5
Federal Information Resources Management Regulations 41, Subtitle E,
Ch. 201
Federal Property Management Regulations System 41, 101, 105
Federal Travel Regulation System 41, Subtitle F
Payment of Expenses Connected With the Death of Certain Employees 41,
303
Reduction in Meeting and Training Allowance Payments 41, 304
Relocation Allowances 41, 302
Travel Allowances 41, 301
Geological Survey 30, IV
Government Ethics, Office of 5, XVI
Government National Mortgage Association 24, III
Grants and Program Systems, Office of 7, XXXII
Great Lakes Pilotage 46, III
Harry S. Truman Scholarship Foundation 45, XVIII
Health and Human Services, Department of 45, Subtitle A
Child Support Enforcement, Office of 45, III
Community Services, Office of 45, X
Family Assistance, Office of 45, II
Family Support Administration 45, II, III, IV, X
Federal Acquisition Regulation 48, 3
Food and Drug Administration 21, I
Health Care Financing Administration 42, IV
Human Development Services Office 45, XIII
Inspector General, Office of 42, V
Public Health Service 42, I
Refugee Resettlement, Office of 45, IV
Social Security Administration 20, III; 45, IV
Health Care Financing Administration 42, IV
Housing and Urban Development, Department of
Community Planning and Development, Office of Assistant Secretary for
24, V, VI
Equal Opportunity, Office of Assistant Secretary for 24, I
Federal Acquisition Regulation 48, 24
Government National Mortgage Association 24, III
Housing -- Federal Housing Commissioner, Office of Assistant
Secretary for 24, II, VIII, X, XX
Inspector General, Office of 24, XII
Mortgage Insurance and Loan Programs Under Emergency Homeowners'
Relief Act 24, XV
Public and Indian Housing, Office of Assistant Secretary for 24, IX
Secretary, Office of 24, Subtitle B, VII
Solar Energy and Energy Conservation Bank 24, XI
Housing -- Federal Housing Commissioner, Office of Assistant
Secretary for 24, II, VIII, X, XX
Human Development Services Office 45, XIII
Immigration and Naturalization Service 8, I
Indian Affairs, Bureau of 25, I
Indian Arts and Crafts Board 25, II
Information Agency, United States 22, V; 48, 19
Information Resources Management, Office of, Agriculture Department
7, XXVII
Information Security Oversight Office 32, XX
Inspector General, Office of, Agriculture Department 7, XXVI
Inspector General, Office of, Health and Human Services Department
42, V
Inspector General, Office of, Housing and Urban Development
Department 24, XII
Inter-American Foundation 22, X
Intergovernmental Relations, Advisory Commission on 5, VII
Interior Department
Endangered Species Committee 50, IV
Federal Acquisition Regulation 48, 14
Federal Property Management Regulations System 41, 114
Fish and Wildlife Service, United States 50, I, IV
Geological Survey 30, IV
Indian Affairs, Bureau of 25, I
Indian Arts and Crafts Board 25, II
Land Management Bureau 43, II
Minerals Management Service 30, II
Mines, Bureau of 30, VI
National Park Service 36, I
Reclamation Bureau 43, I
Secretary of the Interior, Office of 43, Subtitle A
Surface Mining and Reclamation Appeals, Board of 30, III
Surface Mining Reclamation and Enforcement, Office of 30, VII
United States Fish and Wildlife Service 50, I, IV
Internal Revenue Service 26, I
International Boundary and Water Commission, United States and Mexico
22, XI
International Cooperation and Development Office, Department of
Agriculture 7, XXII
International Development, Agency for 22, II
International Development Cooperation Agency 22, XII
International Development, Agency for 22, II
Overseas Private Investment Corporation 22, VII
International Joint Commission, United States and Canada 22, IV
International Organizations Employees Loyalty Board 5, V
International Regulatory Agencies (Fishing and Whaling) 50, III
International Trade Administration 15, III; 19, III
International Trade Commission, United States 19, II
Interstate Commerce Commission 49, X
Japan-United States Friendship Commission 22, XVI
Joint Board for the Enrollment of Actuaries 20, VIII
Justice Department 28, I; 41, 128
Drug Enforcement Administration 21, II
Federal Acquisition Regulation 48, 28
Federal Claims Collection Standards 4, II
Federal Prison Industries, Inc. 28, III
Foreign Claims Settlement Commission of the United States 45, V
Immigration and Naturalization Service 8, I
Offices of Independent Counsel 28, VI
Prisons, Bureau of 28, V
Labor Department
Benefits Review Board 20, VII
Employees' Compensation Appeals Board 20, IV
Employment and Training Administration 20, V
Employment Standards Administration 20, VI
Federal Acquisition Regulation 48, 29
Federal Contract Compliance Programs, Office of 41, 60
Federal Procurement Regulations System 41, 50
Labor-Management Relations and Cooperative Programs, Bureau of 29, II
Labor-Management Standards, Office of 29, IV
Mine Safety and Health Administration 30, I
Occupational Safety and Health Administration 29, XVII
Pension and Welfare Benefits Administration 29, XXV
Public Contracts 41, 50
Secretary of Labor, Office of 29, Subtitle A
Veterans' Employment and Training, Office of the Assistant Secretary
for 41, 61; 20, IX
Wage and Hour Division 29, V
Workers' Compensation Programs, Office of 20, I
Labor-Management Relations and Cooperative Programs, Bureau of 29, II
Labor-Management Standards, Office of 29, IV
Land Management, Bureau of 43, II
Legal Services Corporation 45, XVI
Library of Congress 36, VII
Copyright Office 37, II
Management and Budget, Office of 5, III; 48, 99
Marine Mammal Commission 50, V
Maritime Administration 46, II
Merit Systems Protection Board 5, II
Micronesian Status Negotiations, Office for 32, XXVII
Mine Safety and Health Administration 30, I
Minerals Management Service 30, II
Mines, Bureau of 30, VI
Minority Business Development Agency 15, XIV
Miscellaneous Agencies 1, IV
Monetary Offices 31, I
Mortgage Insurance and Loan Programs Under the Emergency Homeowners'
Relief Act, Department of Housing and Urban Development 24, XV
National Aeronautics and Space Administration 14, V; 48, 18
National Agricultural Library 7, XLI
National Agricultural Statistics Service 7, XXXVI
National Archives and Records Administration 36, XII
National Bureau of Standards 15, II
National Capital Planning Commission 1, IV
National Commission for Employment Policy 1, IV
National Commission on Libraries and Information Science 45, XVII
National Credit Union Administration 12, VII
National Foundation on the Arts and the Humanities 45, XI
National Highway Traffic Safety Administration 23, II, III; 49, V
National Indian Gaming Commission 25, III
National Institute of Standards and Technology 15, II
National Labor Relations Board 29, I
National Marine Fisheries Service 50, II, IV
National Mediation Board 29, X
National Oceanic and Atmospheric Administration 15, IX; 50, II, III,
IV, VI
National Park Service 36, I
National Railroad Adjustment Board 29, III
National Railroad Passenger Corporation (AMTRAK) 49, VII
National Science Foundation 45, VI; 48, 25
National Security Council 32, XXI
National Security Council and Office of Science and Technology Policy
47, II
National Telecommunications and Information Administration 15, XXIII;
47, III
National Transportation Safety Board 49, VIII
Navy Department 32, VI; 48, 52
Neighborhood Reinvestment Corporation 24, XXV
Nuclear Regulatory Commission 10, I
Occupational Safety and Health Administration 29, XVII
Occupational Safety and Health Review Commission 29, XX
Office of Independent Counsel 28, VII
Office of Navajo and Hopi Indian Relocation 25, IV
Offices of Independent Counsel, Department of Justice 28, VI
Operations Office, Department of Agriculture 7, XXVIII
Overseas Private Investment Corporation 22, VII
Oversight Board 12, XV
Packers and Stockyards Administration 9, II
Panama Canal Commission 48, 35
Panama Canal Regulations 35, I
Patent and Trademark Office 37, I
Payment of Expenses Connected With the Death of Certain Employees 41,
303
Peace Corps 22, III
Pennsylvania Avenue Development Corporation 36, IX
Pension and Welfare Benefits Administration, Department of Labor 29,
XXV
Pension Benefit Guaranty Corporation 29, XXVI
Personnel Management, Office of 5, I; 45, VIII; 48, 17
Federal Employees Health Benefits Acquisition Regulation 48, 16
Postal Rate Commission 39, III
Postal Service, United States 39, I
Postsecondary Education, Office of 34, VI
President's Commission on White House Fellowships 1, IV
Presidential Documents 3
Prisons, Bureau of 28, V
Productivity, Technology and Innovation, Assistant Secretary
(Commerce) 37, IV
Property Management Regulations System, Federal 41, Subtitle C
Public Contracts, Department of Labor 41, 50
Public Health Service 42, I
Railroad Retirement Board 20, II
Reclamation Bureau 43, I
Reduction in Meeting and Training Allowance Payments 41, 304
Refugee Resettlement, Office of 45, IV
Regional Action Planning Commissions 13, V
Relocation Allowances 41, 302
Research and Special Programs Administration 49, I
Resolution Trust Corporation 12, XVI
Rural Electrification Administration 7, XVII
Rural Telephone Bank 7, XVI
Saint Lawrence Seaway Development Corporation 33, IV
Science and Technology Policy, Office of 32, XXIV
Science and Technology Policy, Office of, and National Security
Council 47, II
Secret Service 31, IV
Securities and Exchange Commission 17, II
Selective Service System 32, XVI
Small Business Administration 13, I; 48, 22
Smithsonian Institution 36, V
Social Security Administration 20, III; 45, IV
Soil Conservation Service 7, VI
Solar Energy and Energy Conservation Bank, Department of Housing and
Urban Development 24, XI
Soldiers' and Airmen's Home, United States 5, XI
Special Counsel, Office of 5, VIII
Special Education and Rehabilitative Services, Office of 34, III
State Department 22, I
Federal Acquisition Regulation 48, 6
Surface Mining and Reclamation Appeals, Board of 30, III
Susquehanna River Basin Commission 18, VIII
Technology Administration 15, XI
Tennessee Valley Authority 18, XIII
Thrift Supervision Office, Department of the Treasury 12, V
Trade Representative, United States, Office of 15, XX
Transportation, Department of 44, IV
Coast Guard 33, I; 46, I, III; 49, IV
Commercial Space Transportation, Office of 14, III
Contract Appeals Board 48, 63
Federal Acquisition Regulation 48, 12
Federal Aviation Administration 14, I
Federal Highway Administration 23, I, II; 49, III
Federal Railroad Administration 49, II
Maritime Administration 46, II
National Highway Traffic Safety Administration 23, II, III; 49, V
Research and Special Programs Administration 49, I
Saint Lawrence Seaway Development Corporation 33, IV
Secretary of Transportation, Office of 14, II; 49, Subtitle A
Urban Mass Transportation Administration 49, VI
Transportation, Office of, Department of Agriculture 7, XXXIII
Travel Allowance 41, 301
Travel and Tourism Administration, United States 15, XII
Treasury Department 17, IV
Alcohol, Tobacco and Firearms, Bureau of 27, I
Comptroller of the Currency 12, I
Customs Service, United States 19, I
Engraving and Printing, Bureau of 31, VI
Federal Acquisition Regulation 48, 10
Federal Law Enforcement Training Center 31, VII
Fiscal Service 31, II
Foreign Assets Control, Office of 31, V
Internal Revenue Service 26, I
Monetary Offices 31, I
Secret Service 31, IV
Secretary of the Treasury, Office of 31, Subtitle A
Thrift Supervision Office 12, V
United States Customs Service 19, I
Truman, Harry S. Scholarship Foundation 45, XVIII
Under Secretary for Technology, Department of Commerce 37, V
United States and Canada, International Joint Commission 22, IV
United States Arms Control and Disarmament Agency 22, VI
United States Customs Service 19, I
United States Fish and Wildlife Service 50, I, IV
United States Information Agency 22, V; 48, 19
United States International Development Cooperation Agency 22, XII
United States International Trade Commission 19, II
United States Postal Service 39, I
United States Soldiers' and Airmen's Home 5, XI
United States Trade Representative, Office of 15, XX
United States Travel and Tourism Adminstration 15, XII
Urban Mass Transportation Administration 49, VI
Veterans Affairs Department 38, I; 48, 8
Veterans' Employment and Training, Office of the Assistant Secretary
for 41, 61; 20, IX
Vice President of the United States, Office of 32, XXVIII
Vocational and Adult Education, Office of 34, IV
Wage and Hour Division 29, V
Water Resources Council 18, VI
Workers' Compensation Programs, Office of 20, I
World Agriculture Outlook Board 7, XXXVIII
26 CFR 1.997-1 26 CFR (4-1-92 Edition)
26 CFR 1.997-1 OMB Control Numbers
26 CFR 1.997-1
26 CFR 1.997-1
26 CFR 1.997-1 Table of OMB Control Numbers
The OMB control numbers for chapter I of title 26 were consolidated
into 601.9000 and 602.101 at 50 FR 10221, Mar. 14, 1985. Sections
601.9000 and 602.101 are reprinted below for the convenience of the
user.
26 CFR 1.997-1 Subpart J -- OMB Control Numbers Under the Paperwork Reduction Act
26 CFR 601.9000 OMB control numbers for the statement of procedural
rules.
(a) Purpose. This section collects and displays the control numbers
assigned to Internal Revenue Service collections of information in the
Statement of Procedural Rules (26 CFR Part 601) by the Office of
Management and Budget (OMB) under the Paperwork Reduction Act of 1980.
The Internal Revenue Service intends that this section (together with 26
CFR Part 602) comply with the requirements of 1320.7(f), 1320.12,
1320.13, and 1320.14 of 5 CFR Part 1320 (OMB regulations implementing
the Paperwork Reduction Act of 1980) for the display of control numbers
assigned by OMB to collections of information of the Internal Revenue
Service in the Statement of Procedural Rules. This section does not
display control numbers assigned by OMB to collections of information of
the Bureau of Alcohol, Tobacco, and Firearms in the Statement of
Procedural Rules.
(b) Cross-reference. For display of control numbers assigned by the
Office of Management and Budget to collections of information of the
Internal Revenue Service in regulations elsewhere than in the Statement
of Procedural Rules, see 26 CFR Part 602.
(c) Display.
(Sec. 7805 of the Internal Revenue Code of 1954 (68A Stat. 917; 26
U.S.C. 7805))
(T.D. 8011, 50 FR 10222, Mar. 14, 1985, as amended at 51 FR 7442,
Mar. 4, 1986. Redesignated at 53 FR 19187, May 26, 1988)
26 CFR 601.9000 Pt. 602
26 CFR 601.9000 PART 602 -- OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
26 CFR 602.101 OMB Control Numbers.
(a) Purpose. This part collects and displays the control numbers
assigned to collections of information in Internal Revenue Service
regulations by the Office of Management and Budget (OMB) under the
Paperwork Reduction Act of 1980. The Internal Revenue Service intends
that this part (together with 26 CFR 601.9000) comply with the
requirements of 1320.7(f), 1320.12, 1320.13, and 1320.14 of 5 CFR part
1320 (OMB regulations implementing the Paperwork Reduction Act), for the
display of control numbers assigned by OMB to collections of information
in Internal Revenue Service regulations. This part does not display
control numbers assigned by the Office of Management and Budget to
collections of information of the Bureau of Alcohol, Tobacco, and
Firearms.
(b) Cross-reference. For display of control numbers assigned by the
Office of Management and Budget to Internal Revenue Service collections
of information in the Statement of Procedural Rules (26 CFR part 601),
see 26 CFR 601.9000.
(c) Display.
(26 U.S.C. 7805)
(T.D. 8011, 50 FR 10222, Mar. 14, 1985)
Editorial Note: For Federal Register citations affecting 602.101,
see the List of CFR Sections Affected in the Findings Aids section of 26
CFR part 600 -- End.
26 CFR 602.101 26 CFR (4-1-92 Edition)
26 CFR 602.101 List of CFR Sections Affected
26 CFR 602.101 List of CFR Sections Affected
All changes to sections of part 1 ( 1.851 to 1.1000) of title 26 of
the Code of Federal Regulations which were made by documents published
in the Federal Register since January 1, 1986, are enumerated in the
following list. Entries indicate the nature of the changes effected.
Page numbers refer to Federal Register pages. The user should consult
the entries for chapters and parts as well as sections for revisions.
For the period before January 1, 1986, see the ''List of CFR Sections
Affected, 1949-1963, 1964-1972, and 1973-1985'' published in seven
separate volumes.
26 CFR 602.101 1986
26 CFR
51 FR
Page
Chapter I
1.936-4 Added 21524
1.936-5 Added 21524
(a) Example (2), (b)(4) and (7) corrected 27174
1.936-6 Added 21532
(b)(1)(iv) Example (2) corrected 27174
1.936-7 Added 21545
26 CFR 602.101 1987
26 CFR
52 FR
Page
Chapter I
1.921-1T (a)(4) Question 4A and Answer 4A, (9) Question 11A and
Answer 11A, and (10) Question 12A and Answer 12A added (temporary) 6434
(b)(1) Answer 1 revised; (b)(12) Answer 12 amended (temporary) 6435
1.921-2 Added 6469
1.921-2T Removed 6469
1.921-3T Added (temporary) 6435
1.922-1 Added 6470
1.922-1T Removed 6469
1.923-1T Added (temporary) 6438
1.924(a)-1T Added (temporary) 6438
1.924(c)-1 Added 5089
1.924(c)-1T Removed 10742
1.924(d)-1 Added 5090
1.924(d)-1T Removed 10742
1.924(e)-1 Added 5094
1.924(e)-1T Removed 10742
1.925(a)-1T Added (temporary) 6443
1.925(b)-1T Removed 6435
Added (temporary) 6455
1.925(c)-1T Removed 6435
1.926(a)-1T Added (temporary) 6458
1.927-1T Removed 6465
1.927(a)-1T Added (temporary) 6459
1.927(b)-1T Added (temporary) 6464
1.927(d)-1 Added 6473
1.927(d)-1T Removed 6469
1.927(d)-2T Added (temporary) 6465
1.927(e)-1T Added (temporary) 6465
1.927(e)-2T Added (temporary) 6465
1.927(f)-1 Added 6475
1.927(f)-1T Removed 6469
26 CFR 602.101 1988
26 CFR
53 FR
Page
Chapter I
1.936-6 Intercompany pricing rules study 43522
1.954-0T Added 27491
1.954-1 Redesignated as 1.954A-1 27492
1.954-1T Added (temporary) 27492
1.954-2 Redesignated as 1.954A-2 27498
1.954-2T Added (temporary) 27498
(a)(3)(ii) Example (2) corrected 29801
1.954A-1 Redesignated from 1.954-1 27492
1.954A-2 Redesignated from 1.954-2 27498
1.956-1 (b)(4) removed 22171
1.956-1T Added (temporary) 22171
1.956-2 (d)(2) removed 22171
1.956-2T Added (temporary) 22171
1.956-3T Added (temporary) 22169
1.957-1 (a) removed 27510
1.957-1T Added (temporary) 27510
1.985-0T Added (temporary) 20311
1.985-1T Added (temporary) 20311
(c)(6) and (f) Example (11) corrected 23232
1.985-2T Added (temporary) 20314
1.985-3T Added (temporary) 20315
(c)(8) Example (1) and table and (d)(2) introductory text corrected;
(d)(6) heading correctly revised 23232
1.985-4T Added (temporary) 20319
1.985-5T Heading added (temporary) 20319
1.987-0T Added (temporary) 32385
Correctly designated 35953
1.987-1T Added (temporary) 32386
(a)(1) corrected 35467
(a)(2) corrected 35953
1.989(a)-0T Added (temporary) 20613
1.989(a)-1T Added (temporary) 20613
1.989(c)-0T Added (temporary) 20616
1.989(c)-1T Added (temporary) 20616
26 CFR 602.101 1989
26 CFR
54 FR
Page
Chapter I
1.911-1 -- 1.911-8 Undesignated center heading added 3021
1.912-2 Revised 28620
1.936-8T Added (temporary) 38973
1.936-9T Added (temporary) 38973
1.936-10T Added (temporary) 38973
1.985-0 Added 38653
1.985-0T -- 1.985-4T Removed 38653
1.985-1 Added 38653
1.985-2 Added 38656
1.985-3 Added 38658
1.985-4 Added 38661
1.985-5T Revised 38662
1.985-6T Added 38663
1.988-0T Added (temporary) 38823
1.988-1T Added (temporary) 38824
(a)(3) Example (11) corrected 41443
(a)(6)(ii) Example (1) corrected 41443
1.988-2T Added 38829
(d)(4)(ii) corrected 41443
1.988-3T Added 38841
1.988-4T Added 38842
1.988-5T Added 38843
(a)(5)(vi) corrected 41443
(b)(4)(vi) corrected 41443
1.989(b)-1T Added (temporary) 38664
26 CFR 602.101 1990
26 CFR
55 FR
Page
Chapter I
1.964-1T Added (temporary) 2516
(g)(6) Example (1)(iii) and (g)(6) Example (2)(iii) and (g)(6)
Example (3)(iii) corrected 7711
1.988-1T (a)(6)(ii) Example (1) corrected 3792
1.988-5T Corrected 3792
1.989(a)-0T Removed 284
1.989(a)-1 Added 284
1.989(a)-1T Removed 284
26 CFR 602.101 1991
26 CFR
56 FR
Page
Chapter I
1.926(a)-1 Added 11093
1.926(a)-1T (b)(1) revised 11093
1.936-10 Added 21927
1.936-10T Removed 21927
1.952-1 (a)(2) amended 2846
1.954A-1 (a), (b)(3)(i), (c), (e) introductory text, (f) introductory
text and (3) amended; (f)(4) added 2846
1.954-8 Added 2847
(c)(4) Example 4 corrected 11511
1.964-4 (d)(4) through (10) redesignated as (d)(5) through (11); new
(d)(4) added 2849
1.987-0T Removed 48434
1.987-1 Added 48434
1.987-1T Removed 48434
1.987-2 Added 48434
1.987-3 Added 48434
1.987-4 Added 48434
1.987-5 Added 48434
(g) corrected 65684
1.989(b)-1T Redesignated as 1.989(b)-1 48437
1.989(b)-1 Redesignated from 1.989(b)-1T; heading amended 48437
1.989(c)-0T Removed 48437
1.989(c)-1 Added 48437
1.989(c)-1T Removed 48437
1.992-1 (a)(6) and (i) removed; (d)(1) revised 55235
26 CFR 602.101 1992
26 CFR
57 FR
Page
Chapter I
1.988-0 Added 9177
1.988-0T Removed 9177
1.988-1 Added 9178
1.988-1T Removed 9177
1.988-2 Added 9183
1.988-2T Removed 9177
1.988-3 Added 9197
1.988-3T Removed 9177
1.988-4 Added 9199
1.988-4T Removed 9177
1.988-5 Added 9199
1.988-5T Removed 9177
1.989(b)-1 Correctly redesignated from 1.989(b)-1T 6060
1.989(b)-1T Correctly redesignated as 1.989(b)-1 6060
26
Internal Revenue
PART 1 ( 1.908 to 1.1000)
Revised as of April 1, 1992
CONTAINING
A CODIFICATION OF DOCUMENTS
OF GENERAL APPLICABILITY
AND FUTURE EFFECT
AS OF APRIL 1, 1992
With Ancillaries
Published by
the Office of the Federal Register
National Archives and Records
Administration
as a Special Edition of
the Federal Register
Washington, DC 20402-9328
26 CFR 602.101 Table of Contents
Page
Explanation v
Title 26:
Chapter I -- Internal Revenue Service, Department of the Treasury
(Continued)
Finding Aids:
Table of CFR Titles and Chapters
Alphabetical List of Agencies Appearing in the CFR
Table of OMB Control Numbers
List of CFR Sections Affected
26 CFR 602.101 Explanation
The Code of Federal Regulations is a codification of the general and
permanent rules published in the Federal Register by the Executive
departments and agencies of the Federal Government. The Code is divided
into 50 titles which represent broad areas subject to Federal
regulation. Each title is divided into chapters which usually bear the
name of the issuing agency. Each chapter is further subdivided into
parts covering specific regulatory areas.
Each volume of the Code is revised at least once each calendar year
and issued on a quarterly basis approximately as follows:
Title 1 through Title 16 as of January 1
Title 17 through Title 27 as of April 1
Title 28 through Title 41 as of July 1
Title 42 through Title 50 as of October 1
The appropriate revision date is printed on the cover of each volume.
LEGAL STATUS
The contents of the Federal Register are required to be judicially
noticed (44 U.S.C. 1507). The Code of Federal Regulations is prima facie
evidence of the text of the original documents (44 U.S.C. 1510).
HOW TO USE THE CODE OF FEDERAL REGULATIONS
The Code of Federal Regulations is kept up to date by the individual
issues of the Federal Register. These two publications must be used
together to determine the latest version of any given rule.
To determine whether a Code volume has been amended since its
revision date (in this case, April 1, 1992), consult the ''List of CFR
Sections Affected (LSA),'' which is issued monthly, and the ''Cumulative
List of Parts Affected,'' which appears in the Reader Aids section of
the daily Federal Register. These two lists will identify the Federal
Register page number of the latest amendment of any given rule.
EFFECTIVE AND EXPIRATION DATES
Each volume of the Code contains amendments published in the Federal
Register since the last revision of that volume of the Code. Source
citations for the regulations are referred to by volume number and page
number of the Federal Register and date of publication. Publication
dates and effective dates are usually not the same and care must be
exercised by the user in determining the actual effective date. In
instances where the effective date is beyond the cut-off date for the
Code a note has been inserted to reflect the future effective date. In
those instances where a regulation published in the Federal Register
states a date certain for expiration, an appropriate note will be
inserted following the text.
OMB CONTROL NUMBERS
The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires Federal
agencies to display an OMB control number with their information
collection request. Many agencies have begun publishing numerous OMB
control numbers as amendments to existing regulations in the CFR. These
OMB numbers are placed as close as possible to the applicable
recordkeeping or reporting requirements.
OBSOLETE PROVISIONS
Provisions that become obsolete before the revision date stated on
the cover of each volume are not carried. Code users may find the text
of provisions in effect on a given date in the past by using the
appropriate numerical list of sections affected. For the period before
January 1, 1986, consult either the List of CFR Sections Affected,
1949-1963, 1964-1972, or 1973-1985, published in seven separate volumes.
For the period beginning January 1, 1986, a ''List of CFR Sections
Affected'' is published at the end of each CFR volume.
CFR INDEXES AND TABULAR GUIDES
A subject index to the Code of Federal Regulations is contained in a
separate volume, revised annually as of January 1, entitled CFR Index
and Finding Aids. This volume contains the Parallel Table of Statutory
Authorities and Agency Rules (Table I), and Acts Requiring Publication
in the Federal Register (Table II). A list of CFR titles, chapters, and
parts and an alphabetical list of agencies publishing in the CFR are
also included in this volume.
An index to the text of ''Title 3 -- The President'' is carried
within that volume.
The Federal Register Index is issued monthly in cumulative form.
This index is based on a consolidation of the ''Contents'' entries in
the daily Federal Register.
A List of CFR Sections Affected (LSA) is published monthly, keyed to
the revision dates of the 50 CFR titles.
REPUBLICATION OF MATERIAL
There are no restrictions on the republication of material appearing
in the Code of Federal Regulations.
INQUIRIES AND SALES
For a summary, legal interpretation, or other explanation of any
regulation in this volume, contact the issuing agency. Inquiries
concerning editing procedures and reference assistance with respect to
the Code of Federal Regulations may be addressed to the Director, Office
of the Federal Register, National Archives and Records Administration,
Washington, DC 20408 (telephone 202-523-3517). All mail order sales are
handled exclusively by the Superintendent of Documents, Attn: New
Orders, P.O. Box 371954, Pittsburgh, PA 15250-7954. Charge orders may
be telephoned to the Government Printing Office order desk at
202-783-3238.
Martha L. Girard,
Director,
Office of the Federal Register.
April 1, 1992.
26 CFR 602.101 THIS TITLE
Title 26 -- Internal Revenue is composed of eighteen volumes. The
contents of these volumes represent all current regulations issued by
the Internal Revenue Service, Department of the Treasury, as of April 1,
1991. The first eleven volumes comprise part 1 (Subchapter A -- Income
Tax) and are arranged by sections as follows: 1.0-1 -- 1.60;
1.61-1.169; 1.170-1.300; 1.301-1.400; 1.401-1.500;
1.501-1.640; 1.641-1.850; 1.851-1.907; 1.908-1.1000;
1.1001-1.1400 and 1.1401 to End. The twelfth volume containing parts
2-29, includes the remainder of subchapter A and all of Subchapter B --
Estate and Gift Taxes. The last six volumes contain parts 30-39
(Subchapter C -- Employment Taxes and Collection of Income Tax at
Source); parts 40-49; parts 50-299 (Subchapter D -- Miscellaneous
Excise Taxes); parts 300-499 (Subchapter F -- Procedure and
Administration); parts 500-599 (Subchapter G -- Regulations under Tax
Conventions); and part 600 to End (Subchapter H -- Internal Revenue
Practice).
The OMB control numbers for title 26 appear in 601.9000 and 602.101
of this chapter. For the convenience of the user, 601.9000 and
602.101 appear in the Finding Aids section of the volumes containing
parts 1 to 599.
For this volume, Rob Sheehan was Chief Editor. The Code of Federal
Regulations publication program is under the direction of Richard L.
Claypoole, assisted by Alomha S. Morris.
26 CFR 602.101 List of CFR Sections Affected
All changes to sections of part 1 ( 1.170 to 1.300) of title 26 of
the Code of Federal Regulations which were made by documents published
in the Federal Register since January 1, 1986, are enumerated in the
following list. Entries indicate the nature of the changes effected.
Page numbers refer to Federal Register pages. The user should consult
the entries for chapters and parts as well as sections for revisions.
For the period before January 1, 1986, see the ''List of CFR Sections
Affected, 1949-1963, 1964-1972, and 1973-1985'' published in seven
separate volumes.
26 CFR 602.101 1986
26 CFR
51 FR
Page
Chapter I
1.170A-7 (b)(1)(ii) and (c) amended; (b)(5) added; (e) revised 1498
1.170A-9 (c)(1) revised 31614
1.170A-14 Added 1499
(b)(2) and (f) Example 5 corrected 5322
(d)(4)(ii)(A) introductory text and (3), (g)(2) and (4)(ii)(A)(2),
and (h)(4) Examples (10) and (12) corrected 6219
1.172-1 (f) removed; (g) and (h) redesignated as (f) and (g); (e)
revised 43345
1.172-2 Revised 43345
1.172-3 (a) introductory text and (b) amended; (e) removed; (f)
redesignated as (e) 43345
1.172-4 (a)(1)(ii) amended; (a)(1)(x) added 30482
(a)(1) and (b) revised; (a)(5) removed; (a)(6), (7), and (8)
redesignated as (a)(5), (6), and (7); new (a)(7) amended 43345
1.172-5 (a)(1) and (b) removed; (a)(2), (3), (4), and (5)
redesignated as (a)(1), (2), (3), and (4); new (a)(3) and (4) amended
43346
1.172-7 (a) amended 43346
1.172-8 Removed; new 1.172-8 redesignated from 1.172-10; (a)
revised; (d) removed; (e) redesignated as (d) 43346
1.172-9 Removed; new 1.172-9 redesignated from 1.172-11 43346
(c)(2) and (d) removed; (c)(3), (e), and (f) redesignated as (c)(2),
(d), and (e); new (c)(2) introductory text, (ii), and flush text
following (iv), (d)(1) and (3) Example (1), and (e) amended 43346
1.172-10 Redesignated as 1.172-8; (a) revised; (d) removed; (e)
redesignated as (d) 43346
Redesignated from 1.172-12; (a)(2) and (c) redesignated as (a)(8)
and (d); new (a)(1) and (7) and (c) added; new (d) amended 43346
1.172-11 Redesignated as 1.172-9; (c)(2) and (d) removed; (c)(3),
(e), and (f) redesignated as (c)(2), (d), and (e); new (c)(2)
introductory text, (ii), and flush text following (iv), (d)(1) and (3)
Example (1), and (e) amended 43346
1.172-12 Redesignated as 1.172-10; (a)(2) and (c) redesignated as
(a)(8) and (d); new (a)(1) and (7) and (c) added; new (c) amended
43346
1.172-13 Added 30482
26 CFR 602.101 1987
26 CFR
52 FR
Page
1.174-2 (a)(1) amended 10084
1.179-1 Revised 410
1.179-2 Revised 412
1.179-3 Revised 413
1.179-4 Revised 414
1.179-5 Added 414
1.263(a)-1 (c) (4) and (5) redesignated as (c) (5) and (6); new
(c)(4) added 414
(b) amended 10084
1.263(a)-2 (b) amended 10084
1.263(a)-3 (b) (5) through (10) redesignated as (b) (6) through (11);
new (b)(5) added 414
1.263A-1T Added (temporary) 10060
(a)(5)(iii)(A), (b)(2)(iii)(I), (c)(4)(i)(C), (d)(3)(ii)(A)(1), (C)
(3), and (4) and (5), (e)(1), (3)(iii), (7)(iii) and (11)(iii) revised;
(b)(2)(vii), (5)(vii) and (6)(vi), (c)(5)(iii), (e)(7)(iv), (9)(ii)
Examples (4) and (5) and (11)(v) added (temporary) 29378
26 CFR 602.101 1988
26 CFR
53 FR
Page
Chapter I
1.170A-4 (c)(2) and (D) Examples (5) through (8) and (10) revised
5569
1.170A-13 (b)(1) and (3)(i)(B) revised; (c) added 16080
(c)(3)(iv)(B), (4)(iv)(A)(2) and (D), and (7)(v)(C) flush text
corrected 18372
1.170A-13T Removed 16079
1.170A-14 (i) amended 16085
1.191-1 (a), (b)(1)(i) and (3), and (c)(2)(iii) revised; (f) added
39603
1.191-2 (e)(8) revised 39604
1.191-3 (b)(4) revised 39604
1.274-3 (b)(2)(iii) flush text revised; (e)(2) amended; (d), (e),
and (f) redesignated as (e), (f), and (g); (b)(2)(iv) and new (d) added
36451
1.280C-3 Added 38715
1.280F-1T (b) table, (c) (1) and (3) amended (temporary) 29881
1.280F-5T (a), (d)(1) introductory text, (e)(1), (6)(i), (f)(1), (g)
introductory text, (h)(1), and (i) Examples (5) and (6) amended; (e)
heading and (f)(2) introductory text revised (temporary) 29881
1.280F-7T Added (temporary) 29881
(b)(3) Example corrected 32821
1.280H-0T Added (temporary) 19711
1.280H-1T Added (temporary) 19711
26 CFR 602.101 1989
26 CFR
54 FR
Page
Chapter I
1.218-0 Amended 21204
1.267(f)-1T (h) revised (temporary) 38823
(h)(2) corrected 41443
1.274-5T (g) amended 51027
26 CFR 602.101 1990
26 CFR
55 FR
Page
Chapter I
1.170A-1 (h)(5) and (i) revised; (h)(11) added 35587
1.216-1 (a) introductory text, (c)(1) and (d)(1) amended; (c)(2)
redesignated as (c)(3) and amended; new (c) (2), and (3) Examples 3, 4,
and 5 added; (d)(2) and (e) revised; (c) through (g) redesignated as
(d) through (h) 42004
1.216-2 (c) revised 42006
1.267(f)-3T Added (temporary) 49038
1.280C-4 Added 2376
(b)(2) introductory text corrected 4049
1.280F-7T (a)(2)(i), (ii), and (iv) introductory text revised;
(a)(2)(iv) table heading and (v) added (temporary) 13770
26 CFR 602.101 1991
26 CFR
56 FR
Page
Chapter I
1.267(f)-3 Redesignated from 1.267(f)-3T and revised 47389
1.267(f)-3T Redesignated from 1.267(f)-3 and revised 47389
26 CFR 602.101 1992
26 CFR
57 FR
Page
Chapter I
1.267(f)-1 Added; (h) redesignated from 1.267(f)-1T(h); (h)(2) and
(3) revised 9177
1.267(f)-1T (h) redesignated as 1.267(f)-1(h); (h)(2) and (3)
revised 9177
1.269-1 Introductory text amended 345
1.269-3 (a) amended; (d) and (e) added 345
1.269-5 Revised 346
1.269-6 Heading revised 346
1.269-7 Added 346
26
Internal Revenue
PART 1 ( 1.170 TO 1.300)
Revised as of April 1, 1992
CONTAINING
A CODIFICATION OF DOCUMENTS
OF GENERAL APPLICABILITY
AND FUTURE EFFECT
AS OF APRIL 1, 1992
With Ancillaries
Published by
the Office of the Federal Register
National Archives and Records
Administration
as a Special Edition of
the Federal Register
Washington, DC 20402-9328
26 CFR 602.101 Table of Contents
Page
Explanation v
Title 26:
Chapter I -- Internal Revenue Service, Department of the Treasury
(Continued) 3
Finding Aids:
Table of CFR Titles and Chapters
Alphabetical List of Agencies Appearing in the CFR
Table of OMB Control Numbers
List of CFR Sections Affected
26 CFR 602.101 Explanation
The Code of Federal Regulations is a codification of the general and
permanent rules published in the Federal Register by the Executive
departments and agencies of the Federal Government. The Code is divided
into 50 titles which represent broad areas subject to Federal
regulation. Each title is divided into chapters which usually bear the
name of the issuing agency. Each chapter is further subdivided into
parts covering specific regulatory areas.
Each volume of the Code is revised at least once each calendar year
and issued on a quarterly basis approximately as follows:
Title 1 through Title 16 as of January 1
Title 17 through Title 27 as of April 1
Title 28 through Title 41 as of July 1
Title 42 through Title 50 as of October 1
The appropriate revision date is printed on the cover of each volume.
LEGAL STATUS
The contents of the Federal Register are required to be judicially
noticed (44 U.S.C. 1507). The Code of Federal Regulations is prima facie
evidence of the text of the original documents (44 U.S.C. 1510).
HOW TO USE THE CODE OF FEDERAL REGULATIONS
The Code of Federal Regulations is kept up to date by the individual
issues of the Federal Register. These two publications must be used
together to determine the latest version of any given rule.
To determine whether a Code volume has been amended since its
revision date (in this case, April 1, 1992), consult the ''List of CFR
Sections Affected (LSA),'' which is issued monthly, and the ''Cumulative
List of Parts Affected,'' which appears in the Reader Aids section of
the daily Federal Register. These two lists will identify the Federal
Register page number of the latest amendment of any given rule.
EFFECTIVE AND EXPIRATION DATES
Each volume of the Code contains amendments published in the Federal
Register since the last revision of that volume of the Code. Source
citations for the regulations are referred to by volume number and page
number of the Federal Register and date of publication. Publication
dates and effective dates are usually not the same and care must be
exercised by the user in determining the actual effective date. In
instances where the effective date is beyond the cut-off date for the
Code a note has been inserted to reflect the future effective date. In
those instances where a regulation published in the Federal Register
states a date certain for expiration, an appropriate note will be
inserted following the text.
OMB CONTROL NUMBERS
The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires Federal
agencies to display an OMB control number with their information
collection request. Many agencies have begun publishing numerous OMB
control numbers as amendments to existing regulations in the CFR. These
OMB numbers are placed as close as possible to the applicable
recordkeeping or reporting requirements.
OBSOLETE PROVISIONS
Provisions that become obsolete before the revision date stated on
the cover of each volume are not carried. Code users may find the text
of provisions in effect on a given date in the past by using the
appropriate numerical list of sections affected. For the period before
January 1, 1986, consult either the List of CFR Sections Affected,
1949-1963, 1964-1972, or 1973-1985, published in seven separate volumes.
For the period beginning January 1, 1986, a ''List of CFR Sections
Affected'' is published at the end of each CFR volume.
CFR INDEXES AND TABULAR GUIDES
A subject index to the Code of Federal Regulations is contained in a
separate volume, revised annually as of January 1, entitled CFR Index
and Finding Aids. This volume contains the Parallel Table of Statutory
Authorities and Agency Rules (Table I), and Acts Requiring Publication
in the Federal Register (Table II). A list of CFR titles, chapters, and
parts and an alphabetical list of agencies publishing in the CFR are
also included in this volume.
An index to the text of ''Title 3 -- The President'' is carried
within that volume.
The Federal Register Index is issued monthly in cumulative form.
This index is based on a consolidation of the ''Contents'' entries in
the daily Federal Register.
A List of CFR Sections Affected (LSA) is published monthly, keyed to
the revision dates of the 50 CFR titles.
REPUBLICATION OF MATERIAL
There are no restrictions on the republication of material appearing
in the Code of Federal Regulations.
INQUIRIES AND SALES
For a summary, legal interpretation, or other explanation of any
regulation in this volume, contact the issuing agency. Inquiries
concerning editing procedures and reference assistance with respect to
the Code of Federal Regulations may be addressed to the Director, Office
of the Federal Register, National Archives and Records Administration,
Washington, DC 20408 (telephone 202-523-3517). All mail order sales are
handled exclusively by the Superintendent of Documents, Attn: New
Orders, P.O. Box 371954, Pittsburgh, PA 15250-7954. Charge orders may
be telephoned to the Government Printing Office order desk at
202-783-3238.
Martha L. Girard,
Director,
Office of the Federal Register.
April 1, 1992.
26 CFR 602.101 THIS TITLE
Title 26 -- Internal Revenue is composed of eighteen volumes. The
contents of these volumes represent all current regulations issued by
the Internal Revenue Service, Department of the Treasury, as of April 1,
1992. The first eleven volumes comprise part 1 (Subchapter A -- Income
Tax) and are arranged by sections as follows: 1.0-1 -- 1.60;
1.61-1.169; 1.170-1.300; 1.301-1.400; 1.401-1.500;
1.501-1.640; 1.641-1.850; 1.851-1.907; 1.908-1.1000;
1.1001-1.1400 and 1.1401 to End. The twelfth volume containing parts
2-29, includes the remainder of subchapter A and all of Subchapter B --
Estate and Gift Taxes. The last six volumes contain parts 30-39
(Subchapter C -- Employment Taxes and Collection of Income Tax at
Source); Parts 40-49; Parts 50-299 (Subchapter D -- Miscellaneous
Excise Taxes); parts 300-499 (Subchapter F -- Procedure and
Administration); parts 500-599 (Subchapter G -- Regulations under Tax
Conventions); and part 600 to End (Subchapter H -- Internal Revenue
Practice).
The OMB control numbers for title 26 appear in 601.9000 and 602.101
of this chapter. For the convenience of the user, 601.9000 and
602.101 appear in the Finding Aids section of the volumes containing
parts 1 to 599.
For this volume, Ms. S. Meyer was Chief Editor. The Code of Federal
Regulations publication program is under the direction of Richard L.
Claypoole, assisted by Alomha S. Morris.
26 CFR 0.0 26 CFR Ch. I (4-1-92 Edition)
26 CFR 0.0 Internal Revenue Service, Treasury
26 CFR 0.0 Title 26 -- Internal Revenue
26 CFR 0.0 (This book contains part 1, 1.301 to 1.400)
Part
chapter i -- Internal Revenue Service, Department of the Treasury
(Continued) 1
26 CFR 0.0 26 CFR Ch. I (4-1-92 Edition)
26 CFR 0.0 Internal Revenue Service, Treasury
26 CFR 0.0 CHAPTER I -- INTERNAL REVENUE SERVICE,
26 CFR 0.0 DEPARTMENT OF THE TREASURY
26 CFR 0.0 (Continued)
Editorial Note: IRS published a document at 45 FR 6088, Jan. 25,
1980, deleting statutory sections from their regulations. In Chapter I
cross references to the deleted material have been changed to the
corresponding sections of the IRS Code of 1954 or to the appropriate
regulations sections. When either such change produced a redundancy,
the cross reference has been deleted. For further explanation, see 45
FR 20795, March 31, 1980.
26 CFR 0.0 SUBCHAPTER A -- INCOME TAX
Part
Page
1 Income tax; taxable years beginning after December 31, 1953
(Continued) 4
Supplementary Publication: Internal Revenue Service Looseleaf
Regulations System.
Additional supplementary publications are issued covering Alcohol and
Tobacco Tax Regulations, and Regulations Under Tax Conventions.
26 CFR 0.0 SUBCHAPTER A -- INCOME TAX (Continued)
26 CFR 0.0 PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953 (Continued)
26 CFR 0.0 Normal Taxes and Surtaxes (Continued)
26 CFR 0.0 Pt. 1
Sec.
1.301-1 Rules applicable with respect to distributions of money and
other property.
1.302-1 General.
1.302-2 Redemptions not taxable as dividends.
1.302-3 Substantially disproportionate redemption.
1.302-4 Termination of shareholder's interest.
1.303-1 General.
1.303-2 Requirements.
1.303-3 Application of other sections.
1.304-1 General.
1.304-2 Acquisition by related corporation (other than subsidiary).
1.304-3 Acquisition by a subsidiary.
1.304-4T Special rule for use of a related corporation to acquire for
property the stock of another commonly owned corporation (temporary).
1.305-1 Stock dividends.
1.305-2 Distributions in lieu of money.
1.305-3 Disproportionate distributions.
1.305-4 Distributions of common and preferred stock.
1.305-5 Distributions on preferred stock.
1.305-6 Distributions of convertible preferred.
1.305-7 Certain transactions treated as distributions.
1.305-8 Effective dates.
1.306-1 General
1.306-2 Exception
1.306-3 Section 306 stock defined.
1.307-1 General.
1.307-2 Exception.
1.311-1 General.
1.311-2 Appreciated property used to redeem stock.
1.312-1 Adjustment to earnings and profits reflecting distributions
by corporations.
1.312-2 Distribution of inventory assets.
1.312-3 Liabilities.
1.312-4 Examples of adjustments provided in section 312(c).
1.312-5 Special rule for partial liquidations and certain
redemptions.
1.312-6 Earnings and profits.
1.312-7 Effect on earnings and profits of gain or loss realized after
February 28, 1913.
1.312-8 Effect on earnings and profits of receipt of tax-free
distributions requiring adjustment or allocation of basis of stock.
1.312-9 Adjustments to earnings and profits reflecting increase in
value accrued before March 1, 1913.
1.312-10 Allocation of earnings in certain corporate separations.
1.312-11 Effect on earnings and profits of certain other tax-free
exchanges, tax-free distributions, and tax-free transfers from one
corporation to another.
1.312-12 Distributions of proceeds of loans guaranteed by the United
States.
1.312-15 Effect of depreciation on earnings and profits.
1.316-1 Dividends.
1.316-2 Sources of distribution in general.
1.317-1 Property defined.
1.318-1 Constructive ownership of stock; introduction.
1.318-2 Application of general rules.
1.318-3 Estates, trusts, and options.
1.318-4 Constructive ownership as actual ownership; exceptions.
1.331-1 Corporate liquidations.
1.332-1 Distributions in liquidation of subsidiary corporation;
general.
1.332-2 Requirements for nonrecognition of gain or loss.
1.332-3 Liquidations completed within one taxable year.
1.332-4 Liquidations covering more than one taxable year.
1.332-5 Distributions in liquidation as affecting minority interests.
1.332-6 Records to be kept and information to be filed with return.
1.332-7 Indebtedness of subsidiary to parent.
1.333-1 Corporate liquidations in some one calendar month.
1.333-2 Qualified electing shareholder.
1.333-3 Making and filing of written elections.
1.333-4 Treatment of gain.
1.333-5 Special rule for treatment of gain.
1.333-6 Records to be kept and information to be filed with return.
1.334-1 Basis of property received in liquidations.
1.334-2 Property received in liquidation under section 333.
1.336-1 General rule on liquidation of corporation.
1.337-1 General.
1.337-2 Sales or exchanges within the scope of section 337.
1.337-3 Property defined.
1.337-4 Limitation of gain.
1.337-5 Special rule for certain minority shareholders.
1.337-6 Information to be filed.
1.337(d)-1 Transitional loss limitation rule.
1.337(d)-1T (Reserved)
1.337(d)-2 Loss limitation window period.
1.338-1T Elections under section 338(g) of the Internal Revenue Code
of 1954 (temporary).
1.338-2T Transitional rule elections (temporary).
1.338-3T Miscellaneous rules under section 224 of TEFRA (temporary).
1.338-4T Questions and answers relating to miscellaneous issues under
section 338 (temporary).
1.338-5T International aspects of section 338 (Temporary).
1.338-6T Treatment of gain or loss on deemed sale of affected target
stock (temporary).
1.338(b)-1T Adjusted grossed-up basis (temporary).
1.338(b)-2T Allocation of adjusted grossed-up basis among target
assets (temporary).
1.338(b)-3T Subsequent adjustments to adjusted grossed-up basis
(temporary).
1.338(b)-4T Transitional allocation election under section 338
(temporary).
1.338(h)(10)-1T Elective recognition by selling consolidated group of
deemed sale gain or loss on target's assets (temporary).
Companies
1.341-1 Collapsible corporations; in general.
1.341-2 Definitions.
1.341-3 Presumptions.
1.341-4 Limitations on application of section.
1.341-5 Application of section.
1.341-6 Exceptions to application of section.
1.341-7 Certain sales of stock of consenting corporations.
1.342-1 General.
1.346-1 Partial liquidation.
1.346-2 Treatment of certain redemptions.
1.346-3 Effect of certain sales.
1.351-1 Transfer to corporation controlled by transferor.
1.351-2 Receipt of property.
1.351-3 Records to be kept and information to be filed.
1.354-1 Exchanges of stock and securities in certain reorganizations.
1.355-0 Inorder to facilitate the use of 1.355-1 through 1.355-6,
this section lists the paragraphs, subparagraphs, and subdivisions in
those sections.
1.355-1 Distribution of stock and securities of controlled
corporation.
1.355-2 Limitations.
1.355-3 Active conduct of a trade or business.
1.355-4 Non pro rata distributions, etc.
1.355-5 Records to be kept and information to be filed.
1.355-6 Certain distributions qualifying under section 355 made
ineligible for norecognition of gain to the distributing corporation
under 337(d). (Reserved)
1.356-1 Receipt of additional consideration in connection with an
exchange.
1.356-2 Receipt of additional consideration not in connection with an
exchange.
1.356-3 Rules for treatment of securities as ''other property''.
1.356-4 Exchanges for section 306 stock.
1.356-5 Transactions involving gift or compensation.
1.357-1 Assumption of liability.
1.357-2 Liabilities in excess of basis.
1.358-1 Basis to distributees.
1.358-2 Allocation of basis among nonrecognition property.
1.358-3 Treatment of assumption of liabilities.
1.358-4 Exceptions.
1.358-5 Certain exchanges involving ConRail.
1.361-1 Nonrecognition of gain or loss to corporations.
1.362-1 Basis to corporations.
1.362-2 Certain contributions to capital.
1.367(a)-1T Transfers to foreign corporations subject to section
367(a): In general (temporary).
1.367(a)-2T Exception for transfers of property for use in the active
conduct of a trade or business (temporary).
1.367(a)-3T Treatment of transfers of stock or securities for foreign
corporations (temporary).
1.367(a)-4T Special rules applicable to specified transfers of
property (temporary).
1.367(a)-5T Property subject to section 367(a)(1) regardless of use
in trade or business (temporary).
1.367(a)-6T Transfer of foreign branch with previously deducted
losses (temporary).
1.367(a)-7T Temporary regulations providing a transitional rule for
certain transfers of intangibles.
1.367(b)-2 Definitions.
1.367(b)-7 Exchange of stock described in section 354.
1.367(b)-8 Transfer of assets by a foreign corporation in an exchange
described in section 351.
1.367(b)-9 Attribution of earnings and profits on an exchange
described in section 351, 354, or 356.
1.367(d)-1T Transfers of intangible property to foreign corporations
(temporary).
1.367(e)-0T Treatment of distributions or liquidations under section
367(e); table of contents (temporary).
1.367(e)-1T Distributions described in section 367(e)(1) (temporary).
1.367(e)-2T Distributions described in section 367(e)(2) (temporary).
1.368-1 Purpose and scope of exception of reorganization exchanges.
1.368-2 Definition of terms.
1.368-3 Records to be kept and information to be filed with returns.
1.371-1 Exchanges by corporations.
1.371-2 Exchanges by security holders.
1.372-1 Corporations.
1.374-1 Exchanges by insolvent railroad corporations.
1.374-2 Basis of property acquired after December 31, 1938, by
railroad corporation in a receivership or railroad reorganization
proceeding.
1.374-3 Records to be kept and information to be filed.
1.374-4 Property acquired by electric railway corporation in
corporate reorganization proceeding.
1.381(a)-1 General rule relating to carryovers in certain corporate
acquisitions.
1.381(b)-1 Operating rules applicable to carryovers in certain
corporate acquisitions.
1.381(c)(1)-1 Net operating loss carryovers in certain corporate
acquisitions.
1.381(c)(1)-2 Net operating loss carryovers; two or more dates of
distribution or transfer in the taxable year.
1.381(c)(2)-1 Earnings and profits.
1.381(c)(3)-1 Capital loss carryovers.
1.381(c)(4)-1 Method of accounting.
1.381(c)(5)-1 Inventories.
1.381(c)(6)-1 Depreciation method.
1.381(c)(8)-1 Installment method.
1.381(c)(9)-1 Amortization of bond discount or premium.
1.381(c)(10)-1 Deferred exploration and development expenditures.
1.381(c)(11)-1 Contributions to pension plan, employees' annuity
plans, and stock bonus and profit-sharing plans.
1.381(c)(12)-1 Recovery of bad debts, prior taxes, or delinquency
amounts.
1.381(c)(13)-1 Involuntary conversions.
1.381(c)(14)-1 Dividend carryover to personal holding company.
1.381(c)(15)-1 Indebtedness of certain personal holding companies.
1.381(c)(16)-1 Obligations of distributor or transferor corporation.
1.381(c)(17)-1 Deficiency dividend of personal holding company.
1.381(c)(18)-1 Depletion on extraction of ores or minerals from the
waste or residue of prior mining.
1.381(c)(19)-1 Charitable contribution carryovers in certain
acquisitions.
1.381(c)(21)-1 Pre-1954 adjustments resulting from change in method
of accounting.
1.381(c)(22)-1 Successor life insurance company.
1.381(c)(23)-1 Investment credit carryovers in certain corporate
acquisitions.
1.381(c)(24)-1 Work incentive program credit carryovers in certain
corporate acquisitions.
1.381(c)(25)-1 Deficiency dividend of a qualified investment entity.
1.381(c)(26)-1 Credit for employment of certain new employees.
1.381(d)-1 Operations loss carryovers of life insurance companies.
1.382-0 Effective date.
1.382-1 Limitations on the use of certain tax attributes following an
ownership change. (Reserved)
1.382-1T Limitation on net operating loss carryforwards and certain
built-in losses following ownership change (temporary).
1.382-2 Definition of ownership change under section 382 as amended
by the Tax Reform Act of 1986.
1.382-2T Definition of ownership change under section 382, as amended
by the Tax Reform Act of 1986 (temporary).
1.382-3 Special rules under section 382 for corporations under the
jurisdiction of a court in a title 11 or similar case.
1.382-1A Purchase of a corporation and change in its trade or
business (Pre-Tax Reform Act of 1986).
1.382-2A Change of ownership as the result of a reorganization
(Pre-Tax Reform Act of 1986).
1.382-3A Definition of stock (Pre-Tax Reform Act of 1986).
1.382-4A Election of application of sections 382 and 383, as amended
by the Tax Reform Act of 1976 (Pre-Tax Reform Act of 1986).
1.383-0 Effective date.
1.383-1 Special limitations on certain capital losses and excess
credits.
1.383-2 Limitations on certain capital losses and excess credits in
computing alternative minimum tax. (Reserved)
1.383-1A Special limitations on carryovers of unused investment
credits, work incentive program credits, foreign taxes, and capital
losses (Pre-Tax Reform Act of 1986).
1.383-2A Purchase of a corporation and change in its trade or
business (Pre-Tax Reform Act of 1986).
1.383-3A Change in ownership as the result of a reorganization
(Pre-Tax Reform Act of 1986).
Authority: Sec. 7805, 68A Stat. 917; 26 U.S.C. 7805, unless
otherwise noted.
Section 1.337(d)-1 also issued under 26 U.S.C. 337(d).
Section 1.337(d)-2 also issued under 26 U.S.C. 337(d).
Section 1.338(b)-3T also issued under 26 U.S.C. 338.
Section 1.338-6T also issued under 26 U.S.C. 338.
Section 1.367 (b)-2 also issued under 26 U.S.C. 367(b).
Section 1.367 (b)-7 also issued under 26 U.S.C. 367(b).
Section 1.367 (b)-8 also issued under 26 U.S.C. 367(b).
Section 1.367 (b)-9 also issued under 26 U.S.C. 367(b).
Section 1.382-2 also issued under 26 U.S.C. 382(k)(1) and 26 U.S.C.
382(m).
Section 1.382-3 also issued under 26 U.S.C. 382(m).
Section 1.382-2T also issued under 26 U.S.C. 382(g)(4)(C), 26 U.S.C.
382(i), 26 U.S.C. 382(k)(1), 26 U.S.C. 382(k)(6), 26 U.S.C. 382(1)(3),
26 U.S.C. 382(m), and 26 U.S.C. 383.
Section 1.383-1 also issued under 26 U.S.C. 383.
Section 1.383-2 also issued under 26 U.S.C. 383.
Section 1.383-2 also issued under 26 U.S.C. 383.
Source: T.D. 6500, 25 FR 11607, Nov. 26, 1960; 25 FR 14021, Dec.
31, 1960, unless otherwise noted.
26 CFR 0.0 26 CFR Ch. I (4-1-92 Edition)
26 CFR 0.0 Internal Revenue Service, Treasury
26 CFR 0.0 CORPORATE DISTRIBUTIONS AND ADJUSTMENTS
26 CFR 0.0 Distributions by Corporations
26 CFR 0.0 effects on recipients
26 CFR 1.301-1 Rules applicable with respect to distributions of money
and other property.
(a) General. Section 301 provides the general rule for treatment of
distributions on or after June 22, 1954, of property by a corporation to
a shareholder with respect to its stock. The term ''property'' is
defined in section 317(a). Such distributions, except as otherwise
provided in this chapter, shall be treated as provided in section
301(c). Under section 301(c), distributions may be included in gross
income, applied against and reduce the adjusted basis of the stock,
treated as gain from the sale or exchange of property, or (in the case
of certain distributions out of increase in value accrued before March
1, 1913) may be exempt from tax. The amount of the distributions to
which section 301 applies is determined in accordance with the
provisions of section 301(b). The basis of property received in a
distribution to which section 301 applies is determined in accordance
with the provisions of section 301(d). Accordingly, except as otherwise
provided in this chapter, a distribution on or after June 22, 1954, of
property by a corporation to a shareholder with respect to its stock
shall be included in gross income to the extent the amount distributed
is considered a dividend under section 316. For examples of
distributions treated otherwise, see sections 116, 301(c)(2),
301(c)(3)(B), 301(e), 302(b), 303, and 305. See also part II (relating
to distributions in partial or complete liquidation), part III (relating
to corporate organizations and reorganizations), and part IV (relating
to insolvency reorganizations), subchapter C, chapter 1 of the Code.
(b) Time of inclusion in gross income and of determination of fair
market value. A distribution made by a corporation to its shareholders
shall be included in the gross income of the distributees when the cash
or other property is unqualifiedly made subject to their demands.
However, if such distribution is a distribution other than in cash, the
fair market value of the property shall be determined as of the date of
distribution without regard to whether such date is the same as that on
which the distribution is includible in gross income. For example, if a
corporation distributes a taxable dividend in property (the adjusted
basis of which exceeds its fair market value on December 31, 1955) on
December 31, 1955, which is received by, or unqualifiedly made subject
to the demand of, its shareholders on January 2, 1956, the amount to be
included in the gross income of the shareholders will be the fair market
value of such property on December 31, 1955, although such amount will
not be includible in the gross income of the shareholders until January
2, 1956.
(c) Application of section to shareholders. Section 301 is not
applicable to an amount paid by a corporation to a shareholder unless
the amount is paid to the shareholder in his capacity as such.
(d) Distributions to corporate shareholders. (1) If the shareholder
is a corporation, the amount of any distribution to be taken into
account under section 301(c) shall be:
(i) The amount of money distributed,
(ii) An amount equal to the fair market value of any property
distributed which consists of any obligations of the distributing
corporation, stock of the distributing corporation treated as property
under section 305(b), or rights to acquire such stock treated as
property under section 305(b), plus
(iii) In the case of a distribution not described in subdivision (iv)
of this subparagraph, an amount equal to (a) the fair market value of
any other property distributed or, if lesser, (b) the adjusted basis of
such other property in the hands of the distributing corporation
(determined immediately before the distribution and increased for any
gain recognized to the distributing corporation under section 311 (b),
(c), or (d), or under section 341(f), 617(d), 1245(a), 1250(a), 1251(c),
or 1252(a)), or
(iv) In the case of a distribution made after November 8, 1971, to a
shareholder which is a foreign corporation, an amount equal to the fair
market value of any other property distributed, but only if the
distribution received by such shareholder is not effectively connected
for the taxable year with the conduct of a trade or business in the
United States by such shareholder.
(2) In the case of a distribution the amount of which is determined
by reference to the adjusted basis described in subparagraph (1)(iii)(b)
of this paragraph:
(i) That portion of the distribution which is a dividend under
section 301(c)(1) may not exceed such adjusted basis, or
(ii) If the distribution is not out of earnings and profits, the
amount of the reduction in basis of the shareholder's stock, and the
amount of any gain resulting from such distribution, are to be
determined by reference to such adjusted basis of the property which is
distributed.
(3) Notwithstanding paragraph (d)(1)(iii), if a distribution of
property described in such paragraph is made after December 31, 1962, by
a foreign corporation to a shareholder which is a corporation, the
amount of the distribution to be taken into account under section 301(c)
shall be determined under section 301(b)(1)(C) and paragraph (n) of this
section.
(e) Adjusted basis. In determining the adjusted basis of property
distributed in the hands of the distributing corporation immediately
before the distribution for purposes of section 301(b)(1)(B)(ii),
(b)(1)(C)(i), and (d)(2)(B), the basis to be used shall be the basis for
determining gain upon a sale or exchange.
(f) Examples. The application of this section (except paragraph (n))
may be illustrated by the following examples:
Example (1). On January 1, 1955, A, an individual owned all of the
stock of Corporation M with an adjusted basis of $2,000. During 1955, A
received distributions from Corporation M totaling $30,000, consisting
of $10,000 in cash and listed securities having a basis in the hands of
Corporation M and a fair market value on the date distributed of
$20,000. Corporation M's taxable year is the calendar year. As of
December 31, 1954, Corporation M had earnings and profits accumulated
after February 28, 1913, in the amount of $26,000, and it had no
earnings and profits and no deficit for 1955. Of the $30,000 received
by A, $26,000 will be treated as an ordinary dividend; the remaining
$4,000 will be applied against the adjusted basis of his stock; the
$2,000 in excess of the adjusted basis of his stock will either be
treated as gain from the sale or exchange of property (under section
301(c)(3)(A)) or, if out of increase in value accrued before March 1,
1913, will (under section 301(c)(3)(B)) be exempt from tax. If A
subsequently sells his stock in Corporation M, the basis for determining
gain or loss on the sale will be zero.
Example (2). The facts are the same as in Example 1 with the
exceptions that the shareholder of Corporation M is Corporation W and
that the securities which were distributed had an adjusted basis to
Corporation M of $15,000. The distribution received by Corporation W
totals $25,000 consisting of $10,000 in cash and securities with an
adjusted basis of $15,000. The total $25,000 will be treated as a
dividend to Corporation W since the earnings and profits of Corporation
M ($26,000) are in excess of the amount of the distribution.
Example (3). Corporation X owns timber land which it acquired prior
to March 1, 1913, at a cost of $50,000 with $5,000 allocated as the
separate cost of the land. On March 1, 1913, this property had a fair
market value of $150,000 of which $135,000 was attributable to the
timber and $15,000 to the land. All of the timber was cut prior to 1955
and the full appreciation in the value thereof, $90,000
($135,000^$45,000), realized through depletion allowances based on March
1, 1913, value. None of this surplus from realized appreciation had
been distributed. In 1955, Corporation X sold the land for $20,000
thereby realizing a gain of $15,000. Of this gain, $10,000 is due to
realized appreciation in value which accrued before March 1, 1913
($15,000^$5,000). Of the gain of $15,000, $5,000 is taxable.
Therefore, at December 31, 1955, Corporation X had a surplus from
realized appreciation in the amount of $100,000. It had no accumulated
earnings and profits and no deficit at January 1, 1955. The net
earnings for 1955 (including the $5,000 gain on the sale of the land)
were $20,000. During 1955, Corporation X distributed $75,000 to its
stockholders. Of this amount, $20,000 will be treated as a dividend.
The remaining $55,000, which is a distribution of realized appreciation,
will be applied against and reduce the adjusted basis of the
shareholders' stock. If any part of the $55,000 is in excess of the
adjusted basis of a shareholder's stock, such part will be exempt from
tax.
(g) Reduction for liabilities. For the purpose of section 301(a),
the amount of any distribution shall be reduced by --
(1) The amount of any liability of the corporation assumed by the
shareholder in connection with the distribution, and
(2) The amount of any liability to which the property received by the
shareholder is subject immediately before and immediately after the
distribution.
Such reduction, however, shall not cause the amount of the
distribution to be reduced below zero.
(h) Basis. The basis of property received in the distribution to
which section 301 applies shall be --
(1) If the shareholder is not a corporation, the fair market value of
such property;
(2) If the shareholder is a corporation --
(i) In the case of a distribution of the obligations of the
distributing corporation or of the stock of such corporation or rights
to acquire such stock (if such stock or rights are treated as property
under section 305(b)), the fair market value of such obligations, stock,
or rights;
(ii) In the case of the distribution of any other property, except as
provided in subdivision (iii) (relating to certain distributions by a
foreign corporation) or subdivision (iv) (relating to certain
distributions to foreign corporate distributees) of this subparagraph,
whichever of the following is the lesser --
(a) The fair market value of such property; or
(b) The adjusted basis (in the hands of the distributing corporation
immediately before the distribution) of such property increased in the
amount of gain to the distributing corporation which is recognized under
section 311(b) (relating to distributions of LIFO inventory), section
311(c) (relating to distributions of property subject to liabilities in
excess of basis), section 311(d) (relating to appreciated proterty used
to redeem stock), section 341(f) (relating to certain sales of stock of
consenting corporations), section 617(d) (relating to gain from
dispositions of certain mining property), section 1245(a) or 1250(a)
(relating to gain from dispositions of certain depreciable property),
section 1251(c) (relating to gain from disposition of farm recapture
property), or section 1252(a) (relating to gain from disposition of farm
land);
(iii) In the case of the distribution by a foreign corporation of any
other property after December 31, 1962, in a distribution not described
in subdivision (iv) of this subparagraph, the amount determined under
paragraph (n) of this section;
(iv) In the case of the distribution of any other property made after
November 8, 1971, to a shareholder which is a foreign corporation, the
fair market value of such property, but only if the distribution
received by such shareholder is not effectively connected for the
taxable year with the conduct of a trade or business in the United
States by such shareholder.
(i) (Reserved)
(j) Transfers for less than fair market value. If property is
transferred by a corporation to a shareholder which is not a corporation
for an amount less than its fair market value in a sale or exchange,
such shareholder shall be treated as having received a distribution to
which section 301 applies. In such case, the amount of the distribution
shall be the difference between the amount paid for the property and its
fair market value. If property is transferred in a sale or exchange by
a corporation to a shareholder which is a corporation, for an amount
less than its fair market value and also less than its adjusted basis,
such shareholder shall be treated as having received a distribution to
which section 301 applies, and --
(1) Where the fair market value of the property equals or exceeds its
adjusted basis in the hands of the distributing corporation the amount
of the distribution shall be the excess of the adjusted basis (increased
by the amount of gain recognized under section 311 (b), (c), or (d), or
under section 341(f), 617(d), 1245(a), 1250(a), 1251(c), or 1252(a) to
the distributing corporation) over the amount paid for the property;
(2) Where the fair market value of the property is less than its
adjusted basis in the hands of the distributing corporation, the amount
of the distribution shall be the excess of such fair market value over
the amount paid for the property. If property is transferred in a sale
or exchange after December 31, 1962, by a foreign corporation to a
shareholder which is a corporation for an amount less than the amount
which would have been computed under paragraph (n) of this section if
such property had been received in a distribution to which section 301
applied, such shareholder shall be treated as having received a
distribution to which section 301 applies, and the amount of the
distribution shall be the excess of the amount which would have been
computed under paragraph (n) of this section with respect to such
property over the amount paid for the property. In all cases, the
earnings and profits of the distributing corporation shall be decreased
by the excess of the basis of the property in the hands of the
distributing corporation over the amount received therefor. In
computing gain or loss from the subsequent sale of such property, its
basis shall be the amount paid for the property increased by the amount
of the distribution.
If property is transferred in a sale or exchange after December 31,
1962, by a foreign corporation to a shareholder which is a corporation
for an amount less than the amount which would have been computed under
paragraph (n) of this section if such property had been received in a
distribution to which section 301 applied, such shareholder shall be
treated as having received a distribution to which section 301 applies,
and the amount of the distribution shall be the excess of the amount
which would have been computed under paragraph (n) of this section with
respect to such property over the amount paid for the property.
Notwithstanding the preceding provisions of this paragraph, if property
is transferred in a sale or exchange after November 8, 1971, by a
corporation to a shareholder which is a foreign corporation, for an
amount less than its fair market value, and if paragraph (d)(1)(iv) of
this section would apply if such property were received in a
distribution to which section 301 applies, such shareholder shall be
treated as having received a distribution to which section 301 applies
and the amount of the distribution shall be the difference between the
amount paid for the property and its fair market value. In all cases,
the earnings and profits of the distributing corporation shall be
decreased by the excess of the basis of the property in the hands of the
distributing corporation over the amount received therefor. In
computing gain or loss from the subsequent sale of such property, its
basis shall be the amount paid for the property increased by the amount
of the distribution.
(k) Application of rule respecting transfers for less than fair
market value. The application of paragraph (j) of this section may be
illustrated by the following examples:
Example (1). On January 1, 1955, A, an individual shareholder of
corporation X, purchased property from that corporation for $20. The
fair market value of such property was $100, and its basis in the hands
of corporation X was $25. The amount of the distribution determined
under section 301(b) is $80. If A were a corporation, the amount of the
distribution would be $5 (assuming that sections 311 (b) and (c),
1245(a), and 1250(a) do not apply), the excess of the basis of the
property in the hands of corporation X over the amount received
therefor. The basis of such property to corporation A would be $25. If
the basis of the property in the hands of corporation X were $10, the
corporate shareholder, A, would not receive a distribution. The basis
of such property to corporation A would be $20. Whether or not A is a
corporation, the excess of the amount paid over the basis of the
property in the hands of corporation X ($20 over $10) would be a taxable
gain to corporation X.
Example (2). On January 1, 1963, corporation A, which is a
shareholder of corporation B (a foreign corporation engaged in business
within the United States), purchased one share of corporation X stock
from B for $20. The fair market value of the share was $100, and its
adjusted basis in the hands of B was $25. Assume that if the share of
corporation X stock had been received by A in a distribution to which
section 301 applied, the amount of the distribution under paragraph (n)
of this section would have been $55. The amount of the distribution
under section 301 is $35, i.e., $55 (amount computed under paragraph (n)
of this section) minus $20 (amount paid for the property). The basis of
such property to A is $55.
(l) Transactions treated as distributions. A distribution to
shareholders with respect to their stock is within the terms of section
301 although it takes place at the same time as another transaction if
the distribution is in substance a separate transaction whether or not
connected in a formal sense. This is most likely to occur in the case
of a recapitalization, a reincorporation, or a merger of a corporation
with a newly organized corporation having substantially no property.
For example, if a corporation having only common stock outstanding,
exchanges one share of newly issued common stock and one bond in the
principal amount of $10 for each share of outstanding common stock, the
distribution of the bonds will be a distribution of property (to the
extent of their fair market value) to which section 301 applies, even
though the exchange of common stock for common stock may be pursuant to
a plan of reorganization under the terms of section 368(a)(1)(E)
(recapitalization) and even though the exchange of common stock for
common stock may be tax free by virtue of section 354.
(m) Cancellation of indebtedness. The cancellation of indebtedness
of a shareholder by a corporation shall be treated as a distribution of
property.
(n) Distributions of certain property by foreign corporations to
corporate shareholders. (1) If a foreign corporation distributes
property (other than money, the obligations of the distributing
corporation, stock of the distributing corporation treated as property
under section 305(b), or rights to acquire such stock treated as
property under section 305(b)) after December 31, 1962, to a shareholder
which is a corporation in a distribution not described in paragraph
(d)(1)(iv) of this section, then, except as provided in subparagraph (2)
of this paragraph the fair market value of the property shall be taken
into account under section 301(c).
(2) If any deduction is allowable to the recipient under section 245
with respect to a distribution of property described in subparagraph (1)
of this paragraph and if the fair market value of the property exceeds
its adjusted basis in the hands of the distributing corporation
(increased by any gain to the distributing corporation recognized under
section 311 (b), (c), or (d), or under section 341(f), 617(d), 1245(a),
1250(a), 1251(c), or 1252(a)), then the amount taken into account under
section 301(c) shall be determined under subparagraph (3) of this
paragraph.
In order to determine such amount --
(i) First, compute the portion, if any, of the adjusted basis of the
property (increased by any gain to the distributing corporation
recognized under section 311 (b), (c), or (d), or under section 341(f),
617(d), 1245(a), 1250(a), 1251(c), or 1252(a)) which is out of earnings
and profits of the taxable year (within the meaning of section
316(a)(2)).
(ii) Second, compute the portion, if any, of the adjusted basis of
the property (increased by any gain to the distributing corporation
recognized under section 311 (b), (c), or (d), or under section 341(f),
617(d), 1245(a), 1250(a), 1251(c), or 1252(a)) which is out of earnings
and profits accumulated during the portion of the uninterrupted period
described in section 245(a) which ends at the beginning of the taxable
year.
(iii) Third, compute the portion, if any, of the adjusted basis of
the property (increased by any gain to the distributing corporation
recognized under section 311 (b), (c), or (d), or under section 341(f),
617(d), 1245(a), 1250(a), 1251(c), or 1252(a)) which is out of sources
other than earnings and profits of the taxable year and earnings and
profits accumulated during the uninterrupted period described in section
245(a).
(iv) Fourth, with respect to each of the portions computed under
subdivisions (i), (ii), and (iii) of this subparagraph, determine the
proportionate part of the fair market value of the property attributable
to such portion. The proportionate part of the fair market value
attributable to each portion shall be such fair market value multiplied
by the ratio which such portion bears to the sum of all portions.
(3) The amount taken into account under section 301(c) shall be the
sum of --
(i) The portion computed under subparagraph (2) (i) of this
paragraph, multiplied by the ratio which the gross income of the
distributing corporation for the taxable year which is effectively
connected for the taxable year with the conduct of a trade or business
in the United States by that corporation bears to its entire gross
income for such taxable year,
(ii) The portion computed under subparagraph (2)(ii) of this
paragraph, multiplied by the ratio which the gross income of the
distributing corporation which is effectively connected, for the portion
of the uninterrupted period described in section 245(a) which ends at
the beginning of the taxable year, with the conduct of a trade or
business in the United States by that corporation bears to its entire
gross income for such portion of such uninterrupted period,
(iii) The proportionate part of the fair market value of the property
attributable to the portion of the adjusted basis computed under
subparagraph (2)(i) of this paragraph, multiplied by the ratio which the
gross income of the distributing corporation for the taxable year which
is not effectively connected for the taxable year with the conduct of a
trade or business in the United States by that corporation bears to its
entire gross income for such taxable year,
(iv) The proportionate part of the fair market value of the property
attributable to the portion of the adjusted basis computed under
subparagraph (2)(ii) of this paragraph, multiplied by the ratio which
the gross income of the distributing corporation which is not
effectively connected, for the portion of the uninterrupted period
described in section 245(a) which ends at the beginning of the taxable
year, with the conduct of a trade or business in the United States by
that corporation bears to its entire gross income for such portion of
such uninterrupted period, and
(v) The proportionate part of the fair market value of the property
attributable to the portion of the adjusted basis computed under
subparagraph (2)(iii) of this paragraph.
For purposes of subdivisions (i) and (ii) of this subparagraph, the
gross income of the distributing corporation for any period before its
first taxable year beginning after December 31, 1966, which is from
sources within the United States shall be treated as gross income which
is effectively connected for that period with the conduct of a trade or
business in the United States by that corporation. For purposes of
subdivisions (iii) and (iv) of this subparagraph, the gross income of
the distributing corporation for any period before its first taxable
year beginning after December 31, 1966, which is from sources without
the United States shall be treated as gross income which is not
effectively connected for that period with the conduct of a trade or
business in the United States by that corporation. For the
determination of the source of income and the income which is
effectively connected with the conduct of a trade or business in the
United States, see sections 861 through 864, and the regulations
thereunder.
(4) See section 301(b)(2) and paragraph (g) of this section for
reduction in the amount of a distribution on account of certain
liabilities.
(5) The application of this paragraph may be illustrated by the
following examples:
Example (1). Corporation A (a foreign corporation filing its income
tax returns on a calendar year basis) whose stock is 100 percent owned
by corporation B (a domestic corporation filing its income tax returns
on a calendar year basis) for the first time engaged in trade or
business in the United States on January 1, 1966, and qualifies under
section 245(a) for the entire period beginning on that date and ending
on December 31, 1970. During the period January 1, 1966, through
December 31, 1969, 80 percent of corporation A's gross income is treated
as effectively connected for that period with the conduct of a trade or
business in the United States by that corporation, and for 1970, 90
percent of corporation A's gross income is treated as effectively
connected for that year with the conduct of a trade or business in the
United States by that corporation. As of December 31, 1969, A has
earnings and profits of $50,000 accumulated during the period January 1,
1966, through December 31, 1969, and for the year 1970 A has earnings
and profits of $10,000. On December 31, 1970, corporation A distributes
to corporation B 100 shares of stock in domestic corporation C which
have an adjusted basis of $40,000 in A's hands and a fair market value
of $100,000. Corporation A makes no other distribution during 1970.
Since a deduction is allowable to B under section 245(a) with respect to
the distribution, and since the fair market value of the property
($100,000) exceeds the adjusted basis of the property in A's hands
($40,000), the amount of the distribution taken into account under
section 301(c) is $50,500, which is the sum of --
(i) $9,000, i.e., $10,000 (the portion of the adjusted basis of the
property which is out of earnings and profits for 1970), multiplied by
90 percent (the ratio which the gross income of A which is effectively
connected for 1970 with the conduct of a trade or business in the United
States by A bears to A's entire gross income for 1970),
(ii) $24,000, i.e., $30,000 (the portion of the adjusted basis of
property which is out of earnings and profits accumulated during the
period January 1, 1966, through December 31, 1969), multiplied by 80
percent (the ratio which the gross income of A which is effectively
connected for that period with the conduct of a trade or business in the
United States by A bears to A's entire gross income for that period),
(iii) $2,500, i.e., $25,000 (the proportionate part of the fair
market value of the property attributable to the portion of the adjusted
basis which is out of earnings and profits for 1970 ($100,000 multiplied
by $10,000/ $40,000)), multiplied by 10 percent (the ratio which the
gross income of A for 1970 which is not effectively connected for that
year with the conduct of a trade or business in the United States by A
bears to A's entire gross income for 1970), and
(iv) $15,000, i.e., $75,000 (the proportionate part of the fair
market value of the property attributable to the portion of the adjusted
basis which is out of earnings and profits accumulated during the period
January 1, 1966, through December 31, 1969 ($100,000 multiplied by
$30,000/$40,000)), multiplied by 20 percent (the ratio which the gross
income of A for that period which is not effectively connected for that
period with the conduct of a trade or business in the United States by A
bears to A's entire gross income for that period).
Example (2). Assume the same facts as in example (1) except that as
of December 31, 1969, A has earnings and profits of $20,000 accumulated
during the period January 1, 1966, through December 31, 1969. Since a
deduction is allowable to B under section 245(a) with respect to the
distribution and since the fair market value of the property ($100,000)
exceeds the adjusted basis of the property in A's hands ($40,000), the
amount of the distribution taken into account under section 301(c) is
$62,500, which is the sum of --
(i) $9,000, i.e., $10,000 (the portion of the adjusted basis of the
property which is out of earnings and profits for 1970), multiplied by
90 percent (the ratio which the gross income of A which is effectively
connected for 1970 with the conduct of a trade or business in the United
States by A bears to A's entire gross income for such year),
(ii) $16,000, i.e., $20,000 (the portion of the adjusted basis of the
property which is out of earnings and profits accumulated during the
period January 1, 1966, through December 31, 1969), multiplied by 80
percent (the ratio which the gross income of A which is effectively
connected for that period with the conduct of a trade or business in the
United States by A bears to A's entire gross income for that period),
(iii) $2,500, i.e., $25,000 (the proportionate part of the fair
market value of the property attributable to the portion of the adjusted
basis which is out of earnings and profits for 1970 ($100,000 multiplied
by $10,000/$40,000)), multiplied by 10 percent (the ratio which the
gross income of A for 1970 which is not effectively connected for that
year with the conduct of a trade or business in the United States by A
bears to A's entire gross income for 1970),
(iv) $10,000, i.e., $50,000 (the proportionate part of the fair
market value of the property attributable to the portion of the adjusted
basis which is out of earnings and profits accumulated during the period
January 1, 1966, through December 31, 1969 ($100,000 multiplied by
$20,000/$40,000)), multiplied by 20 percent (the ratio which the gross
income of A for that period which is not effectively connected for that
period with the conduct of a trade or business in the United States by A
bears to A's entire gross income of that period), and
(v) $25,000, the proportionate part of the fair market value of the
property attributable to the portion of the adjusted basis which is out
of sources other than earnings and profits for 1970 and earnings and
profits accumulated during the uninterrupted period described in section
245(a) ($100,000 multiplied by $10,000/$40,000).
(o) Distributions of certain property by DISC's to corporate
shareholders. See 1.997-1 for the rule that if a corporation which is
a DISC or former DISC (as defined in section 992(a) (1) or (3) as the
case may be) makes a distribution of property (other than money and
other than the obligations of the DISC or former DISC) out of
accumulated DISC income (as defined in section 996(f)(1)) or previously
taxed income (as defined in section 996(f)(2)), such distribution of
property shall be treated as if it were made to an individual and that
the basis of the property distributed, in the hands of the recipient
corporation, shall be determined as if such property were distributed to
an individual.
(p) Cross references. For certain rules relating to adjustments to
earnings and profits and for determining the extent to which a
distribution is a dividend, see sections 312 and 316 and regulations
thereunder.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6752, 29
FR 12701, Sept. 9, 1964; T.D. 7084, 36 FR 267, Jan. 8, 1971; T.D.
7209, 37 FR 20800, Oct. 5, 1972; 38 FR 20824, Aug. 3, 1973; 38 FR
32794, Nov. 28, 1973; T.D. 7556, 44 FR 1376, Jan. 5, 1979)
26 CFR 1.302-1 General.
(a) Under section 302(d), unless otherwise provided in subchapter C,
chapter 1 of the Code, a distribution in redemption of stock shall be
treated as a distribution of property to which section 301 applies if
the distribution is not within any of the provisions of section 302(b).
A distribution in redemption of stock shall be considered a distribution
in part or full payment in exchange for the stock under section 302(a)
provided paragraph (1), (2), (3), or (4) of section 302(b) applies.
Section 318(a) (relating to constructive ownership of stock) applies to
all redemptions under section 302 except that in the termination of a
shareholder's interest certain limitations are placed on the application
of section 318(a)(1) by section 302(c)(2). The term ''redemption of
stock'' is defined in section 317(b). Section 302 does not apply to
that portion of any distribution which qualifies as a distribution in
partial liquidation under section 346. For special rules relating to
redemption of stock to pay death taxes see section 303. For special
rules relating to redemption of section 306 stock see section 306. For
special rules relating to redemption of stock in partial or complete
liquidation see section 331.
(b) If, in connection with a partial liquidation under the terms of
section 346, stock is redeemed in an amount in excess of the amount
specified by section 331(a)(2), section 302(b) shall first apply as to
each shareholder to which it is applicable without limitation because of
section 331(a)(2). That portion of the total distribution which is used
in all redemptions from specific shareholders which are within the terms
of section 302(a) shall be excluded in determining the application of
sections 346 and 331(a)(2). For example, Corporation X has $50,000
which is attributable to the sale of one of two active businesses and
which, if distributed in redemption of stock, would qualify as a partial
liquidation under the terms of section 346(b). Corporation X
distributes $60,000 to its shareholders in redemption of stock, $20,000
of which is in redemption of all of the stock of shareholder A within
the meaning of section 302(b)(3). The $20,000 distributed in redemption
of the stock of shareholder A will be excluded in determining the
application of sections 346 and 331(a)(2). The entire $60,000 will be
treated as in part or full payment for stock ($20,000 qualifying under
section 302(a) and $40,000 qualifying under sections 346 and 331(a)(2)).
26 CFR 1.302-2 Redemptions not taxable as dividends.
(a) The fact that a redemption fails to meet the requirements of
paragraph (2), (3) or (4) of section 302(b) shall not be taken into
account in determining whether the redemption is not essentially
equivalent to a dividend under section 302(b)(1). See, however,
paragraph (b) of this section. For example, if a shareholder owns only
nonvoting stock of a corporation which is not section 306 stock and
which is limited and preferred as to dividends and in liquidation, and
one-half of such stock is redeemed, the distribution will ordinarily
meet the requirements of paragraph (1) of section 302(b) but will not
meet the requirements of paragraph (2), (3) or (4) of such section. The
determination of whether or not a distribution is within the phrase
''essentially equivalent to a dividend'' (that is, having the same
effect as a distribution without any redemption of stock) shall be made
without regard to the earnings and profits of the corporation at the
time of the distribution. For example, if A owns all the stock of a
corporation and the corporation redeems part of his stock at a time when
it has no earnings and profits, the distribution shall be treated as a
distribution under section 301 pursuant to section 302(d).
(b) The question whether a distribution in redemption of stock of a
shareholder is not essentially equivalent to a dividend under section
302(b)(1) depends upon the facts and circumstances of each case. One of
the facts to be considered in making this determination is the
constructive stock ownership of such shareholder under section 318(a).
All distributions in pro rata redemptions of a part of the stock of a
corporation generally will be treated as distributions under section 301
if the corporation has only one class of stock outstanding. However,
for distributions in partial liquidation, see section 346. The
redemption of all of one class of stock (except section 306 stock)
either at one time or in a series of redemptions generally will be
considered as a distribution under section 301 if all classes of stock
outstanding at the time of the redemption are held in the same
proportion. Distribution in redemption of stock may be treated as
distributions under section 301 regardless of the provisions of the
stock certificate and regardless of whether all stock being redeemed was
acquired by the stockholders from whom the stock was redeemed by
purchase or otherwise. In every case in which a shareholder transfers
stock to the corporation which issued such stock in exchange for
property, the facts and circumstances shall be reported on his return
except as provided in paragraph (d) of 1.331-1. See sections 346(a) and
6043 for requirements relating to returns by corporations.
(c) In any case in which an amount received in redemption of stock is
treated as a distribution of a dividend, proper adjustment of the basis
of the remaining stock will be made with respect to the stock redeemed.
The following examples illustrate the application of this rule:
Example (1). A, an individual, purchased all of the stock of
Corporation X for $100,000. In 1955 the corporation redeems half of the
stock for $150,000, and it is determined that this amount constitutes a
dividend. The remaining stock of Corporation X held by A has a basis of
$100,000.
Example (2). H and W, husband and wife, each own half of the stock
of Corporation X. All of the stock was purchased by H for $100,000
cash. In 1950 H gave one-half of the stock to W, the stock transferred
having a value in excess of $50,000. In 1955 all of the stock of H is
redeemed for $150,000, and it is determined that the distribution to H
in redemption of his shares constitutes the distribution of a dividend.
Immediately after the transaction, W holds the remaining stock of
Corporation X with a basis of $100,000.
Example (3). The facts are the same as in Example (2) with the
additional facts that the outstanding stock of Corporation X consists of
1,000 shares and all but 10 shares of the stock of H is redeemed.
Immediately after the transaction, H holds 10 shares of the stock of
Corporation X with a basis of $50,000, and W holds 500 shares with a
basis of $50,000.
26 CFR 1.302-3 Substantially disproportionate redemption.
(a) Section 302(b)(2) provides for the treatment of an amount
received in redemption of stock as an amount received in exchange for
such stock if --
(1) Immediately after the redemption the shareholder owns less than
50 percent of the total combined voting power of all classes of stock as
provided in section 302(b)(2)(B),
(2) The redemption is a substantially disproportionate redemption
within the meaning of section 302(b)(2)(C), and
(3) The redemption is not pursuant to a plan described in section
302(b)(2)(D).
Section 318(a) (relating to constructive ownership of stock) shall
apply both in making the disproportionate redemption test and in
determining the percentage of stock ownership after the redemption. The
requirements under section 302(b)(2) shall be applied to each
shareholder separately and shall be applied only with respect to stock
which is issued and outstanding in the hands of the shareholders.
Section 302(b)(2) only applies to a redemption of voting stock or to a
redemption of both voting stock and other stock. Section 302(b)(2) does
not apply to the redemption solely of nonvoting stock (common or
preferred). However, if a redemption is treated as an exchange to a
particular shareholder under the terms of section 302(b)(2), such
section will apply to the simultaneous redemption of nonvoting preferred
stock (which is not section 306 stock) owned by such shareholder and
such redemption will also be treated as an exchange. Generally, for
purposes of this section, stock which does not have voting rights until
the happening of an event, such as a default in the payment of dividends
on preferred stock, is not voting stock until the happening of the
specified event. Subsection 302(b)(2)(D) provides that a redemption
will not be treated as substantially disproportionate if made pursuant
to a plan the purpose or effect of which is a series of redemptions
which result in the aggregate in a distribution which is not
substantially disproportionate. Whether or not such a plan exists will
be determined from all the facts and circumstances.
(b) The application of paragraph (a) of this section is illustrated
by the following example:
Example. Corporation M has outstanding 400 shares of common stock of
which A, B, C and D each own 100 shares or 25 percent. No stock is
considered constructively owned by A, B, C or D under section 318.
Corporation M redeems 55 shares from A, 25 shares from B, and 20 shares
from C. For the redemption to be disproportionate as to any
shareholder, such shareholder must own after the redemptions less than
20 percent (80 percent of 25 percent) of the 300 shares of stock then
outstanding. After the redemptions, A owns 45 shares (15 percent), B
owns 75 shares (25 percent), and C owns 80 shares (26 2/3 percent). The
distribution is disproportionate only with respect to A.
26 CFR 1.302-4 Termination of shareholder's interest.
Section 302(b)(3) provides that a distribution in redemption of all
of the stock of the corporation owned by a shareholder shall be treated
as a distribution in part or full payment in exchange for the stock of
such shareholder. In determining whether all of the stock of the
shareholder has been redeemed, the general rule of section 302(c)(1)
requires that the rules of constructive ownership provided in section
318(a) shall apply. Section 302(c)(2), however, provides that section
318(a)(1) (relating to constructive ownership of stock owned by members
of a family) shall not apply where the specific requirements of section
302(c)(2) are met. The following rules shall be applicable in
determining whether the specific requirements of section 302(c)(2) are
met:
(a)(1) The agreement specified in section 302(c)(2)(A)(iii) shall be
in the form of a separate statement in duplicate signed by the
distributee and attached to the first return filed by the distributee
for the taxable year in which the distribution described in section
302(b)(3) occurs. The agreement shall recite that the distributee has
not acquired, other than by bequest or inheritance, any interest in the
corporation (as described in section 302(c)(2)(A)(i)) since the
distribution and that the distributee agrees to notify the district
director for the internal revenue district in which the distributee
resides of any acquistition, other than by bequest or inheritance, of
such an interest in the corporation within 30 days after the
acquisition, if the acquisition occurs within 10 years from the date of
the distribution.
(2) If the distributee fails to file the agreement specified in
section 302(c) (2) (A) (iii) at the time provided in paragraph (a)(1) of
this section, then the district director for the internal revenue
district in which the distributee resided at the time of filing the
first return for the taxable year in which the distribution occurred
shall grant a reasonable extension of time for filing such agreement,
provided (i) it is established to the satisfaction of the district
director that there was reasonable cause for failure to file the
agreement within the prescribed time and (ii) a request for such
extension is filed within such time as the district director considers
reasonable under the circumstances.
(b) The distributee who files an agreement under section 302(c)(2)(A)
(iii) shall retain copies of income tax returns and any other records
indicating fully the amount of tax which would have been payable had the
redemption been treated as a distribution subject to section 301.
(c) If stock of a parent corporation is redeemed, section
302(c)(2)(A), relating to acquisition of an interest in the corporation
within 10 years after termination shall be applied with reference to an
interest both in the parent corporation and any subsidiary of such
parent corporation. If stock of a parent corporation is sold to a
subsidiary in a transaction described in section 304, section
302(c)(2)(A) shall be applicable to the acquisition of an interest in
such subsidiary corporation or in the parent corporation. If stock of a
subsidiary corporation is redeemed, section 302(c)(2)(A) shall be
applied with reference to an interest both in such subsidiary
corporation and its parent. Section 302(c)(2)(A) shall also be applied
with respect to an interest in a corporation which is a successor
corporation to the corporation the interest in which has been
terminated.
(d) For the purpose of section 302(c)(2)(A)(i), a person will be
considered to be a creditor only if the rights of such person with
respect to the corporation are not greater or broader in scope than
necessary for the enforcement of his claim. Such claim must not in any
sense be proprietary and must not be subordinate to the claims of
general creditors. An obligation in the form of a debt may thus
constitute a proprietary interest. For example, if under the terms of
the instrument the corporation may discharge the principal amount of its
obligation to a person by payments, the amount or certainty of which are
dependent upon the earnings of the corporation, such a person is not a
creditor of the corporation. Furthermore, if under the terms of the
instrument the rate of purported interest is dependent upon earnings,
the holder of such instrument may not, in some cases, be a creditor.
(e) In the case of a distributee to whom section 302(b)(3) is
applicable, who is a creditor after such transaction, the acquisition of
the assets of the corporation in the enforcement of the rights of such
creditor shall not be considered an acquisition of an interest in the
corporation for purposes of section 302(c)(2) unless stock of the
corporation, its parent corporation, or, in the case of a redemption of
stock of a parent corporation, of a subsidiary of such corporation is
acquired.
(f) In determining whether an entire interest in the corporation has
been terminated under section 302(b)(3), under all circumstances
paragraphs (2), (3), (4), and (5) of section 318(a) (relating to
constructive ownership of stock) shall be applicable.
(g) Section 302(c)(2)(B) provides that section 302(c)(2)(A) shall not
apply --
(1) If any portion of the stock redeemed was acquired directly or
indirectly within the 10-year period ending on the date of the
distribution by the distributee from a person, the ownership of whose
stock would (at the time of distribution) be attributable to the
distributee under section 318(a), or
(2) If any person owns (at the time of the distribution) stock, the
ownership of which is attributable to the distributee under section
318(a), such person acquired any stock in the corporation directly or
indirectly from the distributee within the 10-year period ending on the
date of the distribution, and such stock so acquired from the
distributee is not redeemed in the same transaction,unless the
acquisition (described in subparagraph (1) of this paragraph) or the
disposition by the distributee (described in subparagraph (2) of this
paragraph) did not have as one of its principal purposes the avoidance
of Federal income tax. A transfer of stock by the transferor, within
the 10-year period ending on the date of the distribution, to a person
whose stock would be attributable to the transferor shall not be deemed
to have as one of its principal purposes the avoidance of Federal income
tax merely because the transferee is in a lower income tax bracket than
the transferor.
(Sec. 302(c)(2)(A)(iii) (68A Stat. 87; 26 U.S.C. 302
(c)(2)(A)(iii)))
(T.D. 7535, 43 FR 10686, Mar. 15, 1978)
26 CFR 1.303-1 General.
Section 303 provides that in certain cases a distribution in
redemption of stock, the value of which is included in determining the
value of the gross estate of a decedent, shall be treated as a
distribution in full payment in exchange for the stock so redeemed.
26 CFR 1.303-2 Requirements.
(a) Section 303 applies only where the distribution is with respect
to stock of a corporation the value of whose stock in the gross estate
of the decedent for Federal estate tax purposes is an amount in excess
of (1) 35 percent of the value of the gross estate of such decedent, or
(2) 50 percent of the taxable estate of such decedent. For the purposes
of such 35 percent and 50 percent requirements, stock of two or more
corporations shall be treated as the stock of a single corporation if
more than 75 percent in value of the outstanding stock of each such
corporation is included in determining the value of the decedent's gross
estate. For the purpose of the 75 percent requirement, stock which, at
the decedent's death, represents the surviving spouse's interest in
community property shall be considered as having been included in
determining the value of the decedent's gross estate.
(b) For the purpose of section 303(b)(2)(A)(i), the term ''gross
estate'' means the gross estate as computed in accordance with section
2031 (or, in the case of the estate of a decedent nonresident not a
citizen of the United States, in accordance with section 2103). For the
purpose of section 303(b)(2)(A)(ii), the term ''taxable estate'' means
the taxable estate as computed in accordance with section 2051 (or, in
the case of the estate of a decedent nonresident not a citizen of the
United States, in accordance with section 2106). In case the value of
an estate is determined for Federal estate tax purposes under section
2032 (relating to alternate valuation), then, for purposes of section
303(b)(2), the value of the gross estate, the taxable estate, and the
stock shall each be determined on the applicable date prescribed in
section 2032.
(c)(1) In determining whether the estate of the decedent is comprised
of stock of a corporation of sufficient value to satisfy the percentage
requirements of section 303(b)(2)(A) and section 303(b)(2)(B), the total
value, in the aggregate, of all classes of stock of the corporation
includible in determining the value of the gross estate is taken into
account. A distribution under section 303(a) may be in redemption of
the stock of the corporation includible in determining the value of the
gross estate, without regard to the class of such stock.
(2) The above may be illustrated by the following example:
Example. The gross estate of the decedent has a value of $1,000,000,
the taxable estate is $700,000, and the sum of the death taxes and
funeral and administration expenses is $275,000. Included in
determining the gross estate of the decedent is stock of three
corporations which, for Federal estate tax purposes, is valued as
follows:
The stock of Corporation A and Corporation C included in the estate
of the decedent constitutes all of the outstanding stock of both
corporations. The stock of Corporation A and the stock of Corporation
C, treated as the stock of a single corporation under section
303(b)(2)(B), has a value in excess of $350,000 (35 percent of the gross
estate or 50 percent of the taxable estate). Likewise, the stock of
Corporation B has a value in excess of $350,000. The distribution by
one or more of the above corporations, within the period prescribed in
section 303(b)(1), of amounts not exceeding, in the aggregate, $275,000,
in redemption of preferred stock or common stock of such corporation or
corporations, will be treated as in full payment in exchange for the
stock so redeemed.
(d) If stock includible in determining the value of the gross estate
of a decedent is exchanged for new stock, the basis of which is
determined by reference to the basis of the old stock, the redemption of
the new stock will be treated the same under section 303 as the
redemption of the old stock would have been. Thus section 303 shall
apply with respect to a distribution in redemption of stock received by
the estate of a decedent (1) in connection with a reorganization under
section 368, (2) in a distribution or exchange under section 355 (or so
much of section 356 as relates to section 355), (3) in an exchange under
section 1036 or (4) in a distribution to which section 305(a) applies.
Similarly, a distribution in redemption of stock will qualify under
section 303, notwithstanding the fact that the stock redeemed is section
306 stock to the extent that the conditions of section 303 are met.
(e) Section 303 applies to distributions made after the death of the
decedent and (1) before the expiration of the 3-year period of
limitations for the assessment of estate tax provided in section 6501(a)
(determined without the application of any provisions of law extending
or suspending the running of such period of limitations), or within 90
days after the expiration of such period, or (2) if a petition for
redetermination of a deficiency in such estate tax has been filed with
the Tax Court within the time prescribed in section 6213, at any time
before the expiration of 60 days after the decision of the Tax Court
becomes final. The extension of the period of distribution provided in
section 303(b)(1)(B) has reference solely to bona fide contests in the
Tax Court and will not apply in the case of a petition for
redetermination of a deficiency which is initiated solely for the
purpose of extending the period within which section 303 would otherwise
be applicable.
(f) While section 303 will most frequently have application in the
case where stock is redeemed from the executor or administrator of an
estate, the section is also applicable to distributions in redemption of
stock included in the decedent's gross estate and held at the time of
the redemption by any person who acquired the stock by any of the means
comprehended by part III, subchapter A, chapter 11 of the Code,
including the heir, legatee, or donee of the decedent, a surviving joint
tenant, surviving spouse, appointee, or taker in default of appointment,
or a trustee of a trust created by the decedent. Thus section 303 may
apply with respect to a distribution in redemption of stock from a donee
to whom the decedent has transferred stock in contemplation of death
where the value of such stock is included in the decedent's gross estate
under section 2035. Similarly, section 303 may apply to the redemption
of stock from a beneficiary of the estate to whom an executor has
distributed the stock pursuant to the terms of the will of the decedent.
However, section 303 is not applicable to the case where stock is
redeemed from a stockholder who has acquired the stock by gift or
purchase from any person to whom such stock has passed from the
decedent. Nor is section 303 applicable to the case where stock is
redeemed from a stockholder who has acquired the stock from the executor
in satisfaction of a specific monetary bequest.
(g) (1) The total amount of the distributions to which section 303
may apply with respect to redemptions of stock included in the gross
estate of a decedent may not exceed the sum of the estate, inheritance,
legacy, and succession taxes (including any interest collected as a part
of such taxes) imposed because of the decedent's death and the amount of
funeral and administration expenses allowable as deductions to the
estate. Where there is more than one distribution in redemption of
stock described in section 303(b)(2) during the period of time
prescribed in section 303(b)(1), the distributions shall be applied
against the total amount which qualifies for treatment under section 303
in the order in which the distributions are made. For this purpose, all
distributions in redemption of such stock shall be taken into account,
including distributions which under another provision of the Code are
treated as in part or full payment in exchange for the stock redeemed.
(2) Subparagraph (1) of this paragraph may be illustrated by the
following example:
Example. (i) The gross estate of the decedent has a value of
$800,000, the taxable estate is $500,000, and the sum of the death taxes
and funeral and administrative expenses is $225,000. Included in
determining the gross estate of the decedent is the stock of a
corporation which for Federal estate tax purposes is valued at $450,000.
During the first year of administration, one-third of such stock is
distributed to a legatee and shortly thereafter this stock is redeemed
by the corporation for $150,000. During the second year of
administration, another one-third of such stock includible in the estate
is redeemed for $150,000.
(ii) The first distribution of $150,000 is applied against the
$225,000 amount that qualifies for treatment under section 303,
regardless of whether the first distribution was treated as in payment
in exchange for stock under section 302(a). Thus, only $75,000 of the
second distribution may be treated as in full payment in exchange for
stock under section 303. The tax treatment of the remaining $75,000
would be determined under other provisions of the Code.
(h) For the purpose of section 303, the estate tax or any other
estate, inheritance, legacy, or succession tax shall be ascertained
after the allowance of any credit, relief, discount, refund, remission
or reduction of tax.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6724, 29
FR 5343, Apr. 21, 1964; T.D. 7346, 40 FR 10669, Mar. 7, 1975)
26 CFR 1.303-3 Application of other sections.
(a) The sole effect of section 303 is to exempt from tax as a
dividend a distribution to which such section is applicable when made in
redemption of stock includible in a decedent's gross estate. Such
section does not, however, in any other manner affect the principles set
forth in sections 302 and 306. Thus, if stock of a corporation is owned
equally by A, B, and the C Estate, and the corporation redeems one-half
of the stock of each shareholder, the determination of whether the
distributions to A and B are essentially equivalent to dividends shall
be made without regard to the effect which section 303 may have upon the
taxability of the distribution to the C Estate.
(b) See section 304 relative to redemption of stock through the use
of related corporations.
26 CFR 1.304-1 General.
(a) Except as provided in paragraph (b) of this section, section 304
is applicable where a shareholder sells stock of one corporation to a
related corporation as defined in section 304. Sales to which section
304 is applicable shall be treated as redemptions subject to sections
302 and 303.
(b) In the case of --
(1) Any acquisition of stock described in section 304 which occurred
before June 22, 1954, and
(2) Any acquisition of stock described in section 304 which occurred
on or after June 22, 1954, and on or before December 31, 1958, pursuant
to a contract entered into before June 22, 1954.
The extent to which the property received in return for such
acquisition shall be treated as a dividend shall be determined as if the
Internal Revenue Code of 1939 continued to apply in respect of such
acquisition and as if the Internal Revenue Code of 1954 had not been
enacted. See section 391. In cases to which this paragraph applies,
the basis of the stock received by the acquiring corporation shall be
determined as if the Internal Revenue Code of 1939 continued to apply in
respect of such acquisition and as if the Internal Revenue Code of 1954
had not been enacted.
(T.D. 6533, 26 FR 401, Jan. 19, 1961)
26 CFR 1.304-2 Acquisition by related corporation (other than
subsidiary).
(a) If a corporation, in return for property, acquires stock of
another corporation from one or more persons, and the person or persons
from whom the stock was acquired were in control of both such
corporations before the acquisition, then such property shall be treated
as received in redemption of stock of the acquiring corporation. The
stock received by the acquiring corporation shall be treated as a
contribution to the capital of such corporation. See section 362(a) for
determination of the basis of such stock. The transferor's basis for
his stock in the acquiring corporation shall be increased by the basis
of the stock surrendered by him. (But see below in this paragraph for
subsequent reductions of basis in certain cases.) As to each person
transferring stock, the amount received shall be treated as a
distribution of property under section 302(d), unless as to such person
such amount is to be treated as received in exchange for the stock under
the terms of section 302(a) or section 303. In applying section 302(b),
reference shall be had to the shareholder's ownership of stock in the
issuing corporation and not to his ownership of stock in the acquiring
corporation (except for purposes of applying section 318(a)). In
determining control and applying section 302(b), section 318(a)
(relating to the constructive ownership of stock) shall be applied
without regard to the 50-percent limitation contained in section 318(a)
(2)(C) and (3)(C). A series of redemptions referred to in section
302(b)(2)(D) shall include acquisitions by either of the corporations of
stock of the other and stock redemptions by both corporations. If
section 302(d) applies to the surrender of stock by a shareholder, his
basis for his stock in the acquiring corporation after the transaction
(increased as stated above in this paragraph) shall not be decreased
except as provided in section 301. If section 302(d) does not apply,
the property received shall be treated as received in a distribution in
payment in exchange for stock of the acquiring corporation under section
302(a), which stock has a basis equal to the amount by which the
shareholder's basis for his stock in the acquiring corporation was
increased on account of the contribution to capital as provided for
above in this paragraph. Accordingly, such amount shall be applied in
reduction of the shareholder's basis for his stock in the acquiring
corporation. Thus, the basis of each share of the shareholder's stock
in the acquiring corporation will be the same as the basis of such share
before the entire transaction. The holding period of the stock which is
considered to have been redeemed shall be the same as the holding period
of the stock actually surrendered.
(b) In any case in which two or more persons, in the aggregate,
control two corporations, section 304(a)(1) will apply to sales by such
persons of stock in either corporation to the other (whether or not made
simultaneously) provided the sales by each of such persons are related
to each other. The determination of whether the sales are related to
each other shall be dependent upon the facts and circumstances
surrounding all of the sales. For this purpose, the fact that the sales
may occur during a period of one or more years (such as in the case of a
series of sales by persons who together control each of such
corporations immediately prior to the first of such sales and
immediately subsequent to the last of such sales) shall be disregarded,
provided the other facts and circumstances indicate related
transactions.
(c) The application of section 304(a)(1) may be illustrated by the
following examples:
Example (1). Corporation X and corporation Y each have outstanding
200 shares of common stock. One-half of the stock of each corporation
is owned by an individual, A, and one-half by another individual, B, who
is unrelated to A. On or after August 31, 1964, A sells 30 shares of
corporation X stock to corporation Y for $50,000, such stock having an
adjusted basis of $10,000 to A. After the sale, A is considered as
owning corporation X stock as follows: (i) 70 shares directly, and (ii)
15 shares constructively, since by virtue of his 50-percent ownership of
Y he constructively owns 50 percent of the 30 shares owned directly by
Y. Since A's percentage of ownership of X's voting stock after the sale
(85 out of 200 shares, or 42.5%) is not less than 80 percent of his
percentage of ownership of X's voting stock before the sale (100 out of
200 shares, or 50%), the transfer is not ''substantially
disproportionate'' as to him as provided in section 302(b)(2). Under
these facts, and assuming that section 302(b)(1) is not applicable, the
entire $50,000 is treated as a dividend to A to the extent of the
earnings and profits of corporation Y. The basis of the corporation X
stock to corporation Y is $10,000, its adjusted basis to A. The amount
of $10,000 is added to the basis of the stock of corporation Y in the
hands of A.
Example (2). The facts are the same as in example (1) except that A
sells 80 shares of corporation X stock to corporation Y, and the sale
occurs before August 31, 1964. After the sale, A is considered as
owning corporation X stock as follows: (i) 20 shares directly, and (ii)
90 shares indirectly, since by virtue of his 50-percent ownership of Y
he constructively owns 50 percent of the 80 shares owned directly by Y
and 50 percent of the 100 shares attributed to Y because they are owned
by Y's stockholder, B. Since after the sale A owns a total of more than
50 percent of the voting power of all of the outstanding stock of X (110
out of 200 shares, or 55%), the transfer is not ''substantially
disproportionate'' as to him as provided in section 302(b)(2).
Example (3). Corporation X and corporation Y each have outstanding
100 shares of common stock. A, an individual, owns one-half the stock
of corporation X, and C owns one-half the stock of corporation Y. A, B,
and C are unrelated. A sells 30 shares of the stock of corporation X to
corporation Y for $50,000, such stock having an adjusted basis of
$10,000 to him. After the sale, A is considered as owning 35 shares of
the stock of corporation X (20 shares directly and 15 constructively
because one-half of the 30 shares owned by corporation Y are attributed
to him). Since before the sale he owned 50 percent of the stock of
corporation X and after the sale he owned directly and constructively
only 35 percent of such stock, the redemption is substantially
disproportionate as to him pursuant to the provisions of section
302(b)(2). He, therefore, realizes a gain of $40,000 ($50,000 minus
$10,000). If the stock surrendered is a capital asset, such gain is
long-term or short-term capital gain depending on the period of time
that such stock was held. The basis to A for the stock of corporation Y
is not changed as a result of the entire transaction. The basis to
corporation Y for the stock of corporation X is $50,000, i.e., the basis
of the transferor ($10,000), increased in the amount of gain recognized
to the transferor ($40,000) on the transfer.
Example (4). Corporation X and corporation Y each have outstanding
100 shares of common stock. H, an individual, W, his wife, S, his son,
and G, his grandson, each own 25 shares of stock of each corporation. H
sells all of his 25 shares of stock of corporation X to corporation Y.
Since both before and after the transaction H owned directly and
constructively 100 percent of the stock of corporation X, and assuming
that section 302(b)(1) is not applicable, the amount received by him for
his stock of corporation X is treated as a dividend to him to the extent
of the earnings and profits of corporation Y.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33
FR 11997, Aug. 23, 1968)
26 CFR 1.304-3 Acquisition by a subsidiary.
(a) If a subsidiary acquires stock of its parent corporation from a
shareholder of the parent corporation, the acquisition of such stock
shall be treated as though the parent corporation had redeemed its own
stock. For the purpose of this section, a corporation is a parent
corporation if it meets the 50 percent ownership requirements of section
304(c). The determination whether the amount received shall be treated
as an amount received in payment in exchange for the stock shall be made
by applying section 303, or by applying section 302(b) with reference to
the stock of the issuing parent corporation. If such distribution would
have been treated as a distribution of property (pursuant to section
302(d)) under section 301, the entire amount of the selling price of the
stock shall be treated as a dividend to the seller to the extent of the
earnings and profits of the parent corporation determined as if the
distribution had been made to it of the property that the subsidiary
exchanged for the stock. In such cases, the transferor's basis for his
remaining stock in the parent corporation will be determined by
including the amount of the basis of the stock of the parent corporation
sold to the subsidiary.
(b) Section 304(a)(2) may be illustrated by the following example:
Example. Corporation M has outstanding 100 shares of common stock
which are owned as follows: B, 75 shares, C, son of B, 20 shares, and
D, daughter of B, 5 shares. Corporation M owns the stock of Corporation
X. B sells his 75 shares of Corporation M stock to Corporation X.
Under section 302(b)(3) this is a termination of B's entire interest in
Corporation M and the full amount received from the sale of his stock
will be treated as payment in exchange for this stock, provided he
fulfills the requirements of section 302(c)(2) (relating to an
acquisition of an interest in the corporations).
26 CFR 1.304-4T Special rule for use of a related corporation to
acquire for property the stock of another commonly owned corporation
(temporary).
(a) In general. At the discretion of the District Director, for
purposes of determining the amount constituting a dividend, and source
thereof, under section 304(b)(2), a corporation (deemed acquiring
corporation) will be considered to have acquired for property the stock
of a corporation (issuing corporation) acquired for property by another
corporation (acquiring corporation) that is controlled by the deemed
acquiring corporation, if one of the principal purposes for creating,
organizing, or funding the acquiring corporation, through capital
contributions or debt, is to avoid the application of section 304 to the
deemed acquiring corporation. The following example illustrates the
application of this paragraph (a).
Example. P, a domestic corporation, owns all of the stock of CFC1, a
controlled foreign corporation with substantial accumulated earnings and
profits. CFC1 is organized in Country X, which imposes a high rate of
tax on CFC1's income. P also owns all of the stock of CFC2, another
controlled foreign corporation, which has accumulated earnings and
profits of $200x. CFC2 is organized in Country Y which imposes a low
rate of tax on CFC2's income. P wishes to own all of its foreign
corporations in a direct chain and to effectuate a repatriation of
CFC2's cash to P. In order to avoid having to obtain Country X approval
for the acquisition of CFC1 (a Country X corporation) by CFC2 (a Country
Y corporation) and to avoid a dividend to P out of CFC2's earnings and
profits that would otherwise occur as a result of the application of
section 304, P causes CFC2 to form RFC as a Country X wholly-owned
subsidiary and to contribute $100x to RFC. RFC will purchase, for
$100x, all of the stock of CFC1 from P. Because one of P's principal
purposes for having CFC1 owned by RFC is to avoid section 304, under
1.304-4T(a), CFC2 is considered to have acquired the stock of CFC1 for
$100x for purposes of determining the amount constituting a dividend
(and source thereof) for purposes of section 304(b)(2).
(b) Availability to taxpayers. Nothing in this regulation shall be
construed to provide a taxpayer the right to compel the Internal Revenue
Service to disregard the form of its transaction for Federal income tax
purposes.
(c) Effective date. This section is effective June 14, 1988, with
respect to acquisitions of stock occurring on or after June 14, 1988.
(T.D. 8209, 53 FR 22171, June 14, 1988)
26 CFR 1.305-1 Stock dividends.
(a) In general. Under section 305, a distribution made by a
corporation to its shareholders in its stock or in rights to acquire its
stock is not included in gross income except as provided in section
305(b) and the regulations promulgated under the authority of section
305(c). A distribution made by a corporation to its shareholders in its
stock or rights to acquire its stock which would not otherwise be
included in gross income by reason of section 305 shall not be so
included merely because such distribution was made out of Treasury stock
or consisted of rights to acquire Treasury stock. See section 307 for
rules as to basis of stock and stock rights acquired in a distribution.
(b) Amount of distribution. (1) In general, where a distribution of
stock or rights to acquire stock of a corporation is treated as a
distribution of property to which section 301 applies by reason of
section 305(b), the amount of the distribution, in accordance with
section 301(b) and 1.301-1, is the fair market value of such stock or
rights on the date of distribution. See example (1) of 1.305-2(b).
(2) Where a corporation which regularly distributes its earnings and
profits, such as a regulated investment company, declares a dividend
pursuant to which the shareholders may elect to receive either money or
stock of the distributing corporation of equivalent value, the amount of
the distribution of the stock received by any shareholder electing to
receive stock will be considered to equal the amount of the money which
could have been received instead. See example (2) of 1.305-2(b).
(3) For rules for determining the amount of the distribution where
certain transactions, such as changes in conversion ratios or periodic
redemptions, are treated as distributions under section 305(c), see
examples (6), (8), (9), and (15) of 1.305-3(e).
(c) Adjustment in purchase price. A transfer of stock (or rights to
acquire stock) or an increase or decrease in the conversion ratio or
redemption price of stock which represents an adjustment of the price to
be paid by the distributing corporation in acquiring property (within
the meaning of section 317(a)) is not within the purview of section 305
because it is not a distribution with respect to its stock. For
example, assume that on January 1, 1970, pursuant to a reorganization,
corporation X acquires all the stock of corporation Y solely in exchange
for its convertible preferred class B stock. Under the terms of the
class B stock, its conversion ratio is to be adjusted in 1976 under a
formula based upon the earnings of corporation Y over the 6-year period
ending on December 31, 1975. Such an adjustment in 1976 is not covered
by section 305.
(d) Definitions. (1) For purposes of this section and 1.305-2
through 1.305-7, the term ''stock'' includes rights or warrants to
acquire such stock.
(2) For purposes of 1.305-2 through 1.305-7, the term
''shareholder'' includes a holder of rights or warrants or a holder of
convertible securities.
(T.D. 7281, 38 FR 18532, July 12, 1973; 38 FR 19910, July 25, 1973)
26 CFR 1.305-2 Distributions in lieu of money.
(a) In general. Under section 305(b)(1), if any shareholder has the
right to an election or option with respect to whether a distribution
shall be made either in money or any other property, or in stock or
rights to acquire stock of the distributing corporation, then, with
respect to all shareholders, the distribution of stock or rights to
acquire stock is treated as a distribution of property to which section
301 applies regardless of --
(1) Whether the distribution is actually made in whole or in part in
stock or in stock rights;
(2) Whether the election or option is exercised or exercisable before
or after the declaration of the distribution;
(3) Whether the declaration of the distribution provides that the
distribution will be made in one medium unless the shareholder
specifically requests payment in the other;
(4) Whether the election governing the nature of the distribution is
provided in the declaration of the distribution or in the corporate
charter or arises from the circumstances of the distribution; or
(5) Whether all or part of the shareholders have the election.
(b) Examples. The application of section 305(b)(1) may be
illustrated by the following examples:
Example (1). (i) Corporation X declared a dividend payable in
additional shares of its common stock to the holders of its outstanding
common stock on the basis of two additional shares for each share held
on the record date but with the provision that, at the election of any
shareholder made within a specified period prior to the distribution
date, he may receive one additional share for each share held on the
record date plus $12 principal amount of securities of corporation Y
owned by corporation X. The fair market value of the stock of
corporation X on the distribution date was $10 per share. The fair
market value of $12 principal amount of securities of corporation Y on
the distribution date was $11 but such securities had a cost basis to
corporation X of $9.
(ii) The distribution to all shareholders of one additional share of
stock of corporation X (with respect to which no election applies) for
each share outstanding is not a distribution to which section 301
applies.
(iii) The distribution of the second share of stock of corporation X
to those shareholders who do not elect to receive securities of
corporation Y is a distribution of property to which section 301
applies, whether such shareholders are individuals or corporations. The
amount of the distribution to which section 301 applies is $10 per share
of stock of corporation X held on the record date (the fair market value
of the stock of corporation X on the distribution date).
(iv) The distribution of securities of corporation Y in lieu of the
second share of stock of corporation X to the shareholders of
corporation X whether individuals or corporations, who elect to receive
such securities, is also a distribution of property to which section 301
applies.
(v) In the case of the individual shareholders of corporation X who
elects to receive such securities, the amount of the distribution to
which section 301 applies is $11 per share of stock of corporation X
held on the record date (the fair market value of the $12 principal
amount of securities of corporation Y on the distribution date).
(vi) In the case of the corporate shareholders of corporation X
electing to receive such securities, the amount of the distribution to
which section 301 applies is $9 per share of stock of corporation X held
on the record date (the basis of the securities of corporation Y in the
hands of corporation X).
Example (2). On January 10, 1970, corporation X, a regulated
investment company, declared a dividend of $1 per share on its common
stock payable on February 11, 1970, in cash or in stock of corporation X
of equivalent value determined as of January 22, 1970, at the election
of the shareholder made on or before January 22, 1970. The amount of
the distribution to which section 301 applies is $1 per share whether
the shareholder elects to take cash or stock and whether the shareholder
is an individual or a corporation. Such amount will also be used in
determining the dividend paid deduction of corporation X and the
reduction in earnings and profits of corporation X.
(T.D. 7281, 38 FR 18532, July 12, 1973)
26 CFR 1.305-3 Disproportionate distributions.
(a) In general. Under section 305(b)(2), a distribution (including a
deemed distribution) by a corporation of its stock or rights to acquire
its stock is treated as a distribution of property to which section 301
applies if the distribution (or a series of distributions of which such
distribution is one) has the result of (1) the receipt of money or other
property by some shareholders, and (2) an increase in the proportionate
interests of other shareholders in the assets or earnings and profits of
the corporation. Thus, if a corporation has two classes of common stock
outstanding and cash dividends are paid on one class and stock dividends
are paid on the other class, the stock dividends are treated as
distributions to which section 301 applies.
(b) Special rules. (1) As used in section 305(b)(2), the term ''a
series of distributions'' encompasses all distributions of stock made or
deemed made by a corporation which have the result of the receipt of
cash or property by some shareholders and an increase in the
proportionate interests of other shareholders.
(2) In order for a distribution of stock to be considered as one of a
series of distributions it is not necessary that such distribution be
pursuant to a plan to distribute cash or property to some shareholders
and to increase the proportionate interests of other shareholders. It
is sufficient if there is an actual or deemed distribution of stock (of
which such distribution is one) and as a result of such distribution or
distributions some shareholders receive cash or property and other
shareholders increase their proportionate interests. For example, if a
corporation pays quarterly stock dividends to one class of common
shareholders and annual cash dividends to another class of common
shareholders the quarterly stock dividends constitute a series of
distributions of stock having the result of the receipt of cash or
property by some shareholders and an increase in the proportionate
interests of other shareholders. This is so whether or not the stock
distributions and the cash distributions are steps in an overall plan or
are independent and unrelated. Accordingly, all the quarterly stock
dividends are distributions to which section 301 applies.
(3) There is no requirement that both elements of section 305(b)(2)
(i.e., receipt of cash or property by some shareholders and an increase
in proportionate interests of other shareholders) occur in the form of a
distribution or series of distributions as long as the result of a
distribution or distributions of stock is that some shareholders'
proportionate interests increase and other shareholders in fact receive
cash or property. Thus, there is no requirement that the shareholders
receiving cash or property acquire the cash or property by way of a
corporate distribution with respect to their shares, so long as they
receive such cash or property in their capacity as shareholders, if
there is a stock distribution which results in a change in the
proportionate interests of some shareholders and other shareholders
receive cash or property. However, in order for a distribution of
property to meet the requirement of section 305(b)(2), such distribution
must be made to a shareholder in his capacity as a shareholder, and must
be a distribution to which section 301, 356(a)(2), 871(a)(1)(A),
881(a)(1), 852(b), or 857(b) applies. (Under section 305(d)(2), the
payment of interest to a holder of a convertible debenture is treated as
a distribution of property to a shareholder for purposes of section
305(b)(2).) For example if a corporation makes a stock distribution to
its shareholders and, pursuant to a prearranged plan with such
corporation, a related corporation purchases such stock from those
shareholders who want cash, in a transaction to which section 301
applies by virtue of section 304, the requirements of section 305(b)(2)
are satisfied. In addition, a distribution of property incident to an
isolated redemption of stock (for example, pursuant to a tender offer)
will not cause section 305(b)(2) to apply even though the redemption
distribution is treated as a distribution of property to which section
301, 871(a)(1)(A), 881(a)(1), or 356(a)(2) applies.
(4) Where the receipt of cash or property occurs more than 36 months
following a distribution or series of distributions of stock, or where a
distribution or series of distributions of stock is made more than 36
months following the receipt of cash or property, such distribution or
distributions will be presumed not to result in the receipt of cash or
property by some shareholders and an increase in the proportionate
interest of other shareholders, unless the receipt of cash or property
and the distribution or series of distributions of stock are made
pursuant to a plan. For example, if, pursuant to a plan, a corporation
pays cash dividends to some shareholders on January 1, 1971 and
increases the proportionate interests of other shareholders on March 1,
1974, such increases in proportionate interests are distributions to
which section 301 applies.
(5) In determining whether a distribution or a series of
distributions has the result of a disproportionate distribution, there
shall be treated as outstanding stock of the distributing corporation
(i) any right to acquire such stock (whether or not exercisable during
the taxable year), and (ii) any security convertible into stock of the
distributing corporation (whether or not convertible during the taxable
year).
(6) In cases where there is more than one class of stock outstanding,
each class of stock is to be considered separately in determining
whether a shareholder has increased his proportionate interest in the
assets or earnings and profits of a corporation. The individual
shareholders of a class of stock will be deemed to have an increased
interest if the class of stock as a whole has an increased interest in
the corporation.
(c) Distributions of cash in lieu of fractional shares. (1) Section
305(b)(2) will not apply if --
(i) A corporation declares a dividend payable in stock of the
corporation and distributes cash in lieu of fractional shares to which
shareholders would otherwise be entitled, or
(ii) Upon a conversion of convertible stock or securities a
corporation distributes cash in lieu of fractional shares to which
shareholders would otherwise be entitled.
Provided the purpose of the distribution of cash is to save the
corporation the trouble, expense, and inconvenience of issuing and
transferring fractional shares (or scrip representing fractional
shares), or issuing full shares representing the sum of fractional
shares, and not to give any particular group of shareholders an
increased interest in the assets or earnings and profits of the
corporation. For purposes of paragraph (c)(1)(i) of this section, if
the total amount of cash distributed in lieu of fractional shares is 5
percent or less of the total fair market value of the stock distributed
(determined as of the date of declaration), the distribution shall be
considered to be for such valid purpose.
(2) In a case to which subparagraph (1) of this paragraph applies,
the transaction will be treated as though the fractional shares were
distributed as part of the stock distribution and then were redeemed by
the corporation. The treatment of the cash received by a shareholder
will be determined under section 302.
(d) Adjustment in conversion ratio. (1) (i) Except as provided in
subparagraph (2) of this paragraph, if a corporation has convertible
stock or convertible securities outstanding (upon which it pays or is
deemed to pay dividends or interest in money or other property) and
distributes a stock dividend (or rights to acquire such stock) with
respect to the stock into which the convertible stock or securities are
convertible, an increase in proportionate interest in the assets or
earnings and profits of the corporation by reason of such stock dividend
shall be considered to have occurred unless a full adjustment in the
conversion ratio or conversion price to reflect such stock dividend is
made. Under certain circumstances, however, the application of an
adjustment formula which in effect provides for a ''credit'' where stock
is issued for consideration in excess of the conversion price may not
satisfy the requirement for a ''full adjustment.'' Thus, if under a
''conversion price'' antidilution formula the formula provides for a
''credit'' where stock is issued for consideration in excess of the
conversion price (in effect as an offset against any decrease in the
conversion price which would otherwise be required when stock is
subsequently issued for consideration below the conversion price) there
may still be an increase in proportionate interest by reason of a stock
dividend after application of the formula, since any downward adjustment
of the conversion price that would otherwise be required to reflect the
stock dividend may be offset, in whole or in part, by the effect of
prior sales made at prices above the conversion price. On the other
hand, if there were no prior sales of stock above the conversion price
then a full adjustment would occur upon the application of such an
adjustment formula and there would be no change in proportionate
interest. Similarly, if consideration is to be received in connection
with the issuance of stock, such as in the case of a rights offering or
a distribution of warrants, the fact that such consideration is taken
into account in making the antidilution adjustment will not preclude a
full adjustment. See paragraph (b) of the example in this subparagraph
for a case where the application of an adjustment formula with a
cumulative feature does not result in a full adjustment and where a
change in proportionate interest therefore occurs. See paragraph (c)
for a case where the application of an adjustment formula with a
cumulative feature does result in a full adjustment and where no change
in proportionate interest therefore occurs. See paragraph (d) for an
application of an antidilution formula in the case of a rights offering.
See paragraph (e) for a case where the application of a noncumulative
type adjustment formula will in all cases prevent a change in
proportionate interest from occurring in the case of a stock dividend,
because of the omission of the cumulative feature.
(ii) The principles of this subparagraph may be illustrated by the
following example.
Example. (a) Corporation S has two classes of securities outstanding,
convertible debentures and common stock. At the time of issuance of the
debentures the corporation had 100 shares of common stock outstanding.
Each debenture is interest-paying and is convertible into common stock
at a conversion price of $2. The debenture's conversion price is
subject to reduction pursuant to the following formula:
(Number of common shares outstanding at date of issue of debentures
times initial conversion price) plus (Consideration received upon
issuance of additional common shares) divided by (Number of common
shares outstanding at date of issue of debentures) plus (Number of
additional common shares issued)
Under the formula, common stock dividends are treated as an issue of
common stock for zero consideration. If the computation results in a
figure which is less than the existing conversion price the conversion
price is reduced. However, under the formula, the existing conversion
price is never increased. The formula works upon a cumulative basis
since the numerator includes the consideration received upon the
issuance of all common shares subsequent to the issuance of the
debentures, and the reduction effected by the formula because of a sale
or issuance of common stock below the existing conversion price is thus
limited by any prior sales made above the existing conversion price.
(b) In 1972 corporation S sells 100 common shares at $3 per share.
In 1973 the corporation declares a stock dividend of 20 shares to all
holders of common stock. Under the antidilution formula no adjustment
will be made to the conversion price of the debentures to reflect the
stock dividend to common stockholders since the prior sale of common
stock in excess of the conversion price in 1972 offsets the reduction in
the conversion price which would otherwise result, as follows:
Since $2.27 is greater than the existing conversion price of $2 no
adjustment is required. As a result, there is an increase in
proportionate interest of the common stockholders by reason of the stock
dividend and the additional shares of common stock will be treated,
pursuant to section 305(b)(2), as a distribution of property to which
section 301 applies.
(c) Assume the same facts as above, but instead of selling 100 common
shares at $3 per share in 1972, assume corporation S sold no shares.
Application of the antidilution formula would give rise to an adjustment
in the conversion price as follows:
The conversion price, being reduced from $2 to $1.67, fully reflects
the stock dividend distributed to the common stockholders. Hence, the
distribution of common stock is not treated under section 305(b)(2) as
one to which section 301 applies because the distribution does not
increase the proportionate interests of the common shareholders as a
class.
(d) Corporation S distributes to its shareholders rights entitling
the shareholders to purchase a total of 20 shares at $1 per share.
Application of the antidilution formula would produce an adjustment in
the conversion price as follows:
The conversion price, being reduced from $2 to $1.83, fully reflects
the distribution of rights to purchase stock at a price lower than the
conversion price. Hence, the distribution of the rights is not treated
under section 305(b)(2) as one to which section 301 applies because the
distribution does not increase the proportionate interests of the common
shareholders as a class.
(e) Assume the same facts as in (b) above, but instead of using a
''conversion price'' antidilution formula which operates on a cumulative
basis, assume corporation S has employed a formula which operates as
follows with respect to all stock dividends: The conversion price in
effect at the opening of business on the day following the dividend
record date is reduced by multiplying such conversion price by a
fraction the numerator of which is the number of shares of common stock
outstanding at the close of business on the record date and the
denominator of which is the sum of such shares so outstanding and the
number of shares constituting the stock dividend. Under such a formula
the following adjustment would be made to the conversion price upon the
declaration of a stock dividend of 20 shares in 1973:
The conversion price, being reduced from $2 to $1.82, fully reflects
the stock dividend distributed to the common stockholders. Hence, the
distribution of common stock is not treated under section 305(b)(2) as
one to which section 301 applies because the distribution does not
increase the proportionate interests of the common shareholders as a
class.
(2) (i) A distributing corporation either must make the adjustment
required by subparagraph (1) of this paragraph as of the date of the
distribution of the stock dividend, or must elect (in the manner
provided in subdivision (iii) of this subparagraph) to make such
adjustment within the time provided in subdivision (ii) of this
subparagraph.
(ii) If the distributing corporation elects to make such adjustment,
such adjustment must be made no later than the earlier of (a) 3 years
after the date of the stock dividend, or (b) that date as of which the
aggregate stock dividends for which adjustment of the conversion ratio
has not previously been made total at least 3 percent of the issued and
outstanding stock with respect to which such stock dividends were
distributed.
(iii) The election provided by subdivision (ii) of this subparagraph
shall be made by filing with the income tax return for the taxable year
during which the stock dividend is distributed --
(a) A statement that an adjustment will be made as provided by that
subdivision, and
(b) A description of the antidilution provisions under which the
adjustment will be made.
(3) Notwithstanding the preceding subparagraph, if a distribution has
been made before July 12, 1973, and the adjustment required by
subparagraph (1) or the election to make such adjustment was not made
before such date, the adjustment or the election to make such
adjustment, as the case may be, shall be considered valid if made no
later than 15 days following the date of the first annual meeting of the
shareholders after July 12, 1973, or July 12, 1974, whichever is
earlier. If the election is made within such period, and, if the income
tax return has been filed before the time of such election, the
statement of adjustment and the description of the antidilution
provisions required by subparagraph (2)(iii) shall be filed with the
Internal Revenue Service Center with which the income tax return was
filed.
(4) See 1.305-7(b) for a discussion of antidilution adjustments in
connection with the application of section 305(c) in conjunction with
section 305(b).
(e) Examples. The application of section 305(b)(2) to distributions
of stock and section 305(c) to deemed distributions of stock may be
illustrated by the following examples:
Example (1). Corporation X is organized with two classes of common
stock, class A and class B. Each share of stock is entitled to share
equally in the assets and earnings and profits of the corporation.
Dividends may be paid in stock or in cash on either class of stock
without regard to the medium of payment of dividends on the other class.
A dividend is declared on the class A stock payable in additional
shares of class A stock and a dividend is declared on class B stock
payable in cash. Since the class A shareholders as a class will have
increased their proportionate interests in the assets and earnings and
profits of the corporation and the class B shareholders will have
received cash, the additional shares of class A stock are distributions
of property to which section 301 applies. This is true even with
respect to those shareholders who may own class A stock and class B
stock in the same proportion.
Example (2). Corporation Y is organized with two classes of stock,
class A common, and class B, which is nonconvertible and limited and
preferred as to dividends. A dividend is declared upon the class A
stock payable in additional shares of class A stock and a dividend is
declared on the class B stock payable in cash. The distribution of
class A stock is not one to which section 301 applies because the
distribution does not increase the proportionate interests of the class
A shareholders as a class.
Example (3). Corporation K is organized with two classes of stock,
class A common, and class B, which is nonconvertible preferred stock. A
dividend is declared upon the class A stock payable in shares of class B
stock and a dividend is declared on the class B stock payable in cash.
Since the class A shareholders as a class have an increased interest in
the assets and earnings and profits of the corporation, the stock
distribution is treated as a distribution to which section 301 applies.
If, however, a dividend were declared upon the class A stock payable in
a new class of preferred stock that is subordinated in all respects to
the class B stock, the distribution would not increase the proportionate
interests of the class A shareholders in the assets or earnings and
profits of the corporation and would not be treated as a distribution to
which section 301 applies.
Example (4). (i) Corporation W has one class of stock outstanding,
class A common. The corporation also has outstanding interest paying
securities convertible into class A common stock which have a fixed
conversion ratio that is not subject to full adjustment in the event
stock dividends or rights are distributed to the class A shareholders.
Corporation W distributes to the class A shareholders rights to acquire
additional shares of class A stock. During the year, interest is paid
on the convertible securities.
(ii) The stock rights and convertible securities are considered to be
outstanding stock of the corporation and the distribution increases the
proportionate interests of the class A shareholders in the assets and
earnings and profits of the corporation. Therefore, the distribution is
treated as a distribution to which section 301 applies. The same result
would follow if, instead of convertible securities, the corporation had
outstanding convertible stock. If, however, the conversion ratio of the
securities or stock were fully adjusted to reflect the distribution of
rights to the class A shareholders, the rights to acquire class A stock
would not increase the proportionate interests of the class A
shareholders in the assets and earnings and profits of the corporation
and would not be treated as a distribution to which section 301 applies.
Example (5). (i) Corporation S is organized with two classes of
stock, class A common and class B convertible preferred. The class B is
fully protected against dilution in the event of a stock dividend or
stock split with respect to the class A stock; however, no adjustment
in the conversion ratio is required to be made until the stock dividends
equal 3 percent of the common stock issued and outstanding on the date
of the first such stock dividend except that such adjustment must be
made no later than 3 years after the date of the stock dividend. Cash
dividends are paid annually on the class B stock.
(ii) Corporation S pays a 1 percent stock dividend on the class A
stock in 1970. In 1971, another 1 percent stock dividend is paid and in
1972 another 1 percent stock dividend is paid. The conversion ratio of
the class B stock is increased in 1972 to reflect the three stock
dividends paid on the class A stock. The distributions of class A stock
are not distributions to which section 301 applies because they do not
increase the proportionate interests of the class A shareholders in the
assets and earnings and profits of the corporation.
Example (6). (i) Corporation M is organized with two classes of
stock outstanding, class A and class B. Each class B share may be
converted, at the option of the holder, into class A shares. During the
first year, the conversion ratio is one share of class A stock for each
share of class B stock. At the beginning of each subsequent year, the
conversion ratio is increased by 0.05 share of class A stock for each
share of class B stock. Thus, during the second year, the conversion
ratio would be 1.05 shares of class A stock for each share of class B
stock, during the third year, the ratio would be 1.10 shares, etc.
(ii) M pays an annual cash dividend on the class A stock. At the
beginning of the second year, when the conversion ratio is increased to
1.05 shares of class A stock for each share of class B stock, a
distribution of 0.05 shares of class A stock is deemed made under
section 305(c) with respect to each share of class B stock, since the
proportionate interests of the class B shareholders in the assets or
earnings and profits of M are increased and the transaction has the
effect described in section 305(b)(2). Accordingly, sections 305(b)(2)
and 301 apply to the transaction.
Example (7). (i) Corporation N has two classes of stock outstanding,
class A and class B. Each class B share is convertible into class A
stock. However, in accordance with a specified formula, the conversion
ratio is decreased each time a cash dividend is paid on the class B
stock to reflect the amount of the cash dividend. The conversion ratio
is also adjusted in the event that cash dividends are paid on the class
A stock to increase the number of class A shares into which the class B
shares are convertible to compensate the class B shareholders for the
cash dividend paid on the class A stock.
(ii) In 1972, a $1 cash dividend per share is declared and paid on
the class B stock. On the date of payment, the conversion ratio of the
class B stock is decreased. A distribution of stock is deemed made
under section 305(c) to the class A shareholders, since the
proportionate interest of the class A shareholders in the assets or
earnings and profits of the corporation is increased and the transaction
has the effect described in section 305(b)(2). Accordingly, sections
305(b)(2) and 301 apply to the transaction.
(iii) In the following year a cash dividend is paid on the class A
stock and none is paid on the class B stock. The increase in conversion
rights of the class B shares is deemed to be a distribution under
section 305(c) to the class B shareholders since their proportionate
interest in the assets or earnings and profits of the corporation is
increased and since the transaction has the effect described in section
305(b)(2). Accordingly, sections 305(b)(2) and 301 apply to the
transaction.
Example (8). Corporation T has 1,000 shares of stock outstanding. C
owns 100 shares. Nine other shareholders each owns 100 shares.
Pursuant to a plan for periodic redemptions, T redeems up to 5 percent
of each shareholder's stock each year. During the year, each of the
nine other shareholders has 5 shares of his stock redeemed for cash.
Thus, C's proportionate interest in the assets and earnings and profits
of T is increased. Assuming that the cash received by the nine other
shareholders is taxable under section 301, C is deemed under section
305(c) to have received a distribution under section 305(b)(2) of 5.25
shares of T stock to which section 301 applies. The amount of C's
distribution is measured by the fair market value of the number of
shares which would have been distributed to C had the corporation sought
to increase his interest by 0.47 percentage points (C owned 10 percent
of the T stock immediately before the redemption and 10.47 percent
immediately thereafter) and the other shareholders continued to hold 900
shares (i.e.,
(a) 100 955=10.47% (percent of C's ownership after redemption)
(b) 100+x 1000+x=10.47%; x=5.25 (additional shares considered to be
distributed to C)).
Since in computing the amount of additional shares deemed to be
distributed to C the redemption of shares is disregarded, the redemption
of shares will be similarly disregarded in determining the value of the
stock of the corporation which is deemed to be distributed. Thus, in
the example, 1,005.25 shares of stock are considered as outstanding
after the redemption. The value of each share deemed to be distributed
to C is then determined by dividing the 1,005.25 shares into the
aggregate fair market value of the actual shares outstanding (955) after
the redemption.
Example (9). (i) Corporation O has a stock redemption program under
which, instead of paying out earnings and profits to its shareholders in
the form of dividends, it redeems the stock of its shareholders up to a
stated amount which is determined by the earnings and profits of the
corporation. If the stock tendered for redemption exceeds the stated
amount, the corporation redeems the stock on a pro rata basis up to the
stated amount.
(ii) During the year corporation O offers to distribute $10,000 in
redemption of its stock. At the time of the offering, corporation O has
1,000 shares outstanding of which E and F each owns 150 shares and G and
H each owns 350 shares. The corporation redeems 15 shares from E and 35
shares from G. F and H continue to hold all of their stock.
(iii) F and H have increased their proportionate interests in the
assets and earnings and profits of the corporation. Assuming that the
cash E and G receive is taxable under section 301, F will be deemed
under section 305(c) to have received a distribution under section
305(b)(2) of 16.66 shares of stock to which section 301 applies and H
will be deemed under section 305(c) to have received a distribution
under section 305(b)(2) of 38.86 shares of stock to which section 301
applies. The amount of the distribution to F and H is measured by the
number of shares which would have been distributed to F and H had the
corporation sought to increase the interest of F by 0.79 percentage
points (F owned 15 percent of the stock immediately before the
redemption and 15.79 percent immediately thereafter) and the interest of
H by 1.84 percentage points (H owned 35 percent of the stock immediately
before the redemption and 36.84 percent immediately thereafter) and E
and G had continued to hold 150 shares and 350 shares, respectively
(i.e.,
(a) 150 950+350 950=52.63% (percent of F and H's ownership after
redemption)
(b) 500+y 1000+y=52.63%; y=55.52 (additional shares considered to be
distributed to F and H)
(c) (1) 150 500 55.52=16.66 (shares considered to be distributed to
F)
Since in computing the amount of additional shares deemed to be
distributed to F and H the redemption of shares is disregarded, the
redemption of shares will be similarly disregarded in determining the
value of the stock of the corporation which is deemed to be distributed.
Thus, in the example, 1,055.52 shares of stock are considered as
outstanding after the redemption. The value of each share deemed to be
distributed to F and H is then determined by dividing the 1,055.52
shares into the aggregate fair market value of the actual shares
outstanding (950) after the redemption.
Example (10). Corporation P has 1,000 shares of stock outstanding.
T owns 700 shares of the P stock and G owns 300 shares of the P stock.
In a single and isolated redemption to which section 301 applies, the
corporation redeems 150 shares of T's stock. Since this is an isolated
redemption and is not a part of a periodic redemption plan, G is not
treated as having received a deemed distribution under section 305(c) to
which sections 305(b)(2) and 301 apply even though he has an increased
proportionate interest in the assets and earnings and profits of the
corporation.
Example (11). Corporation Q is a large corporation whose sole class
of stock is widely held. However, the four largest shareholders are
officers of the corporation and each owns 8 percent of the outstanding
stock. In 1974, in a distribution to which section 301 applies, the
corporation redeems 1.5 percent of the stock from each of the four
largest shareholders in preparation for their retirement. From 1970
through 1974, the corporation distributes annual stock dividends to its
shareholders. No other distributions were made to these shareholders.
Since the 1974 redemptions are isolated and are not part of a plan for
periodically redeeming the stock of the corporation, the shareholders
receiving stock dividends will not be treated as having received a
distribution under section 305(b)(2) even though they have an increased
proportionate interest in the assets and earnings and profits of the
corporation and whether or not the redemptions are treated as
distributions to which section 301 applies.
Example (12). Corporation R has 2,000 shares of class A stock
outstanding. Five shareholders own 300 shares each and five
shareholders own 100 shares each. In preparation for the retirement of
the five major shareholders, corporation R, in a single and isolated
transaction, has a recapitalization in which each share of class A stock
may be exchanged either for five shares of new class B nonconvertible
preferred stock plus 0.4 share of new class C common stock, or for two
shares of new class C common stock. As a result of the exchanges, each
of the five major shareholders receives 1,500 shares of class B
nonconvertible preferred stock and 120 shares of class C common stock.
The remaining shareholders each receives 200 shares of class C common
stock. None of the exchanges are within the purview of section 305.
Example (13). Corporation P is a widely-held company whose shares
are listed for trading on a stock exchange. P distributes annual cash
dividends to its shareholders. P purchases shares of its common stock
directly from small stockholders (holders of record of 100 shares or
less) or through brokers where the holders may not be known at the time
of purchase. Where such purchases are made through brokers, they are
pursuant to the rules and regulations of the Securities and Exchange
Commission. The shares are purchased for the purpose of issuance to
employee stock investment plans, to holders of convertible stock or
debt, to holders of stock options, or for future acquisitions. Provided
the purchases are not pursuant to a plan to increase the proportionate
interest of some shareholders and distribute property to other
shareholders, the remaining shareholders of P are not treated as having
received a deemed distribution under section 305(c) to which section
305(b)(2) and 301 apply, even though they have an increased
proportionate interest in the assets and earnings and profits of the
corporation.
Example (14). Corporation U is a large manufacturing company whose
products are sold through independent dealers. In order to assist
individuals who lack capital to become dealers, the corporation has an
established investment plan under which it provides 75 percent of the
capital necessary to form a dealership corporation and the individual
dealer provides the remaining 25 percent. Corporation U receives class
A stock and a note representing its 75 percent interest. The individual
dealer receives class B stock representing his 25 percent interest. The
class B stock is nonvoting until all the class A shares are redeemed.
At least 70 percent of the earnings and profits of the dealership
corporation must be used each year to retire the note and to redeem the
class A stock. The class A stock is redeemed at a fixed price. The
individual dealer has no control over the redemption of stock and has no
right to have his stock redeemed during the period the plan is in
existence. U's investment is thus systematically eliminated and the
individual becomes the sole owner of the dealership corporation. Since
this type of plan is akin to a security arrangement, the redemptions of
the class A stock will not be deemed under section 305(c) as
distributions taxable under sections 305(b)(2) and 301 during the years
in which the class A stock is redeemed.
Example (15). (i) Corporation V is organized with two classes of
stock, class A common and class B convertible preferred. The class B
stock is issued for $100 per share and is convertible into class A at a
fixed ratio that is not subject to full adjustment in the event stock
dividends or rights are distributed to the class A shareholders. The
class B stock pays no dividends but it is redeemable in 10 years for
$200. There are no facts to indicate that a call premium in excess of
10 percent of the issue price is reasonable. Under sections 305(c) and
305(b)(4), $90 of the redemption price (i.e., the excess of the
redemption price over the sum of the issue price and a reasonable call
premium) is deemed to be a distribution of preferred stock on preferred
stock which is taxable as a distribution of property under section 301.
This amount is considered to be distributed ratably over the 10-year
period. During the year, the corporation declares a dividend on the
class A stock payable in additional shares of class A stock.
(ii) The distribution on the class A stock is a distribution to which
sections 305(b)(2) and 301 apply since it increases the proportionate
interests of the class A shareholders in the assets and earnings and
profits of the corporation and the class B stockholders have received
property (i.e., a ratable share of the $90 excessive call premium deemed
distributed pursuant to sections 305(c) and 305(b)(4) and taxable as a
distribution of property under section 301). If, however, the
conversion ratio of the class B stock were subject to full adjustment to
reflect the distribution of stock to class A shareholders, the
distribution of stock dividends on the class A stock would not increase
the proportionate interests of the class A shareholders in the assets
and earnings and profits of the corporation and such distribution would
not be a distribution to which section 301 applies.
(T.D. 7281, 38 FR 18532, July 12, 1973; 38 FR 19910, 19911, July 25,
1973; as amended by T.D. 7329, 39 FR 36860, Oct. 15, 1974)
26 CFR 1.305-4 Distributions of common and preferred stock.
(a) In general. Under section 305(b)(3), a distribution (or a series
of distributions) by a corporation which results in the receipt of
preferred stock whether or not convertible into common stock) by some
common shareholders and the receipt of common stock by other common
shareholders is treated as a distribution of property to which section
301 applies. For the meaning of the term ''a series of distribution,''
see subparagraphs (1) through (6) of 1.305-3(b).
(b) Examples. The application of section 305(b)(3) may be
illustrated by the following examples:
Example (1). Corporation X is organized with two classes of common
stock, class A and class B. Dividends may be paid in stock or in cash
on either class of stock without regard to the medium of payment of
dividends on the other class. A dividend is declared on the class A
stock payable in additional shares of class A stock and a dividend is
declared on class B stock payable in newly authorized class C stock
which is nonconvertible and limited and preferred as to dividends. Both
the distribution of class A shares and the distribution of new class C
shares are distributions to which section 301 applies.
Example (2). Corporation Y is organized with one class of stock,
class A common. During the year the corporation declares a dividend on
the class A stock payable in newly authorized class B preferred stock
which is convertible into class A stock no later than 6 months from the
date of distribution at a price that is only slightly higher than the
market price of class A stock on the date of distribution. Taking into
account the dividend rate, redemption provisions, the marketability of
the convertible stock, and the conversion price, it is reasonable to
anticipate that within a relatively short period of time some
shareholders will exercise their conversion rights and some will not.
Since the distribution can reasonably be expected to result in the
receipt of preferred stock by some common shareholders and the receipt
of common stock by other common shareholders, the distribution is a
distribution of property to which section 301 applies.
(T.D. 7281, 38 FR 18536, July 12, 1973)
26 CFR 1.305-5 Distributions on preferred stock.
(a) In general. Under section 305(b)(4), a distribution by a
corporation of its stock (or rights to acquire its stock) made (or
deemed made under section 305(c)) with respect to its preferred stock is
treated as a distribution of property to which section 301 applies
unless the distribution is made with respect to convertible preferred
stock to take into account a stock dividend, stock split, or any similar
event (such as the sale of stock at less than the fair market value
pursuant to a rights offering) which would otherwise result in the
dilution of the conversion right. For purposes of the preceding
sentence, an adjustment in the conversion ratio of convertible preferred
stock made solely to take into account the distribution by a closed end
regulated investment company of a capital gain dividend with respect to
the stock into which such stock is convertible shall not be considered a
''similar event.'' The term ''preferred stock'' generally refers to
stock which, in relation to other classes of stock outstanding, enjoys
certain limited rights and privileges (generally associated with
specified dividend and liquidation priorities) but does not participate
in corporate growth to any significant extent. The distinguishing
feature of ''preferred stock'' for the purposes of section 305(b)(4) is
not its privileged position as such, but that such privileged position
is limited, and that such stock does not participate in corporate growth
to any significant extent. However, a right to participate which lacks
substance will not prevent a class of stock from being treated as
preferred stock. Thus, stock which enjoys a priority as to dividends
and on liquidation but which is entitled to participate, over and above
such priority, with another less privileged class of stock in earnings
and profits and upon liquidation, may nevertheless be treated as
preferred stock for purposes of section 305 if, taking into account all
the facts and circumstances, it is reasonable to anticipate at the time
a distribution is made (or is deemed to have been made) with respect to
such stock that there is little or no likelihood of such stock actually
participating in current and anticipated earnings and upon liquidation
beyond its preferred interest. Among the facts and circumstances to be
considered are the prior and anticipated earnings per share, the cash
dividends per share, the book value per share, the extent of preference
and of participation of each class, both absolutely and relative to each
other, and any other facts which indicate whether or not the stock has a
real and meaningful probability of actually participating in the
earnings and growth of the corporation. The determination of whether
stock is preferred for purposes of section 305 shall be made without
regard to any right to convert such stock into another class of stock of
the corporation. The term ''preferred stock'', however, does not
include convertible debentures.
(b) Redemption premium. (1) If a corporation issues preferred stock
which may be redeemed after a specified period of time at a price higher
than the issue price, the difference will be considered under the
authority of section 305(c) to be a distribution of additional stock on
preferred stock which is constructively received by the shareholder over
the period of time during which the preferred stock cannot be called for
redemption.
(2) Subparagraph (1) of this paragraph shall not apply to the extent
that the difference between issue price and redemption price is a
reasonable redemption premium. A redemption premium will be considered
reasonable if it is in the nature of a penalty for a premature
redemption of the preferred stock and if such premium does not exceed
the amount the corporation would be required to pay for the right to
make such premature redemption under market conditions existing at the
time of issuance. Such an amount can be established by comparing call
premium rates on comparable stock paying comparable dividends. However,
for purposes of this subparagraph, a redemption premium not in excess of
10 percent of the issue price on stock which is not redeemable for 5
years from the date of issue shall be considered reasonable.
(c) Cross reference. For rules for applying sections 305(b)(4) and
305(c) to recapitalizations, see 1.305-7(c).
(d) Examples. The application of sections 305(b)(4) and 305(c) may
be illustrated by the following examples:
Example (1). (i) Corporation T has outstanding 1,000 shares of $100
par 5-percent cumulative preferred stock and 10,000 shares of no-par
common stock. The corporation is 4 years in arrears on dividends to the
preferred shareholders. The issue price of the preferred stock is $100
per share. Pursuant to a recapitalization under section 368(a)(1)(E),
the preferred shareholders exchange their preferred stock, including the
right to dividend arrearages, on the basis of one old preferred share
for 1.20 newly authorized class A preferred shares. Immediately
following the recapitalization, the new class A shares are traded at
$100 per share. The class A shares are entitled to a liquidation
preference of $100. The preferred shareholders have increased their
proportionate interest in the assets or earnings and profits of
corporation T since the fair market value of 1.20 shares of class A
preferred stock ($120) exceeds the issue price of the old preferred
stock ($100). Accordingly, the preferred shareholders are deemed under
section 305(c) to receive a distribution in the amount of $20 on each
share of old preferred stock and the distribution is one to which
sections 305(b)(4) and 301 apply.
(ii) The same result would occur if the fair market value of the
common stock immediately following the recapitalization were $20 per
share and each share of preferred stock were exchanged for one share of
the new class A preferred stock and one share of common stock.
Example (2). Corporation A, a publicly held company whose stock is
traded on a securities exchange (or in the over-the-counter market) has
two classes of stock outstanding, common and cumulative preferred. Each
share of preferred stock is convertible into .75 shares of common stock.
There are no dividend arrearages. At the time of issue of the
preferred stock, there was no plan or prearrangement by which it was to
be exchanged for common stock. The issue price of the preferred stock
is $100 per share. In order to retire the preferred stock, corporation
A recapitalizes in a transaction to which section 368(a)(1)(E) applies
and each share of preferred stock is exchanged for one share of common
stock. Immediately after the recapitalization the common stock has a
fair market value of $110 per share. Notwithstanding the fact that the
fair market value of the common stock received in the exchange
(determined immediately following the recapitalization) exceeds the
issue price of the preferred stock surrendered, the recapitalization is
not deemed under section 305(c) to result in a distribution to which
sections 305(b)(4) and 301 apply since the recapitalization is not
pursuant to a plan to periodically increase a shareholder's
proportionate interest in the assets or earnings and profits and does
not involve dividend arrearages.
Example (3). Corporation V is organized with two classes of stock,
1,000 shares of class A common and 1,000 shares of class B convertible
preferred. Each share of class B stock may be converted into two shares
of class A stock. Pursuant to a recapitalization under section
368(a)(1)(E), the 1,000 shares of class A stock are surrendered in
exchange for 500 shares of new class A common and 500 shares of newly
authorized class C common. The conversion right of class B stock is
changed to one share of class A stock and one share of class C stock for
each share of class B stock. The change in the conversion right is not
deemed under section 305(c) to be a distribution on preferred stock to
which sections 305(b)(4) and 301 apply.
Example (4). Corporation X issues preferred stock for $100 per
share. The stock is redeemable in 5 years or any time thereafter for
$110. The redemption price at no time exceeds 10 percent of the issue
price. The difference between redemption price and issue price is not
deemed under section 305(c) to be a distribution on preferred stock to
which sections 305(b)(4) and 301 supply.
Example (5). Corporation W issues preferred stock for $100 per
share. The stock pays no dividends but is redeemable at the end of 5
years for $185 with yearly increases thereafter of $15. There are no
facts to indicate that a call premium in excess of $10 is reasonable.
Since the difference between redemption price and issue price exceeds
the reasonable call premium to the extent of $75 that amount is
considered to be a distribution of additional stock on preferred stock
which is constructively received over the 5-year period. Therefore, the
shareholder is deemed under section 305(c) to receive on the last day of
each year during the 5-year period a distribution on his preferred stock
in an amount equal to 15 percent of the issue price. Each $15 increase
in the redemption price thereafter is considered to be a distribution on
the preferred stock at the time each such increase becomes effective.
Example (6). Corporation A, a publicly held company whose stock is
traded on a securities exchange (or in the over-the-counter market) has
two classes of stock outstanding, common and preferred. The preferred
stock is nonvoting and nonconvertible, limited and preferred as to
dividends, and has a fixed liquidation preference. There are no
dividend arrearages. At the time of issue of the preferred stock, there
was no plan or prearrangement by which it was to be exchanged for common
stock. In order to retire the preferred stock, corporation A
recapitalizes in a transaction to which section 368(a)(1)(E) applies and
the preferred stock is exchanged for common stock. The transaction is
not deemed to be a distribution under section 305(c) and sections 305(b)
and 301 do not apply to the transaction. The same result would follow
if the preferred stock was exchanged in any reorganization described in
section 368(a)(1) for a new preferred stock having substantially the
same market value and having no greater call price or liquidation
preference than the old preferred stock, whether the new preferred stock
has voting rights or is convertible into common stock of corporation A
at a fixed ratio subject to change solely to take account of stock
dividends, stock splits, or similar transactions with respect to the
stock into which the preferred stock is convertible.
Example (7). Corporation R has only common stock outstanding.
Corporation R distributes to the common shareholders on a pro rata
basis, newly authorized 2-percent preferred stock. Such stock has a par
value of $100 per share and is redeemable at the end of 5 years for $105
per share. At the time of the distribution, the fair market value of
the preferred stock is $50 per share. There are no facts to indicate
that a call premium in excess of $5 is reasonable. Since the difference
between redemption price and issue price (i.e., the fair market value of
the preferred stock immediately following its distribution as a stock
dividend) exceeds the reasonable call premium to the extent of $50, that
amount is considered to be a distribution of additional stock on
preferred stock which is constructively received over the 5-year period.
Therefore, each shareholder is deemed under section 305(c) to receive
each year during the 5-year period a distribution in the amount of $10
on his preferred stock to which sections 305(b)(4) and 301 apply.
Example (8). Corporation Q is organized with 10,000 shares of class
A stock and 1,000 shares of class B stock. The terms of the class B
stock require that the class B have a preference of $5 per share with
respect to dividends and $100 per share with respect to liquidation. In
addition, upon a distribution of $10 per share to the class A stock,
class B participates equally in any additional dividends. The terms
also provide that upon liquidation the class B stock participates
equally after the class A stock receives $100 per share. Corporation Q
has no accumulated earnings and profits. In 1971 it earned $10,000, the
highest earnings in its history. The corporation is in an industry in
which it is reasonable to anticipate a growth in earnings of 5 percent
per year. In 1971 the book value of corporation Q's assets totalled
$100,000. In that year the corporation paid a dividend of $5 per share
to the class B stock and $.50 per share to the class A. In 1972 the
corporation had no earnings and in lieu of a $5 dividend distributed one
share of class B stock for each outstanding share of class B. No
distribution was made to the class A stock. Since, in 1972, it was not
reasonable to anticipate that the class B stock would participate in the
current and anticipated earnings and growth of the corporation beyond
its preferred interest, the class B stock is preferred stock and the
distribution of class B shares to the class B shareholders is a
distribution to which sections 305(b)(4) and 301 apply.
Example (9). Corporation P is organized with 10,000 shares of class
A stock and 1,000 shares of class B stock. The terms of the class B
stock require that the class B have a preference of $5 per share with
respect to dividends and $100 per share with respect to liquidation. In
addition, upon a distribution of $5 per share to the class A stock,
class B participates equally in any additional dividends. The terms
also provide that upon liquidation the class B stock participates
equally after the class A receives $100 per share. Corporation P has
accumulated earnings and profits of $100,000. In 1971 it earned
$75,000. The corporation is in an industry in which it is reasonable to
anticipate a growth in earnings of 10 percent per year. In 1971 the
book value of corporation P's assets totalled $5 million. In that year
the corporation paid a dividend of $5 per share to the class B stock, $5
per share to the class A stock, and it distributed an additional $1 per
share to both class A and class B stock. In 1972 the corporation had
earnings of $82,500. In that year it paid a dividend of $5 per share to
the class B stock and $5 per share to the class A stock. In addition,
the corporation declared stock dividends of one share of class B stock
for every 10 outstanding shares of class B and one share of class A
stock for every 10 outstanding shares of class A. Since, in 1972, it
was reasonable to anticipate that both the class B stock and the class A
stock would participate in the current and anticipated earnings and
growth of the corporation beyond their preferred interests, neither
class is preferred stock and the stock dividends are not distributions
to which section 305(b)(4) applies.
(T.D. 7281, 38 FR 18536, July 12, 1973, as amended by T.D. 7329, 39
FR 36860, Oct. 15, 1974)
26 CFR 1.305-6 Distributions of convertible preferred.
(a) In general. (1) Under section 305(b)(5), a distribution by a
corporation of its convertible preferred stock or rights to acquire such
stock made or considered as made with respect to its stock is treated as
a distribution of property to which section 301 applies unless the
corporation establishes that such distribution will not result in a
disproportionate distribution as described in 1.305-3.
(2) The distribution of convertible preferred stock is likely to
result in a disproportionate distribution when both of the following
conditions exist: (i) The conversion right must be exercised within a
relatively short period of time after the date of distribution of the
stock; and (ii) taking into account such factors as the dividend rate,
the redemption provisions, the marketability of the convertible stock,
and the conversion price, it may be anticipated that some shareholders
will exercise their conversion rights and some will not. On the other
hand, where the conversion right may be exercised over a period of many
years and the dividend rate is consistent with market conditions at the
time of distribution of the stock, there is no basis for predicting at
what time and the extent to which the stock will be converted and it is
unlikely that a disproportionate distribution will result.
(b) Examples. The application of section 305(b)(5) may be
illustrated by the following examples:
Example (1). Corporation Z is organized with one class of stock,
class A common. During the year the corporation declares a dividend on
the class A stock payable in newly authorized class B preferred stock
which is convertible into class A stock for a period of 20 years from
the date of issuance. Assuming dividend rates are normal in light of
existing conditions so that there is no basis for predicting the extent
to which the stock will be converted, the circumstances will ordinarily
be sufficient to establish that a disproportionate distribution will not
result since it is impossible to predict the extent to which the class B
stock will be converted into class A stock. Accordingly, the
distribution of class B stock is not one to which section 301 applies.
Example (2). Corporation X is organized with one class of stock,
class A common. During the year the corporation declares a dividend on
the class A stock payable in newly authorized redeemable class C
preferred stock which is convertible into class A common stock no later
than 4 months from the date of distribution at a price slightly higher
than the market price of class A stock on the date of distribution. By
prearrangement with corporation X, corporation Y, an insurance company,
agrees to purchase class C stock from any shareholder who does not wish
to convert. By reason of this prearrangement, it is anticipated that
the shareholders will either sell the class C stock to the insurance
company (which expects to retain the shares for investment purposes) or
will convert. As a result, some of the shareholders exercise their
conversion privilege and receive additional shares of class A stock,
while other shareholders sell their class C stock to corporation Y and
receive cash. The distribution is a distribution to which section 301
applies since it results in the receipt of property by some shareholders
and an increase in the proportionate interests of other shareholders.
(T.D. 7281, 38 FR 18538, July 12, 1973)
26 CFR 1.305-7 Certain transactions treated as distributions.
(a) In general. Under section 305(c), a change in conversion ratio,
a change in redemption price, a difference between redemption price and
issue price, a redemption which is treated as a distribution to which
section 301 applies, or any transaction (including a recapitalization)
having a similar effect on the interest of any shareholder may be
treated as a distribution with respect to any shareholder whose
proportionate interest in the earnings and profits or assets of the
corporation is increased by such change, difference, redemption, or
similar transaction. In general, such change, difference, redemption,
or similar transaction will be treated as a distribution to which
sections 305(b) and 301 apply where --
(1) The proportionate interest of any shareholder in the earnings and
profits or assets of the corporation deemed to have made such
distribution is increased by such change, difference, redemption, or
similar transaction; and
(2) Such distribution has the result described in paragraph (2), (3),
(4), or (5) of section 305(b).
Where such change, difference, redemption, or similar transaction is
treated as a distribution under the provisions of this section, such
distribution will be deemed made with respect to any shareholder whose
interest in the earnings and profits or assets of the distributing
corporation is increased thereby. Such distribution will be deemed to
be a distribution of the stock of such corporation made by the
corporation to such shareholder with respect to his stock. Depending
upon the facts presented, the distribution may be deemed to be made in
common or preferred stock. For example, where a redemption price in
excess of a reasonable call premium exists with respect to a class of
preferred stock and the other requirements of this section are also met,
the distribution will be deemed made with respect to such preferred
stock, in stock of the same class. Accordingly, the preferred
shareholders are considered under sections 305(b)(4) and 305(c) to have
received a distribution of preferred stock to which section 301 applies.
See the examples in 1.305-3(e) and 1.305-5(d) for further
illustrations of the application of section 305(c).
(b) Antidilution provisions. (1) For purposes of applying section
305(c) in conjunction with section 305(b), a change in the conversion
ratio or conversion price of convertible preferred stock (or
securities), or in the exercise price of rights or warrants, made
pursuant to a bona fide, reasonable, adjustment formula (including, but
not limited to, either the so-called ''market price'' or ''conversion
price'' type of formulas) which has the effect of preventing dilution of
the interest of the holders of such stock (or securities) will not be
considered to result in a deemed distribution of stock. An adjustment
in the conversion ratio or price to compensate for cash or property
distributions to other shareholders that are taxable under section 301,
356(a)(2), 871(a)(1)(A), 881(a)(1), 852(b), or 857(b) will not be
considered as made pursuant to a bona fide adjustment formula.
(2) The principles of this paragraph may be illustrated by the
following example:
Example. (i) Corporation U has two classes of stock outstanding,
class A and class B. Each class B share is convertible into class A
stock. In accordance with a bonafide, reasonable, antidilution
provision, the conversion price is adjusted if the corporation transfers
class A stock to anyone for a consideration that is below the conversion
price.
(ii) The corporation sells class A stock to the public at the current
market price but below the conversion price. Pursuant to the
antidilution provision, the conversion price is adjusted downward. Such
a change in conversion price will not be deemed to be a distribution
under section 305(c) for the purposes of section 305(b).
(c) Recapitalizations. (1) A recapitalization (whether or not an
isolated transaction) will be deemed to result in a distribution to
which section 305(c) and this section apply if --
(i) It is pursuant to a plan to periodically increase a shareholder's
proportionate interest in the assets or earnings and profits of the
corporation, or
(ii) A shareholder owning preferred stock with dividends in arrears
exchanges his stock for other stock and, as a result, increases his
proportionate interest in the assets or earnings and profits of the
corporation. An increase in a preferred shareholder's proportionate
interest occurs in any case where the fair market value or the
liquidation preference, whichever is greater, of the stock received in
the exchange (determined immediately following the recapitalization),
exceeds the issue price of the preferred stock surrendered.
(2) In a case to which subparagraph (1)(ii) of this paragraph
applies, the amount of the distribution deemed under section 305(c) to
result from the recapitalization is the lesser of (i) the amount by
which the fair market value or the liquidation preference, whichever is
greater, of the stock received in the exchange (determined immediately
following the recapitalization) exceeds the issue price of the preferred
stock surrendered, or (ii) the amount of the dividends in arrears.
(3) For purposes of applying subparagraphs (1) and (2) of this
paragraph with respect to stock issued before July 12, 1973, the term
''issue price of the preferred stock surrendered'' shall mean the
greater of the issue price or the liquidation preference (not including
dividends in arrears) of the stock surrendered.
(4) For an illustration of the application of this paragraph, see
example (12) of 1.305-3(e) and examples (1), (2), (3), and (6) of
1.305-5(d).
(5) For rules relating to redemption premiums on preferred stock, see
1.305-5(b).
(T.D. 7281, 38 FR 18538, July 12, 1973)
26 CFR 1.305-8 Effective dates.
(a) In general. Section 421(b) of the Tax Reform Act of 1969 (83
Stat. 615) provides as follows:
(b) Effective dates. (1) Except as otherwise provided in this
subsection, the amendment made by subsection (a) shall apply with
respect to distributions (or deemed distributions) made after January
10, 1969, in taxable years ending after such date.
(2) (A) Section 305(b)(2) of the Internal Revenue Code of 1954 (as
added by subsection (a) shall not apply to a distribution (or deemed
distribution) of stock made before January 1, 1991, with respect to
stock (i) outstanding on January 10, 1969, (ii) issued pursuant to a
contract binding on January 10, 1969, on the distributing corporation,
(iii) which is additional stock of that class of stock which (as of
January 10, 1969) had the largest fair market value of all classes of
stock of the corporation (taking into account only stock outstanding on
January 10, 1969, or issued pursuant to a contract binding on January
10, 1969), (iv) described in subparagraph (c)(iii), or (v) issued in a
prior distribution described in clause (i), (ii), (iii), or (iv).
(B) Subparagraph (A) shall apply only if --
(i) The stock as to which there is a receipt of property was
outstanding on January 10, 1969 (or was issued pursuant to a contract
binding on January 10, 1969, on the distributing corporation), and
(ii) If such stock and any stock described in subparagraph (A)(i)
were also outstanding on January 10, 1968, a distribution of property
was made on or before January 10, 1969, with respect to such stock, and
a distribution of stock was made on or before January 10, 1969, with
respect to such stock described in subparagraph (A)(i).
(C) Subparagraph (A) shall cease to apply when at any time after
October 9, 1969, the distributing corporation issues any of its stock
(other than in a distribution of stock with respect to stock of the same
class) which is not --
(i) Nonconvertible preferred stock,
(ii) Additional stock of that class of stock which meets the
requirements of subparagraph (A)(iii), or
(iii) Preferred stock which is convertible into stock which meets the
requirements of subparagraph (A)(iii) at a fixed conversion ratio which
takes account of all stock dividends and stock splits with respect to
the stock into which such convertible stock is convertible.
(D) For purposes of this paragraph, the term ''stock'' includes
rights to acquire such stock.
(3) In cases to which Treasury Decision 6990 (promulgated January 10,
1969) would not have applied, in applying paragraphs (1) and (2) April
22, 1969, shall be substituted for January 10, 1969.
(4) Section 305(b)(4) of the Internal Revenue Code of 1954 (as added
by subsection (a)) shall not apply to any distribution (or deemed
distribution) with respect to preferred stock (including any increase in
the conversation ratio of convertible stock) made before January 1,
1991, pursuant to the terms relating to the issuance of such stock which
were in effect on January 10, 1969.
(5) With respect to distributions made or considered as made after
January 10, 1969, in taxable years ending after such date, to the extent
that the amendment made by subsection (a) does not apply by reason of
paragraph (2), (3), or (4) of this subsection, section 305 of the
Internal Revenue Code of 1954 (as in effect before the amendment made by
subsection (a)) shall continue to apply.
(b) Rules of application. (1) The rules contained in section
421(b)(2) of the Tax Reform Act of 1969 (83 Stat. 615), hereinafter
called ''the Act'', shall apply with respect to the application of
section 305(b)(2), section 305(b)(3), and section 305(b)(5). Thus, for
example, section 305(b)(5) of the Code will not apply to a distribution
of convertible preferred stock made before January 1, 1991, with respect
to stock outstanding on January 10, 1969 (or which was issued pursuant
to a contract binding on the distributing corporation on January 10,
1969), provided the distribution is pursuant to the terms relating to
the issuance of such stock which were in effect on January 10, 1969.
(2)(i) For purposes of section 421(b)(2) (A), (B)(i), and (C) of the
Act, stock is considered as outstanding on January 10, 1969, if it could
be acquired on such date or some future date by the exercise of a right
or conversion privilege in existence on such date (including a right or
conversion privilege with respect to stock issued pursuant to a contract
binding, on January 10, 1969, on the distributing corporation). Thus,
if on January 10, 1969, corporation X has outstanding 1,000 shares of
class A common stock and 3,000 shares of class B common stock which are
convertible on a one-to-one basis into class A stock, corporation X is
considered for purposes of section 421(b)(2) (A), (B)(i), and (C) of the
Act to have outstanding on January 10, 1969, 4,000 shares of class A
stock (1,000 shares actually outstanding and 3,000 shares that could be
acquired by the exercise of the conversion privilege contained in the
class B stock) and 3,000 shares of class B stock.
(ii) For the purposes of section 421(b)(2)(A) (other than for the
purpose of determining under section 421(b)(2)(A)(iii) that class of
stock which as of January 10, 1969, had the largest fair market value of
all classes of stock of the corporation), (B)(i), and (C) of the Act,
stock will be considered as outstanding on January 10, 1969, if it is
issued pursuant to a conversion privilege contained in stock issued,
mediately or immediately, as a stock dividend with respect to stock
outstanding on January 10, 1969.
(3) If, after applying subparagraph (2) of this paragraph, the class
of stock which as of January 10, 1969, had the largest fair market value
of all classes of stock of the corporation is a class of stock which is
convertible into another class of nonconvertible stock, then for
purposes of section 421(b)(2)(C)(ii) of the Act stock issued upon
conversion of any such convertible stock (whether or not outstanding on
January 10, 1969) into stock of such other class shall be deemed to be
stock which meets the requirements of section 421(b)(2)(A)(iii) of the
Act.
(4) For purposes of section 421(b) of the Act, stock of a corporation
held in its treasury will not be considered as outstanding and a
distribution of such stock will be considered to be an issuance of such
stock on the date of distribution. Stock of a parent corporation held
by its subsidiary is not considered treasury stock.
(5) The following stock shall not be taken into account for purposes
of applying section 421(b)(2)(B)(i) of the Act: (i) Stock issued after
January 10, 1969, and before October 10, 1969 (other than stock which
was issued pursuant to a contract binding on January 10, 1969, on the
distributing corporation); (ii) stock described in section 421(b)(2)(C)
(i), (ii), or (iii) of the Act; and (iii) stock issued, mediately or
immediately, as a stock dividend with respect to stock of the same class
outstanding on January 10, 1969. For example, if on June 1, 1970,
corporation Y issues additional stock of that class of stock which as of
January 10, 1969, had the largest fair market value of all classes of
stock of the corporation, such additional stock will not be taken into
account for the purpose of meeting the requirement under section
421(b)(2)(B)(i) of the Act that the stock as to which there is a receipt
of property must have been outstanding on January 10, 1969, and thus
subparagraph (A) of section 421(b)(2) of the Act will not, where
otherwise applicable, cease to apply.
(6) Section 421(b)(2)(A) of the Act, if otherwise applicable, will
not cease to apply if the distributing corporation issues after October
9, 1969, securities which are convertible into stock that meets the
requirements of section 421(b)(2)(A)(iii) of the Act at a fixed
conversion ratio which takes account of all stock dividends and stock
splits with respect to the stock into which the securities are
convertible.
(7) Under section 421(b)(4) of the Act, section 305(b)(4) does not
apply to any distribution (or deemed distribution) by a corporation with
respect to preferred stock made before January 1, 1991, if such
distribution is pursuant to the terms relating to the issuance of such
stock which were in effect on January 10, 1969. For example, if as of
January 10, 1969, a corporation had followed the practice of paying
stock dividends on preferred stock (or of periodically increasing the
conversion ratio of convertible preferred stock) or if the preferred
stock provided for a redemption price in excess of the issue price, then
section 305(b)(4) would not apply to any distribution of stock made (or
which would be considered made if section 305(b)(4) applied) before
January 1, 1991, pursuant to such practice.
(8) If section 421(b)(2) is not applicable and, for that reason, a
distribution (or deemed distribution) is treated as a distribution to
which section 301 applies by virtue of the application of section
305(b)(2), (b)(3), or (b)(5), it is irrelevant that, by reason of the
application of section 421(b)(4) of such Act, section 305(b)(4) is not
applicable to the distribution.
(T.D. 7281, 38 FR 18539, July 12, 1973)
26 CFR 1.306-1 General.
(a) Section 306 provides, in general, that the proceeds from the sale
or redemption of certain stock (referred to as ''section 306 stock'')
shall be treated either as ordinary income or as a distribution of
property to which section 301 applies. Section 306 stock is defined in
section 306(c) and is usually preferred stock received either as a
nontaxable dividend or in a transaction in which no gain or loss is
recognized. Section 306(b) lists certain circumstances in which the
special rules of section 306(a) shall not apply.
(b) (1) If a shareholder sells or otherwise disposes of section 306
stock (other than by redemption or within the exceptions listed in
section 306(b)), the entire proceeds received from such disposition
shall be treated as ordinary income to the extent that the fair market
value of the stock sold, on the date distributed to the shareholder,
would have been a dividend to such shareholder had the distributing
corporation distributed cash in lieu of stock. Any excess of the amount
received over the sum of the amount treated as ordinary income plus the
adjusted basis of the stock disposed of, shall be treated as gain from
the sale of a capital asset or noncapital asset as the case may be. No
loss shall be recognized. No reduction of earnings and profits results
from any disposition of stock other than a redemption. The term
''disposition'' under section 306(a)(1) includes, among other things,
pledges of stock under certain circumstances, particularly where the
pledgee can look only to the stock itself as its security.
(2) Section 306(a)(1) may be illustrated by the following examples:
Example (1). On December 15, 1954, A and B owned equally all of the
stock of Corporation X which files its income tax return on a calendar
year basis. On that date Corporation X distributed pro rata 100 shares
of preferred stock as a dividend on its outstanding common stock. On
December 15, 1954, the preferred stock had a fair market value of
$10,000. On December 31, 1954, the earnings and profits of Corporation
X were $20,000. The 50 shares of preferred stock so distributed to A
had an allocated basis to him of $10 per share or a total of $500 for
the 50 shares. Such shares had a fair market value of $5,000 when
issued. A sold the 50 shares of preferred stock on July 1, 1955, for
$6,000. Of this amount $5,000 will be treated as ordinary income; $500
($6,000 minus $5,500) will be treated as gain from the sale of a capital
or noncapital asset as the case may be.
Example (2). The facts are the same as in Example 1 except that A
sold his 50 shares of preferred stock for $5,100. Of this amount $5,000
will be treated as ordinary income. No loss will be allowed. There
will be added back to the basis of the common stock of Corporation X
with respect to which the preferred stock was distributed, $400, the
allocated basis of $500 reduced by the $100 received.
Example (3). The facts are the same as in example 1 except that A
sold 25 of his shares of preferred stock for $2,600. Of this amount
$2,500 will be treated as ordinary income. No loss will be allowed.
There will be added back to the basis of the common stock of Corporation
X with respect to which the preferred stock was distributed, $150, the
allocated basis of $250 reduced by the $100 received.
(c) The entire amount received by a shareholder from the redemption
of section 306 stock shall be treated as a distribution of property
under section 301. See also section 303 (relating to distribution in
redemption of stock to pay death taxes).
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7556, 43
FR 34128, Aug. 3, 1978)
26 CFR 1.306-2 Exception.
(a) If a shareholder terminates his entire stock interest in a
corporation --
(1) By a sale or other disposition within the requirements of section
306(b)(1)(A), or
(2) By redemption under section 302(b)(3) (through the application of
section 306(b)(1)(B)),
the amount received from such disposition shall be treated as an
amount received in part or full payment for the stock sold or redeemed.
In the case of a sale, only the stock interest need be terminated. In
determining whether an entire stock interest has been terminated under
section 306(b)(1)(A), all of the provisions of section 318(a) (relating
to constructive ownership of stock) shall be applicable. In determining
whether a shareholder has terminated his entire interest in a
corporation by a redemption of his stock under section 302(b)(3), all of
the provisions of section 318(a) shall be applicable unless the
shareholder meets the requirements of section 302(c)(2) (relating to
termination of all interest in the corporation). If the requirements of
section 302(c)(2) are met, section 318(a)(1) (relating to members of a
family) shall be inapplicable. Under all circumstances paragraphs (2),
(3), (4), and (5) of section 318(a) shall be applicable.
(b) Section 306(a) does not apply to --
(1) Redemptions of section 306 stock pursuant to a partial or
complete liquidation of a corporation to which part II (section 331 and
following), subchapter C, chapter 1 of the Code applies,
(2) Exchanges of section 306 stock solely for stock in connection
with a reorganization or in an exchange under section 351, 355, or
section 1036 (relating to exchanges of stock for stock in the same
corporation) to the extent that gain or loss is not recognized to the
shareholder as the result of the exchange of the stock (see paragraph
(d) of 1.306-3 relative to the receipt of other property), and
(3) A disposition or redemption, if it is established to the
satisfaction of the Commissioner that the distribution, and the
disposition or redemption, was not in pursuance of a plan having as one
of its principal purposes the avoidance of Federal income tax. However,
in the case of a prior or simultaneous disposition (or redemption) of
the stock with respect to which the section 306 stock disposed of (or
redeemed) was issued, it is not necessary to establish that the
distribution was not in pursuance of such a plan. For example, in the
absence of such a plan and of any other facts the first sentence of this
subparagraph would be applicable to the case of dividends and isolated
dispositions of section 306 stock by minority shareholders. Similarly,
in the absence of such a plan and of any other facts, if a shareholder
received a distribution of 100 shares of section 306 stock on his
holdings of 100 shares of voting common stock in a corporation and sells
his voting common stock before he disposes of his section 306 stock, the
subsequent disposition of his section 306 stock would not ordinarily be
considered a disposition one of the principal purposes of which is the
avoidance of Federal income tax.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33
FR 11998, Aug. 23, 1968)
26 CFR 1.306-3 Section 306 stock defined.
(a) For the purpose of subchapter C, chapter 1 of the code, the term
''section 306 stock'' means stock which meets the requirements of
section 306(c)(1). Any class of stock distributed to a shareholder in a
transaction in which no amount is includible in the income of the
shareholder or no gain or loss is recognized may be section 306 stock,
if a distribution of money by the distributing corporation in lieu of
such stock would have been a dividend in whole or in part. However,
except as provided in section 306(g), if no part of a distribution of
money by the distributing corporation in lieu of such stock would have
been a dividend, the stock distributed will not constitute section 306
stock.
(b) For the purpose of section 306, rights to acquire stock shall be
treated as stock. Such rights shall not be section 306 stock if no part
of the distribution would have been a dividend if money had been
distributed in lieu of the rights. When stock is acquired by the
exercise of rights which are treated at section 306 stock, the stock
acquired is section 306 stock. Upon the disposition of such stock
(other than by redemption or within the exceptions listed in section
306(b)), the proceeds received from the disposition shall be treated as
ordinary income to the extent that the fair market value of the stock
rights, on the date distributed to the shareholder, would have been a
dividend to the shareholder had the distributing corporation distributed
cash in lieu of stock rights. Any excess of the amount realized over
the sum of the amount treated as ordinary income plus the adjusted basis
of the stock, shall be treated as gain from the sale of the stock.
(c) Section 306(c)(1)(A) provides that section 306 stock is any stock
(other than common issued with respect to common) distributed to the
shareholder selling or otherwise disposing thereof if, under section
305(a) (relating to distributions of stock and stock rights) any part of
the distribution was not included in the gross income of the
distributee.
(d) Section 306(c)(1)(B) includes in the definition of section 306
stock any stock except common stock, which is received by a shareholder
in connection with a reorganization under section 368 or in a
distribution or exchange under section 355 (or so much of section 356 as
relates to section 355) provided the effect of the transaction is
substantially the same as the receipt of a stock dividend, or the stock
is received in exchange for section 306 stock. If, in a transaction to
which section 356 is applicable, a shareholder exchanges section 306
stock for stock and money or other property, the entire amount of such
money and of the fair market value of the other property (not limited to
the gain recognized) shall be treated as a distribution of property to
which section 301 applies. Common stock received in exchange for
section 306 stock in a recapitalization shall not be considered section
306 stock. Ordinarily, section 306 stock includes stock which is not
common stock received in pursuance of a plan of reorganization (within
the meaning of section 368(a)) or received in a distribution or exchange
to which section 355 (or so much of section 356 as relates to section
355) applies if cash received in lieu of such stock would have been
treated as a dividend under section 356(a)(2) or would have been treated
as a distribution to which section 301 applies by virtue of section
356(b) or section 302(d). The application of the preceding sentence is
illustrated by the following examples:
Example (1). Corporation A, having only common stock outstanding, is
merged in a statutory merger (qualifying as a reorganization under
section 368(a)) with Corporation B. Pursuant to such merger, the
shareholders of Corporation A received both common and preferred stock
in Corporation B. The preferred stock received by such shareholders is
section 306 stock.
Example (2). X and Y each own one-half of the 2,000 outstanding
shares of preferred stock and one-half of the 2,000 outstanding shares
of common stock of Corporation C. Pursuant to a reorganization within
the meaning of section 368(a)(1)(E) (recapitalization) each shareholder
exchanges his preferred stock for preferred stock of a new issue which
is not substantially different from the preferred stock previously held.
Unless the preferred stock exchanged was itself section 306 stock the
preferred stock received is not section 306 stock.
(e) Section 306(c)(1)(C) includes in the definition of section 306
stock any stock (except as provided in section 306(c)(1)(B)) the basis
of which in the hands of the person disposing of such stock, is
determined by reference to section 306 stock held by such shareholder or
any other person. Under this paragraph common stock can be section 306
stock. Thus, if a person owning section 306 stock in Corporation A
transfers it to Corporation B which is controlled by him in exchange for
common stock of Corporation B in a transaction to which section 351 is
applicable, the common stock so received by him would be section 306
stock and subject to the provisions of section 306(a) on its
disposition. In addition, the section 306 stock transferred is section
306 stock in the hands of Corporation B, the transferee. Section 306
stock transferred by gift remains section 306 stock in the hands of the
donee. Stock received in exchange for section 306 stock under section
1036(a) (relating to exchange of stock for stock in the same
corporation) or under so much of section 1031(b) as relates to section
1036(a) becomes section 306 stock and acquires, for purposes of section
306, the characteristics of the section 306 stock exchanged. The entire
amount of the fair market value of the other property received in such
transaction shall be considered as received upon a disposition (other
than a redemption) to which section 306(a) applies. Section 306 stock
ceases to be so classified if the basis of such stock is determined by
reference to its fair market value on the date of the
decedent-stockholder's death or the optional valuation date under
section 1014.
(f) If section 306 stock which was distributed with respect to common
stock is exchanged for common stock in the same corporation (whether or
not such exchange is pursuant to a conversion privilege contained in
section 306 stock), such common stock shall not be section 306 stock.
This paragraph applies to exchanges not coming within the purview of
section 306(c)(1)(B). Common stock which is convertible into stock
other than common stock or into property, shall not be considered common
stock. It is immaterial whether the conversion privilege is contained
in the stock or in some type of collateral agreement.
(g) If there is a substantial change in the terms and conditions of
any stock, then, for the purpose of this section --
(1) The fair market value of such stock shall be the fair market
value at the time of distribution or the fair market value at the time
of such change, whichever is higher;
(2) Such stock's ratable share of the amount which would have been a
dividend if money had been distributed in lieu of stock shall be
determined by reference to the time of distribution or by reference to
the time of such change, whichever ratable share is higher; and
(3) Section 306(c)(2) shall be inapplicable if there would have been
a dividend to any extent if money had been distributed in lieu of the
stock either at the time of the distribution or at the time of such
change.
(h) When section 306 stock is disposed of, the amount treated under
section 306(a)(1)(A) as ordinary income, for the purposes of part I,
subchapter N, chapter 1 of the Code, be treated as derived from the same
source as would have been the source if money had been received from the
corporation as a dividend at the time of the distribution of such stock.
If the amount is determined to be derived from sources within the
United States, the amount shall be considered to be fixed or
determinable annual or periodic gains, profits, and income within the
meaning of section 871(a) or section 881(a), relating, respectively, to
the tax on nonresident alien individuals and on foreign corporations not
engaged in business in the United States.
(i) Section 306 shall be inapplicable to stock received before June
22, 1954, and to stock received on or after June 22, 1954, in
transactions subject to the provisions of the Internal Revenue Code of
1939.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7281, 38
FR 18540, July 12, 1973; T.D. 7556, 43 FR 34128, Aug. 3, 1978)
26 CFR 1.307-1 General.
(a) If a shareholder receives stock or stock rights as a distribution
on stock previously held and under section 305 such distribution is not
includible in gross income then, except as provided in section 307(b)
and 1.307-2, the basis of the stock with respect to which the
distribution was made shall be allocated between the old and new stocks
or rights in proportion to the fair market values of each on the date of
distribution. If a shareholder receives stock or stock rights as a
distribution on stock previously held and pursuant to section 305 part
of the distribution is not includible in gross income, then (except as
provided in section 307(b) and 1.307-2) the basis of the stock with
respect to which the distribution is made shall be allocated between (1)
the old stock and (2) that part of the new stock or rights which is not
includible in gross income, in proportion to the fair market values of
each on the date of distribution. The date of distribution in each case
shall be the date the stock or the rights are distributed to the
stockholder and not the record date. The general rule will apply with
respect to stock rights only if such rights are exercised or sold.
(b) The application of paragraph (a) of this section is illustrated
by the following example:
Example. A taxpayer in 1947 purchased 100 shares of common stock at
$100 per share and in 1954 by reason of the ownership of such stock
acquired 100 rights entitling him to subscribe to 100 additional shares
of such stock at $90 a share. Immediately after the issuance of the
rights, each of the shares of stock in respect of which the rights were
acquired had a fair market value, ex-rights, of $110 and the rights had
a fair market value of $19 each. The basis of the rights and the common
stock for the purpose of determining the basis for gain or loss on a
subsequent sale or exercise of the rights or a sale of the old stock is
computed as follows:
100 (shares) $100=$10,000, cost of old stock (stock in respect of
which the rights were acquired).
100 (shares) $110=$11,000, market value of old stock.
100 (rights) $19=$1,900, market value of rights.
11,000/12,900 of $10,000=$8,527.13, cost of old stock apportioned to
such stock.
1,900/12,900 of $10,000=$1,472.87, cost of old stock apportioned to
rights.
If the rights are sold, the basis for determining gain or loss will
be $14.7287 per right. If the rights are exercised, the basis of the
new stock acquired will be the subscription price paid therefor ($90)
plus the basis of the rights exercised ($14.7287 each) or $104.7287 per
share. The remaining basis of the old stock for the purpose of
determining gain or loss on a subsequent sale will be $85.2713 per
share.
26 CFR 1.307-2 Exception.
The basis of rights to buy stock which are excluded from gross income
under section 305(a), shall be zero if the fair market value of such
rights on the date of distribution is less than 15 percent of the fair
market value of the old stock on that date, unless the shareholder
elects to allocate part of the basis of the old stock to the rights as
provided in paragraph (a) of 1.307-1. The election shall be made by a
shareholder with respect to all the rights received by him in a
particular distribution in respect of all the stock of the same class
owned by him in the issuing corporation at the time of such
distribution. Such election to allocate basis to rights shall be in the
form of a statement attached to the shareholder's return for the year in
which the rights are received. This election, once made, shall be
irrevocable with respect to the rights for which the election was made.
Any shareholder making such an election shall retain a copy of the
election and of the tax return with which it was filed, in order to
substantiate the use of an allocated basis upon a subsequent disposition
of the stock acquired by exercise.
26 CFR 1.307-2 effects on corporation
26 CFR 1.311-1 General.
(a) Except as provided in subsections (b), (c), and (d) of section
311, section 453(d) (relating to installment obligations) and such other
provisions of the Code as sections 341(f), 617(d), 1245(a), 1250(a),
1251(c), and 1252(a), no gain or loss is recognized to a corporation on
the distribution, with respect to its stock, of stock, or rights to
acquire its stock, or property (regardless of the fact that such
property may have appreciated or depreciated in value since its
acquisition by the corporation). However, the proceeds of the sale of
property in form made by a shareholder receiving such property in kind
from the corporation may be imputed to the corporation if, in substance
the corporation made the sale. Moreover, where property is distributed
by a corporation, which distribution is in effect an anticipatory
assignment of income, such income may be taxable to the corporation.
The term ''distributions with respect to its stock'' includes
distributions made in redemption of stock (other than distributions in
complete or partial liquidations). See, however, paragraph (e) of this
section for distributions to which section 311 does not apply. For the
rule respecting the taxation of a corporation making a distribution of
property in partial or complete liquidation, see section 336.
(b) In any case in which a corporation distributes with respect to
its stock assets which have been part of an inventory, the value of
which has been computed for income tax purposes under the method
provided in section 472 (relating to last-in, first-out inventories),
such corporation shall --
(1) Compute the amount of its inventory under the method provided in
section 472 immediately prior to the distribution and immediately after
such distribution;
(2) Compute the difference between the two amounts described in
subparagraph (1) of this paragraph;
(3) Compute the amount of its inventory under the method authorized
by section 471 (relating to general rule for inventories) immediately
prior to the distribution and immediately after such distribution:
(4) Compute the difference between the two amounts determined under
subparagraph (3) of this paragraph.
If the amount computed under subparagraph (4) of this paragraph is in
excess of the amount computed under subparagraph (2) of this paragraph,
then such excess shall, under section 311(b), be included in the income
of the corporation for the year in which such distribution occurs. In
any case in which a corporation distributes assets which have been a
part of an inventory whose value has been computed for income tax
purposes under the method provided in section 472, such corporation
shall on the date of distribution record a specific statement of the
amount of its inventory under each of the applicable methods for use in
the determination of the amount of income includible under section 311.
Section 311(b) and this paragraph do not apply to any distribution which
is governed by section 311(d)(1).
(c) The following example illustrates the application of section
311(b):
Example. Corporation R, a manufacturing corporation inventorying
goods under the method provided in section 472, distributes 200 units of
its inventory assets to its shareholders on November 15, 1955.
Immediately before the distribution, the corporation held 300 identical
inventory units at the following basis determined by reference to the
value computed by using the LIFO method and the value computed by using
the FIFO method, in the order of acquisition:
The amount includible in income pursuant to section 311(b) is $4,000
computed as follows:
(d) Section 311(c) provides in general for the inclusion in the
income of a corporation, on a distribution of property by such
corporation to its shareholders, of an amount equal to the excess of a
liability over the basis of the property distributed. Thus, section
311(c) applies where the property distributed is subject to a liability
or where the shareholder assumes a liability of the corporation in
connection with the distribution. For example, if property which is a
capital asset having an adjusted basis to the distributing corporation
of $100 and a fair market value of $1,000 (but subject to a liability of
$900) is distributed to a shareholder, such distribution is taxable (as
long-term or short-term gain, as the case may be) to the corporation to
the extent of the excess of the liability ($900) over the adjusted basis
($100) or $800. However, if in the preceding example the fair market
value of the property distributed were $800, the amount taxable to the
corporation is limited to the excess of the fair market value of the
property ($800) over its adjusted basis ($100) or $700. If the property
subject to a liability were not a capital asset in the hands of the
distributing corporation, the gain would be taxable as gain from the
sale of a noncapital asset. The holding period of assets so distributed
shall be determined as if such property were sold on the date of the
distribution. Section 311(c) and this paragraph do not apply to any
distribution which is governed by section 311(d)(1).
(e) (1) Section 311 is limited to distributions which are made by
reason of the corporation-stockholder relationship. Section 311 does
not apply to transactions between a corporation and a shareholder in his
capacity as debtor, creditor, employee, or vendee, where the fact that
such debtor, creditor, employee, or vendee is a shareholder is
incidental to the transaction. Thus, if the corporation receives its
own stock as consideration upon the sale of property by it, or in
satisfaction of indebtedness to it, the gain or loss resulting is to be
computed in the same manner as though the payment had been made in any
other property.
(2) The following examples illustrate the application of subparagraph
(1) of this paragraph:
Example (1). Corporation A has a claim against Corporation B for
damages for loss of profits due to patent infringement. Corporation B
satisfies such claim by surrendering shares of the stock of Corporation
A to Corporation A. The fair market value of such stock is includible
in the gross income of Corporation A.
Example (2). Corporation C, a corporation engaged in the manufacture
and sale of automobiles, sells an automobile to individual X, and
receives in payment therefor shares of the stock of Corporation C. The
transaction will be treated in the same manner as if an amount of cash
equal to the fair market value of such stock had been received by
Corporation C.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7209, 37
FR 20801, Oct. 5, 1972; 37 FR 22375, Oct. 19, 1972)
26 CFR 1.311-2 Appreciated property used to redeem stock.
(a) In general. (1) Section 311(d)(1) provides, in general, that
gain is recognized to a corporation which distributes appreciated
property (other than an obligation of such corporation) to its
shareholders after November 30, 1969, in a redemption (as defined in
section 317(b) of its stock to which subpart A, part I, subchapter C,
chapter 1 of the Code applies, regardless of whether the redemption is
treated as a distribution of property to which section 301 applies.
Paragraphs (b) through (i) of this section contain exceptions and
limitations provided by section 311(d)(2) and section 905(c) of the Tax
Reform Act of 1969 to the application of section 311(d)(1). These
exceptions and limitations prevent the recognition of gain to a
corporation upon a distribution of appreciated property, but do not
broaden the general nonrecognition provisions of section 311(a). Thus,
for example, if the proceeds of the sale of property in form made by a
shareholder, who received such property from a corporation, are imputed
to the corporation (see 1.311-1(a)), the exceptions and limitations of
section 311(d)(2) would have no application.
(2) Section 311(d) applies only where there is an actual redemption
of stock as a result of the distribution. Thus, section 311(d) does not
apply where there is a distribution of appreciated property pro rata
among all shareholders and such shareholders do not transfer any of
their stock to the distributing corporation in exchange for such
property even though the effect of the transaction would have been the
same if there had been actual redemptions. Section 311(d) applies where
an acquisition of stock by a corporation is treated under section 304 as
a distribution in redemption of the stock of either the acquiring or
issuing corporation. Section 311(d)(1) does not apply to a distribution
in partial or complete liquidation of a corporation (see sections 331
through 346). In general, the section does not apply to a distribution
pursuant to a reorganization to which part III or IV of subchapter C
applies or to a distribution of stock or securities of a controlled
corporation to which section 355 (or so much of section 356 as relates
to section 355) applies. However, if the distribution is in substance a
redemption, section 311(d) will apply. Thus, if one class of
shareholders exchanges preferred stock for a lesser amount of new
preferred stock (having similar rights and privileges) and for other
property, the transaction will be considered a redemption for purposes
of section 311(d) rather than a distribution pursuant to a
reorganization to which part III or IV of subchapter C would apply.
(3) For purposes of this section, the term ''appreciated property''
means any property whose fair market value on the date of distribution
exceeds its adjusted basis in the hands of the distributing corporation.
For purposes of determining the amount of gain which will be recognized
under this section, gain realized from the distribution of appreciated
property shall not be offset by any loss realized from the distribution
of property whose adjusted basis exceeds its fair market value. The
amount and nature of gain recognized to a corporation which distributes
appreciated property shall be determined as if such property were sold
for its fair market value on the date of distribution. The nature of
such gain shall be determined by reference to all applicable provisions
of law, including section 1245.
(b) Complete redemption of a 10-percent shareholder. (1) Section
311(d)(2)(A) provides that section 311(d)(1) shall not apply to a
distribution in complete redemption of all the stock of a ''10-percent
shareholder,'' provided such distribution qualifies as a redemption in
complete termination of such shareholder's interest under section
302(b)(3). Sales and redemptions of stock which are substantially
contemporaneous in time and pursuant to a single plan shall be treated
as having occurred simultaneously for purposes of determining whether a
complete redemption has occurred and whether the distributee is a
''10-percent shareholder''. For purposes of this paragraph, section
318(a)(1) shall not apply with respect to a distribution described in
section 302(b)(3) where section 302(c)(2)(B) does not apply and where
immediately after the distribution the distributee has no interest in
the corporation (including an interest as an officer, director, or
employee) other than an interest as a creditor.
(2) A ''10-percent shareholder,'' for purposes of this paragraph, is
a person who, at all times within the 12-month period ending on the date
of distribution, owned at least 10 percent of the fair market value of
all the outstanding stock of the distributing corporation. For purposes
of this paragraph, the ownership of stock shall be determined without
the application of section 318 (relating to constructive ownership of
stock), and where under the provisions of subpart E, part I, subchapter
J, of the Code, any person is treated as the owner of any portion of a
trust, stock owned by such trust shall not be considered as owned by
such person. For purposes of this paragraph, a person shall be
considered to have owned stock during the period he is considered to
have held the stock by reason of the application of section 1223 but
where, under the provisions of subpart E, part I, subchapter J, of the
Code, any person is treated as the owner of any portion of a trust, the
holding period of such trust for any of its stock shall not include the
holding period of such person.
(c) Distribution of stock of controlled corporation. (1) Section
311(d)(2)(B) provides that section 311(d)(1) shall not apply to a
distribution of stock or an obligation of a controlled corporation --
(i) Which is engaged in at least one trade or business, and
(ii) Which has not received property (including money) constituting a
substantial part of its assets from the distributing corporation, in a
transaction to which section 351 applied or as a contribution to
capital, within the 5-year period ending on the date of distribution.
For purposes of this paragraph, a corporation is a ''controlled
corporation'' if at least 50 percent of the fair market value of its
outstanding stock was owned by the distributing corporation at any time
within the 9-year period ending 1 year before the date of distribution.
A distribution of stock of a controlled corporation does not qualify for
treatment under section 311(d)(2)(B) if the trade or business of such
corporation was acquired for the purpose of qualifying the distribution
for treatment under that section. However, a trade or business which
was acquired more than 1 year before the date of distribution will be
presumed not to have been acquired for such a purpose. For purposes of
this paragraph, the corporation whose stock is distributed will be
considered to be engaged in a trade or business if it owns stock
possessing at least 80 percent of the total combined voting power of all
classes of stock entitled to vote and at least 80 percent of the total
number of shares of all other classes of stock of another corporation
which has been engaged in the active conduct of a trade or business
throughout the 1-year period ending on the date of distribution. The
term ''active conduct of a trade or business'' shall have the same
meaning in this paragraph as in paragraph (c) of 1.355-1.
(2)(i) In determining, for purposes of subparagraph (1)(ii) of this
paragraph, whether property received from the distributing corporation
within the 5-year period ending on the date of distribution constitutes
a substantial part of the controlled corporation's assets, the amount of
money received within such period plus the total fair market value
(determined on the date of distribution) of the items of property
specified in subdivisions (ii), (iii), and (iv) of this subparagraph
shall be compared with the total fair market value of all the controlled
corporation's assets on the date of distribution.
(ii) Property other than money received from the distributing
corporation shall be taken into account, provided it is held or owned by
the controlled corporation on the date of distribution.
(iii) If money is transferred from the distributing corporation to
the controlled corporation and then is used, pursuant to a plan of the
distributing corporation existing at the time of transfer, to acquire
property which the controlled corporation holds or owns on the date of
distribution, then the acquired property, in lieu of the money
transferred, shall be taken into account.
(iv) If property (other than money) received from the distributing
corporation (or property acquired pursuant to plan with money received
from the distributing corporation) is exchanged for other property in a
transaction in which gain or loss is not recognized in whole or in part
to the controlled corporation, the property received in the exchange
shall be taken into account, provided it is held or owned by the
controlled corporation on the date of distribution.
(3) The principles of this paragraph may be illustrated by the
following examples:
Example (1). Corporation M, a toy manufacturer, is a controlled
corporation of corporation N. On June 1, 1970, N contributes $200,000
to M's capital. On January 1, 1971, N contributes real estate with a
fair market value of $50,000 to M's capital. On February 1, 1975, when
N distributes M stock to its shareholders in redemption of its own
stock, such real estate, still owned by M, has a fair market value of
$100,000. On the date of distribution the total fair market value of
all M's assets is $10 million. The distribution meets the requirements
of section 311(d)(2)(B) and therefore no gain is recognized to N under
section 311(d)(1).
Example (2). Corporation R is a controlled corporation of
corporation S. On April 1, 1970, S contributes $500,000 to R which,
pursuant to a plan of S existing at the time of the contribution, R uses
to purchase certain securities. On July 1, 1970, S contributes an
office building to R. On December 1, 1972, such building is exchanged
for another building in a transaction to which section 1031 (relating to
exchange of property held for productive use or investment) applies. On
February 1, 1975, when S distributes R stock to its shareholders in
redemption of its own stock, both the purchased securities and the
building received in the exchange are owned by R. On such date, the
building and the securities each has a fair market value of $2 million.
The total value of contributed property for purposes of subparagraph
(1)(ii) of this paragraph is $4 million. On the date of distribution
the total fair market value of all R's assets is $8 million. The
distribution fails to meet the requirements of section 311(d)(2)(B)
since S contributed to R's capital a substantial part of R's assets
within the 5-year period ending on the date of distribution.
(d) Certain distributions made before December 1, 1974. Section
311(d)(2)(C) provides that section 311(d)(1) shall not apply to a
distribution before December 1, 1974, of stock of a corporation
substantially all of the assets of which the distributing corporation
(or a corporation which is a member of the same affiliated group (as
defined in section 1504(a)) as the distributing corporation) held on
November 30, 1969, if such assets constitute a trade or business which
has been actively conducted throughout the 1-year period ending on the
date of distribution. For purposes of this paragraph, the determination
that a corporation is a member of the same affiliated group (as defined
in section 1504(a)) as the distributing corporation must be satisfied
only on November 30, 1969, and not on the date of the distribution to
which this paragraph applies. Thus, if the assets of a trade or
business were held on November 30, 1969, by any member of the affiliated
group and such trade or business has been actively conducted throughout
the 1-year period ending on the date of distribution, section 311(d)(1)
will not apply to a distribution of stock of any member of the
affiliated group substantially all the assets of which consists of
either (1) the assets so held on November 30, 1969, (2) stock possessing
at least 80 percent of the total combined voting power of all classes of
stock entitled to vote and at least 80 percent of the total number of
shares of all other classes of stock of another corporation
substantially all the assets of which consist of the assets so held on
November 30, 1969, or (3) both. The term ''active conduct of a trade or
business'' shall have the same meaning in this paragraph as in paragraph
(c) of 1.355-1.
(e) Distributions pursuant to antitrust judgments. Section
311(d)(2)(D) provides that section 311(d)(1) shall not apply to a
distribution of stock or securities pursuant to the terms of a final
judgment rendered by a court with respect to the distributing
corporation in a court proceeding under the Sherman Act (26 Stat. 209;
15 U.S.C. 1-7) or the Clayton Act (38 Stat. 730; 15 U.S.C. 12-27), or
both, to which the United States is a party, but only if the
distribution of such stock or securities in redemption of the
distributing corporation's stock is in furtherance of the purposes of
the judgment. A distribution in redemption of the distributing
corporation's stock will be considered in furtherance of the purposes of
the judgment if the court finds that such distribution is necessary or
appropriate to effectuate the policies of the Sherman Act, or the
Clayton Act, or both. Absent such a finding by the court, it is a
question of fact in each case whether the distribution is in furtherance
of the purposes of the judgment.
(f) Distributions in redemption of stock to pay death taxes. Section
311(d)(2)(E) provides that section 311(d)(1) shall not apply to a
distribution to the extent that section 303(a) (relating to
distributions in redemption of stock to pay death taxes) applies to such
distribution. If a corporation distributes both appreciated property
and other property in a single distribution and if the total
distribution exceeds the amount which qualifies for treatment under
section 303, then for purposes of applying section 311(d)(2)(E) and this
paragraph, the appreciated property shall be considered as distributed
before such other property and to be in redemption of stock described in
section 303(a) to the extent thereof.
(g) Distributions to private foundations. Section 311(d)(2)(F)
provides that section 311(d)(1) shall not apply to a distribution to a
private foundation (as defined in section 509) in redemption of stock
described in section 537(b)(2) (A) and (B) and the regulations
thereunder. If a corporation distributes to a private foundation both
appreciated property and other property in a single distribution and if
the total distribution exceeds the amount which qualifies for treatment
under section 537(b)(2) (A) and (B), then for purposes of applying
section 311(d)(2)(F) and this paragraph, the appreciated property shall
be considered as distributed before such other property and to be in
redemption of stock described in section 537(b)(2) (A) and (B), to the
extent thereof.
(h) Distribution by regulated investment company. Section
311(d)(2)(G) provides that section 311(d)(1) shall not apply to a
distribution by a corporation to which part I, subchapter M, chapter 1
of the Code (relating to regulated investment companies) applies,
provided such distribution is in redemption of a redeemable security (as
defined in section 2(a)(32) of the Investment Company Act of 1940 (54
Stat. 790; 15 U.S.C. 80a-2(a)(32))).
(i) Transitional Rules. Section 311(d) does not apply to --
(1) A distribution before April 1, 1970, pursuant to the terms of --
(i) A written contract which was binding on the distributing
corporation on November 30, 1969, and at all times thereafter before the
distribution,
(ii) An offer made by the distributing corporation before December 1,
1969,
(iii) An offer made in accordance with a request for a ruling filed
by the distributing corporation with the Internal Revenue Service before
December 1, 1969, or
(iv) An offer made in accordance with a registration statement filed
with the Securities and Exchange Commission before December 1, 1969.
For purposes of subdivisions (ii), (iii), and (iv) of this
subparagraph, an offer shall be treated as an offer only if it was in
writing and not revocable by its express terms.
(2) A distribution by a corporation of specific property in
redemption of stock outstanding on November 30, 1969, if --
(i) Every holder of such stock on such date had the right to demand
redemption of his stock in such specific property, and
(ii) The corporation had such specific property on hand on such date
in a quantity sufficient to redeem all of such stock.
For purposes of the preceding sentence, stock shall be considered to
have been outstanding on November 30, 1969, if it could have been
acquired on such date through the exercise of an existing right of
conversion contained in other stock held on such date.
(3) A distribution by a corporation of property (held on December 1,
1969, by the distributing corporation or a corporation which was a
wholly owned subsidiary of the distributing corporation on such date) in
redemption of stock outstanding on November 30, 1969, which is redeemed
and canceled before July 31, 1971, if --
(i) Such redemption is pursuant to a resolution adopted before
November 1, 1969, by the Board of Directors authorizing the redemption
of a specific amount of stock constituting more than 10 percent of the
outstanding stock of the corporation at the time of the adoption of such
resolution; and
(ii) More than 40 percent of the stock authorized to be redeemed
pursuant to such resolution was redeemed before December 30, 1969, and
more than one-half of the stock so redeemed was redeemed with property
other than money.
(4) A distribution of stock by a corporation organized prior to
December 1, 1969, for the principal purpose of providing an equity
participation plan for employees of the corporation whose stock is being
distributed (hereinafter referred to as the ''employer corporation'') if
--
(i) The stock being distributed was owned by the distributing
corporation on November 30, 1969,
(ii) The stock being redeemed was acquired before January 1, 1973,
pursuant to such equity participation plan by the shareholder presenting
such stock for redemption (or by a predecessor of such shareholder),
(iii) The employment of the shareholder presenting the stock for
redemption (or the predecessor of such shareholder) by the employer
corporation commenced before January 1, 1971,
(iv) At least 90 percent in value of the assets of the distributing
corporation on November 30, 1969, consisted of common stock of the
employer corporation, and
(v) At least 50 percent of the outstanding voting stock of the
employer corporation is owned by the distributing corporation at any
time within the 9-year period ending 1 year before the date of such
distribution.
(T.D. 7209, 37 FR 20801, Oct. 5, 1972; 37 FR 22375, Oct. 19, 1972)
26 CFR 1.312-1 Adjustment to earnings and profits reflecting
distributions by corporations.
(a) In general, on the distribution of property by a corporation with
respect to its stock, its earnings, and profits (to the extent thereof)
shall be decreased by --
(1) The amount of money,
(2) The principal amount of the obligations of such corporation
issued in such distribution, and
(3) The adjusted basis of other property.
For special rule with respect to distributions to which section
312(e) applies, see 1.312-5.
(b) The adjustment provided in section 312(a)(3) and paragraph (a)(3)
of this section with respect to a distribution of property (other than
money or its own obligations) shall be made notwithstanding the fact
that such property has appreciated or depreciated in value since
acquisition.
(c) The application of paragraphs (a) and (b) of this section may be
illustrated by the following examples:
Example (1). Corporation A distributes to its sole shareholder
property with a value of $10,000 and a basis of $5,000. It has $12,500
in earnings and profits. The reduction in earnings and profits by
reason of such distribution is $5,000. Such is the reduction even
though the amount of $10,000 is includible in the income of the
shareholder (other than a corporation) as a dividend.
Example (2). The facts are the same as in example (1) above except
that the property has a basis of $15,000 and the earnings and profits of
the corporation are $20,000. The reduction in earnings and profits is
$15,000. Such is the reduction even though only the amount of $10,000
is includible in the income of the shareholder as a dividend.
(d) In the case of a distribution of stock or rights to acquire stock
a portion of which is includible in income by reason of section 305(b),
the earnings and profits shall be reduced by the fair market value of
such portion. No reduction shall be made if a distribution of stock or
rights to acquire stock is not includible in income under the provisions
of section 305.
(e) No adjustment shall be made in the amount of the earnings and
profits of the issuing corporation upon a disposition of section 306
stock unless such disposition is a redemption.
26 CFR 1.312-2 Distribution of inventory assets.
Section 312(b) provides for the increase and the decrease of the
earnings and profits of a corporation which distributes, with respect to
its stock, inventory assets as defined in section 312(b)(2), where the
fair market value of such assets exceeds their adjusted basis. The
rules provided in section 312(b) (relating to distributions of certain
inventory assets) shall be applicable without regard to the method used
in computing inventories for the purpose of the computation of taxable
income. Section 312(b) does not apply to distributions described in
section 312(e).
26 CFR 1.312-3 Liabilities.
The amount of any reductions in earnings and profits described in
section 312 (a) or (b) shall be (a) reduced by the amount of any
liability to which the property distributed was subject and by the
amount of any other liability of the corporation assumed by the
shareholder in connection with such distribution, and (b) increased by
the amount of gain recognized to the corporation under section 311 (b),
(c), or (d), or under section 341(f), 617(d), 1245(a), 1250(a), 1251(c),
or 1252(a).
(T.D. 7209, 37 FR 20804, Oct. 5, 1972)
26 CFR 1.312-4 Examples of adjustments provided in section 312(c).
The adjustments provided in section 312(c) may be illustrated by the
following examples:
Example (1). On December 2, 1954, Corporation X distributed to its
sole shareholder, A, an individual, as a dividend in kind a vacant lot
which was not an inventory asset. On that date, the lot had a fair
market value of $5,000 and was subject to a mortgage of $2,000. The
adjusted basis of the lot was $3,100. The amount of the earnings and
profits was $10,000. The amount of the dividend received by A is $3,000
($5,000, the fair market value, less $2,000, the amount of the mortgage)
and the reduction in the earnings and profits of Corporation X is $1,100
($3,100, the basis, less $2,000, the amount of mortgage).
Example (2). The facts are the same as in example (1) above with the
exception that the amount of the mortgage to which the property was
subject was $4,000. The amount of the dividend received by A is $1,000,
and there is no reduction in the earnings and profits of the corporation
as a result of the distribution (disregarding such reduction as may
result from an increase in tax to Corporation X because, of gain
resulting from the distribution). There is a gain of $900 recognized to
Corporation X, the difference between the basis of the property ($3,100)
and the amount of the mortgage ($4,000), under section 311(c) and an
increase in earnings and profits of $900.
Example (3). Corporation A, having accumulated earnings and profits
of $100,000, distributed in kind to its shareholders, not in
liquidation, inventory assets which had a basis to it on the ''Lifo''
method (section 472) of $46,000 and on the basis of cost or market
(section 471) of $50,000. The inventory had a fair market value of
$55,000 and was subject to a liability of $35,000. This distribution
results in a net decrease in earnings and profits of Corporation A of
$11,000, (without regard to any tax on Corporation A) computed as
follows:
26 CFR 1.312-5 Special rule for partial liquidations and certain
redemptions.
The part of the distribution properly chargeable to capital account
within the provisions of section 312(e) shall not be considered a
distribution of earnings and profits within the meaning of section 301
for the purpose of determining taxability of subsequent distributions by
the corporation.
26 CFR 1.312-6 Earnings and profits.
(a) In determining the amount of earnings and profits (whether of the
taxable year, or accumulated since February 28, 1913, or accumulated
before March 1, 1913) due consideration must be given to the facts, and,
while mere bookkeeping entries increasing or decreasing surplus will not
be conclusive, the amount of the earnings and profits in any case will
be dependent upon the method of accounting properly employed in
computing taxable income (or net income, as the case may be). For
instance, a corporation keeping its books and filing its income tax
returns under subchapter E, chapter 1 of the Code, on the cash receipts
and disbursements basis may not use the accrual basis in determining
earnings and profits; a corporation computing income on the installment
basis as provided in section 453 shall, with respect to the installment
transactions, compute earnings and profits on such basis; and an
insurance company subject to taxation under section 831 shall exclude
from earnings and profits that portion of any premium which is unearned
under the provisions of section 832(b)(4) and which is segregated
accordingly in the unearned premium reserve.
(b) Among the items entering into the computation of corporate
earnings and profits for a particular period are all income exempted by
statute, income not taxable by the Federal Government under the
Constitution, as well as all items includible in gross income under
section 61 or corresponding provisions of prior revenue acts. Gains and
losses within the purview of section 1002 or corresponding provisions of
prior revenue acts are brought into the earnings and profits at the time
and to the extent such gains and losses are recognized under that
section. Interest on State bonds and certain other obligations,
although not taxable when received by a corporation, is taxable to the
same extent as other dividends when distributed to shareholders in the
form of dividends.
(c)(1) In the case of a corporation in which depletion or
depreciation is a factor in the determination of income, the only
depletion or depreciation deductions to be considered in the computation
of the total earnings and profits are those based on cost or other basis
without regard to March 1, 1913, value. In computing the earnings and
profits for any period beginning after February 28, 1913, the only
depletion or depreciation deductions to be considered are those based on
(i) cost or other basis, if the depletable or depreciable asset was
acquired subsequent to February 28, 1913, or (ii) adjusted cost or March
1, 1913, value, whichever is higher, if acquired before March 1, 1913.
Thus, discovery or percentage depletion under all revenue acts for mines
and oil and gas wells is not to be taken into consideration in computing
the earnings and profits of a corporation. Similarly, where the basis
of property in the hands of a corporation is a substituted basis, such
basis, and not the fair market value of the property at the time of the
acquisition by the corporation, is the basis for computing depletion and
depreciation for the purpose of determining earnings and profits of the
corporation.
(2) The application of subparagraph (1) of this paragraph may be
illustrated by the following example:
Example. Oil producing property which A had acquired in 1949 at a
cost of $28,000 was transferred to Corporation Y in December 1951, in
exchange for all of its capital stock. The fair market value of the
stock and of the property as of the date of the transfer was $247,000.
Corporation Y, after four years' operation, effected in 1955 a cash
distribution to A in the amount of $165,000. In determining the extent
to which the earnings and profits of Corporation Y available for
dividend distributions have been increased as the result of production
and sale of oil, the depletion to be taken into account is to be
computed upon the basis of $28,000 established in the nontaxable
exchange in 1951 regardless of the fair market value of the property or
of the stock issued in exchange therefor.
(d) A loss sustained for a year before the taxable year does not
affect the earnings and profits of the taxable year. However, in
determining the earnings and profits accumulated since February 28,
1913, the excess of a loss sustained for a year subsequent to February
28, 1913, over the undistributed earnings and profits accumulated since
February 28, 1913, and before the year for which the loss was sustained,
reduces surplus as of March 1, 1913, to the extent of such excess. If
the surplus as of March 1, 1913, was sufficient to absorb such excess,
distributions to shareholders after the year of the loss are out of
earnings and profits accumulated since the year of the loss to the
extent of such earnings.
(e) With respect to the effect on the earnings and profits
accumulated since February 28, 1913, of distributions made on or after
January 1, 1916, and before August 6, 1917, out of earnings or profits
accumulated before March 1, 1913, which distributions were specifically
declared to be out of earnings and profits accumulated before March 1,
1913, see section 31(b) of the Revenue Act of 1916, as added by section
1211 of the Revenue Act of 1917 (40 Stat. 336).
26 CFR 1.312-7 Effect on earnings and profits of gain or loss realized
after February 28, 1913.
(a) In order to determine the effect on earnings and profits of gain
or loss realized from the sale or other disposition (after February 28,
1913) of property by a corporation, section 312(f)(1) prescribed certain
rules for --
(1) The computation of the total earnings and profits of the
corporation of most frequent application in determining invested
capital; and
(2) The computation of earnings and profits of the corporation for
any period beginning after February 28, 1913, of most frequent
application in determining the source of dividend distributions.
Such rules are applicable whenever under any provision of subtitle A
of the Code it is necessary to compute either the total earnings and
profits of the corporation or the earnings and profits for any period
beginning after February 28, 1913. For example, since the earnings and
profits accumulated after February 28, 1913, or the earnings and profits
of the taxable year, are earnings and profits for a period beginning
after February 28, 1913, the determination of either must be in
accordance with the regulations prescribed by this section for the
ascertainment of earnings and profits for any period beginning after
February 28, 1913. Under subparagraph (1) of this paragraph, such gain
or loss is determined by using the adjusted basis (under the law
applicable to the year in which the sale or other disposition was made)
for determining gain, but disregarding value as of March 1, 1913. Under
subparagraph (2) of this paragraph, there is used such adjusted basis
for determining gain, giving effect to the value as of March 1, 1913,
whenever applicable. In both cases the rules are the same as those
governing depreciation and depletion in computing earnings and profits
(see 1.312-6). Under both subparagraphs (1) and (2) of this paragraph,
the adjusted basis is subject to the limitations of the third sentence
of section 312(f)(1) requiring the use of adjustments proper in
determining earnings and profits. The proper adjustments may differ
under section 312(f)(1) (A) and (B) depending upon the basis to which
the adjustments are to be made. If the application of section
312(f)(1)(B) results in a loss and if the application of section
312(f)(1)(A) to the same transaction reaches a different result, then
the loss under section 312(f)(1)(B) will be subject to the adjustment
thereto required by section 312(g)(2). (See 1.312-9.)
(b) (1) The gain or loss so realized increases or decreases the
earnings and profits to, but not beyond, the extent to which such gain
or loss was recognized in computing taxable income (or net income, as
the case may be) under the law applicable to the year in which such sale
or disposition was made. As used in this paragraph, the term
''recognized'' has reference to that kind of realized gain or loss which
is recognized for income tax purposes by the statute applicable to the
year in which the gain or loss was realized. For example, see section
356. A loss (other than a wash sale loss with respect to which a
deduction is disallowed under the provisions of section 1091 or
corresponding provisions of prior revenue laws) may be recognized though
not allowed as a deduction (by reason, for example, of the operation of
sections 267 and 1211 and corresponding provisions of prior revenue
laws) but the mere fact that it is not allowed does not prevent decrease
in earnings and profits by the amount of such disallowed loss. Wash
sale losses, however, disallowed under section 1091 and corresponding
provisions of prior revenue laws, are deemed nonrecognized losses and do
not reduce earnings or profits. The ''recognized'' gain or loss for the
purpose of computing earnings and profits is determined by applying the
recognition provisions to the realized gain or loss computed under the
provisions of section 312(f)(1) as distinguished from the realized gain
or loss used in computing taxable income (or net income, as the case may
be).
(2) The application of subparagraph (1) of this paragraph may be
illustrated by the following examples:
Example (1). Corporation X on January 1, 1952, owned stock in
Corporation Y which it had acquired from Corporation Y in December 1951,
in an exchange transaction in which no gain or loss was recognized. The
adjusted basis to Corporation X of the property exchanged by it for the
stock in Corporation Y was $30,000. The fair market value of the stock
in Corporation Y when received by Corporation X was $930,000. On April
9, 1955, Corporation X made a cash distribution of $900,000 and, except
for the possible effect of the transaction in 1951, had no earnings or
profits accumulated after February 28, 1913, and had no earnings or
profits for the taxable year. The amount of $900,000 representing the
excess of the fair market value of the stock of Corporation Y over the
adjusted basis of the property exchanged therefor was not recognized
gain to Corporation X under the provisions of section 112 of the
Internal Revenue Code of 1939. Accordingly, the earnings and profits of
Corporation X are not increased by $900,000, the amount of the gain
realized but not recognized in the exchange, and the distribution was
not a taxable dividend. The basis in the hands of Corporation Y of the
property acquired by it from Corporation X is $30,000. If such property
is thereafter sold by Corporation Y, gain or loss will be computed on
such basis of $30,000, and earnings and profits will be increased or
decreased accordingly.
Example (2). On January 2, 1910, Corporation M acquired
nondepreciable property at a cost of $1,000. On March 1, 1913, the fair
market value of such property in the hands of Corporation M was $2,200.
On December 31, 1952, Corporation M transfers such property to
Corporation N in exchange for $1,900 in cash and all Corporation N's
stock, which has a fair market value of $1,100. For the purpose of
computing the total earnings and profits of Corporation M, the gain on
such transaction is $2,000 (the sum of $1,900 in cash and stock worth
$1,100 minus $1,000, the adjusted basis for computing gain, determined
without regard to March 1, 1913, value), $1,900 of which is recognized
under section 356, since this was the amount of money received, although
for the purpose of computing net income the gain is only $800 (the sum
of $1,900 in cash and stock worth $1,100, minus $2,200, the adjusted
basis for computing gain determined by giving effect to March 1, 1913,
value). Such earnings and profits will therefore be increased by only
$800 as a reputing the earnings and profits of Corporation M for any
period beginning after February 28, 1913, however, the gain arising from
the transaction, like the taxable gain, is only $800, all of which is
recognized under section 112(c) of the Internal Revenue Code of 1939,
the money received being in excess of such amount. Such earnings and
profits will therefore be increased by only $800 as a result of the
transaction. For increase in that part of the earnings and profits
consisting of increase in value of property accrued before, but realized
on or after March 1, 1913, see 1.312-9.
Example (3). On July 31, 1955, Corporation R owned oil-producing
property acquired after February 28, 1913, at a cost of $200,000, but
having an adjusted basis (by reason of taking percentage depletion) of
$100,000 for determining gain. However, the adjusted basis of such
property to be used in computing gain or loss for the purpose of
earnings and profits is, because of the provisions of the third sentence
of section 312(f)(1), $150,000. On such day Corporation R transferred
such property to Corporation S in exchange for $25,000 in cash and all
of the stock of Corporation S, which had a fair market value of
$100,000. For the purpose of computing taxable income, Corporation R
has realized a gain of $25,000 as a result of this transaction, all of
which is recognized under section 356. For the purpose of computing
earnings and profits, however, Corporation R has realized a loss of
$25,000, none of which is recognized owing to the provisions of section
356(c). The earnings and profits of Corporation R are therefore neither
increased nor decreased as a result of the transaction. The adjusted
basis of the Corporation S stock in the hands of Corporation R for
purposes of computing earnings and profits, however, will be $125,000
(though only $100,000 for the purpose of computing taxable income),
computed as follows:
If, therefore, Corporation R should subsequently sell the Corporation
S stock for $100,000, a loss of $25,000 will again be realized for the
purpose of computing earnings and profits, all of which will be
recognized and will be applied to decrease the earnings and profits of
Corporation R.
(c)(1) The third sentence of section 312(f)(1) provides for cases in
which the adjustments, prescribed in section 1016, to the basis
indicated in section 312(f)(1) (A) or (B), as the case may be, differ
from the adjustments to such basis proper for the purpose of determining
earnings or profits. The adjustments provided by such third sentence
reflect the treatment provided by 1.312-6 and 1.312-15 relative to
cases where the deductions for depletion and depreciation in computing
taxable income (or net income, as the case may be) differ from the
deductions proper for the purpose of computing earnings and profits.
(2) The effect of the third sentence of section 312(f)(1) may be
illustrated by the following examples:
Example (1). Corporation X purchased on January 2, 1931, an oil
lease at a cost of $10,000. The lease was operated only for the years
1931 and 1932. The deduction for depletion in each of the years 1931
and 1932 amounted to $2,750, of which amount $1,750 represented
percentage depletion in excess of depletion based on cost. The lease
was sold in 1955 for $15,000. Under section 1016(a)(2), in determining
the gain or loss from the sale of the property, the basis must be
adjusted for cost depletion of $1,000 in 1931 and percentage depletion
of $2,750 in 1932. However, the adjustment of such basis, proper for
the determination of earnings and profits, is $1,000 for each year, or
$2,000. Hence, the cost is to be adjusted only to the extent of $2,000,
leaving an adjusted basis of $8,000 and the earnings and profits will be
increased by $7,000, and not by $8,750. The difference of $1,750 is
equal to the amount by which the percentage depletion for the year 1932
($2,750) exceeds the depletion on cost for that year ($1,000) and has
already been applied in the computation of earnings and profits for the
year 1932 by taking into account only $1,000 instead of $2,750 for
depletion in the computation of such earnings and profits. (See
1.316-1.)
Example (2). If, in example (1), above, the property, instead of
being sold, is exchanged in a transaction described in section 1031 for
like property having a fair market value of $7,750 and cash of $7,250,
then the increase in earnings and profits amounts to $7,000, that is,
$15,000 ($7,750 plus $7,250) minus the basis of $8,000. However, in
computing taxable income of Corporation X, the gain is $8,750, that is,
$15,000 minus $6,250 ($10,000 less depletion of $3,750), of which only
$7,250 is recognized because the recognized gain cannot exceed the sum
of money received in the transaction. See section 1031(b) and the
corresponding provisions of prior revenue laws. If, however, the cash
received was only $2,250 and the value of the property received was
$12,750, then the increase in earnings and profits would be $2,250, that
amount being the gain recognized under section 1031.
Example (3). On January 1, 1973, corporation X purchased for $10,000
a depreciable asset with an estimated useful life of 20 years and no
salvage value. In computing depreciation on the asset, corporation X
used the declining balance method with a rate twice the straight line
rate. On December 31, 1976, the asset was sold for $9,000. Under
section 1016(a)(2), the basis of the asset is adjusted for depreciation
allowed for the years 1973 through 1976, or a total of $3,439. Thus, X
realizes a gain of $2,439 (the excess of the amount realized, $9,000,
over the adjusted basis, $6,561). However, the proper adjustment to
basis for the purpose of determining earnings and profits is only
$2,000, i.e., the total amount which, under 1.312-15, was applied in
the computation of earnings and profits for the years 1973-76. Hence,
upon sale of the asset, earnings and profits are increased by only
$1,000, i.e., the excess of the amount realized, $9,000, over the
adjusted basis for earnings and profits purposes, $8,000.
(d) For adjustment and allocation of the earnings and profits of the
transferor as between the transferor and the transferee in cases where
the transfer of property by one corporation to another corporation
results in the nonrecognition in whole or in part of gain or loss, see
1.312-10; and see section 381 for earnings and profits of successor
corporations in certain transactions.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7221, 37
FR 24746, Nov. 21, 1972)
26 CFR 1.312-8 Effect on earnings and profits of receipt of tax-free
distributions requiring adjustment or allocation of basis of stock.
(a) In order to determine the effect on earnings and profits, where a
corporation receives (after February 28, 1913) from a second corporation
a distribution which (under the law applicable to the year in which the
distribution was made) was not a taxable dividend to the shareholders of
the second corporation, section 312(f) prescribes certain rules. It
provides that the amount of such distribution shall not increase the
earnings and profits of the first or receiving corporation in the
following cases: (1) No such increase shall be made in respect of the
part of such distribution which (under the law applicable to the year in
which the distribution was made) is directly applied in reduction of the
basis of the stock in respect of which the distribution was made and (2)
no such increase shall be made if (under the law applicable to the year
in which the distribution was made) the distribution causes the basis of
the stock in respect of which the distribution was made to be allocated
between such stock and the property received (or such basis would but
for section 307(b) be so allocated). Where, therefore, the law
(applicable to the year in which the distribution was made, as, for
example, a distribution in 1934 from earnings and profits accumulated
before March 1, 1913) requires that the amount of such distribution
shall be applied against and reduce the basis of the stock with respect
to which the distribution was made, there is no increase in the earnings
and profits by reason of the receipt of such distribution. Similarly,
where there is received by a corporation a distribution from another
corporation in the form of a stock dividend and the law applicable to
the year in which such distribution was made requires the allocation, as
between the old stock and the stock received as a dividend, of the basis
of the old stock (or such basis would but for section 307(b) be so
allocated), then there is no increase in the earnings and profits by
reason of the receipt of such stock dividend even though such stock
dividend constitutes income within the meaning of the sixteenth
amendment to the Constitution.
(b) The principles set forth in paragraph (a) of this section may be
illustrated by the following examples:
Example (1). Corporation X in 1955 distributed to Corporation Y, one
of its shareholders, $10,000 which was out of earnings or profits
accumulated before March 1, 1913, and did not exceed the adjusted basis
of the stock in respect of which the distribution was made. This amount
of $10,000 was, therefore, a tax-free distribution and under the
provisions of section 301(c)(2) must be applied against and reduce the
adjusted basis of the stock in respect of which the distribution was
made. The earnings and profits of Corporation Y are not increased by
reason of the receipt of this distribution.
Example (2). Corporation Z in 1955 had outstanding common and
preferred stock of which Corporation Y held 100 shares of the common and
no preferred. The stock had a cost basis to Corporation Y of $100 per
share, or a total cost of $10,000. In December of that year it received
a dividend of 100 shares of the preferred stock of Corporation Z. Such
distribution is a stock dividend which, under section 305, was not
taxable and was accordingly not included in the gross income of
Corporation Y. The original cost of $10,000 is allocated to the 200
shares of Corporation Z none of which has been sold or otherwise
disposed of by Corporation Y. See section 307 and 1.307-1. The
earnings and profits of Corporation Y are not increased by reason of the
receipt of such stock dividend.
26 CFR 1.312-9 Adjustments to earnings and profits reflecting increase
in value accrued before March 1, 1913.
(a) In order to determine, for the purpose of ascertaining the source
of dividend distributions, that part of the earnings and profits which
is represented by increase in value of property accrued before, but
realized on or after, March 1, 1913, section 312(g) prescribes certain
rules.
(b)(1) Section 312(g)(1) sets forth the general rule with respect to
computing the increase to be made in that part of the earnings and
profits consisting of increase in value of property accrued before, but
realized on or after, March 1, 1913.
(2) The effect of section 312(g)(1) may be illustrated by the
following examples:
Example (1). Corporation X acquired nondepreciable property before
March 1, 1913, at a cost of $10,000. Its fair market value as of March
1, 1913, was $12,000 and it was sold in 1955 for $15,000. The increase
in earnings and profits based on the value as of March 1, 1913,
representing earnings and profits accumulated since February 28, 1913,
is $3,000. If the basis is determined without regard to the value as of
March 1, 1913, there would be an increase in earnings and profits of
$5,000. The difference of $2,000 ($5,000 minus $3,000) represents the
increase to be made in that part of the earnings and profits of
Corporation X consisting of the increase in value of property accrued
before, but realized on or after, March 1, 1913.
Example (2). Corporation Y acquired depreciable property in 1908 at
a cost of $100,000. Assuming no additions or betterments, and that the
depreciation sustained before March 1, 1913, was $10,000, the adjusted
cost as of that date was $90,000. Its fair market value as of March 1,
1913, was $94,000 and on February 28, 1955, it was sold for $25,000.
For the purpose of determining gain from the sale, the basis of the
property is the fair market value of $94,000 as of March 1, 1913,
adjusted for depreciation for the period subsequent to February 28,
1913, computed on such fair market value. If the amount of the
depreciation deduction allowed after February 28, 1913, and properly
allowable for each of such years to the date of the sale in 1955 is the
aggregate sum of $81,467, the adjusted basis for determining gain in
1955 ($94,000 less $81,467) is $12,533 and the gain would be $12,467
($25,000 less $12,533). The increase in earnings and profits
accumulated since February 28, 1913, by reason of the sale, based on the
value as of March 1, 1913, adjusted for depreciation is $12,467. If the
depreciation since February 28, 1913, had been based on the adjusted
cost of $90,000 ($100,000 less $10,000) instead of the March 1, 1913,
value of $94,000, the depreciation sustained from that date to the date
of sale would have been $78,000 instead of $81,467 and the actual gain
on the sale based on the cost of $100,000 adjusted by depreciation on
such cost to $12,000 ($100,000 reduced by the sum of $10,000 and
$78,000) would be $13,000 ($25,000 less $12,000). If the adjusted basis
of the property was determined without regard to the value as of March
1, 1913, there would be an increase in earnings and profits of $13,000.
The difference of $533 ($13,000 minus $12,467) represents the increase
to be made in that part of the earnings and profits of Corporation Y
consisting of the increase in value of property accrued before, but
realized on or after, March 1, 1913 (assuming that the proper increase
in such surplus had been made each year for the difference between
depreciation based on cost and the depreciation based on March 1, 1913,
value). Thus, the total increase in that part of earnings and profits
consisting of the increase in value of property accrued before, but
realized on or after, March 1, 1913, is $4,000 ($94,000 less $90,000).
(c)(1) Section 312(g)(2) is an exception to the general rule in
section 312(g)(1) and also operates as a limitation on the application
of section 312(f). It provides that, if the application of section
312(f)(1)(B) to a sale or other disposition after February 28, 1913,
results in a loss which is to be applied in decrease of earnings and
profits for any period beginning after February 28, 1913, then,
notwithstanding section 312(f) and in lieu of the rule provided in
section 312(g)(1), the amount of such loss so to be applied shall be
reduced by the amount, if any, by which the adjusted basis of the
property used in determining the loss, exceeds the adjusted basis
computed without regard to the fair market value of the property on
March 1, 1913. If the amount so applied in reduction of the loss
exceeds such loss, the excess over such loss shall increase that part of
the earnings and profits consisting of increase in value of property
accrued before, but realized on or after March 1, 1913.
(2) The application of section 312(g)(2) may be illustrated by the
following examples:
Example (1). Corporation Y acquired nondepreciable property before
March 1, 1913, at a cost of $8,000. Its fair market value as of March
1, 1913, was $13,000, and it was sold in 1955 for $10,000. Under
section 312(f)(1)(B) the adjusted basis would be $13,000 and there would
be a loss of $3,000. The application of section 312(f)(1)(B) would
result in a loss from the sale in 1955 to be applied in decrease of
earnings and profits for that year. Section 312(g)(2), however, applies
and the loss of $3,000 is reduced by the amount by which the adjusted
basis of $13,000 exceeds the cost of $8,000 (the adjusted basis computed
without regard to the value on March 1, 1913), namely $5,000. The
amount of the loss is, accordingly, reduced from $3,000 to zero and
there is no decrease in earnings and profits of Corporation Y for the
year 1955 as a result of the sale. The amount applied in reduction of
the decrease, namely, $5,000, exceeds $3,000. Accordingly, as a result
of the sale the excess of $2,000 increases that part of the earnings and
profits of Corporation Y consisting of increase in value of property
accrued before, but realized on or after March 1, 1913.
Example (2). Corporation Z acquired nondepreciable property before
March 1, 1913, at a cost of $10,000. Its fair market value as of March
1, 1913, was $12,000, and it was sold in 1955 for $8,000. Under section
312(f)(1)(B) the adjusted basis would be $12,000 and there would be a
loss of $4,000. The application of section 312(f)(1)(B) would result in
a loss from the sale in 1955 to be applied in decrease of earnings and
profits for that year. Section 312(g)(2), however, applies and the loss
of $4,000 is reduced by the amount by which the adjusted basis of
$12,000 exceeds the cost of $10,000 (the adjusted basis computed without
regard to the value on March 1, 1913), namely, $2,000. The amount of
the loss is, accordingly, reduced from $4,000 to $2,000 and the decrease
in earnings and profits of Corporation Z for the year 1955 as a result
of the sale is $2,000 instead of $4,000. The amount applied in
reduction of the decrease, namely, $2,000, does not exceed $4,000.
Accordingly, as a result of the sale there is no increase in that part
of the earnings and profits of Corporation Z consisting of increase in
value of property accrued before, but realized on or after, March 1,
1913.
26 CFR 1.312-10 Allocation of earnings in certain corporate
separations.
(a) If one corporation transfers part of its assets constituting an
active trade or business to another corporation in a transaction to
which section 368(a)(1)(4) applies and immediately thereafter the stock
and securities of the controlled corporation are distributed in a
distribution or exchange to which section 355 (or so much of section 356
as relates to section 355) applies, the earnings and profits of the
distributing corporation immediately before the transaction shall be
allocated between the distributing corporation and the controlled
corporation. In the case of a newly created controlled corporation,
such allocation generally shall be made in proportion to the fair market
value of the business or businesses (and interests in any other
properties) retained by the distributing corporation and the business or
businesses (and interests in any other properties) of the controlled
corporation immediately after the transaction. In a proper case,
allocation shall be made between the distributing corporation and the
controlled corporation in proportion to the net basis of the assets
transferred and of the assets retained or by such other method as may be
appropriate under the facts and circumstances of the case. The term
''net basis'' means the basis of the assets less liabilities assumed or
liabilities to which such assets are subject. The part of the earnings
and profits of the taxable year of the distributing corporation in which
the transaction occurs allocable to the controlled corporation shall be
included in the computation of the earnings and profits of the first
taxable year of the controlled corporation ending after the date of the
transaction.
(b) If a distribution or exchange to which section 355 applies (or so
much of section 356 as relates to section 355) is not in pursuance of a
plan meeting the requirements of a reorganization as defined in section
368(a)(1)(D), the earnings and profits of the distributing corporation
shall be decreased by the lesser of the following amounts:
(1) The amount by which the earnings and profits of the distributing
corporation would have been decreased if it had transferred the stock of
the controlled corporation to a new corporation in a reorganization to
which section 368(a)(1)(D) applied and immediately thereafter
distributed the stock of such new corporation or,
(2) The net worth of the controlled corporation. (For this purpose
the term ''net worth'' means the sum of the basis of all of the
properties plus cash minus all liabilities.)
If the earnings and profits of the controlled corporation immediately
before the transaction are less than the amount of the decrease in
earnings and profits of the distributing corporation (including a case
in which the controlled corporation has a deficit) the earnings and
profits of the controlled corporation, after the transaction, shall be
equal to the amount of such decrease. If the earnings and profits of
the controlled corporation immediately before the transaction are more
than the amount of the decrease in the earnings and profits of the
distributing corporation, they shall remain unchanged.
(c) In no case shall any part of a deficit of a distributing
corporation within the meaning of section 355 be allocated to a
controlled corporation.
26 CFR 1.312-11 Effect on earnings and profits of certain other
tax-free exchanges, tax-free distributions, and tax-free transfers from
one corporation to another.
(a) If property is transferred by one corporation to another, and,
under the law applicable to the year in which the transfer was made, no
gain or loss was recognized (or was recognized only to the extent of the
property received other than that permitted by such law to be received
without the recognition of gain), then proper adjustment and allocation
of the earnings and profits of the transferor shall be made as between
the transferor and the transferee. Transfers to which the preceding
sentence applies include contributions to capital, transfers under
section 351, transfers in connection with reorganizations under section
368, transfers in liquidations under section 332 and intercompany
transfers during a period of affiliation. However, if, for example,
property is transferred from one corporation to another in a transaction
under section 351 or as a contribution to capital and the transfer is
not followed or preceded by a reorganization, a transaction under
section 302(a) involving a substantial part of the transferor's stock,
or a total or partial liquidation, then ordinarily no allocation of the
earnings and profits of the transferor shall be made. For specific
rules as to allocation of earnings and profits in certain
reorganizations under section 368 and in certain liquidations under
section 332 see section 381 and the regulations thereunder. For
allocation of earnings and profits in certain corporate separations see
section 312(i) and 1.312-10.
(b) The general rule provided in section 316 that every distribution
is made out of earnings or profits to the extent thereof and from the
most recently accumulated earnings or profits does not apply to:
(1) The distribution, in pursuance of a plan of reorganization, by or
on behalf of a corporation a party to the reorganization, or in a
transaction subject to section 355, to its shareholders --
(i) Of stock or securities in such corporation or in another
corporation a party to the reorganization in any taxable year beginning
before January 1, 1934, without the surrender by the distributees of
stock or securities in such corporation (see section 112(g) of the
Revenue Act of 1932 (47 Stat. 197)); or
(ii) Of stock (other than preferred stock) in another corporation
which is a party to the reorganization without the surrender by the
distributees of stock in the distributing corporation if the
distribution occurs after October 20, 1951, and is subject to section
112(b)(11) of the Internal Revenue Code of 1939; or
(iii) Of stock or securities in such corporation or in another
corporation a party to the reorganization in any taxable year beginning
before January 1, 1939, or on or after such date, in exchange for its
stock or securities in a transaction to which section 112(b)(3) of the
Internal Revenue Code of 1939 was applicable; or
(iv) Of stock or securities in such corporation or in another
corporation in exchange for its stock or securities in a transaction
subject to section 354 or 355,
if no gain to the distributees from the receipt of such stock or
securities was recognized by law.
(2) The distribution in any taxable year (beginning before January 1,
1939, or on or after such date) of stock or securities, or other
property or money, to a corporation in complete liquidation of another
corporation, under the circumstances described in section 112(b)(6) of
the Revenue Act of 1936 (49 Stat. 1679), the Revenue Act of 1938 (52
Stat. 485), of the Internal Revenue Code of 1939, or section 332 of the
Internal Revenue Code of 1954.
(3) The distribution in any taxable year (beginning after December
31, 1938), of stock or securities, or other property or money, in the
case of an exchange or distribution described in section 371 of the
Internal Revenue Code of 1939 or in section 1081 of the Internal Revenue
Code of 1954 (relating to exchanges and distributions in obedience to
orders of the Securities and Exchange Commission), if no gain to the
distributee from the receipt of such stock, securities, or other
property or money was recognized by law.
(4) A stock dividend which was not subject to tax in the hands of the
distributee because either it did not constitute income to him within
the meaning of the sixteenth amendment to the Constitution or because
exempt to him under section 115(f) of the Revenue Act of 1934 (48 Stat.
712) or a corresponding provision of a prior Revenue Act, or section 305
of the Code.
(5) The distribution, in a taxable year of the distributee beginning
after December 31, 1931, by or on behalf of an insolvent corporation, in
connection with a section 112(b)(10) reorganization under the Internal
Revenue Code of 1939, or in a transaction subject to section 371 of the
Internal Revenue Code of 1954, of stock or securities in a corporation
organized or made use of to effectuate the plan of reorganization, if
under section 112(e) of the Internal Revenue Code of 1939 or section 371
of the Internal Revenue Code of 1954 no gain to the distributee from the
receipt of such stock or securities was recognized by law.
(c) A distribution described in paragraph (b) of this section does
not diminish the earnings or profits of any corporation. In such cases,
the earnings or profits remain intact and available for distribution as
dividends by the corporation making such distribution, or by another
corporation to which the earnings or profits are transferred upon such
reorganization or other exchange. In the case, however, of amounts
distributed in liquidation (other than a taxfree liquidation or
reorganization described in paragraph (b) (1), (2), (3), or (5) of this
section) the earnings or profits of the corporation making the
distribution are diminished by the portion of such distribution properly
chargeable to earnings or profits accumulated after February 28, 1913,
after first deducting from the amount of such distribution the portion
thereof allocable to capital account.
(d) For the purposes of this section, the terms ''reorganization''
and ''party to the reorganization'' shall, for any taxable year
beginning before January 1, 1934, have the meanings assigned to such
terms in section 112 of the Revenue Act of 1932 (47 Stat. 196); for any
taxable year beginning after December 31, 1933, and before January 1,
1936, have the meanings assigned to such terms in section 112 of the
Revenue Act of 1934 (48 Stat. 704); for any taxable year beginning
after December 31, 1935, and before January 1, 1938, have the meanings
assigned to such terms in section 112 of the Revenue Act of 1936 (49
Stat. 1678); for any taxable year beginning after December 31, 1937,
and before January 1, 1939, have the meanings assigned to such terms in
section 112 of the Revenue Act of 1938 (52 Stat. 485); and for any
taxable year beginning after December 31, 1938, and ending before June
22, 1954, providing no election is made under section 393(b)(2) of the
Internal Revenue Code of 1954, have the meanings assigned to such terms
in section 112(g)(1) of the Internal Revenue Code of 1939.
26 CFR 1.312-12 Distributions of proceeds of loans guaranteed by the
United States.
(a) The provisions of section 312(j) are applicable with respect to a
loan, any portion of which is guaranteed by an agency of the United
States Government without regard to the percentage of such loan subject
to such guarantee.
(b) The application of section 312(j) is illustrated by the following
example:
Example. Corporation A borrowed $1,000,000 for the purpose of
construction of an apartment house, the cost and adjusted basis of which
was $900,000. This loan was guaranteed by an agency of the United
States Government. One year after such loan was made and after the
completion of construction of the building (but before such corporation
had received any income) it distributed $100,000 cash to its
shareholders. The earnings and profits of the taxable year of such
corporation are increased (pursuant to section 312(j)) by $100,000
immediately prior to such distribution and are decreased by $100,000
immediately after such distribution. Such decrease, however, does not
reduce the earnings and profits below zero. Two years later, it has no
accumulated earnings and has earnings of the taxable year of $100,000.
Before it has made any payments on the loan, it distributes $200,000 to
its shareholders. The earnings and profits of the taxable year of the
corporation ($100,000) are increased by $100,000, the excess of the
amount of the guaranteed loan over the adjusted basis of the apartment
house (calculated without adjustment for depreciation). The entire
amount of each distribution is treated as a distribution out of earnings
and profits and, accordingly, as a taxable dividend.
26 CFR 1.312-15 Effect of depreciation on earnings and profits.
(a) Depreciation for taxable years beginning after June 30, 1972 --
(1) In general. Except as provided in subparagraph (2) of this
paragraph and paragraph (c) of this section, for purposes of computing
the earnings and profits of a corporation (including a real estate
investment trust as defined in section 856) for any taxable year
beginning after June 30, 1972, the allowance for depreciation (and
amortization, if any) shall be deemed to be the amount which would be
allowable for such year if the straight line method of depreciation had
been used for all property for which depreciation is allowable for each
taxable year beginning after June 30, 1972. Thus, for taxable years
beginning after June 30, 1972, in determining the earnings and profits
of a corporation, depreciation must be computed under the straight line
method, notwithstanding that in determining taxable income the
corporation uses an accelerated method of depreciation described in
subparagraph (A), (B), or (C) of section 312(m)(2) or elects to amortize
the basis of property under section 169, 184, 187, or 188, or any
similar provision.
(2) Exception. (i) If, for any taxable year beginning after June 30,
1972, a method of depreciation is used by a corporation in computing
taxable income which the Secretary or his delegate has determined
results in a reasonable allowance under section 167(a) and which is not
a declining balance method of depreciation (described in 1.167(b)-2),
the sum of the years-digits method (described in 1.167(b)-3), or any
other method allowed solely by reason of the application of subsection
(b)(4) or (j)(1)(C) of section 167, then the adjustment to earnings and
profits for depreciation for such year shall be determined under the
method so used (in lieu of the straight line method).
(ii) The Commissioner has determined that the ''unit of production''
(see 1.167(b)-0(b)), and the ''machine hour'' methods of depreciation,
when properly used under appropriate circumstances, meet the
requirements of subdivision (i) of this subparagraph. Thus, the
adjustment to earnings and profits for depreciation (for the taxable
year for which either of such methods is properly used under appropriate
circumstances) shall be determined under whichever of such methods is
used to compute taxable income.
(3) Determinations under straight line method. (i) In the case of
property with respect to which an allowance for depreciation is claimed
in computing taxable income, the determination of the amount which would
be allowable under the straight line method shall be based on the manner
in which the corporation computes depreciation in determining taxable
income. Thus, if an election under 1.167(a)-11 is in effect with
respect to the property, the amount of depreciation which would be
allowable under the straight line method shall be determined under
1.167(a)-11(g)(3). On the other hand, if property is not depreciated
under the provisions of 1.167(a)-11, the amount of depreciation which
would be allowable under the straight line method shall be determined
under 1.167(b)-1. Any election made under section 167(f), with respect
to reducing the amount of salvage value taken into account in computing
the depreciation allowance for certain property, or any convention
adopted under 1.167(a)-10(b) or 1.167(a)-11(c)(2), with respect to
additions and retirements from multiple asset accounts, which is used in
computing depreciation for taxable income shall be used in computing
depreciation for earnings and profits purposes.
(ii) In the case of property with respect to which an election to
amortize is in effect under section 169, 184, 187, or 188, or any
similar provision, the amount which would be allowable under the
straight line method of depreciation shall be determined under the
provisions of 1.167(b)-1. Thus, the cost or other basis of the
property, less its estimated salvage value, is to be deducted in equal
annual amounts over the period of the estimated useful life of the
property. In computing the amount of depreciation for earnings and
profits purposes, a taxpayer may utilize the provisions of section
167(f) (relating to the reduction in the amount of salvage value taken
into account in computing the depreciation allowance for certain
property) and any convention which could have been adopted for such
property under 1.167(a)-10(b) (relating to additions and retirements
from multiple asset accounts).
(b) Transitional rules -- (1) Depreciation. If, for the taxable year
which includes June 30, 1972, (i) the allowance for depreciation of any
property is computed under a method other than the straight line method
or a method described in paragraph (a)(2) of this section, and (ii)
paragraph (a)(1) of this section applies to such property for the first
taxable year beginning after June 30, 1972, then adjustments to earnings
and profits for depreciation of such property for taxable years
beginning after June 30, 1972, shall be determined as if the corporation
changed to the straight line method with respect to such property as of
the first day of the first taxable year beginning after June 30, 1972.
Thus, if an election under 1.167 (a)-11 is in effect with respect to
the property, the change shall be made under the provisions of
1.167(a)-11(c)(1)(iii), except that no statement setting forth the
vintage accounts for which the change is made shall be furnished with
the income tax return of the year of change if the change is only for
purposes of computing earnings and profits. In all other cases, the
unrecovered cost or other basis of the property (less a reasonable
estimate for salvage) as of such first day shall be recovered through
equal annual allowances over the estimated remaining useful life
determined in accordance with the circumstances existing at that time.
See paragraph (a)(3)(i) of this section for rules relating to the
applicability of section 167(f) in determining salvage value.
(2) Amortization. If, for the taxable year which includes June 30,
1972, the basis of any property is amortized under section 169, 184,
187, or 188, or any similar provision, then adjustments to earnings and
profits for depreciation or amortization of such property for taxable
years beginning after June 30, 1972, shall be determined as if the
unrecovered cost or other basis of the property (less a reasonable
estimate for salvage) as of the first day of the first taxable year
beginning after June 30, 1972, were recovered through equal annual
allowances over the estimated remaining useful life of the property
determined in accordance with the circumstances existing at that time.
See paragraph (a)(3)(ii) of this section for rules relating to the
applicability of section 167(f).
(c) Certain foreign corporations. Paragraphs (a) and (b) of this
section shall not apply in computing the earnings and profits of a
foreign corporation for any taxable year for which less than 20 percent
of the gross income from all sources of such corporation is derived from
sources within the United States.
(d) Books and records. Wherever different methods of depreciation
are used for taxable income and earnings and profits purposes, records
shall be maintained which show the depreciation taken for earnings and
profits purposes each year and which will allow computation of the
adjusted basis of the property in each account using the depreciation
taken for earnings and profits purposes.
(T.D. 7221, 37 FR 24746, Nov. 21, 1972)
26 CFR 1.312-15 definitions; constructive ownership of stock
26 CFR 1.316-1 Dividends.
(a) (1) The term dividend for the purpose of subtitle A of the Code
(except when used in subchapter L, chapter 1 of the Code, in any case
where the reference is to dividends and similar distributions of
insurance companies paid to policyholders as such) comprises any
distribution of property as defined in section 317 in the ordinary
course of business, even though extraordinary in amount, made by a
domestic or foreign corporation to its shareholders out of either --
(i) Earnings and profits accumulated since February 28, 1913, or
(ii) Earnings and profits of the taxable year computed without regard
to the amount of the earnings and profits (whether of such year or
accumulated since February 28, 1913) at the time the distribution was
made.
The earnings and profits of the taxable year shall be computed as of
the close of such year, without diminution by reason of any
distributions made during the taxable year. For the purpose of
determining whether a distribution constitutes a dividend, it is
unnecessary to ascertain the amount of the earnings and profits
accumulated since February 28, 1913, if the earnings and profits of the
taxable year are equal to or in excess of the total amount of the
distributions made within such year.
(2) Where a corporation distributes property to its shareholders on
or after June 22, 1954, the amount of the distribution which is a
dividend to them may not exceed the earnings and profits of the
distributing corporation.
(3) The rule of (2) above may be illustrated by the following
example:
Example. X and Y, individuals, each own one-half of the stock of
Corporation A which has earnings and profits of $10,000. Corporation A
distributes property having a basis of $6,000 and a fair market value of
$16,000 to its shareholders, each shareholder receiving property with a
basis of $3,000 and with a fair market value of $8,000 in a distribution
to which section 301 applies. The amount taxable to each shareholder as
a dividend under section 301(c) is $5,000.
(b) (1) In the case of a corporation which, under the law applicable
to the taxable year in which a distribution is made, is a personal
holding company or which, for the taxable year in respect of which a
distribution is made under section 563 (relating to dividends paid
within 2 1/2 months after the close of the taxable year), or section 547
(relating to deficiency dividends), or corresponding provisions of a
prior income tax law, was under the applicable law a personal holding
company, the term ''dividend'', in addition to the meaning set forth in
the first sentence of section 316, also means a distribution to its
shareholders as follows: A distribution within a taxable year of the
corporation, or of a shareholder, is a dividend to the extent of the
corporation's undistributed personal holding company income (determined
under section 545 without regard to distributions under section
316(b)(2)) for the taxable year in which, or, in the case of a
distribution under section 563 or section 547, the taxable year in
respect of which, the distribution was made. This subparagraph does not
apply to distributions in partial or complete liquidation of a personal
holding company. In the case of certain complete liquidations of a
personal holding company see subparagraph (2) of this paragraph.
(2) In the case of a corporation which, under the law applicable to
the taxable year in which a distribution is made, is a personal holding
company or which, for the taxable year in respect of which a
distribution is made under section 563, or section 547, or corresponding
provisions of a prior income tax law, was under the applicable law a
personal holding company, the term ''dividend'', in addition to the
meaning set forth in the first sentence of section 316, also means, in
the case of a complete liquidation occuring within 24 months after the
adoption of a plan of liquidation, a distribution of property to its
shareholders within such period, but --
(i) Only to the extent of the amounts distributed to distributees
other than corporate shareholders, and
(ii) Only to the extent that the corporation designates such amounts
as a dividend distribution and duly notifies such distributees in
accordance with subparagraph (5) of this paragraph, but
(iii) Not in excess of the sum of such distributees' allocable share
of the undistributed personal holding company income for such year
(determined under section 545 without regard to sections 562(b) and
316(b)(2)(B)).
Section 316(b)(2)(B) and this subparagraph apply only to
distributions made in any taxable year of the distributing corporation
beginning after December 31, 1963. The amount designated with respect
to a noncorporate distributee may not exceed the amount actually
distributed to such distributee. For purposes of determining a
noncorporate distributee's gain or loss on liquidation, amounts
distributed in complete liquidation to such distributee during a taxable
year are reduced by the amounts designated as a dividend with respect to
such distributee for such year. For purposes of section 333(e)(1), a
shareholder's ratable share of the earnings and profits of the
corporation accumulated after February 28, 1913, shall be reduced by the
amounts designated as a dividend with respect to such shareholder (even
though such designated amounts are distributed during the 1-month period
referred to in section 333).
(3) For purposes of subparagraph (2)(iii) of this paragraph --
(i) Except as provided in subdivision (ii) of this subparagraph, the
sum of the noncorporate distributees' allocable share of undistributed
personal holding company income for the taxable year in which, or in
respect of which, the distribution was made (computed without regard to
sections 562(b) and 316(b)(2)(B)) shall be determined by multiplying
such undistributed personal holding company income by the ratio which
the aggregate value of the stock held by all noncorporate shareholders
immediately before the record date of the last liquidating distribution
in such year bears to the total value of all stock outstanding on such
date. For rules applicable in a case where the distributing corporation
has more than one class of stock, see subdivision (iii) of this
subparagraph.
(ii) If more than one liquidating distribution was made during the
year, and if, after the record date of the first distribution but before
the record date of the last distribution, there was a change in the
relative shareholdings as between noncorporate shareholders and
corporate shareholders, then the sum of the noncorporate distributees'
allocable share of undistributed personal holding company income for the
taxable year in which, or in respect of which, the distributions were
made (computed without regard to sections 562(b) and 316(b)(2)(B)) shall
be determined as follows:
(a) First, allocate the corporation's undistributed personal holding
company income among the distributions made during the taxable year by
reference to the ratio which the aggregate amount of each distribution
bears to the total amount of all distributions during such year;
(b) Second, determine the noncorporate distributees' allocable share
of the corporation's undistributed personal holding company income for
each distribution by multiplying the amount determined under (a) of this
subdivision (ii) for each distribution by the ratio which the aggregate
value of the stock held by all noncorporate shareholders immediately
before the record date of such distribution bears to the total value of
all stock outstanding on such date; and
(c) Last, determine the sum of the noncorporate distributees'
allocable share of the corporation's undistributed personal holding
company income for all such distributions.
For rules applicable in a case where the distributing corporation has
more than one class of stock, see subdivision (iii) of this
subparagraph.
(iii) Where the distributing corporation has more than one class of
stock --
(a) The undistributed personal holding company income for the taxable
year in which, or in respect of which the distribution was made shall be
treated as a fund from which dividends may properly be paid and shall be
allocated between or among the classes of stock in a manner consistent
with the dividend rights of such classes under local law and the
pertinent governing instruments, such as, for example, the distributing
corporation's articles or certificate of incorporation and bylaws;
(b) The noncorporate distributees' allocable share of the
undistributed personal holding company income for each class of stock
shall be determined separately in accordance with the rules set forth in
subdivisions (i) or (ii) of this subparagraph, as if each class of stock
were the only class of stock outstanding; and
(c) The sum of the noncorporate distributees' allocable share of the
undistributed personal holding company income for the taxable year in
which, or in respect of which, the distribution was made shall be the
sum of the noncorporate distributees' allocable share of the
undistributed personal holding company income for all classes of stock.
(iv) For purposes of this subparagraph, in any case where the record
date of a liquidating distribution cannot be ascertained, the record
date of the distribution shall be the date on which the liquidating
distribution was actually made.
(4) The amount designated as a dividend to a noncorporate distributee
for any taxable year of the distributing corporation may not exceed an
amount equal to the sum of the noncorporate distributees' allocable
share of undistributed personal holding company income (as determined
under subparagraph (3) of this paragraph) for such year multiplied by
the ratio which the aggregate value of the stock held by such
distributee immediately before the record date of the liquidating
distribution or, if the record date cannot be ascertained, immediately
before the date on which the liquidating distribution was actually made,
bears to the aggregate value of stock outstanding held by all
noncorporate distributees on such date. In any case where more than one
liquidating distribution is made during the taxable year, the aggregate
amount which may be designated as a dividend to a noncorporate
distributee for such year may not exceed the aggregate of the amounts
determined by applying the principle of the preceding sentence to the
amounts determined under subparagraphs (3)(ii) (a) and (b) of this
paragraph for each distribution. Where the distributing corporation has
more than one class of stock, the limitation on the amount which may be
designated as a dividend to a noncorporate distributee for any taxable
year shall be determined by applying the rules of this subparagraph
separately with respect to the noncorporate distributees' allocable
share of the undistributed personal holding company income for each
class of stock (as determined under subparagraphs (3)(iii) (a) and (b)
of this paragraph).
(5) A corporation may designate as a dividend to a shareholder all or
part of a distribution in complete liquidation described in section
316(b)(2)(B) of this paragraph by:
(i) Claiming a dividends paid deduction for such amount in its return
for the year in which, or in respect of which, the distribution is made,
(ii) Including such amount as a dividend in Form 1099 filed in
respect of such shareholder pursuant to section 6042(a) and the
regulations thereunder and in a written statement of dividend payments
furnished to such shareholder pursuant to section 6042(c) and 1.6042-4,
and
(iii) Indicating on the written statement of dividend payments
furnished to such shareholder the amount included in such statement
which is designated as a dividend under section 316(b)(2)(B) and this
paragraph.
If a corporation complies with the procedure prescribed in the
preceding sentence, it satisfies both the designation and notification
requirements of section 316(b)(2)(B)(ii) and paragraph (b)(2)(ii) of
this section. An amount designated as a dividend shall not be included
as a distribution in liquidation on Form 1099L filed pursuant to
1.6043-2 (relating to returns of information respecting distributions in
liquidation). If a corporation designates a dividend in accordance with
this subparagraph, it shall attach to the return in which it claims a
deduction for such designated dividend a schedule indicating all facts
necessary to determine the sum of the noncorporate distributees'
allocable share of undistributed personal holding company income
(determined in accordance with subparagraph (3) of this paragraph) for
the year in which, or in respect of which, the distribution is made.
(c) Except as provided in section 316(b)(1), the term ''dividend''
includes any distribution of property to shareholders to the extent made
out of accumulated or current earnings and profits. See, however,
section 331 (relating to distributions in complete or partial
liquidation), section 301(e) (relating to distributions by personal
service corporations), section 302(b) (relating to redemptions treated
as amounts received from the sale or exchange of stock), and section 303
(relating to distributions in redemption of stock to pay death taxes).
See also section 305(b) for certain distributions of stock or stock
rights treated as distributions of property.
(d) In the case of a corporation which, under the law applicable to
the taxable year in respect of which a distribution is made under
section 860 (relating to deficiency dividends), was a regulated
investment company (within the meaning of section 851), or a real estate
investment trust (within the meaning of section 856), the term
''dividend,'' in addition to the meaning set forth in paragraphs (a) and
(b) of section 316, means a distribution of property to its shareholders
which constitutes a ''deficiency dividend'' as defined in section
860(f).
(e) The application of section 316 may be illustrated by the
following examples:
Example (1). At the beginning of the calendar year 1955, Corporation
M had an operating deficit of $200,000 and the earnings and profits for
the year amounted to $100,000. Beginning on March 16, 1955, the
corporation made quarterly distributions of $25,000 during the taxable
year to its shareholders. Each distribution is a taxable dividend in
full, irrespective of the actual or the pro rata amount of the earnings
and profits on hand at any of the dates of distribution, since the total
distributions made during the year ($100,000) did not exceed the total
earnings and profits of the year ($100,000).
Example (2). At the beginning of the calendar year 1955, Corporation
N, a personal holding company, had no accumulated earnings and profits.
During that year it made no earnings and profits but, due to the
disallowance of certain deductions, its undistributed personal holding
company income (determined under section 545 without regard to
distributions under section 316(b)(2)) was $16,000. It distributed to
shareholders on December 15, 1955, $15,000, and on February 1, 1956,
$1,000, the latter amount being claimed as a deduction under section 563
in its personal holding company schedule for 1955 filed with its return
for 1955 on March 15, 1956. Both distributions are taxable dividends in
full, since they do not exceed the undistributed personal holding
company income (determined without regard to such distributions) for
1955, the taxable year in which the distribution of $15,000 was made and
with respect to which the distribution of $1,000 was made. It is
immaterial whether Corporation N is a personal holding company for the
taxable year 1956 or whether it had any income for that year.
Example (3). In 1959, a deficiency in personal holding company tax
was established against Corporation O for the taxable year 1955 in the
amount of $35,500 based on an undistributed personal holding company
income of $42,000. Corporation O complied with the provisions of
section 547 and in December 1959 distributed $42,000 to its stockholders
as ''deficiency dividends.'' The distribution of $42,000 is a taxable
dividend since it does not exceed $42,000 (the undistributed personal
holding company income for 1955, the taxable year with respect to which
the distribution was made). It is immaterial whether Corporation O is a
personal holding company for the taxable year 1959 or whether it had any
income for that year.
Example (4). At the beginning of the taxable year 1955, Corporation
P, a personal holding company, had a deficit in earnings and profits of
$200,000. During that year it made earnings and profits of $90,000.
For that year, however, it had an undistributed personal holding income
(determined under section 545 without regard to distributions under
section 316(b)(2)) of $80,000. During such taxable year it distributed
to its shareholders $100,000. The distribution of $100,000 is a taxable
dividend to the extent of $90,000 since its earnings and profits for
that year, $90,000, exceed $80,000, the undistributed personal holding
company income determined without regard to such distribution.
Example (5). Corporation O, a calendar year taxpayer, is completely
liquidated on December 31, 1964, pursuant to a plan of liquidation
adopted July 1, 1964. No distributions in liquidation were made
pursuant to the plan of liquidation adopted July 1, 1964, until the
distribution in complete liquidation on December 31, 1964. Corporation
O has undistributed personal holding company income of $300,000 for the
year 1964 (computed without regard to section 562(b) or section
316(b)(2)(B)). On December 31, 1964, immediately before the record date
of the distribution in complete liquidation, individual A owns 200
shares of Corporation O's outstanding stock and Corporation P owns the
remaining 100 shares of outstanding stock. All shares are equal in
value. The noncorporate distributees' allocable share of undistributed
personal holding company income for 1964 is $200,000
If at least $200,000 is distributed to A in the liquidation, then
Corporation O may designate $200,000 to A as a dividend in accordance
with paragraph (b)(5) of this section, and, if such amount is
designated, then A must treat $200,000 as a dividend to which section
301 applies. For an example of the treatment of the distribution to
Corporation P see paragraph (b)(2)(iii) of 1.562-1.
Example (6). Corporation Q, a calendar year taxpayer, is completely
liquidated on December 31, 1964, pursuant to a plan of liquidation
adopted July 1, 1964. No distributions in liquidation were made
pursuant to the plan of liquidation adopted July 1, 1964, until the
distribution in complete liquidation on December 31, 1964. Corporation
Q has undistributed personal holding company income of $40,000 for the
year 1964 (computed without regard to section 562(b) or section
316(b)(2)(B)). On December 31, 1964, immediately before the record date
of the distribution in complete liquidation, Corporation Q has
outstanding 300 shares of common stock and 100 shares of noncumulative
preferred stock. Corporation Q's articles of incorporation provide that
the preferred stock is entitled to dividends of $10 per share per year.
Of Corporation Q's stock, individual B owns 200 shares of the common
stock and 50 shares of the preferred stock, and Corporation R owns all
remaining shares. All of the common shares are equal in value, and all
of the preferred shares are equal in value. No dividends had been paid
on the preferred stock during the year 1964. Of the $40,000 of
undistributed personal holding company income, $1,000 must be allocated
to the preferred stock because of the rights of the holders of such
stock, under Q's articles of incorporation, to receive that amount in
dividends for the year 1964. The noncorporate distributees' allocable
share of undistributed personal holding company income for 1964 is
$26,500.
50 preferred shares 100 preferred shares $1,000+200 common shares
300 common shares $39,000
If at least $26,500 is distributed to B in the liquidation, then
corporation Q may designate $26,500 to B as a dividend in accordance
with paragraph (b)(5) of this section, and, if such amount is
designated, then B must treat $26,500 as a dividend to which section 301
applies.
Example (7). In 1979, a deficiency of $46,000 in the tax on real
estate investment trust taxable income is established against
corporation R for the taxable year 1977, based on an increase in real
estate investment trust taxable income of $100,000. Corporation R
complied with the provisions of section 860 and in December 1979
distributed to its stockholders $100,000, which qualified as
''deficiency dividends'' under section 860. The distribution of
$100,000 is a taxable dividend. It is immaterial whether corporation R
is a real estate investment trust for the taxable year 1979 or whether
it had accumulated or current earnings and profits in 1979. See section
316(b)(3).
(Sec. 860(l) (92 Stat. 2849, 26 U.S.C. 860(l)); sec. 860(g) (92
Stat. 2850, 26 U.S.C. 860(g)); and sec. 7805 (68A Stat. 917, 26 U.S.C.
7805))
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6625, 27
FR 12541, Dec. 19, 1962; T.D. 6949, 33 FR 5519, Apr. 9, 1968; T.D.
7767, 46 FR 11264, Feb. 6, 1981; T.D. 7936, 49 FR 2105, Jan. 18, 1984)
26 CFR 1.316-2 Sources of distribution in general.
(a) For the purpose of income taxation every distribution made by a
corporation is made out of earnings and profits to the extent thereof
and from the most recently accumulated earnings and profits. In
determining the source of a distribution, consideration should be given
first, to the earnings and profits of the taxable year; second, to the
earnings and profits accumulated since February 28, 1913, only in the
case where, and to the extent that, the distributions made during the
taxable year are not regarded as out of the earnings and profits of that
year; third, to the earnings and profits accumulated before March 1,
1913, only after all the earnings and profits of the taxable year and
all the earnings and profits accumulated since February 28, 1913, have
been distributed; and, fourth, to sources other than earnings and
profits only after the earnings and profits have been distributed.
(b) If the earnings and profits of the taxable year (computed as of
the close of the year without diminution by reason of any distributions
made during the year and without regard to the amount of earnings and
profits at the time of the distribution) are sufficient in amount to
cover all the distributions made during that year, then each
distribution is a taxable dividend. See 1.316-1. If the distributions
made during the taxable year consist only of money and exceed the
earnings and profits of such year, then that proportion of each
distribution which the total of the earnings and profits of the year
bears to the total distributions made during the year shall be regarded
as out of the earnings and profits of that year. The portion of each
such distribution which is not regarded as out of earnings and profits
of the taxable year shall be considered a taxable dividend to the extent
of the earnings and profits accumulated since February 28, 1913, and
available on the date of the distribution. In any case in which it is
necessary to determine the amount of earnings and profits accumulated
since February 28, 1913, and the actual earnings and profits to the date
of a distribution within any taxable year (whether beginning before
January 1, 1936, or, in the case of an operating deficit, on or after
that date) cannot be shown, the earnings and profits for the year (or
accounting period, if less than a year) in which the distribution was
made shall be prorated to the date of the distribution not counting the
date on which the distribution was made.
(c) The provisions of the section may be illustrated by the following
example:
Example. At the beginning of the calendar year 1955, Corporation M
had $12,000 in earnings and profits accumulated since February 28, 1913.
Its earnings and profits for 1955 amounted to $30,000. During the year
it made quarterly cash distributions of $15,000 each. Of each of the
four distributions made, $7,500 (that portion of $15,000 which the
amount of $30,000, the total earnings and profits of the taxable year,
bears to $60,000, the total distributions made during the year) was paid
out of the earnings and profits of the taxable year; and of the first
and second distributions, $7,500 and $4,500, respectively, were paid out
of the earnings and profits accumulated after February 28, 1913, and
before the taxable year, as follows:
(d) Any distribution by a corporation out of earnings and profits
accumulated before March 1, 1913, or out of increase in value of
property accrued before March 1, 1913 (whether or not realized by sale
or other disposition, and, if realized, whether before, on, or after
March 1, 1913), is not a dividend within the meaning of subtitle A of
the Code.
(e) A reserve set up out of gross income by a corporation and
maintained for the purpose of making good any loss of capital assets on
account of depletion or depreciation is not a part of surplus out of
which ordinary dividends may be paid. A distribution made from a
depletion or a depreciation reserve based upon the cost or other basis
of the property will not be considered as having been paid out of
earnings and profits, but the amount thereof shall be applied against
and reduce the cost or other basis of the stock upon which declared. If
such a distribution is in excess of the basis, the excess shall be taxed
as a gain from the sale or other disposition of property as provided in
section 301(c)(3)(A). A distribution from a depletion reserve based
upon discovery value to the extent that such reserve represents the
excess of the discovery value over the cost or other basis for
determining gain or loss, is, when received by the shareholders, taxable
as an ordinary dividend. The amount by which a corporation's percentage
depletion allowance for any year exceeds depletion sustained on cost or
other basis, that is, determined without regard to discovery or
percentage depletion allowances for the year of distribution or prior
years, constitutes a part of the corporation's ''earnings and profits
accumulated after February 28, 1913,'' within the meaning of section
316, and, upon distribution to shareholders, is taxable to them as a
dividend. A distribution made from that portion of a depletion reserve
based upon a valuation as of March 1, 1913, which is in excess of the
depletion reserve based upon cost, will not be considered as having been
paid out of earnings and profits, but the amount of the distribution
shall be applied against and reduce the cost or other basis of the stock
upon which declared. See section 301. No distribution, however, can be
made from such a reserve until all the earnings and profits of the
corporation have first been distributed.
26 CFR 1.317-1 Property defined.
The term property, for purposes of part 1, subchapter C, chapter 1 of
the Code, means any property (including money, securities, and
indebtedness to the corporation) other than stock, or rights to acquire
stock, in the corporation making the distribution.
26 CFR 1.318-1 Constructive ownership of stock; introduction.
(a) For the purposes of certain provisions of chapter 1 of the Code,
section 318(a) provides that stock owned by a taxpayer includes stock
constructively owned by such taxpayer under the rules set forth in such
section. An individual is considered to own the stock owned, directly
or indirectly, by or for his spouse (other than a spouse who is legally
separated from the individual under a decree of divorce or separate
maintenance), and by or for his children, grandchildren, and parents.
Under section 318(a) (2) and (3), constructive ownership rules are
established for partnerships and partners, estates and beneficiaries,
trusts and beneficiaries, and corporations and stockholders. If any
person has an option to acquire stock, such stock is considered as owned
by such person. The term ''option'' includes an option to acquire such
an option and each of a series of such options.
(b) In applying section 318(a) to determine the stock ownership of
any person for any one purpose --
(1) A corporation shall not be considered to own its own stock by
reason of section 318(a)(3)(C);
(2) In any case in which an amount of stock owned by any person may
be included in the computation more than one time, such stock shall be
included only once, in the manner in which it will impute to the person
concerned the largest total stock ownership; and
(3) In determining the 50-percent requirement of section 318(a)
(2)(C) and (3)(C), all of the stock owned actually and constructively by
the person concerned shall be aggregated.
(T.D. 6969, 33 FR 11999, Aug. 23, 1968)
26 CFR 1.318-2 Application of general rules.
(a) The application of paragraph (b) of 1.318-1 may be illustrated
by the following examples:
Example (1). H, an individual, owns all of the stock of corporation
A. Corporation A is not considered to own the stock owned by H in
corporation A.
Example (2). H, an individual, his wife, W, and his son, S, each own
one-third of the stock of the Green Corporation. For purposes of
determining the amount of stock owned by H, W, or S for purposes of
section 318(a) (2)(C) and (3)(C), the amount of stock held by the other
members of the family shall be added pursuant to paragraph (b)(3) of
1.318-1 in applying the 50-percent requirement of such section. H, W,
or S, as the case may be, is for this purpose deemed to own 100 percent
of the stock of the Green Corporation.
(b) The application of section 318(a)(1), relating to members of a
family, may be illustrated by the following example:
Example. An individual, H, his wife, W, his son, S, and his grandson
(S's son), G, own the 100 outstanding shares of stock of a corporation,
each owning 25 shares. H, W, and S are each considered as owning 100
shares. G is considered as owning only 50 shares, that is, his own and
his father's.
(c) The application of section 318(a) (2) and (3), relating to
partnerships, trusts and corporations, may be illustrated by the
following examples:
Example (1). A, an individual, has a 50 percent interest in a
partnership. The partnership owns 50 of the 100 outstanding shares of
stock of a corporation, the remaining 50 shares being owned by A. The
partnership is considered as owning 100 shares. A is considered as
owning 75 shares.
Example (2). A testamentary trust owns 25 of the outstanding 100
shares of stock of a corporation. A, an individual, who holds a vested
remainder in the trust having a value, computed actuarially equal to 4
percent of the value of the trust property, owns the remaining 75
shares. Since the interest of A in the trust is a vested interest
rather than a contingent interest (whether or not remote), the trust is
considered as owning 100 shares. A is considered as owning 76 shares.
Example (3). The facts are the same as in (2), above, except that
A's interest in the trust is a contingent remainder. A is considered as
owning 76 shares. However, since A's interest in the trust is a remote
contingent interest, the trust is not considered as owning any of the
shares owned by A.
Example (4). A and B, unrelated individuals, own 70 percent and 30
percent, respectively, in value of the stock of Corporation M.
Corporation M owns 50 of the 100 outstanding shares of stock of
Corporation O, the remaining 50 shares being owned by A. Corporation M
is considered as owning 100 shares of Corporation O, and A is considered
as owning 85 shares.
Example (5). A and B, unrelated individuals, own 70 percent and 30
percent, respectively, of the stock of corporation M. A, B, and
corporation M all own stock of corporation O. Since B owns less than 50
percent in value of the stock of corporation M, neither B nor
corporation M constructively owns the stock of corporation O owned by
the other. However, for purposes of certain sections of the Code, such
as sections 304 and 856(d), the 50-percent limitation of section 318(a)
(2)(C) and (3)(C) is disregarded or is reduced to less than 30 percent.
For such purposes, B constructively owns his proportionate share of the
stock of corporation O owned directly by corporation M, and corporation
M constructively owns the stock of corporation O owned by B.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33
FR 11999, Aug. 23, 1968)
26 CFR 1.318-3 Estates, trusts, and options.
(a) For the purpose of applying section 318(a), relating to estates,
property of a decedent shall be considered as owned by his estate if
such property is subject to administration by the executor or
administrator for the purpose of paying claims against the estate and
expenses of administration notwithstanding that, under local law, legal
title to such property vests in the decedent's heirs, legatees or
devisees immediately upon death. The term ''beneficiary'' includes any
person entitled to receive property of a decedent pursuant to a will or
pursuant to laws of descent and distribution. A person shall no longer
be considered a beneficiary of an estate when all the property to which
he is entitled has been received by him, when he no longer has a claim
against the estate arising out of having been a beneficiary, and when
there is only a remote possibility that it will be necessary for the
estate to seek the return of property or to seek payment from him by
contribution or otherwise to satisfy claims against the estate or
expenses of administration. When, pursuant to the preceding sentence, a
person ceases to be a beneficiary, stock owned by him shall not
thereafter be considered owned by the estate, and stock owned by the
estate shall not thereafter be considered owned by him. The application
of section 318(a) relating to estates may be illustrated by the
following examples:
Example (1). (a) A decedent's estate owns 50 of the 100 outstanding
shares of stock of corporation X. The remaining shares are owned by
three unrelated individuals, A, B, and C, who together own the entire
interest in the estate. A owns 12 shares of stock of corporation X
directly and is entitled to 50 percent of the estate. B owns 18 shares
directly and has a life estate in the remaining 50 percent of the
estate. C owns 20 shares directly and also owns the remainder interest
after B's life estate.
(b) If section 318(a)(5)(C) applies (see paragraph (c)(3) of
1.318-4), the stock of corporation X is considered to be owned as
follows: the estate is considered as owning 80 shares, 50 shares
directly, 12 shares constructively through A, and 18 shares
constructively through B; A is considered as owning 37 shares, 12
shares directly, and 25 shares constructively (50 percent of the 50
shares owned directly by the estate); B is considered as owning 43
shares, 18 shares directly and 25 shares constructively (50 percent of
the 50 shares owned directly by the estate); C is considered as owning
20 shares directly and no shares constructively. C is not considered a
beneficiary of the estate under section 318(a) since he has no direct
present interest in the property held by the estate nor in the income
produced by such property.
(c) If section 318(a)(5)(C) does not apply, A is considered as owning
nine additional shares (50 percent of the 18 shares owned constructively
by the estate through B), and B is considered as owning six additional
shares (50 percent of the 12 shares owned constructively by the estate
through A).
Example (2). Under the will of A, Blackacre is left to B for life,
remainder to C, an unrelated individual. The residue of the estate
consisting of stock of a corporation is left to D. B and D are
beneficiaries of the estate under section 318(a). C is not considered a
beneficiary since he has no direct present interest in Blackacre nor in
the income produced by such property. The stock owned by the estate is
considered as owned proportionately by B and D.
(b) For the purpose of section 318(a)(2)(B) stock owned by a trust
will be considered as being owned by its beneficiaries only to the
extent of the interest of such beneficiaries in the trust. Accordingly,
the interest of income beneficiaries, remainder beneficiaries, and other
beneficiaries will be computed on an actuarial basis. Thus, if a trust
owns 100 percent of the stock of Corporation A, and if, on an actuarial
basis, W's life interest in the trust is 15 percent, Y's life interest
is 25 percent, and Z's remainder interest is 60 percent, under this
provision W will be considered to be the owner of 15 percent of the
stock of Corporation A, Y will be considered to be the owner of 25
percent of such stock, and Z will be considered to be the owner of 60
percent of such stock. The factors and methods prescribed in 20.2031-7
of this chapter (Estate Tax Regulations) for use in ascertaining the
value of an interest in property for estate tax purposes shall be used
in determining a beneficiary's actuarial interest in a trust for
purposes of this section. See 20.2031-7 of this chapter (Estate Tax
Regulations) for examples illustrating the use of these factors and
methods.
(c) The application of section 318(a) relating to options may be
illustrated by the following example:
Example. A and B, unrelated individuals, own all of the 100
outstanding shares of stock of a corporation, each owning 50 shares. A
has an option to acquire 25 of B's shares and has an option to acquire a
further option to acquire the remaining 25 of B's shares. A is
considered as owning the entire 100 shares of stock of the corporation.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33
FR 11999, Aug. 23, 1968)
26 CFR 1.318-4 Constructive ownership as actual ownership; exceptions.
(a) In general. Section 318(a)(5)(A) provides that, except as
provided in section 318(a)(5) (B) and (C), stock constructively owned by
a person by reason of the application of section 318(a) (1), (2), (3),
or (4) shall be considered as actually owned by such person for purposes
of applying section 318(a) (1), (2), (3), and (4). For example, if a
trust owns 50 percent of the stock of corporation X, stock of
corporation Y owned by corporation X which is attributed to the trust
may be further attributed to the beneficiaries of the trust.
(b) Constructive family ownership. Section 318(a)(5)(B) provides
that stock constructively owned by an individual by reason of ownership
by a member of his family shall not be considered as owned by him for
purposes of making another family member the constructive owner of such
stock under section 318(a)(1). For example, if F and his two sons, A
and B, each own one-third of the stock of a corporation, under section
318(a)(1), A is treated as owning constructively the stock owned by his
father but is not treated as owning the stock owned by B. Section
318(a)(5)(B) prevents the attribution of the stock of one brother
through the father to the other brother, an attribution beyond the scope
of section 318(a)(1) directly.
(c) Reattribution. (1) Section 318(a)(5)(C) provides that stock
constructively owned by a partnership, estate, trust, or corporation by
reason of the application of section 318(a)(3) shall not be considered
as owned by it for purposes of applying section 318(a)(2) in order to
make another the constructive owner of such stock. For example, if two
unrelated individuals are beneficiaries of the same trust, stock held by
one which is attributed to the trust under section 318(a)(3) is not
reattributed from the trust to the other beneficiary. However, stock
constructively owned by reason of section 318(a)(2) may be reattributed
under section 318(a)(3). Thus, for example, if all the stock of
corporations X and Y is owned by A, stock of corporation Z held by X is
attributed to Y through A.
(2) Section 318(a)(5)(C) does not prevent reattribution under section
318(a)(2) of stock constructively owned by an entity under section
318(a)(3) if the stock is also constructively owned by the entity under
section 318(a)(4). For example, if individuals A and B are
beneficiaries of a trust and the trust has an option to buy stock from
A, B is considered under section 318(a)(2)(B) as owning a proportionate
part of such stock.
(3) Section 318(a)(5)(C) is effective on and after August 31, 1964,
except that for purposes of sections 302 and 304 it does not apply with
respect to distributions in payment for stock acquisitions or
redemptions if such acquisitions or redemptions occurred before August
31, 1964.
(T.D. 6969, 33 FR 11999, Aug. 23, 1968)
26 CFR 1.318-4 Corporate Liquidations
26 CFR 1.318-4 effects on recipients
26 CFR 1.331-1 Corporate liquidations.
(a) Section 331 contains rules governing the extent to which gain or
loss is recognized to a shareholder receiving a distribution in complete
or partial liquidation of a corporation. Under section 331(a)(1), it is
provided that amounts distributed in complete liquidation of a
corporation shall be treated as in full payment in exchange for the
stock. Under section 331(a)(2), it is provided that amounts distributed
in partial liquidation of a corporation shall be treated as in full or
part payment in exchange for the stock. For this purpose, the term
''partial liquidation'' shall have the meaning ascribed in section 346.
If section 331 is applicable to the distribution of property by a
corporation, section 301 (relating to the effects on a shareholder of
distributions of property) has no application other than to a
distribution in complete liquidation to which section 316(b)(2)(B)
applies. See paragraph (b)(2) of 1.316-1.
(b) The gain or loss to a shareholder from a distribution in partial
or complete liquidation is to be determined under section 1001 by
comparing the amount of the distribution with the cost or other basis of
the stock. The gain or loss will be recognized to the extent provided
in section 1002 and will be subject to the provisions of parts I, II,
and III (section 1201 and following), subchapter P, chapter 1 of the
Code.
(c) A liquidation which is followed by a transfer to another
corporation of all or part of the assets of the liquidating corporation
or which is preceded by such a transfer may, however, have the effect of
the distribution of a dividend or of a transaction in which no loss is
recognized and gain is recognized only to the extent of ''other
property.'' See sections 301 and 356.
(d) In every case in which a shareholder transfers stock in exchange
for property to the corporation which issued such stock, the facts and
circumstances shall be reported on his return unless the property is
part of a distribution made pursuant to a corporate resolution reciting
that the distribution is made in liquidation of the corporation and the
corporation is completely liquidated and dissolved within one year after
the distribution. See section 6043 for requirements relating to returns
by corporations.
(e) The provisions of this section may be illustrated by the
following example:
Example. A, an individual who makes his income tax returns on the
calendar year basis, owns 20 shares of stock of the P Corporation, a
domestic corporation, 10 shares of which were acquired in 1951 at a cost
of $1,500 and the remainder of 10 shares in December 1954 at a cost of
$2,900. He receives in April 1955 a distribution of $250 per share in
complete liquidation, or $2,500 on the 10 shares acquired in 1951, and
$2,500 on the 10 shares acquired in December 1954. The gain of $1,000
on the shares acquired in 1951 is a long-term capital gain to be treated
as provided in parts I, II, and III (section 1201 and following),
subchapter P, chapter 1 of the Code. The loss of $400 on the shares
acquired in 1954 is a short-term capital loss to be treated as provided
in parts I, II, and III (section 1201 and following), subchapter P,
chapter 1 of the Code.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6949, 33
FR 5521, Apr. 9, 1968)
26 CFR 1.332-1 Distributions in liquidation of subsidiary corporation;
general.
Under the general rule prescribed by section 331 for the treatment of
distributions in liquidation of a corporation, amounts received by one
corporation in complete liquidation of another corporation are treated
as in full payment in exchange for stock in such other corporation, and
gain or loss from the receipt of such amounts is to be determined as
provided in section 1001. Section 332 excepts from the general rule
property received, under certain specifically described circumstances,
by one corporation as a distribution in complete liquidation of the
stock of another corporation and provides for the nonrecognition of gain
or loss in those cases which meet the statutory requirements. Section
367 places a limitation on the application of section 332 in the case of
foreign corporations. See section 334(b) for the basis for determining
gain or loss from the subsequent sale of property received upon complete
liquidations such as described in this section. See section
453(d)(4)(A) relative to distribution of installment obligations by
subsidiary.
26 CFR 1.332-2 Requirements for nonrecognition of gain or loss.
(a) The nonrecognition of gain or loss is limited to the receipt of
such property by a corporation which is the actual owner of stock (in
the liquidating corporation) possessing at least 80 percent of the total
combined voting power of all classes of stock entitled to vote and the
owner of at least 80 percent of the total number of shares of all other
classes of stock (except nonvoting stock which is limited and preferred
as to dividends). The recipient corporation must have been the owner of
the specified amount of such stock on the date of the adoption of the
plan of liquidation and have continued so to be at all times until the
receipt of the property. If the recipient corporation does not continue
qualified with respect to the ownership of stock of the liquidating
corporation and if the failure to continue qualified occurs at any time
prior to the completion of the transfer of all the property, the
provisions for the nonrecognition of gain or loss do not apply to any
distribution received under the plan.
(b) Section 332 applies only to those cases in which the recipient
corporation receives at least partial payment for the stock which it
owns in the liquidating corporation. If section 332 is not applicable,
see section 165(g) relative to allowance of losses on worthless
securities.
(c) To constitute a distribution in complete liquidation within the
meaning of section 332, the distribution must be (1) made by the
liquidating corporation in complete cancellation or redemption of all of
its stock in accordance with a plan of liquidation, or (2) one of a
series of distributions in complete cancellation or redemption of all
its stock in accordance with a plan of liquidation. Where there is more
than one distribution, it is essential that a status of liquidation
exist at the time the first distribution is made under the plan and that
such status continue until the liquidation is completed. Liquidation is
completed when the liquidating corporation and the receiver or trustees
in liquidation are finally divested of all the property (both tangible
and intangible). A status of liquidation exists when the corporation
ceases to be a going concern and its activities are merely for the
purpose of winding up its affairs, paying its debts, and distributing
any remaining balance to its shareholders. A liquidation may be
completed prior to the actual dissolution of the liquidating
corporation. However, legal dissolution of the corporation is not
required. Nor will the mere retention of a nominal amount of assets for
the sole purpose of preserving the corporation's legal existence
disqualify the transaction. (See 26 CFR (1939) 39.22(a)-20 (Regulations
118).)
(d) If a transaction constitutes a distribution in complete
liquidation within the meaning of the Internal Revenue Code of 1954 and
satisfies the requirements of section 332, it is not material that it is
otherwise described under the local law. If a liquidating corporation
distributes all of its property in complete liquidation and if pursuant
to the plan for such complete liquidation a corporation owning the
specified amount of stock in the liquidating corporation receives
property constituting amounts distributed in complete liquidation within
the meaning of the Code and also receives other property attributable to
shares not owned by it, the transfer of the property to the recipient
corporation shall not be treated, by reason of the receipt of such other
property, as not being a distribution (or one of a series of
distributions) in complete cancellation or redemption of all of the
stock of the liquidating corporation within the meaning of section 332,
even though for purposes of those provisions relating to corporate
reorganizations the amount received by the recipient corporation in
excess of its ratable share is regarded as acquired upon the issuance of
its stock or securities in a tax-free exchange as described in section
361 and the cancellation or redemption of the stock not owned by the
recipient corporation is treated as occurring as a result of a taxfree
exchange described in section 354.
(e) The application of these rules may be illustrated by the
following example:
Example. On September 1, 1954, the M Corporation had outstanding
capital stock consisting of 3,000 shares of common stock, par value $100
a share, and 1,000 shares of preferred stock, par value $100 a share,
which preferred stock was limited and preferred as to dividends and had
no voting rights. On that date, and thereafter until the date of
dissolution of the M Corporation, the O Corporation owned 2,500 shares
of common stock of the M Corporation. By statutory merger consummated
on October 1, 1954, pursuant to a plan of liquidation adopted on
September 1, 1954, the M Corporation was merged into the O Corporation,
the O Corporation under the plan issuing stock which was received by the
other holders of the stock of the M Corporation. The receipt by the O
Corporation of the properties of the M Corporation is a distribution
received by the O Corporation in complete liquidation of the M
Corporation within the meaning of section 332, and no gain or loss is
recognized as the result of the receipt of such properties.
26 CFR 1.332-3 Liquidations completed within one taxable year.
If in a liquidation completed within one taxable year pursuant to a
plan of complete liquidation, distributions in complete liquidation are
received by a corporation which owns the specified amount of stock in
the liquidating corporation and which continues qualified with respect
to the ownership of such stock until the transfer of all the property
within such year is completed (see paragraph (a) of 1.332-2), then no
gain or loss shall be recognized with respect to the distributions
received by the recipient corporation. In such case no waiver or bond
is required of the recipient corporation under section 332.
26 CFR 1.332-4 Liquidations covering more than one taxable year.
(a) If the plan of liquidation is consummated by a series of
distributions extending over a period of more than one taxable year, the
nonrecognition of gain or loss with respect to the distributions in
liquidation shall, in addition to the requirements of 1.332-2, be
subject to the following requirements:
(1) In order for the distribution in liquidation to be brought within
the exception provided in section 332 to the general rule for computing
gain or loss with respect to amounts received in liquidation of a
corporation, the entire property of the corporation shall be transferred
in accordance with a plan of liquidation, which plan shall include a
statement showing the period within which the transfer of the property
of the liquidating corporation to the recipient corporation is to be
completed. The transfer of all the property under the liquidation must
be completed within three years from the close of the taxable year
during which is made the first of the series of distributions under the
plan.
(2) For each of the taxable years which falls wholly or partly within
the period of liquidation, the recipient corporation shall, at the time
of filing its return, file with the district director of internal
revenue a waiver of the statute of limitations on assessment. The
waiver shall be executed on such form as may be prescribed by the
Commissioner and shall extend the period of assessment of all income and
profits taxes for each such year to a date not earlier than one year
after the last date of the period for assessment of such taxes for the
last taxable year in which the transfer of the property of such
liquidating corporation to the controlling corporation may be completed
in accordance with section 332. Such waiver shall also contain such
other terms with respect to assessment as may be considered by the
Commissioner to be necessary to insure the assessment and collection of
the correct tax liability for each year within the period of
liquidation.
(3) For each of the taxable years which falls wholly or partly within
the period of liquidation, the recipient corporation may be required to
file a bond, the amount of which shall be fixed by the district
director. The bond shall contain all terms specified by the
Commissioner, including provisions unequivocally assuring prompt payment
of the excess of income and profits taxes (plus penalty, if any, and
interest) as computed by the district director without regard to the
provisions of sections 332 and 334(b) over such taxes computed with
regard to such provisions, regardless of whether such excess may or may
not be made the subject of a notice of deficiency under section 6212 and
regardless of whether it may or may not be assessed. Any bond required
under section 332 shall have such surety or sureties as the Commissioner
may require. However, see 6 U.S.C. 15, providing that where a bond is
required by law or regulations, in lieu of surety or sureties there may
be deposited bonds or notes of the United States. Only surety companies
holding certificates of authority from the Secretary as acceptable
sureties on Federal bonds will be approved as sureties. The bonds shall
be executed in triplicate so that the Commissioner, the taxpayer, and
the surety or the depositary may each have a copy. On and after
September 1, 1953, the functions of the Commissioner with respect to
such bonds shall be performed by the district director for the internal
revenue district in which the return was filed and any bond filed on or
after such date shall be filed with such district director.
(b) Pending the completion of the liquidation, if there is a
compliance with paragraph (a) (1), (2), and (3) of this section and
1.332-2 with respect to the nonrecognition of gain or loss, the income
and profits tax liability of the recipient corporation for each of the
years covered in whole or in part by the liquidation shall be determined
without the recognition of any gain or loss on account of the receipt of
the distributions in liquidation. In such determination, the basis of
the property or properties received by the recipient corporation shall
be determined in accordance with section 334(b). However, if the
transfer of the property is not completed within the three-year period
allowed by section 332 or if the recipient corporation does not continue
qualified with respect to the ownership of stock of the liquidating
corporation as required by that section, gain or loss shall be
recognized with respect to each distribution and the tax liability for
each of the years covered in whole or in part by the liquidation shall
be recomputed without regard to the provisions of section 332 or section
334(b) and the amount of any additional tax due upon such recomputation
shall be promptly paid.
26 CFR 1.332-5 Distribution in liquidation as affecting minority
interests.
Upon the liquidation of a corporation in pursuance of a plan of
complete liquidation, the gain or loss of minority shareholders shall be
determined without regard to section 332, since it does not apply to
that part of distributions in liquidation received by minority
shareholders.
26 CFR 1.332-6 Records to be kept and information to be filed with
return.
(a) Permanent records in substantial form shall be kept by every
corporation receiving distributions in complete liquidation within the
exception provided in section 332 showing the information required by
this section to be submitted with its return. The plan of liquidation
must be adopted by each of the corporations parties thereto; and the
adoption must be shown by the acts of its duly constituted responsible
officers, and appear upon the official records of each such corporation.
(b) For the taxable year in which the liquidation occurs, or, if the
plan of liquidation provides for a series of distributions over a period
of more than one year, for each taxable year in which a distribution is
received under the plan the recipient must file with its return a
complete statement of all facts pertinent to the nonrecognition of gain
or loss, including:
(1) A certified copy of the plan for complete liquidation, and of the
resolutions under which the plan was adopted and the liquidation was
authorized, together with a statement under oath showing in detail all
transactions incident to, or pursuant to, the plan.
(2) A list of all the properties received upon the distribution,
showing the cost or other basis of such properties to the liquidating
corporation at the date of distribution and the fair market value of
such properties on the date distributed.
(3) A statement of any indebtedness of the liquidating corporation to
the recipient corporation on the date the plan of liquidation was
adopted and on the date of the first liquidating distribution. If any
such indebtedness was acquired at less than face value, the cost thereof
to the recipient corporation must also be shown.
(4) A statement as to its ownership of all classes of stock of the
liquidating corporation (showing as to each class the number of shares
and percentage owned and the voting power of each share) as of the date
of the adoption of the plan of liquidation, and at all times since, to
and including the date of the distribution in liquidation. The cost or
other basis of such stock and the date or dates on which purchased must
also be shown.
26 CFR 1.332-7 Indebtedness of subsidiary to parent.
If section 332(a) is applicable to the receipt of the subsidiary's
property in complete liquidation, then no gain or loss shall be
recognized to the subsidiary upon the transfer of such properties even
though some of the properties are transferred in satisfaction of the
subsidiary's indebtedness to its parent. However, any gain or loss
realized by the parent corporation on such satisfaction of indebtedness,
shall be recognized to the parent corporation at the time of the
liquidation. For example, if the parent corporation purchased its
subsidiary's bonds at a discount and upon liquidation of the subsidiary
the parent corporation receives payment for the face amount of such
bonds, gain shall be recognized to the parent corporation. Such gain
shall be measured by the difference between the cost or other basis of
the bonds to the parent and the amount received in payment of the bonds.
26 CFR 1.333-1 Corporate liquidations in some one calendar month.
(a) In general. Section 333 provides a special rule, in the case of
certain specifically described complete liquidations of domestic
corporations occurring within some one calendar month, for the treatment
of gain on the shares of stock owned by qualified electing shareholders
at the time of the adoption of the plan of liquidation. The effect of
such section is in general to postpone the recognition of that portion
of a qualified electing shareholder's gain on the liquidation which
would otherwise be recognized and which is attributable to appreciation
in the value of certain corporate assets unrealized by the corporation
at the time such assets are distributed in complete liquidation. Only
qualified electing shareholders are entitled to the benefits of section
333. The determination of who is a qualified electing shareholder is to
be made under section 333(c). Section 333(g) provides a rule for the
treatment of gain in the case of liquidations which meet the
requirements of section 333(g) in addition to the other requirements of
section 333. (See 1.333-5.) For the basis of property received on such
liquidations, see section 334(c). Section 333 has no application to
gain in respect of stock of a collapsible corporation to which section
341(a) applies.
(b) Type of liquidation. (1) The liquidation must be in pursuance of
a plan of liquidation adopted on or after June 22, 1954. The plan must
be adopted before the first distribution under the liquidation occurs.
The 1954 Code requires that the transfer of all the property, both
tangible and intangible, of the corporation to its shareholders shall
occur entirely within some one calendar month. This requirement will be
considered to have been complied with if cash is set aside under
arrangements for the payment, after the close of such month, of
unascertained or contingent liabilities and expenses, and such
arrangements are made in good faith and the amount set aside is
reasonable. It is not necessary that the month in which the transfer
occurs must fall within the taxable or calendar year in which the plan
of liquidation is adopted. Though it is not necessary that the
corporation dissolve in the month of liquidation, it is essential that a
status of liquidation exist at the time the first distribution is made
under the plan and that such status continue to the date of dissolution
of the corporation. A status of liquidation exists when the corporation
ceases to be a going concern and its activities are merely for the
purpose of winding up its affairs, paying its debts, and distributing
any remaining balance to its shareholders.
(2) If a transaction constitutes a distribution in complete
liquidation within the meaning of the Code and satisfies the
requirements of section 333, it is immaterial that it is otherwise
described under the local law.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6949, 33
FR 5521, Apr. 9, 1968)
26 CFR 1.333-2 Qualified electing shareholder.
(a) No corporate shareholder may be a qualified electing shareholder
if at any time between January 1, 1954, and the date of the adoption of
the plan of liquidation, both dates inclusive, it is the owner of stock
of the liquidating corporation possessing 50 percent or more of the
total combined voting power of all classes of stock entitled to vote
upon the adoption of the plan of liquidation. All other shareholders
are divided into two groups for the purpose of determining whether they
are qualified electing shareholders: (1) shareholders other than
corporations, and (2) corporate shareholders.
(b) Any shareholder of either of such two groups, whether or not the
stock he owns is entitled to vote on the adoption of the plan of
liquidation, is a qualified electing shareholder if:
(1) His written election to be governed by the provisions of section
333, which cannot be withdrawn or revoked (except in the case of a
conditional election made pursuant to section 333(g)(4) and paragraph
(g) of 1.333-5), has been made and filed as prescribed in 1.333-3;
and
(2) Like elections have been made and filed by owners of stock
possessing at least 80 percent of the total combined voting power of all
classes of stock owned by shareholders of the same group at the time of,
and entitled to vote upon, the adoption of the plan of liquidation,
whether or not the shareholders making such elections actually realize
gain upon the cancellation or redemption of such stock upon the
liquidation.
(c) The application of this section may be illustrated by the
following example:
Example. The R Corporation has outstanding 20 shares of common stock
on July 1, 1954, at the time of the adoption of a plan of liquidation
within the provisions of section 333, each entitled to one vote upon the
adoption of such plan of liquidation. At that time ten of such shares
are owned by the S Corporation, two each by the X Corporation and the Y
Corporation, one by the Z Corporation, and one each by A, B, C, D, and
E, individuals. There are also outstanding at such time two shares of
preferred stock, not entitled to vote on liquidation, one share being
owned by F, an individual, and one share by the P Corporation. The S
Corporation, being a corporate shareholder and the owner of 50 percent
of the voting stock, may not be a qualified electing shareholder under
any circumstances. In order for any other corporate shareholder to be a
qualified electing shareholder, it is necessary that the X Corporation
and the Y Corporation file their written elections to be governed by
section 333. If this is done, the P Corporation will also be a
qualified electing shareholder if it has filed a like election.
Similarly, in the case of the individual shareholders, some combination
of four of the individual holders of the common stock must have filed
their written elections, before any individual shareholder may be
considered a qualified electing shareholder, but if this is done, F will
also be a qualified electing shareholder if he has filed a like
election.
(d) An election to be governed by the provisions of section 333
relates to the treatment of gain realized upon the cancellation or
redemption of stock upon liquidation. Such election, therefore, can be
made only by or on behalf of the person by whom gains, if any, will be
realized. Thus, the shareholder who may make such election must be the
actual owner of stock and not a mere record holder, such as a nominee.
(e) A shareholder is entitled to make an election relative to the
gain only on stock owned by him at the time of the adoption of the plan
of liquidation. The election is personal to the shareholder making it
and does not follow such stock into the hands of a transferee.
(T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6949, 33
FR 5521, Apr. 9, 1968)
26 CFR 1.333-3 Making and filing of written elections.
An election to be governed by section 333 shall be made on Form 964
(revised) in accordance with the instructions printed thereon and with
this section. The original and one copy shall be filed by the
shareholder with the district director with whom the final income tax
return of the corporation will be filed. The elections must be filed
within 30 days after the adoption of the plan of liquidation.
Under no circumstances shall section 333 be applicable to any
shareholders who fail to file their elections within the 30-day period
prescribed. An election shall be considered as timely filed if it is
placed in the mail on or before midnight of the 30th day after the
adoption of the plan of liquidation, as shown by the postmark on the
envelope containing the written election or as shown by other available
evidence of the mailing date. Another copy of the election shall be
attached to and made a part of the shareholder's income tax return for
his taxable year in which the transfer of all the property under the
liquidation occurs.
26 CFR 1.333-4 Treatment of gain.
(a) Computation of gain. As in the case of shareholders generally,
amounts received by qualified electing shareholders are treated as in
full payment in exchange for their stock, as provided in section 331 and
gain from the receipt of such amounts is determined as provided in
section 1001. Gain or loss must be computed separately on each share of
stock owned by a qualified electing shareholder at the time of the
adoption of the plan of liquidation. The limited recognition and
special treatment accorded by section 333 applies only to the gain on
such shares of stock upon which gain was realized and not to net gain
computed by setting off losses realized on some shares against gain on
others. Since section 333 applies only to gain recognized, losses
realized on the liquidation will be allowable only in the year of
liquidation even though Forms 964 (revised) have been filed by those
shareholders who realize only losses. Such filings may be necessary to
fulfill the 80 percent requirement (under section 333(c)) so that those
shareholders who realize gain may qualify under this section.
(b) Recognition of gain. Pursuant to section 333 only so much of the
gain on each share of stock owned by a qualified electing shareholder at
the time of the adoption of the plan of liquidation is recognized as
does not exceed the greater of the following:
(1) Such share's ratable share of the earnings and profits of the
corporation accumulated after February 28, 1913, computed as of the last
day of the month of liquidation, without diminution by reason of
distributions made during such month, and including in such computation
all items of income and expense accrued up to the date on which the
transfer of all the property under the liquidation is completed; or
(2) Such share's ratable share of the sum of the amount of money
received by such shareholder on shares of the same class and the fair
market value of all the stock or securities so received which were
acquired by the liquidating corporation after December 31, 1953. The
mere replacement after December 31, 1953 of lost or destroyed
certificates or instruments acquired on or before December 31, 1953, or
the mere conversion of certificates or instruments into certificates or
instruments of larger or smaller denominations will not constitute an
acquisition within the meaning of the phrase ''acquired after December
31, 1953.'' Nor will such an acquisition result from the issuance after
December 31, 1953 of certificates of stock in connection with a
subscription made and accepted on or before December 31, 1953.
(c) Treatment of recognized gain. (1) In the case of a qualified
electing shareholder other than a corporation, that part of the
recognized gain on a share of stock owned at the time of the adoption of
the plan of liquidation which is not in excess of his ratable share of
the earnings and profits of the liquidating corporation accumulated
after February 28, 1913, determined as provided in section 333(e)(1), is
treated as a dividend. It retains its character as a dividend for all
tax purposes. The remainder of the gain which is recognized is treated
as a short-term or long-term capital gain, as the case may be. In the
case of a qualified electing shareholder which is a corporation, the
entire amount of the gain which is recognized is treated as a short-term
or long-term capital gain, as the case may be.
(2) The application of subparagraph (1) of this paragraph may be
illustrated by the following example:
Example. (i) X Corporation has only one class of stock outstanding,
owned in equal amounts by three shareholders. The basis of the stock
owned by each shareholder is $50, each having bought his stock in a
single block prior to the date of the adoption of a plan of liquidation
conforming to the requirements of section 333. One of the shareholders
is an individual; two are corporations. All are ''qualified electing
shareholders''.
(ii) X Corporation has earnings and profits accumulated after
February 28, 1913, of $60 (computed as provided in section 333). Its
assets consist of (a) cash of $75, (b) stock and securities acquired
after December 31, 1953, having a fair market value of $90, and (c)
other property having a fair market value of $240. In October 1954, all
of these assets are distributed to the shareholders pro rata in complete
liquidation of the corporation, as provided in section 333. Each
shareholder thus receives $135 in cash and property, and has $85 gain.
(iii) Each shareholder's gain is recognized to the extent of $55
since such amount represents the sum of (a) the cash received by him and
(b) the fair market value of the stock and securities received by him
which were acquired by the X Corporation after December 31, 1953, and is
greater than his ratable share of the earnings and profits ($20). The
remainder of each shareholder's gain ($30) is not recognized.
(iv) In the case of the corporate shareholders the entire amount of
the recognized gain ($55) is treated as capital gain. In the case of
the individual shareholder, $20, being the amount of the shareholder's
ratable share of the earnings and profits, is recognized and treated as
a dividend, and $35, being the difference between the shareholder's
ratable share of the earnings and profits and the sum of the cash and
stock and securities received by him, is treated as a short-term or
long-term capital gain, as the case may be.
(v) If the basis of each shareholder's stock had been $100, instead
of $50, each of the corporate shareholders would be taxed on only $35 as
capital gain and the individual shareholder would be taxed on $20 as a
dividend and on only $15 as capital gain, since the total amount taxed
is limited to the amount of gain realized by the shareholder upon the
cancellation or redemption of his stock.
26 CFR 1.333-5 Special rule for treatment of gain.
(a) In general. In the case of --
(1) A liquidation occurring before January 1, 1967, of a corporation
described in paragraph (f)(1) of this section, and
(2) A liquidation occurring after December 31, 1966, of a corporation
described in paragraph (f)(2) of this section,
notwithstanding the provisions of paragraphs (b) and (c) of 1.333-4,
the amount of gain (determined by reference to paragraph (a) of
1.333-4) on each share of stock owned by a qualified electing
shareholder at the time of the adoption of the plan of liquidation which
is recognized shall be determined under paragraph (b) of this section,
and the treatment of such recognized gain shall be determined under
paragraph (c) or (d) of this section. This section applies only with
respect to distributions made in any taxable year of the distributing
corporation beginning after December 31, 1963.
(b) Recognition of gain. In the case of a liquidation to which this
section applies, the determination of the amount of recognized gain on
each share of stock owned by a qualified electing shareholder at the
time of the adoption of the plan of liquidation shall be made under
paragraph (b) of 1.333-4 except that the date ''December 31, 1962''
shall be substituted for the date ''December 31, 1953'' wherever such
date appears in paragraph (b)(2) of 1.333-4.
(c) Treatment of recognized gain -- Liquidations before January 1,
1967. Where the liquidation of a corporation described in paragraph
(f)(1) of this section occurs before January 1, 1967 --
(1) In the case of a qualified electing shareholder other than a
corporation, the recognized gain on a share of stock owned at the time
of the adoption of the plan of liquidation and which has been held by
such shareholder for more than six months is treated as a long-term
capital gain.
(2) In the case of a qualified electing shareholder other than a
corporation, that part of the recognized gain on a share of stock owned
at the time of the adoption of the plan of liquidation and which has
been held by such shareholder for not more than six months which is not
in excess of his ratable share of the earnings and profits of the
liquidating corporation accumulated after February 28, 1913, determined
as provided in section 333(e)(1), is treated as a dividend and retains
its character as such for all tax purposes. The remainder of the gain
which is recognized is treated as a short-term capital gain.
(3) In the case of a qualified electing shareholder which is a
corporation, the entire amount of the gain which is recognized is
treated as a short-term or long-term capital gain, as the case may be.
(d) Treatment of recognized gain -- Liquidations after December 31,
1966. Where the liquidation of a corporation described in paragraph
(f)(2) of this section occurs after December 31, 1966 --
(1) In the case of a qualified electing shareholder other than a
corporation, the recognized gain on a share of stock owned at the time
of the adoption of the plan of liquidation which has been held by such
shareholder for more than 1-year (6 months for taxable years beginning
before 1977; 9 months for taxable years beginning in 1977) is treated
as follows:
(i) That part of the recognized gain which is not in excess of his
ratable share of the earnings and profits of the liquidating corporation
accumulated after February 28, 1913, and before January 1, 1967, is
treated as a long-term capital gain;
(ii) That part of the recognized gain remaining after subtracting the
part treated as a long-term capital gain under subdivision (i) of this
subparagraph which is not in excess of his ratable share of earnings and
profits of the liquidating corporation accumulated after December 31,
1966, computed as of the last day of the month of liquidation, without
diminution by reason of distributions made during such month, and
including in such computation all items of income and expense accrued up
to the date on which the transfer of all property under the liquidation
is completed, is treated as a dividend and retains its character as such
for all tax purposes; and
(iii) The remainder of the gain which is recognized is treated as a
long-term capital gain.
For purposes of subdivision (i) of this subparagraph, in the case of
a liquidating corporation which, for its taxable year within which falls
December 31, 1966, does not make its return on the basis of a calendar
year, the ratable share of the earnings and profits of such corporation
accumulated after February 28, 1913, and before January 1, 1967, shall
be determined by treating the part of such year occurring before January
1, 1967, as a taxable year. For purposes of subdivision (ii) of this
subparagraph, in the case of a liquidating corporation which, for its
taxable year in which falls January 1, 1967, does not make its return on
the basis of a calendar year, the ratable share of the earnings and
profits of such corporation shall be determined by treating the part of
such year occurring after December 31, 1966, as a taxable year.
(2) In the case of a qualified electing shareholder other than a
corporation, that part of the recognized gain on a share of stock owned
at the time of the adoption of the plan of liquidation and which has
been held by such shareholder for not more than 1 year (6 months for
taxable years beginning before 1977; 9 months for taxable years
beginning in 1977) which is not in excess of his ratable share of the
earnings and profits of the liquidating corporation accumulated after
February 28, 1913, determined as provided in section 333(e)(1), is
treated as a dividend and retains its character as such for all tax
purposes. The remainder of the gain which is recognized is treated as a
short-term capital gain.
(3) In the case of a qualified electing shareholder which is a
corporation, the entire amount of the gain which is recognized is
treated as a short-term or long-term capital gain, as the case may be.
(e) Nonapplicability of paragraphs (c) and (d). (1) The rules for
treatment of recognized gain contained in paragraphs (c) and (d) of this
section do not apply to that part of the recognized gain on a share of
stock which is not in excess of the qualified electing shareholder's
ratable share of earnings and profits to which the liquidating
corporation has succeeded after December 31, 1963, pursuant to any
corporate reorganization or pursuant to any liquidation to which section
332 applies, except earnings and profits which on December 31, 1963,
constituted earnings and profits of a corporation referred to in
paragraph (f)(1) of this section and earnings and profits which were
earned after such date by a corporation referred to in paragraph (f)(1)
of this section. However, the rule for recognition of gain contained in
paragraph (b) of this section applies even though the rules for
treatment of gain (paragraphs (c) and (d) of this section) do not apply
by reason of this paragraph.
(2) The application of subparagraph (1) of this paragraph may be
illustrated by the following example:
Example. M Corporation (a corporation referred to in paragraph (f)(1)
of this section) succeeds to the earnings and profits of N Corporation
(a corporation not referred to in paragraph (f)(1) of this section)
under section 381 in a transaction occurring before January 1, 1964. In
addition, M Corporation succeeds to the earnings and profits of O
Corporation (a corporation not referred to in paragraph (f)(1) of this
section) under section 381 in a transaction occurring after December 31,
1963. On December 31, 1965, M Corporation liquidates in accordance with
section 333 and distributes all of its assets to its sole shareholder A,
an individual. A is a qualified electing shareholder who owned his
stock at the time of the adoption of the plan of liquidation and for
more than 6 months. A's recognized gain is determined under paragraph
(b) of this section. That part of the recognized gain which is not in
excess of the earnings and profits of O Corporation (to which M
succeeded) is treated as a dividend under paragraph (c) of 1.333-4. The
remainder of the gain which is recognized is treated as a long-term
capital gain.
(f) Corporations referred to. (1)(i) For purposes of this section, a
corporation described in this paragraph is a corporation which for at
least 1 of its 2 most recent taxable years ending before February 26,
1964, was not a personal holding company under section 542, but which
would have been a personal holding company under section 542 for such
taxable year if the law applicable for the first taxable year beginning
after December 31, 1963, had been applicable to such taxable year. The
law applicable for the first taxable year beginning after December 31,
1963, for purposes of this section means part II (section 541 and
following), subchapter G, chapter 1 of the Code as applicable to such
year, but does not include amendments to other parts of the Code first
applicable with respect to such year.
(ii) The application of subdivision (i) of this subparagraph may be
illustrated by the following example:
Example. In 1962, 80 percent of the gross income of the P
Corporation, a calendar year taxpayer more than 50 percent of the stock
of which is owned by four individuals, was personal holding company
income as defined in section 542, prior to the amendment of such section
by section 225 of the Revenue Act of 1964. In 1963 additional operating
income was added, with the result that only 70 percent of its gross
income (and adjusted ordinary gross income as defined in section
543(b)(2) for taxable years beginning after December 31, 1963) for the
year was personal holding company income. P Corporation's 2 most recent
taxable years ending before February 26, 1964, are calendar years 1962
and 1963. The P Corporation was a personal holding company for 1962,
but was not a personal holding company for 1963 since it did not meet
the 80-percent income test of the existing section 542(a)(1) for that
year. However, P Corporation would have been a personal holding company
for 1963 if the provisions of sections 542(a)(1) and 543, as amended by
section 225 of the Revenue Act of 1964, and as applicable to taxable
years beginning after December 31, 1963, were applicable to 1963.
Therefore, P is a corporation described in this subparagraph. It is
immaterial whether P Corporation is or is not a personal holding company
for its taxable years beginning after December 31, 1963. If P had been
organized on January 1, 1963, it would still be a corporation referred
to in this subparagraph.
(2) (i) For purposes of this section, a corporation described in
paragraph (d) of this section is one described in subparagraph (1) of
this paragraph which:
(a) On January 1, 1964, owes qualified indebtedness (as defined in
section 545(c)(3) and paragraph (d) of 1.545-3);
(b) Before January 1, 1968, notifies the district director in
accordance with paragraph (h) of this section that it may wish to have
section 333(g)(2)(A) and paragraph (d) of this section apply to it; and
(c) Liquidates before the close of the first taxable year in which it
ceases to owe qualified indebtedness, or, if earlier, the first taxable
year at the close of which its adjusted post-1963 earnings and profits
equal or exceed the amount of such corporation's qualified indebtedness
on January 1, 1964.
(ii) For purposes of this section, the term ''adjusted post-1963
earnings and profits'' means the sum of --
(a) The earnings and profits of the distributing corporation for
taxable years beginning after December 31, 1963, without diminution by
reason of any distributions made out of such earnings and profits, and
(b) The deductions allowed to such corporation for taxable years
beginning after December 31, 1963, for exhaustion, wear and tear,
obsolescence, amortization, or depletion.
(g) Mistake as to qualification. If a shareholder makes a valid
election to be governed by section 333 by filing Form 964 (revised) and
states, in accordance with instructions printed thereon, that such
election is made under the assumption that the liquidating corporation
is a corporation described in paragraph (f)(1) of this section, then
such election shall have no force or effect for any purpose if it is
later determined that the liquidating corporation is not a corporation
described in paragraph (f)(1) of this section. Thus, if the statement
of assumption described in the preceding sentence is made, and it is
later determined that the liquidating corporation is not a corporation
described in paragraph (f)(1) of this section, then the entire election
under section 333 is void even though the electing shareholder desires
section 333 (without regard to section 333(g)) to apply to him. If,
however, the statement of assumption is not made, then, assuming an
otherwise valid election, the treatment of gain shall be determined
under 1.333-4 or this section, whichever is applicable. The
conditional election referred to in this paragraph is the only exception
to the rule of paragraph (b)(1) of 1.333-2 that an election to be
governed by the provisions of section 333 once filed cannot be withdrawn
or revoked.
(h) Notification in case of liquidation after December 31, 1966. (1)
If a corporation referred to in paragraph (f)(1) of this section
determines that it may liquidate after December 31, 1966, under the
provisions of section 333(g)(2)(A) and paragraph (d) of this section,
then it must notify the district director for the district in which it
files its income tax return for the taxable year within which falls the
date of notification. Such notification shall be made by a statement
filed with such district director before January 1, 1968, containing the
following:
(i) The name, address, and employer identification number of the
liquidating corporation;
(ii) A statement that the corporation may liquidate after December
31, 1966, and that it may wish section 333(g)(2)(A) to apply to it;
(iii) A computation indicating that the corporation was not a
personal holding company under section 542 for at least one of its two
most recent taxable years ending before February 26, 1964, but would
have been a personal holding company under section 542 for such taxable
year if the law applicable for the first taxable year beginning after
December 31, 1963, had been applicable to such taxable year; and
(iv) All information necessary to determine whether, and in what
amount, the corporation owed qualified indebtedness (as defined in
section 545(c)(3) and paragraph (d) of 1.545-3) on January 1, 1964, to
what extent the corporation owes qualified indebtedness on the date of
notification, and the adjusted post-1963 earnings and profits of the
corporation at the close of taxable years ending before the date of
notification, including the following:
(a) A summary of the terms upon which the qualified indebtedness was
owed on January 1, 1964, and a summary of any changes occurring in such
terms after such date;
(b) A schedule indicating the qualified indebtedness owed by the
corporation at the close of each taxable year ending after December 31,
1963, if any such year has ended before notification occurs, and the
qualified indebtedness owed on the date when notification is made under
this paragraph; and
(c) A schedule indicating the amount of earnings and profits of the
corporation for each taxable year beginning after December 31, 1963, and
ending before the date of notification, if any such years have ended
before notification occurs, without diminution by reason of any
distribution made out of such earnings and profits; and a schedule
indicating the deductions allowed to the corporation for each taxable
year beginning after December 31, 1963, and ending before the date of
notification, for exhaustion, wear and tear, obsolescence, amortization,
or depletion.
(2) (i) If a corporation referred to in paragraph (f)(1) of this
section actually liquidates after giving notification in accordance with
subparagraph (1) of this paragraph and any shareholder claims the
benefit of section 333(g)(2)(A), then such corporation shall file, with
the district director for the district in which the corporation's Form
966 was filed, a statement containing the information referred to in
subdivision (ii) of this subparagraph. The statement must be filed on
or before February 28 of the year following the calendar year in which
the complete liquidation occurs.
(ii) The information referred to in this subdivision is the
following:
(a) The name, address, and employer identification number of the
corporation;
(b) The date on which the corporation ceased to owe qualified
indebtedness (as defined in section 545(c)); and
(c) The amount of earnings and profits of the corporation for each
taxable year beginning after December 31, 1963, without diminution by
reason of any distribution made out of such earnings and profits; and
the deductions allowed to the corporation for each taxable year
beginning after December 31, 1963, for exhaustion, wear and tear,
obsolescence, amortization, or depletion.
(3) If a corporation actually liquidates during the calendar year
1967 without having notified the district director in accordance with
subparagraph (1) of this paragraph and any shareholder claims the
benefit of section 333(g)(2)(A) and paragraph (d) of this section, then
it shall be deemed to have satisfied the notification and information
requirements of section 333(g)(2)(B)(ii) if it files with the district
director for the district in which such corporation's Form 966 was filed
a statement containing all information necessary to determine whether,
and in what amount, such corporation owed qualified indebtedness on
January 1, 1964, and all information referred to in subparagraph (2)(ii)
of this paragraph. The statement must be filed on or before February
28, 1968.
(i) Examples. The application of this section may be illustrated by
the following examples:
Example (1). On January 2, 1964, Q Corporation which is a
corporation described in paragraph (f)(1) of this section, adopts a plan
of complete liquidation conforming to the requirements of section 333.
Its assets on such date consist of the following items:
On January 1, 1964, Q Corporation's earnings and profits accumulated
after February 28, 1913, are $250,000. Q Corporation distributes all of
its assets in complete liquidation, as provided in section 333, before
January 31, 1964, to individual A, its sole shareholder. A acquired all
of his stock in 1956, and his adjusted basis in such stock is $2
million. A's total gain realized on the liquidation is $1,750,000
($3,750,000 minus $2 million). A is a ''qualified electing
shareholder''. Under paragraph (b) of this section, A recognizes gain
in the amount of $550,000 (the fair market value of the stock of S
Corporation), since such amount is greater than $250,000 (his ratable
share of the earnings and profits). The remainder of A's gain is not
recognized at the time of liquidation of Q Corporation. Under paragraph
(c)(1) of this section, the $550,000 recognized gain is treated as a
long-term capital gain since A has held his stock for more than 6
months.
Example (2). The facts are the same as in example (1) except that A
acquired all of his stock in Q Corporation on September 30, 1963. Since
A held his stock for not more than 6 months, $250,000 (his ratable share
of earnings and profits) of his recognized gain is treated as a
dividend, and $300,000 ($550,000 minus $250,000, the remainder of the
recognized gain) is treated as a short-term capital gain.
Example (3). On January 1, 1964, T Corporation, a calendar year
taxpayer, which is a corporation described in paragraph (f)(1) of this
section, owes qualified indebtedness (as defined in section 545(c)(3))
in the amount of $200,000. No amounts are used or set aside after
December 31, 1963, to retire the qualified indebtedness. T Corporation
has earnings and profits accumulated after February 28, 1913, and before
January 1, 1964, of $500,000. On June 30, 1966, in accordance with
paragraph (h) of this section, T Corporation notifies the appropriate
district director that it may wish to liquidate after December 31, 1966.
T Corporation has earnings and profits of $50,000 for each of its
taxable years 1964, 1965, and 1966, all of which are distributed to its
shareholders in each such year. It has earnings and profits of $40,000
for its short taxable year beginning January 1, 1967, and ending June
30, 1967, the date of complete liquidation. No distributions are made
during the taxable year beginning January 1, 1967, and ending June 30,
1967, other than distributions made in liquidation. For the years 1964,
1965, and 1966, and for the short taxable year beginning January 1,
1967, T Corporation is allowed deductions for depreciation in the total
amount of $35,000. On January 8, 1967, T Corporation, in accordance
with section 333, adopts a plan of complete liquidation and distributes
on June 30, 1967, all of its assets, consisting of the following items:
Each of the assets are distributed equally to individual B and W
Corporation, its two equal shareholders. B acquired all of his stock in
1958 and his adjusted basis in such stock is $1 million. W Corporation
acquired all of its T Corporation stock in 1964, and has an adjusted
basis for such stock of $1,500,000. B realizes gain on the liquidation
of $1 million ($2 million minus $1 million) and W Corporation, $500,000
($2 million minus $1,500,000). B is a ''qualified electing
shareholder''. Under paragraph (b) of this section, B recognizes gain
in the amount of $500,000 (the fair market value of his share of the
stock of V Corporation) since such amount is greater than $270,000 (his
ratable share of the earnings and profits). The $500,000 remainder of
B's gain is not recognized at the time of liquidation of T Corporation.
Such recognized gain of $500,000 is treated as follows:
W Corporation's gain of $500,000 is recognized in full since it is
excluded by section 333(b) from the application of section 333.
Example (4). The facts are the same as in example (3) except that on
December 31, 1965, the sum of T Corporation's earnings and profits and
depreciation deductions for its taxable years 1964 and 1965 was
$185,000. At the close of 1966, the sum of T Corporation's earnings and
profits and depreciation deductions for 1964, 1965, and 1966 was
$250,000. T Corporation is not a corporation to which section
333(g)(2)(A) is applicable since it did not liquidate before December
31, 1966 (the close of the taxable year in which its adjusted post-1963
earnings and profits exceeded its qualified indebtedness). Thus, B is
subject to the treatment prescribed by section 333 without regard to
subsection (g) of such section.
(T.D. 6949, 33 FR 5521, Apr. 9, 1968, as amended by T.D. 7728, 45 FR
72650, Nov. 3, 1980)
26 CFR 1.333-6 Records to be kept and information to be filed with
return.
(a) Permanent records in substantial form shall be kept by every
qualified electing shareholder receiving distributions in complete
liquidation of a domestic corporation. Such shareholder must file with
his income tax return for his taxable year in which the liquidation
occurs a statement of all facts pertinent to the recognition and
treatment of the gain realized by him upon the shares of stock owned by
him at the time of the adoption of the plan of liquidation including:
(1) A statement of his stock ownership in the liquidating corporation
as of the record date of the distribution, showing the number of shares
of each class owned on such date, the cost or other basis of each such
share, and the date of acquisition of each such share;
(2) A list of all the property, including money, received upon the
distribution, showing the fair market value of each item of such
property other than money on the date distributed and stating what
items, if any, consist of stock or securities acquired by the
liquidating corporation after December 31, 1953, or after December 31,
1962, whichever date is applicable;
(3) A statement of his ratable share of the earnings and profits of
the liquidating corporation accumulated after February 28, 1913,
computed without diminution by reason of distributions made during the
month of liquidation (other than designated dividends under section
316(b)(2)(B));
(4) In the case of a liquidation to which section 333(g)(2) applies,
a statement of his ratable share of earnings and profits of the
liquidating corporation accumulated after February 28, 1913, and before
January 1, 1967; and
(5) A copy of such shareholder's written election to be governed by
the provisions of section 333. See 1.333-3.
(b) For information to be filed by the liquidating corporation, see
section 6043.
(T.D. 6949, 33 FR 5524, Apr. 9, 1968)
26 CFR 1.334-1 Basis of property received in liquidations.
(a) In general. Section 334 sets forth rules prescribing the basis
of property received in a distribution in partial or complete
liquidation of a corporation. The general rule of section 334 is set
forth in section 334(a) to the effect that if property is received in a
distribution in partial or complete liquidation and if gain or loss is
recognized on the receipt of such property, then the basis of the
property in the hands of the distributee shall be the fair market value
of such property at the time of the distribution. Such general rule has
no application to a liquidation to which section 332 or section 333
applies. See section 334 (b) and (c).
(b) Transferor's basis. Unless section 334(b)(2) and subsection (c)
of this section apply, property received by a parent corporation in a
complete liquidation to which section 332 is applicable shall, under
section 334(b)(1), have the same basis in the hands of the parent as its
adjusted basis in the hands of the subsidiary. The rule stated above is
applicable even though the subsidiary was indebted to the parent on the
date the plan of liquidation was adopted and part of such property was
received in satisfaction of such indebtedness in a transfer to which
section 332(c) is applicable.
(c) Application of stock basis to property. If section 334(b)(2)
applies to a complete liquidation to which section 332 is applicable,
then property received by a parent corporation in such complete
liquidation shall have a basis determined by reference to the basis of
the stock of the subsidiary corporation with respect to which it is
received. In general, section 334(b)(2) will be applicable to a
distribution in complete liquidation of a subsidiary corporation if the
parent corporation purchased, within the meaning of section 334(b)(3)
and during a period of not more than twelve months, 80 percent or more
of the stock (other than nonvoting stock which is limited and preferred
as to dividends) of the subsidiary corporation and then adopted a plan
of liquidation (on or after June 22, 1954) not more than two years after
the date on which the stock ownership requirement was met. The
application of section 334(b)(2) is subject to the following rules:
(1) Property received with reference to stock owned immediately
before the liquidation by the parent corporation is the only property to
which section 334(b)(2) is applicable. The section is not applicable to
property received with respect to debt or other claims. The basis of
the stock used in determining the basis of the assets is the total basis
of all stock held by the parent corporation whether or not such stock
was acquired by purchase and whether or not such stock is the stock
acquired during the period to which reference is made in section
334(b)(2)(A).
(2) The date of adoption of a plan of liquidation is determined under
section 332(b)(2).
(3) (i) Except as provided in subdivision (ii) of this subparagraph,
in the case of a series of purchases of stock, the two-year period
specified in section 334(b)(2)(A) shall begin on the day following the
earliest date which is the end of a period of twelve months or less
within which the amount of stock required by section 334(b)(2)(B) was
acquired. For example, assume that 20 percent of the stock of
corporation A is purchased on each of the following dates: April 1,
1956, June 30, 1956, September 30, 1956, December 31, 1956, and June 1,
1957. The two-year period shall begin on January 1, 1957. However, if
the first purchase of 20 percent of the stock occurs on November 1, 1955
(instead of April 1, 1956), then the two-year period shall begin on June
2, 1957.
(ii) If a plan of liquidation is adopted on or before December 24,
1958, subdivision (i) of this subparagraph shall not apply and the rule
of subdivision (iii) of this subparagraph shall apply unless the parent
corporation elects to have the rule of subdivision (i) of this
subparagraph apply. Such election shall be made by the parent
corporation either in a statement attached to its return (filed within
the time prescribed for filing, including any extensions of time) for
the taxable year within which such plan is adopted, or in a statement
filed on or before September 22, 1958, with the district director with
whom such corporation's return for such taxable year was filed. The
election, once made, shall be irrevocable.
(iii) The rule referred to in subdivision (ii) of this subparagraph
is as follows:
(a) In the case of a series of purchases of stock, the two-year
period specified in section 334(b)(2)(A) shall begin on the day
following the date of the last such purchase if the amount of stock
specified in section 334(b)(2)(B) is purchased during the preceding
twelve months.
(b) Application of the rule prescribed in (a) of this subdivision may
be illustrated by the following example:
Example. Twenty percent of the stock of corporation A is purchased on
each of the following dates: April 1, 1954, June 30, 1954, September
30, 1954, December 31, 1954, and April 1, 1955. Although 80 percent of
the stock of corporation A had been purchased as of December 31, 1954,
the date of the last transaction of the series of transactions described
in section 334(b)(2)(B) is April 1, 1955, and therefore the two-year
period shall begin on April 2, 1955.
(4) For the purpose of section 334(b)(2) only, the following
adjustments shall be made to the adjusted basis of the subsidiary's
stock in the hands of the parent:
(i) Such adjusted basis shall be reduced by the amount of all
distributions received by the parent from the subsidiary during the
period beginning on the day on which the stock used in determining the
applicability of section 334(b)(2) was purchased (or if such stock was
purchased on more than one day, on the day of the earliest purchase of
the stock so used) and ending when the plan of liquidation is adopted.
(ii) In order to apply the rule of subdivision (i) of this
subparagraph the amount of a distribution in kind shall be whichever of
the following is the greater:
(a) The amount described in section 301(b)(1)(B)(ii) (regardless of
the amount of the distribution under section 301(b)), or
(b) The portion of the adjusted basis of the stock allocable to the
property so distributed.
(iii) The reduction provided in subdivision (i) of this subparagraph
shall be made whether or not such distributions were taxable to the
parent as ordinary dividends.
(iv) The reduction provided in subdivision (i) of this subparagraph
shall not be made --
(a) To the extent that a reduction in the adjusted basis of the stock
is required by section 301(c)(2); or
(b) To the extent that such distributions of the subsidiary are out
of earnings and profits of the period beginning on the date of purchase
and ending upon the date of the last distribution in liquidation.
(v) The adjusted basis of the subsidiary's stock held by the parent
with respect to which the distributions in liquidation are made (reduced
as in subdivision (i) of this subparagraph) --
(a) Shall be increased --
(1) By the amount of any unsecured liabilities assumed by the parent,
and
(2) By the portion of the subsidiary's earnings and profits (less the
amount of any distributions therefrom) of the period beginning on the
date of purchase and ending upon the date of the last distribution in
liquidation attributable to the stock of the subsidiary held by the
parent.
(b) Shall be decreased:
(1) By the amount of any cash and its equivalent received, and
(2) By the portion of the subsidiary's deficit in earnings and
profits of the period beginning on the date of purchase and ending upon
the date of the last distribution in liquidation attributable to the
stock of the subsidiary held by the parent.
(vi) For the purpose of subdivision (v) (a)(2) and (b)(2) of this
subparagraph:
(a) With respect to property held on the date of purchase and
property held on the date additional stock, if any, is acquired any gain
or loss from sales or exchanges of such property (whether tangible or
intangible) and any other items determined by reference to basis of such
property shall be computed by substituting for such basis a new basis
determined by reference to the part of the adjusted basis of the stock
allocable to such property,
(b) The part of the adjusted basis of stock allocable to such
property for the purpose of (a) of this subdivision shall be the basis
of the stock held on the date of purchase or on the date of a later
acquisition of stock allocated among the assets held on such date on the
basis of their net fair market values on such date,
(c) In order to prevent distortion in the adjusted basis of the
stock:
(1) Transactions (including distributions, liquidations, and
reorganizations) involving a corporation the affairs of which the
subsidiary controls at any time after the date of purchase through
ownership of stock (whether or not the subsidiary owns a majority of the
stock of such corporation) may be disregarded in whole or in part, and
(2) Tax-free reorganizations involving the subsidiary may be
disregarded in whole or in part, and
(d) In the case of a subsidiary using the cash receipts and
disbursements method of accounting, the earnings and profits of such
subsidiary shall be computed for the period specified in subdivision (v)
(a)(2) and (b)(2) of this subparagraph as if such subsidiary had used an
accrual method of accounting prior to such period.
(vii) For the purposes of subdivisions (iv), (v), and (vi) of this
subparagraph the expression ''the date of purchase'' means the date of
the transaction described in section 334(b)(2)(B) (or, in the case of a
series of transactions, the date of the last such transaction),
determined without regard to subparagraph (6) (iii) of this paragraph.
(viii) In the case of a distribution by the subsidiary of property
directly or indirectly acquired by the subsidiary through a direct or
indirect contribution to capital by the parent, the basis of such
property to the parent shall be the same as if such contribution had not
been made and the adjusted basis of the stock shall not be increased or
decreased because of such contribution and distribution. Except as
provided in the preceding sentence, the amount of the adjusted basis of
the stock adjusted as provided in this paragraph shall be allocated as
basis among the various assets received (except cash and its equivalent)
both tangible and intangible (whether or not depreciable or
amortizable). Ordinarily, such allocation shall be made in proportion
to the net fair market values of such assets on the date received (the
net fair market value of an asset being its fair market value less any
specific mortgage or pledge to which it is subject). To that portion of
the basis thus determined, for each property against which there is a
lien, should be added the amount of such lien. Where more than one
property is covered by the same lien, the amount of the lien should be
divided among the properties, allocating to each that portion of the
lien which the fair market value of such property bears to the total
fair market value of the properties covered by the same lien. Whether
the mortgage indebtedness is assumed by the parent or the property is
taken subject to the mortgage is immaterial. The basis of the property
received shall be zero if the cash and its equivalent received is equal
to or in excess of the adjusted basis of the stock.
(5) The application of the rules prescribed in subparagraph (4) of
this paragraph may be illustrated by the following examples:
Example (1). Corporation A bought all of the stock of Corporation B
for $1,000 on January 1, 1955. The only asset of Corporation B was a
building having a basis of $100. On July 1, 1955, such building was
sold for $1,050. The amount received was invested in another building
immediately thereafter. On December 30, 1955, Corporation B was
liquidated under section 332 in a transaction in which the basis of the
assets in the hands of the recipient corporation was determined under
section 334(b)(2). The basis of the stock of Corporation B in the hands
of Corporation A is increased by $50 pursuant to paragraph (c)(4) (v)
and (vi) of 1.334-1. The basis of the building received by Corporation
A upon the liquidation of Corporation B is $1,050.
Example (2). The facts are the same as in example (1) except that
the sale price of the building sold was $750. The basis of the building
in the hands of Corporation A upon liquidation is $750.
(6) Except as provided in subparagraph (7) of this paragraph, for
purposes of section 334(b)(2) the term ''purchase'' means any
acquisition of stock, but only if --
(i) The basis of stock in the hands of the distributee is not
determined either in whole or in part by reference to the adjusted basis
of stock in the hands of the person from whom acquired, or under section
1014(a) (relating to property acquired from the decedent);
(ii) The stock is not acquired in an exchange to which section 351
applies; and
(iii) The stock is not acquired from a person the ownership of whose
stock would, under section 318(a), be attributed to the person acquiring
such stock. However, if a corporation acquires stock pursuant to an
option to buy such stock from a person who, without regard to such
option, is not a person the ownership of whose stock would, under
section 818(a), be attributed to such corporation, such stock shall be
considered to have been purchased on the date of the acquisition of such
option, if such option is exercised on or before the last day of a
period of 12 months beginning on the day of the earliest purchase of
stock (including the stock subject to such option) used in determining
the applicability of section 334(b)(2) and for this purpose the stock
with respect to which the option was exercised shall be deemed to have
been purchased on the date such option was acquired.
(7) (i) Notwithstanding subdivision (iii) of subparagraph (6) of this
paragraph, the term ''purchase'' includes an acquisition of stock after
December 31, 1965, from a related corporation if at least 50 percent in
value of the stock of such related corporation was acquired after
December 31, 1965, by purchase (within the meaning of subparagraph (6)
of this paragraph without regard to this subparagraph). For purposes of
this subparagraph, a corporation is a related corporation if stock owned
by the corporation would be considered as owned by the distributee under
section 318(a).
(ii) If subdivision (i) of this subparagraph applies and if all
distributions by the distributing corporation under section 332 are made
after November 13, 1966, then the amount of stock required by section
334(b)(2)(B) must be acquired during a 12-month period beginning with
the earlier of --
(a) The date of the first acquisition by purchase (within the meaning
of subparagraph (6) of this paragraph without regard to this
subparagraph) of any of such stock, or
(b) The date on which the distributee first would be considered under
section 318(a) as owning any of such stock owned by the related
corporation, taking into account in applying section 318(a) only stock
of the related corporation purchased after December 31, 1965 (within the
meaning of subparagraph (6) of this paragraph without regard to this
subparagraph).
(iii) Since a purchase of stock within the meaning of subdivision (i)
of this subparagraph necessarily involves a transaction between two
related corporations, the purchase price will be subjected to close
scrutiny to ascertain whether the price reflects the fair market value
of the stock. If it is determined that the price paid exceeds the fair
market value of the stock purchased, then for purposes of section
334(b)(2) the cost of such stock for purposes of computing its adjusted
basis shall be its fair market value.
(iv) The provisions of this subparagraph may be illustrated by the
following examples:
Example (1). (a) On January 1, 1967, in an exchange to which section
351 applies, corporation R acquires 40 percent of the stock of
corporation S, which owns 100 percent of the stock of corporation T. On
July 1, 1967, R acquires 10 percent of the stock of S for cash. On
December 31, 1967, R causes S to sell to it the 100 percent of T stock
which S owns.
(b) Since R owns at least 50 percent of the stock of S at the time it
acquires the T stock from S, the acquisition will qualify as a purchase
only if the requirements of this subparagraph are met. The acquisition
of the T stock does not qualify under this subparagraph as a purchase
because R has acquired only 10 percent of the stock of S by purchase
(within the meaning of subparagraph (6) without regard to this
subparagraph).
Example (2). (a) Assume the same facts as in example (1), plus the
further fact that on November 1, 1967, R acquires an additional 45
percent of the stock of S for cash.
(b) The acquisition by R of the 100 percent of T stock does qualify
as a purchase under this subparagraph because R has acquired 55 percent
(at least 50 percent) of the stock of S by purchase (within the meaning
of subparagraph (6) without regard to this subparagraph).
(c) During a 12-month period beginning on November 1, 1967 (the date
on which R first would be considered under section 318(a) as owning any
stock owned by S, taking into account only stock of S that R has
purchased within the meaning of subparagraph (6) without regard to this
subparagraph), R has acquired by purchase the amount of stock required
by section 334(b)(2)(B).
Example (3). (a) On January 1, 1968, corporation X acquires for cash
10 percent of the stock of corporation Z. On February 1, 1968, X
acquires for cash at least 50 percent of the stock of corporation Y,
which owns 45 percent of the stock of Z. On March 1, 1968, X causes
corporation Y to sell to it the 45 percent of Z stock which Y owns. On
April 1, 1968, corporation X acquires for cash 25 percent of the stock
of Z.
(b) Since X owns at least 50 percent of the stock of Y at the time of
its acquisition of the 45 percent of Z stock from Y, the acquisition
will qualify as a purchase only if the requirements of this subparagraph
are met. The acquisition of the Z stock does qualify as a purchase
under this subparagraph because X acquired at least 50 percent of the
stock of Y by purchase (within the meaning of subparagraph (6) without
regard to this subparagraph). Therefore, X has acquired by purchase the
amount of stock required by section 334(b)(2)(B) during a 12-month
period beginning on January 1, 1968, the date of the first acquisition
by purchase (within the meaning of subparagraph (6) without regard to
this subparagraph) of any of such stock.
(c) The result would be the same if X purchased 100 percent of the Y
stock on February 1, 1968, and caused Y to be completely liquidated on
March 1, 1968, receiving the 45 percent interest in Z in the
liquidation.
(8) Section 334(b) does not apply to minority shareholders. The
basis of property, other than cash, received by such shareholders shall
be determined under section 334(a), section 334(c), or section 358.
(T.D. 7231, 37 FR 28287, Dec. 22, 1972)
26 CFR 1.334-2 Property received in liquidation under section 333.
The basis of assets (other than money) acquired by stockholders in a
liquidation upon which the amount of gain recognized was limited under
section 333 shall be the same as the basis of the shares of stock
redeemed or cancelled, decreased in the amount of any money received and
increased in the amount of gain recognized and the amount of the
unsecured liabilities assumed by the stockholders. The amount thus
arrived at should be allocated to the various assets received on the
basis of their net fair market values (the net fair market value of an
asset is its fair market value less any specific mortgage or pledge to
which it is subject). To that portion of the basis thus determined, for
each property against which there is a lien, should be added the amount
of such lien. Where more than one property is covered by the same lien,
the amount of the lien should be divided among the properties,
allocating to each that portion of the lien that the fair market value
of such property bears to the total market value of the properties
covered by the same lien. Whether the mortgage indebtedness is assumed
by the shareholders or the property is taken subject to the mortgage is
immaterial. The application of this section may be illustrated by the
following example:
Example. The X corporation distributed all its property in complete
liquidation during the month of October 1954 pursuant to the provisions
of section 333. A, an individual, and a qualifying electing
shareholder, received, in cancellation or redemption of 100 shares of
stock owned by him at the time of the adoption of the plan of
liquidation, $1,000 in cash, property (other than stock or securities
acquired by the corporation after December 31, 1953) with a fair market
value of $22,000 subject to a lien of $1,000, and stock acquired by the
liquidating corporation after December 31, 1953 with a fair market value
of $4,000. A, also assumed a $2,000 liability of the liquidating
corporation. The basis of the shares owned by A was $120 per share or
$12,000. A's ratable share of the earnings and profits of the X
corporation accumulated after February 28, 1913 (computed as provided in
section 333) was $2,500. His gain is $12,000, but under section 333
only $5,000 of this gain is recognized, $2,500 thereof being taxed as a
dividend. The basis of all the property other than money received by A
is $19,000, computed as follows:
The basis, excluding the specific lien attached to the property,
($19,000 less $1,000, $18,000) will be apportioned among the classes of
property other than money received as follows: $21,000/$25,000 of
$18,000 or $15,120 to the property other than stock; $4,000/$25,000 of
$18,000 or $2,880 to the stock. The basis of the property other than
stock, $15,120, must be increased by the amount of the specific lien
attached thereto, $1,000, making a total basis for such property of
$16,120.
26 CFR 1.334-2 effects on corporation
26 CFR 1.336-1 General rule on liquidation of corporation.
Except as provided in section 453(d), no gain or loss is recognized
to a corporation on the distribution by it of property in kind in
partial or complete liquidation (regardless of the fact that such
property may have appreciated or depreciated in value since its
acquisition by the corporation). However, gain or loss is recognized to
a corporation on all sales by it, whether directly or indirectly (as
through trustees or a receiver), except as provided in section 337
(relating to sales or exchanges in connection with certain
liquidations). See sections 61, 6036, 6155(a), 6161(c), 6503(b), 6601,
6871, 6872, and 6873.
26 CFR 1.337-1 General.
Except as provided in section 337(c) and 392(b), if a corporation
distributes all of its assets in complete liquidation within 12 months
after the adoption of a plan of liquidation, which plan must be adopted
on or after June 22, 1954, no gain or loss shall be recognized from the
sale of property (as defined in section 337(b)) during such 12-month
period. For this purpose such sales may be made before the adoption of
the plan of liquidation if made on the same day such plan is adopted.
All assets (less assets retained to meet claims), both tangible and
intangible, must be distributed within the 12-month period. Any assets
retained after the expiration of the 12-month period for the payment of
claims (including unascertained or contingent liabilities or expenses)
must be specifically set apart for that purpose and must be reasonable
in amount in relation to the items involved. The 12-month period shall
begin on the date of adoption of the plan determined as provided in
paragraph (b) of 1.337-2 and no extension of such period can be
granted. See section 453(d)(4)(B) relative to nonrecognition of gain on
the distribution of certain installment obligations. Except to the
extent provided in section 341(e)(4), sales or exchanges made by a
collapsible corporation (as defined in section 341(b)) are excluded from
the operation of section 337 by section 337(c). Accordingly, except as
provided in section 341(e)(4), section 337 does not apply to any sale or
exchange of property whenever the distribution of such property in
partial or complete liquidation to the shareholders in lieu of such sale
or exchange would have resulted in the taxation of the gain from such
distribution in the manner provided in section 341(a) as to any
shareholder or would have resulted in the taxation of the gain in such
manner, but for the application of section 341(d). Likewise, section
337 does not apply to sales or exchanges made by a corporation if such
corporation is liquidated in a transaction to which section 333 is
applicable, or in a transaction to which section 332 applies (except to
the extent provided in section 337(c)(2)(B)). Section 392(b) provides
special rules with respect to the recognition of gain or loss upon
certain sales made by a liquidating corporation during 1954 and 1955.
(T.D. 6806, 30 FR 2850, Mar. 5, 1965)
26 CFR 1.337-2 Sales or exchanges within the scope of section 337.
(a) Provided the other conditions of section 337 are met, sales or
exchanges which occur on or after the date on which the plan of complete
liquidation is adopted and within the 12-month period thereafter are
subject to the provisions of such section. The date on which a sale
occurs depends primarily upon the intent of the parties to be gathered
from the terms of the contract and the surrounding circumstances. In
ascertaining whether a sale or exchange occurs on or after the date on
which the plan of complete liquidation is adopted, the fact that
negotiations for sale may have been commenced, either by the corporation
or its shareholders, or both shall be disregarded. Moreover, an
executory contract to sell is to be distinguished from a contract of
sale. Ordinarily, a sale has not occurred when a contract to sell has
been entered into but title and possession of the property have not been
transferred and the obligation of the seller to sell or the buyer to buy
is conditional.
(b) Ordinarily the date of the adoption of a plan of complete
liquidation by a corporation is the date of adoption by the shareholders
of the resolution authorizing the distribution of all the assets of the
corporation (other than those retained to meet claims) in redemption of
all of its stock. Where the corporation sells substantially all of its
property of the type defined in section 337(b) prior to the date of
adoption by the shareholders of such resolution, then the date of the
adoption of the plan of complete liquidation by such corporation is the
date of the adoption by the shareholders of such resolution and gain or
loss will be recognized with respect to such sales. Where no
substantial part of the property of the type defined in section 337(b)
has been sold by the corporation prior to the date of adoption by the
shareholders of such resolution, the date of the adoption of the plan of
complete liquidation by such corporation is the date of adoption by the
shareholders of such resolution and no gain or loss will be recognized
on sales of such property on or after such date, if all the corporate
assets (other than those retained to meet claims) are distributed in
liquidation to the shareholders within 12 months after the date of the
adoption of such resolution. In all other cases the date of the
adoption of the plan of liquidation shall be determined from all the
facts and circumstances. Section 337 shall not apply in any case in
which all of the corporate assets (other than those retained to meet
claims) are not distributed to the shareholders within 12 months after
the date of the adoption of a resolution by the shareholders authorizing
the distribution of all the corporate assets in redemption of all the
corporate stock. A corporation will be considered to have distributed
all of its property other than assets retained to meet claims even
though it has retained an amount of cash equal to its known liabilities
and liquidating expenses plus an amount of cash set aside under
arrangements for the payment after the close of the 12-month period of
unascertained or contingent liabilities and contingent expenses. Such
arrangements for payment must be made in good faith, the amount set
aside must be reasonable, and no amount may be set aside to meet claims
of shareholders with respect to their stock. If it is established to
the satisfaction of the Commissioner that there are shareholders who
cannot be located, a distribution in liquidation includes a transfer to
a State official, trustee, or other person authorized by law to receive
distributions for the benefit of such shareholders. For the purposes of
this paragraph ''property of the type defined in section 337(b)'' means
property upon the sale of which section 337(a) may provide for the
nonrecognition of gain or loss upon sale or exchange during a 12-month
period, including property described in subparagraph (A) of section
337(b)(1) if sold or exchanged at any time under the conditions set
forth in section 337(b)(2) and including installment obligations
acquired in respect of such sale or exchange.
26 CFR 1.337-3 Property defined.
(a) Except as provided in section 337(b)(2) and this section, the
term property as used in section 337(a) and 1.337-1 does not include,
(1) stock in trade of the corporation, or other property of a kind which
would properly be included in the inventory of the corporation if on
hand at the close of the taxable year and property held by the
corporation primarily for sale to customers in the ordinary course of
its trade or business (hereinafter for purposes of section 337 referred
to as ''inventory''), (2) installment obligations acquired at any time
from the sale or exchange of inventory, or (3) installment obligations
acquired from the sale or exchange of property (other than inventory)
prior to the adoption of the plan of liquidation. With the exceptions
listed in this paragraph, the term ''property'' includes all assets
owned by a corporation.
(b) Except as provided in paragraph (c) of this section, if
substantially all of the inventory is sold or exchanged to one person in
one transaction, then for the purpose of section 337(a) the term
''property'' shall include:
(1) The inventory so sold or exchanged, and
(2) Installment obligations acquired in such sale or exchange.
For this purpose, the term substantially all means substantially all
of the inventory at the time of the sale and includes inventory subject
to liabilities, specific or otherwise. Section 337(b)(2) shall be
inapplicable if the inventory so sold is replaced by like inventory, or
by a new kind of inventory.
(c) The term property in the case of a corporation which is engaged
in two or more distinct businesses shall include the inventory of any
one of such trades or businesses if substantially all of the inventory
attributable to such trade or business is sold or exchanged to one
person in one transaction. If installment obligations are received upon
such a sale, such obligations are also included within the meaning of
the term ''property''.
(d) This section may be illustrated by the following examples:
Example 1. Corporation A operates a grocery store at one location
and a hardware store at another. Neither store handles items similar to
those handled by the other. Both stores are served by a common
warehouse. Pursuant to a plan of liquidation adopted by the
corporation, the grocery store and all of its inventory, including that
part of its inventory held in the warehouse, are sold to one person in
one transaction. Thereafter, and within 12 months after the adoption of
the plan of liquidation, all of the assets of the corporation are
distributed to the shareholders. No gain or loss will be recognized
upon the sale of all of the assets attributable to the grocery business,
including the inventory items.
Example 2. Corporation B operates two department stores, one in the
downtown business district and the other in a suburban shopping center.
Both handle the same items and are served by a common warehouse which
contains an amount of inventory items equal to the total of that in both
stores. The part of the inventory in the warehouse which is
attributable to each store cannot be clearly determined. Pursuant to a
plan of liquidation adopted by the corporation, the assets of the
suburban store, including the inventory held in such store, but not
including any portion of the inventory held in the warehouse, are sold
to one person in one transaction. Thereafter, and within 12 months
after the adoption of the plan of liquidation, all of the assets of the
corporation are distributed to the shareholders. No gain or loss will
be recognized with respect to the sale of the property other than the
inventory, but gain or loss will be recognized upon the sale of the
inventory.
Example 3. The facts are the same as in example (2) except that the
part of the inventory in the warehouse which is attributable to the
suburban store can be clearly determined and both the inventory held in
the store and that part of the inventory in the warehouse attributable
to such store are sold. No gain or loss will be recognized upon the
sale of the inventory.
26 CFR 1.337-4 Limitation of gain.
(a) Section 337(c)(2)(B) provides a limitation upon the amount of
gain not recognized where a corporation sells or exchanges property
pursuant to a plan of complete liquidation (and such property, if
distributed, would take the basis of the stock held by the distributee
pursuant to the provisions of section 334(b)(2) (relating to plans of
liquidation adopted within 2 years after purchase of the stock)). The
amount of gain not recognized shall not be greater than the excess of
(1) that portion of the adjusted basis (further adjusted as provided in
the second sentence of section 334(b)(2) and in paragraph (c) of
1.334-1) of the stock of the liquidating corporation in the hands of its
parent corporation allocable to the property sold or exchanged over (2)
the adjusted basis of such property in the hands of the liquidating
corporation.
(b) Paragraph (a) of this section may be illustrated by the following
example:
Example. Corporation A owns more than 80 percent of the stock of
Corporation B, which it purchased for $10,000. All of the assets of
Corporation B, having a total basis of $4,000 are sold for $12,000. The
portion of the realized gain of $8,000 which is not recognized is
$6,000, computed as follows:
In general, where section 337(c)(2)(B) is applicable and where the
gain realized from the sale of property is greater than the excess of
the selling price of the property over the basis of the stock allocable
to the property sold, the amount of gain to be recognized from such sale
is equal to such excess. In the above example, the $2,000 gain
representing the excess of the selling price of $12,000 over the basis
of the stock allocable to the property sold ($10,000) would be
recognized to the liquidating corporation.
(c) For the purpose of this section only, the basis (adjusted as
described in paragraph (a) of this section) of the liquidating
corporation's stock in the hands of its parent corporation on the date
of the first sale of property, shall be allocated to the assets of the
liquidating corporation (unreduced by any amount applicable to minority
interests) on the basis of the fair market value of such assets (see
paragraph (c) of 1.334-1), both tangible and intangible, on the date
the first property is sold by the liquidating corporation. The
allocation then made shall remain unchanged for the purpose of
determining recognized gain upon subsequent sales of property by the
liquidating corporation unless the stock ownership of the parent
corporation changes. In the event of such a change, a new allocation
shall be made at the time of the next sale of property thereafter. The
new allocation shall be made on the basis of the fair market value of
the liquidating corporation's assets on the date of such sale.
26 CFR 1.337-5 Special rule for certain minority shareholders.
(a) General. If, with respect to a plan of complete liquidation
adopted on or after January 1, 1958, the liquidating corporation fails
to qualify for the treatment prescribed by section 337(a) solely by
reason of the application of section 337(c)(2)(A), then, for the first
taxable year of any shareholder (other than a corporation which meets
the 80-percent stock ownership requirement specified in section
332(b)(1)) in which he receives a distribution in complete liquidation,
the treatment prescribed by section 337(d) and this section shall be
applicable to such shareholder. Since section 337(d) applies only with
respect to distributions in complete liquidation under section 331, it
does not apply with respect to a distribution which is treated as part
of an exchange to which section 354 or 356 applies.
(b) Treatment of minority shareholders. (1) In cases to which
section 337(d) and paragraph (a) of this section apply --
(i) The amount realized by the shareholder on the distribution shall
be increased by his proportionate share of the amount by which the tax
imposed by subtitle A of the Code (income taxes) on the liquidating
corporation would have been reduced if section 337(c)(2)(A) had not been
applicable (see paragraph (c) of this section for determination of the
proportionate share of each shareholder), and
(ii) For purposes of the Code, the shareholder shall be deemed to
have paid on the last day prescribed by section 6151 for the payment of
the tax (the last day prescribed by section 6072 for the filing of his
income tax return) for the taxable year in which he receives the first
distribution in complete liquidation (whether the return is filed
before, on, or after such last day), an amount of income tax equal to
the amount of the increase described in subdivision (i) of this
subparagraph.
(2) If a minority shareholder who receives a distribution to which
section 337(d) and paragraph (a) of this section apply is a partnership,
the amount realized by the partnership for the first taxable year in
which it receives a distribution in liquidation shall be increased by
the amount determined under paragraph (c) of this section, and the
amount of tax referred to in subparagraph (1)(ii) of this paragraph
shall be deemed paid by the partnership. Credit or refund of the tax
deemed paid by the partnership shall be taken into account by the
partners in accordance with section 702(a)(8), and the share taken into
account by each partner shall be deemed paid by him on the last day
prescribed by section 6151 for the payment of the tax for his taxable
year in which or with which the partnership taxable year ends. Finally,
the partners shall make such adjustments to the bases of their
partnership interests as are required by section 705(a) and, for
purposes of that section, the amount of tax deemed paid by the
partnership shall be treated as a nondeductible partnership expenditure.
(3) If a minority shareholder who receives a distribution to which
section 337(d) and paragraph (a) of this section apply is an electing
small business corporation (within the meaning of section 1371(b)), then
--
(i) The increase in the amount realized on such distribution, as
determined under paragraph (c) of this section, shall be deemed received
by such corporation on the last day of its taxable year during which
such distribution is received;
(ii) On such last day the amount of tax referred to in subparagraph
(1)(ii) of this paragraph shall be deemed distributed to those persons
who are shareholders of such corporation on such last day, in the same
proportion as the undistributed taxable income of such corporation would
be included (under section 1373(b)) in the gross income of such persons,
and, for purposes of section 301(c) (2) and (3), the distribution shall
be considered a distribution which is not a dividend; and
(iii) The amount of tax deemed distributed to each shareholder under
subdivision (ii) of this subparagraph shall be deemed paid by each such
shareholder on the last day prescribed by section 6151 for the payment
of the tax for his taxable year in which or with which the taxable year
of such corporation ends.
(c) Determination of each minority shareholder's increase in amount
realized. (1) Under section 337(d) and paragraph (b) of this section,
the amount realized by each minority shareholder of the liquidating
corporation shall be increased by his proportionate share of the amount
by which the tax imposed by subtitle A of the Code on the liquidating
corporation would have been reduced if section 337(c)(2)(A) had not been
applicable. Where the corporation has only the one class of stock
outstanding, the increase in the amount realized by each minority
shareholder shall be determined by multiplying the reduction in the
corporation's tax that would be applicable if section 337(c)(2)(A) did
not apply by a fraction, the numerator of which is equal to the sum of
all liquidating distributions received by such shareholder and the
denominator of which is equal to the sum of all liquidating
distributions received by all shareholders. Where the corporation has
outstanding preferred stock which is limited to a specified amount on
liquidation, as well as common stock, if the holders of the preferred
stock receive the entire amount to which they are entitled, the fraction
described in the preceding sentence shall be applied to determine the
increase in the amount realized by the holders of common stock on the
liquidation without taking the preferred stock into account. In all
other cases, in determining the increase in the amount realized by each
minority shareholder, consideration must be given to the extent to which
different classes of stock are entitled to participate in the assets of
the corporation on liquidation.
(2) If two or more minority shareholders receive distributions in
liquidation with respect to the same stock (e.g., if a minority
shareholder sells his stock after receiving one of a series of
distributions in complete liquidation), the increase in the amount
realized by the minority shareholder who surrenders the stock in
liquidation shall be determined as though he received all the
distributions in liquidation with respect to such stock and shall then
be divided between himself and the shareholder who has already received
distributions in liquidation with respect to the same stock. This
division must be in proportion to the amount each minority shareholder
received in liquidation with respect to such stock.
(d) Claim for credit or refund. Claim for credit or refund of the
tax deemed to have been paid by a shareholder pursuant to section 337(d)
and paragraph (b) of this section shall be made in accordance with
301.6402-3 for the taxable year in which he receives the first
distribution in complete liquidation. In the case of a shareholder
which is a partnership, claim shall be made by the partners for credit
or refund of their distributive shares of the tax deemed to have been
paid by the partnership. In the case of a shareholder which is an
electing small business corporation (within the meaning of section
1371(b)), claim shall be made by those persons who are shareholders of
such corporation on the last day of the corporation's taxable year in
which it received the first distribution in complete liquidation. In
the case of a shareholder which is exempt from tax under section 501(a)
and to which section 511 does not apply for the taxable year, claim for
refund of the tax deemed to have been paid by such shareholder shall be
made on Form 843. For other rules applicable to the filing of claims
for credit or refund of an overpayment of tax, see section 6402 and the
regulations thereunder. For the limitations applicable to the credit or
refund of an overpayment of tax, see section 6511 and the regulations
thereunder.
(e) Illustrations. The application of this section may be
illustrated by the following examples:
Example 1. (i) Assume that corporation S, having only common stock
outstanding, is owned 90 percent by corporation P (which has owned the S
stock for 3 years) and 10 percent by individual A (a calendar year
taxpayer), and that the sole assets of corporation S are two buildings,
each having a fair market value of $100,000 and a basis to the
corporation of $50,000. Assume further that A's basis for his stock is
$10,000. On August 1, 1958, corporation S adopts a plan of complete
liquidation. On September 1, 1958, corporation S sells building No. 1
for $100,000 and, during October 1958, the corporation makes a pro rata
distribution of building No. 2 and the proceeds of the sale of building
No. 1 (less $12,500 retained to pay the tax on such sale at the rate of
25 percent).
(ii) Under section 337(d) and this section, the amount realized by A
on the distribution is increased by $1,250, A's proportionate share (10
percent) of the amount by which the tax imposed on corporation S upon
such sale would have been reduced ($12,500) if section 337(a) had been
applicable. Thus, the tax imposed on A with respect to the complete
liquidation is computed as follows: The amount realized by A is $18,750
($10,000 for A's one-tenth interest in building No. 2, plus $8,750
representing A's proportionate share of the $100,000 received by
corporation S on the sale of building No. 1 less the tax imposed on
corporation S upon such sale) plus $1,250 (the increase in the amount
realized), or $20,000. Since A's basis for his stock is $10,000, the
tax imposed on A with respect to the complete liquidation (assuming A's
gain is taxed at a rate of 25 percent) is $2,500. Under section 337(d)
and this section, A shall be deemed to have paid $1,250 in tax.
Accordingly, A will be left with $17,500 in property and money ($18,750
minus $1,250).
Example 2. (i) Assume all the facts set forth in example (1) and the
following additional facts: Corporation S has outstanding 1,000 shares
of $100 par value preferred stock, the holders of which are entitled to
receive full par value on liquidation, after which the common
shareholders receive the balance of the assets. Individual A owns 10
percent of the preferred stock, with a basis to him of $10,000, as well
as 10 percent of the common stock. Corporation S has, in addition to
its two buildings, $100,000 in cash which it distributes in full payment
in exchange for the outstanding preferred stock.
(ii) Individual A receives $10,000 in exchange for his preferred
stock and recognizes no gain or loss on this portion of the liquidation.
Under section 337(d) and this section, A is accorded the same treatment
described in example (1) with respect to his common stock as though it
were the only stock outstanding. Thus, with respect to his common stock
the amount realized by A on the distribution is increased by $1,250, and
the tax deemed paid by him is $1,250. Accordingly, after credit, A will
be left with $27,500 in property and money ($10,000 on his preferred
stock and $17,500 on his common stock).
Example 3. (i) Assume the same facts as in example (1) except that
on August 2, 1958, corporation S makes a pro rata distribution of
building No. 2 as a first distribution in complete liquidation. Assume
further that on August 15, 1958, individual A sells his stock to B, and
that on October 1, 1958, building No. 1 is sold and final distribution
in liquidation is made of $87,500 ($100,000 sales proceeds less $12,500
retained to pay tax, assuming a 25-percent rate).
(ii) Under section 337(d) and this section, the increase in the
amount realized by B shall first be determined as though he had received
all the distributions in liquidation with respect to such stock. Then
the increase in the amount realized ($1,250) is divided between A and B
in proportion to the amount each shareholder received in liquidation
with respect to such stock. Thus, A's share of the increase in the
amount realized is $666.67 ($1,250 10,000/18,750) and B's share is
$583.33 ($1,250 8,750/18,750). A is deemed to have paid tax in the
amount of $666.67 and B is deemed to have paid tax in the amount of
$583.33.
Example 4. (i) Assume the same facts as in example (1), except that
A files his return for 1958 on April 15, 1959, and that corporation S
sells building No. 1, and distributes the proceeds of such sale (less
tax thereon), in May 1959.
(ii) Since building No. 1 is not sold until after A files his return
for 1958, A's 1958 return will report no gain on the liquidation (A's
pro rata share of building No. 2 being equal to the basis of his stock).
However, under section 337(d) and this section, the amount realized by
A on the liquidating distribution received by him in 1958 (the first
taxable year in which he received a liquidating distribution) is
increased by his entire proportionate share ($1,250) of the amount by
which the tax imposed on corporation S upon the sale of building No. 1
would have been reduced if section 337(a) had been applicable.
Moreover, A is deemed to have paid, on the last day prescribed by law
for the payment of his tax for 1958 (April 15, 1959), an amount of tax
equal to such increase. Thus, A will be obliged to file an amended
return (or claim for refund) for 1958 to reflect the adjustments
required by section 337(d) and this section. The amended return (or
claim for refund) will show that in 1958 A realized gain on the
liquidation in the amount of $1,250, the excess of the amount realized
by A ($10,000 plus $1,250 or $11,250) over his basis ($10,000), and that
A incurred a tax of $312.50 on such gain (assuming the gain is taxed at
a rate of 25 percent). Moreover, the amended return (or claim) will
show that A is deemed to have paid $1,250 in additional tax for 1958.
Accordingly, if the excess of the tax deemed paid over the tax incurred,
or $937.50, constitutes an overpayment of tax for 1958, such excess will
be credited or refunded to A.
(iii) When A receives a further liquidating distribution of $8,750 in
1959 (i.e., his proportionate share of the proceeds of the sale of
building No. 1, less tax thereon) he realizes a further gain of $8,750
(since he fully recovered the basis of his stock in 1958) on which,
assuming the gain is taxed at a rate of 25 percent, he will incur a tax
of $2,187.50. Thus, with respect to the liquidation of corporation S, A
will in effect be left with $17,500 in property and money, determined as
follows:
(T.D. 6533, 26 FR 402, Jan. 19, 1961, as amended by T.D. 7332, 39 FR
44216, Dec. 23, 1974; T.D. 7410, 41 FR 11020, Mar. 16, 1976)
26 CFR 1.337-6 Information to be filed.
(a) Cases to which section 337(a) applies. In cases to which section
337(a) applies, there must be attached to the return of the liquidating
corporation the following information:
(1) A copy of the minutes of the stockholders' meeting at which the
plan of liquidation was formally adopted, including a copy of the plan
of liquidation.
(2) A statement of the assets sold after the adoption of the plan of
liquidation, including the dates of such sales. If section
337(c)(2)(B), relating to limited nonrecognition of gain on sales by
subsidiaries, is applicable, this statement must include a computation
of the total gain and of the gain not recognized under section 337.
(3) Information as to the date of the final liquidating distribution.
(4) A statement of the assets, if any, retained to pay liabilities
and the nature of the liabilities.
(b) Cases to which section 337(d) is applicable. In cases to which
section 337(d) applies, a minority shareholder who claims credit or
refund of tax deemed to have been paid shall file with the return on
which the claim is made (or Form 843 for claims filed before July 1,
1976) or a statement containing the name and address of the liquidating
corporation and the district in which it files its return, together with
all information necessary to support the validity of his claim and a
detailed computation of the amount of his claim.
(c) Election under section 337(e). (1) Section 337(e) applies to a
disposition of converted property (within the meaning of section
1033(a)(2)(E)(ii)) occurring after November 10, 1978, but only if a
proper election is made.
(2) To make the election --
(i) A liquidating corporation must file a statement that it elects
section 337(e) for all of its property involuntarily converted during
the 60-day period described in section 337(e)(2).
(ii) The statement must be filed with its return or amended return
for the earliest taxable year for which income (or loss) would otherwise
be reportable for such conversions.
(iii) The statement must include the name of the liquidating
corporation, its taxpayer identification number, a general description
of the property, and the date or dates of the conversions. The general
description of the property should be sufficient to apprise the
Commissioner as to which business and which assets were involuntarily
converted. The requirement that a general description of the property
be provided is not intended to impose on the taxpayer the burden of
listing each item of property destroyed. For example, assume a fire,
which destroys a men's clothing store and all the contents therein,
precipitates the adoption of a plan of liquidation. A satisfactory
statement would set forth the date of the fire, the location of the
store, and that furniture, fixtures, inventory, and records of a men's
clothing store were destroyed.
(3) If, following the filing of an election under section 337(e), a
liquidating corporation fails to satisfy the requirements for a complete
liquidation under section 337(a), the corporation must file an amended
return reporting any gain or loss that was not recognized by reason of
its election under section 337(e).
(T.D. 6533, 26 FR 404, Jan. 19, 1961, as amended by T.D. 7410, 41 FR
11020, Mar. 16, 1976; T.D. 7722, 45 FR 64907, Oct. 1, 1980)
26 CFR 1.337(d)-1 Transitional loss limitation rule.
(a) Loss limitation rule for transitional subsidiary -- (1) General
rule. No deduction is allowed for any loss recognized by a member of a
consolidated group with respect to the disposition of stock of a
transitional subsidiary.
(2) Allowable loss -- (i) In general. Paragraph (a)(1) of this
section does not apply to the extent the taxpayer establishes that the
loss is not attributable to the recognition of built-in gain by any
transitional subsidiary on the disposition of an asset (including stock
and securities) after January 6, 1987.
(ii) Statement of allowable loss. Paragraph (a)(2)(i) of this
section applies only if a separate statement entitled ''Allowable Loss
Under 1.337(d)-1(a)'' is filed with the taxpayer's return for the year
of the stock disposition. If the separate statement is required to be
filed with a return the due date (including extensions) of which is
before January 16, 1991, or with a return due (including extensions)
after January 15, 1991 but filed before that date, the statement may be
filed with an amended return for the year of the disposition or with the
taxpayer's first subsequent return the due date (including extensions)
of which is after January 15, 1991.
(iii) Contents of statement. The statement required under paragraph
(a)(2)(ii) of this section must contain --
(A) The name and employer identification number (E.I.N.) of the
transitional subsidiary.
(B) The basis of the stock of the transitional subsidiary immediately
before the disposition.
(C) The amount realized on the disposition.
(D) The amount of the deduction not disallowed under paragraph (a)(1)
of this section by reason of this paragraph (a)(2).
(E) The amount of loss disallowed under paragraph (a)(1) of this
section.
(3) Coordination with loss deferral and other disallowance rules.
For purposes of this section, the rules of 1.1502-20(a)(3) apply, with
appropriate adjustments to reflect differences between the approach of
this section and that of 1.1502-20.
(ii) Other loss deferral rules. If paragraph (a)(1) of this section
applies to a loss subject to deferral or disallowance under any other
provision of the Code or the regulations, the other provision applies to
the loss only to the extent it is not disallowed under paragraph (a)(1).
(4) Definitions. For purposes of this section --
(i) The definitions in 1.1502-1 apply.
(ii) Transitional subsidiary means any corporation that became a
subsidiary of the group (whether or not the group was a consolidated
group) after January 6, 1987. Notwithstanding the preceding sentence, a
subsidiary is not a transitional subsidiary if the subsidiary (and each
predecessor) was a member of the group at all times after the
subsidiary's (and each predecessor's) organization.
(iii) Built-in gain of a transitional subsidiary means gain
attributable, directly or indirectly, in whole or in part, to any excess
of value over basis, determined immediately before the transitional
subsidiary became a subsidiary, with respect to any asset owned directly
or indirectly by the transitional subsidiary at that time.
(iv) Disposition means any event in which gain or loss is recognized,
in whole or in part.
(v) Value means fair market value.
(5) Examples. For purposes of the examples in this section, unless
otherwise stated, the group files consolidated returns on a calendar
year basis, the facts set forth the only corporate activity, and all
sales and purchases are with unrelated buyers or sellers. The basis of
each asset is the same determining earnings and profits adjustments and
taxable income. Tax liability and its effect on basis, value, and
earnings and profits are disregarded. ''Investment adjustment system''
means the rules of 1.1502-32 and 1.1502-33(c). The principles of this
paragraph (a) are illustrated by the following examples:
Example 1. Loss attributable to recognized built-in gain. (i) P
buys all the stock of T for $100 on February 1, 1987, and T becomes a
member of the P group. T has an asset with a value of $100 and basis of
$0. T sells the asset in 1989 and recognizes $100 of built-in gain on
the sale (i.e., the asset's value exceeded its basis by $100 at the time
T became a member of the P group). Under the investment adjustment
system, P's basis in the T stock increases to $200. P sells all the
stock of T on December 31, 1989, and recognizes a loss of $100. Under
paragraph (a)(1) of this section, no deduction is allowed to P for the
$100 loss.
(ii) Assume that, after T sells its asset but before P sells the T
stock, T issues additional stock to unrelated persons and ceases to be a
member of the P group. P then sells all its stock of T in 1997.
Although T ceases to be a subsidiary within the meaning of 1.1502-1, T
continues to be a transitional subsidiary within the meaning of this
section. Consequently, under paragraph (a)(1) of this section, no
deduction is allowed to P for its $100 loss.
Example 2. Loss attributable to post-acquisition loss. P buys all
the stock of T for $100 on February 1, 1987, and T becomes a member of
the P group. T has $50 cash and an asset with $50 of built-in gain.
During 1988, T retains the asset but loses $40 of the cash. The P group
is unable to use the loss, and the loss becomes a net operating loss
carryover attributable to T. Under the investment adjustment system,
P's basis in the stock of T remains $100. P sells all the stock of T on
December 31, 1988, for $60 and recognizes a $40 loss. Under paragraph
(a)(2)(i) of this section, P establishes that it did not dispose of the
built-in gain asset. None of P's loss is disallowed under paragraph
(a)(1) if P satisfies the requirements of paragraph (a)(2)(ii) of this
section.
Example 3. Stacking rules -- postacquisition loss offsets
postacquisition gain. (i) P. buys all the stock of T for $100 on
February 1, 1987, and T becomes a member of the P group. T has 2
assets. Asset 1 has a basis and value of $50, and asset 2 has a basis
of $0 and a value of $50. During 1989, asset 1 declines in value to $0,
and T sells asset 2 for $50, and reinvests the proceeds in asset 3. The
value of asset 3 appreciates to $90. Under the investment adjustment
system, P's basis in the stock of T increases from $100 to $150 as a
result of the gain recognized on the sale of asset 2 but is unaffected
by the unrealized post-acquisition decline in the value of asset 1. On
December 31, 1989, P sells all the stock of T for $90 and recognizes a
$60 loss.
(ii) Although T incurred a $50 post-acquisition loss of built-in gain
because of the decline in the value of asset 1, T also recognized $50 of
built-in gain. Under paragraph (a)(2) of this section, any loss on the
sale of stock is treated first as attributable to recognized built-in
gain. Thus, for purposes of determining under paragraph (a)(2) of this
section whether P's $60 loss on the disposition of the T stock is
attributable to the recognition of built-in gain on the disposition of
an asset, T's unrealized post-acquisition gain of $40 offsets $40 of the
$50 of unrealized post-acquisition loss. Therefore, $50 of the $60 loss
is attributable to the recognition of built-in gain on the disposition
of an asset and is disallowed under paragraph (a)(1) of this section.
Example 4. Stacking rules -- built-in loss offsets built-in gain.
(i) P buys all the stock of T for $50 on February 1, 1987, and T becomes
a member of the P group. T has 2 assets. Asset 1 has a basis of $50
and a value of $0, and asset 2 has a basis of $0 and a value of $50.
During 1989, T sells asset 1 for $0 and asset 2 for $50, and reinvests
the $50 proceeds in asset 3. The value of asset 3 declines to $40.
Under the investment adjustment system, P's basis in the stock of T
remains $50 as a result of the offsetting gain and loss recognized on
the sale of assets 1 and 2 and is unaffected by the unrealized
post-acquisition decline in the value of asset 3. On December 31, 1989,
P sells all the stock of T for $40 and recognizes a $10 loss.
(ii) Although T recognized a $50 built-in gain on the sale of asset
2, T also recognized a $50 built-in loss on the sale of asset 1. For
purposes of determining under paragraph (a)(2) of this section whether
P's $10 loss on the disposition of the T stock is attributable to the
recognition of built-in gain on the disposition of an asset, T's
recognized built-in gain is offset by its recognized built-in loss.
Thus none of P's $10 loss is attributable to the recognition of built-in
gain on the disposition of an asset.
(iii) The result would be the same if, instead of a $50 built-in loss
in asset 2, T has a $50 net operating loss carryover when P buys the T
stock, and the net operating loss carryover is used to offset the
built-in gain.
Example 5. Outside basis partially corresponds to inside basis. (i)
Individual A owns all the stock of T, for which A has a basis of $60.
On February 1, 1987, T owns 1 asset with a basis of $0 and a value of
$100, P acquires all the stock of T from A in an exchange to which
section 351(a) applies, and T becomes a member of the P group. P has a
carryover basis of $60 in the T stock. During 1988, T sells the asset
and recognizes $100 of gain. Under the investment adjustment system,
P's basis in the T stock increases from $60 to $160. T reinvests the
$100 proceeds in another asset, which declines in value to $90. On
January 1, 1989, P sells all the stock of T for $90 and recognizes a
loss of $70.
(ii) Although P's basis in the T stock was increased by $100 as a
result of the recognition of built-in gain on the disposition of T's
asset, only $60 of the $70 loss on the sale of the stock is attributable
under paragraph (a)(2) of this section to the recognition of built-in
gain from the disposition of the asset. (Had T's asset not declined in
value to $90, the T stock would have been sold for $100, and a $60 loss
would have been attributable to the recognition of the built-in gain.)
Therefore, $60 of the $70 loss is disallowed under paragraph (a)(2), and
$10 is not disallowed if P satisfies the requirements of paragraph
(a)(2). If P had sold the stock of T for $95 because T's other assets
had unrealized appreciation of $5, $60 of the $65 loss would still be
attributable to T's recognition of built-in gain on the disposition of
assets.
Example 6. Creeping acquisition. P owns 60 percent of the stock of
S on January 6, 1987. On February 1, 1987, P buys an additional 20
percent of the stock of S, and S becomes a member of the P group. P
sells all the S stock on March 1, 1989 and recognizes a loss of $100.
All 80 percent of the stock of S owned by P is subject to the rules of
this section and, under paragraph (a) (1) and (2) of this section, P is
not allowed to deduct the $100 loss, except to the extent P establishes
the loss is not attributable to the recognition by S of built-in gain on
the disposition of assets.
Example 7. Effect of post-acquisition appreciation. P buys all the
stock of T for $100, and T becomes a member of the P group. T has an
asset with a basis of $0 and a value of $100. T sells the asset for
$100. Under the investment adjustment system, P's basis in the T stock
increases to $200. T reinvests the proceeds of the sale in an asset
that appreciates in value to $180. Five years after the sale, P sells
all the stock of T for $180 and recognizes a $20 loss. Under paragraph
(a)(1) of this section, no deduction is allowed to P for the $20 loss.
Example 8. Deferred loss and recognized gain. (i) P is the common
parent of a consolidated group, S is a wholly owned subsidiary of P, and
T is a wholly owned subsidiary of S. S purchased all of the T stock on
February 1, 1987 for $100, and T has an asset with a basis of $40 and a
value of $100. T sells the asset for $100, recognizing $60 of gain.
Under the investment adjustment system, S's basis in the T stock
increases from $100 to $160. S sells its T stock to P for $100 in a
deferred intercompany transaction, recognizing a $60 loss that is
deferred under section 267(f) and 1.1502-13(c). P subsequently sells
all the stock of T for $100 to X, a member of the same controlled group
(as defined in section 267(f)) as P but not a member of the P
consolidated group.
(ii) Under paragraph (a)(3) of this section, the application of
paragraph (a)(1) of this section to S's $60 loss is deferred, because
S's loss is deferred under section 267(f) and 1.1502-13(c). Although
P's sale of the T stock to X would cause S's deferred loss to be taken
into account under 1.1502-13(f)(1)(iii), 1.267(f)-2T(d)(2) provides
that the loss is not taken into account because X is a member of the
same controlled group as P and S. Nevertheless, under paragraph (a)(3)
of this section, because the T stock ceases to be owned by a member of
the P consolidated group, S's deferred loss is eliminated immediately
before the sale and is never taken into account under section 267(f).
(iii) The facts are the same as in (i) of this Example, except that S
is liquidated after its sale of the T stock to P, but before P's sale of
the T stock to X. Section 1.267(f)-2T(d)(2) and 1.267-1T(c)(6) and (7)
provide that, because S liquidated while the T stock is still owned by
P, S's $60 deferred loss is not restored to S. Instead, P's basis in
the T stock is increased by the unrestored deferred loss, from $100 to
$160. Because S's deferred loss is eliminated by section 267(f) before
the occurrence of any of the events described in paragraph (a)(3) of
this section, no deferred loss remains to be disallowed under paragraph
(a)(1) of this section. However, P's $60 loss on its disposition of the
T stock is disallowed under paragraph (a)(1) of this section, because it
is attributable to the recognition of built-in gain by a transitional
subsidiary on the disposition of an asset after January 6, 1987.
(b) Indirect disposition of transitional subsidiary -- (1) Loss
limitation rule for transitional parent. No deduction is allowed for
any loss recognized by a member of a consolidated group with respect to
the disposition of stock of a transitional parent.
(2) Allowable loss -- (i) In general. Paragraph (b)(1) of this
section does not apply to the extent the taxpayer establishes that the
loss exceeds the amount that would be disallowed under paragraph (a) of
this section if each highest tier transitional subsidiary's stock in
which the transitional parent has a direct or indirect interest had been
sold immediately before the disposition of the transitional parent's
stock. In applying the preceding sentence, appropriate adjustments
shall be made to take into account circumstances where less than all the
stock of a transitional parent owned by members of a consolidated group
is disposed of in the same transaction, or the stock of a transitional
subsidiary or a transitional parent is directly owned by more than 1
member.
(ii) Statement of allowable loss. Paragraph (b)(2)(i) of this
section applies only if a separate statement entitled ''Allowable Loss
Under Section 1.337(d)-1(b)'' is filed with the taxpayer's return for
the year of the stock disposition. If the separate statement is
required to be filed with a return the due date (including extensions)
of which is before January 16, 1991, or with a return due (including
extensions) after January 15, 1991 but filed before that date, the
statement may be filed with an amended return for the year of the
disposition or with the taxpayer's first subsequent return the due date
(including extensions) of which is after January 15, 1991.
(iii) Contents of statement. The statement required under paragraph
(b)(2)(ii) of this section must contain --
(A) The name and employer identification number (E.I.N.) of the
transitional parent.
(B) The basis of the stock of the transitional parent immediately
before the disposition.
(C) The amount realized on the disposition.
(D) The amount of the deduction not disallowed under paragraph (b)(1)
of this section by reason of this paragraph (b)(2).
(E) The amount of loss disallowed under paragraph (b)(1) of this
section.
(3) Coordination with loss deferral and other disallowance rules.
For purposes of this section, the rules of 1.1502-20(a)(3) apply, with
appropriate adjustments to reflect differences between the approach of
this section and that of 1.1502-20.
(ii) Other loss deferral rules. If paragraph (b)(1) of this section
applies to a loss subject to deferral or disallowance under any other
provision of the Code or the regulations, the other provision applies to
the loss only to the extent it is not disallowed under paragraph (b)(1).
(4) Definitions. For purposes of this section --
(i) Transitional parent means any subsidiary, other than a
transitional subsidiary, that owned at any time after January 6, 1987, a
direct or indirect interest in the stock of a corporation that is a
transitional subsidiary.
(ii) Highest tier transitional subsidiary means the transitional
subsidiary (or subsidiaries) in which the transitional parent has a
direct or indirect interest and that is the highest transitional
subsidiary (or subsidiaries) in a chain of members.
(5) Examples. The principles of this paragraph (b) are illustrated
by the following examples:
Example 1. Ownership of chain of transitional subsidiaries. (i) P
forms S with $200 on January 1, 1985, and S becomes a member of the P
group. On February 1, 1987, S buys all the stock of T, and T buys all
the stock of T1, and both T and T1 become members of the P group. On
January 1, 1988, P sells all the stock of S and recognizes a $90 loss on
the sale.
(ii) Under paragraph (a)(4)(ii) of this section, both T and T1 are
transitional subsidiaries, because they became members of the P group
after January 6, 1987. Under paragraph (b)(4)(i) of this section, S is
a transitional parent, because it owns a direct interest in stock of
transitional subsidiaries and is not itself a transitional subsidiary.
(iii) Under paragraph (b) (1) and (2) of this section, because S is a
transitional parent, no deduction is allowed to P for its $90 loss
except to the extent the loss exceeds the amount of S's loss that would
have been disallowed if S had sold all the stock of T, S's highest tier
transitional subsidiary, immediately before P's sale of all the S stock.
Assume all the T stock would have been sold for a $90 loss and that all
the loss would be attributable to the recognition of built-in gain from
the disposition of assets. Because in that case $90 of loss would be
disallowed, all of P's loss on the sale of the S stock is disallowed
under paragraph (b).
Example 2. Ownership of brother-sister transitional subsidiaries.
(i) P forms S with $200 on January 1, 1985, and S becomes a member of
the P group. On February 1, 1987, S buys all the stock of both T and
T1, and T and T1 become members of the P group. On January 1, 1988, P
sells all the stock of S and recognizes a $90 loss on the sale.
(ii) Under paragraph (b) (1) and (2) of this section, no deduction is
allowed to P for its $90 loss except to the extent P establishes that
the loss exceeds the amount of S's stock losses that would be disallowed
if S sold all the stock of T and T1, S's highest tier transitional
subsidiaries, immediately before P's sale of all the S stock. Assume
that all the T stock would have been sold for a $50 loss, all the T1
stock of a $40 loss, and that the entire amount of each loss would be
attributable to the recognition of built-in gain on the disposition of
assets. Because $90 of loss would be disallowed with respect to the
sale of S's T and T1 stock, P's $90 loss on the sale of all the S stock
is disallowed under paragraph (b).
(c) Successors -- (1) General rule. This section applies, to the
extent necessary to effectuate the purposes of this section, to --
(i) Any property owned by a member or former member, the basis of
which is determined, directly or indirectly, in whole or in part, by
reference to the basis in a subsidiary's stock, and
(ii) Any property owned by any other person whose basis in the
property is determined, directly or indirectly, in whole or in part, by
reference to a member's (or former member's) basis in a subsidiary's
stock.
(2) Examples. The principles of this paragraph (c) are illustrated
by the following examples:
Example 1. Merger into grandfathered subsidiary. P, the common
parent of a group, owns all the stock of T, a transitional subsidiary.
On January 1, 1989, T merges into S, a wholly owned subsidiary of P that
is not a transitional subsidiary. Under paragraph (c)(1) of this
section, all the stock of S is treated as stock of a transitional
subsidiary. As a result, no deduction is allowed for any loss
recognized by P on the disposition of any S stock, except to the extent
the P group establishes under paragraph (a)(2) that the loss is not
attributable to the recognition of built-in gain on the disposition of
assets of T.
Example 2. Nonrecognition exchange of transitional stock. (i) P,
the common parent of a group, owns all the stock of T, a transitional
subsidiary. On January 1, 1989, P transfers the stock of T to X, a
corporation that is not a member of the P group, in exchange for 20
percent of its stock in a transaction to which section 351(a) applies.
T and X file separate returns.
(ii) Under paragraph (c)(1) of this section, all the stock of X owned
by P is treated as stock of a transitional subsidiary because P's basis
for the X stock is determined by reference to its basis for the T stock.
As a result, no deduction is allowed to P for any loss recognized on
the disposition of the X stock, except to the extent permitted under
paragraph (a) of this section.
(iii) Under paragraph (c)(1), X is treated as a member subject to
paragraph (a) of this section with respect to the T stock because X's
basis for the stock is determined by reference to P's basis for the
stock. Moreover, all of the T stock owned by X continues to be stock of
a transitional subsidiary. As a result, no deduction is allowed to X
for any loss recognized on the disposition of any T stock, except to the
extent permitted under paragraph (a) of this section.
(d) Investment adjustments and earnings and profits -- (1) In
general. For purposes of determining investment adjustments under
1.1502-32 and earnings and profits under 1.1502-33(c) with respect to a
member of a consolidated group that owns stock in a subsidiary, any
deduction that is disallowed under this section is treated as a loss
arising and absorbed by the member in the tax year in which the
disallowance occurs.
(2) Example. (i) In 1986, P forms S with a contribution of $100, and
S becomes a member of the P group. On February 1, 1987, S buys all the
stock of T for $100. T has an asset with a basis of $0 and a value of
$100. In 1988, T sells the asset for $100. Under the investment
adjustment system, S's basis in the T stock increases to adjustment
system, S's basis in the T stock increases to $200, P's basis in the S
stock increases to $200, and P's earnings and profits and S's earnings
and profits increase by $100. In 1989, S sells all of the T stock for
$100, and S's recognized loss of $100 is disallowed under paragraph
(a)(1) of this section.
(ii) Under paragraph (d)(1) of this section, S's earnings and profits
for 1989 are reduced by $100, the amount of the loss disallowed under
paragraph (a)(1). As a result, P's basis in the S stock is reduced from
$200 to $100 under the investment adjustment system. P's earnings and
profits for 1989 are correspondingly reduced by $100.
(e) Effective dates -- (1) General rule. This section applies with
respect to dispositions after January 6, 1987. For dispositions on or
after November 19, 1990, however, this section applies only if the stock
was deconsolidated (as that term is defined in 1.337(d)-2(b)(2)) before
November 19, 1990, and only to the extent the disposition is not subject
to 1.337(d)-2 or 1.1502-20.
(2) Binding contract rule. For purposes of this paragraph (e), if a
corporation became a subsidiary pursuant to a binding written contract
entered into before January 6, 1987, and in continuous effect until the
corporation became a subsidiary, or a disposition was pursuant to a
binding written contract entered into before March 9, 1990, and in
continuous effect until the disposition, the date the contract became
binding shall be treated as the date the corporation became a subsidiary
or as the date of disposition.
(3) Application of 1.1502-20T to certain transactions -- (i) In
general. If a group files the certification described in paragraph
(e)(3)(ii) of this section, it may apply 1.1502-20T (as contained in
the CFR edition revised as of April 1, 1990), to all of its members with
respect to all dispositions and deconsolidations by the certifying group
to which 1.1502-20T otherwise applied by its terms occurring --
(A) On or after March 9, 1990 (but only if not pursuant to a binding
contract described in 1.337(d)-1T(e)(2) (as contained in the CFR
edition revised as of April 1, 1990) that was entered into before March
9, 1990); and
(B) Before November 19, 1990 (or thereafter, if pursuant to a binding
contract described in 1.1502-20T(g)(3) that was entered into on or
after March 9, 1990 and before November 19, 1990).
The certification under this paragraph (e)(3)(i) with respect to the
application of 1.1502-20T to any transaction described in this
paragraph (e)(3)(i) may not be withdrawn and, if the certification is
filed, 1.1502-20T must be applied to all such transactions on all
returns (including amended returns) on which such transactions are
included.
(ii) Time and manner of filing certification. The certification
described in paragraph (e)(3)(i) of this section must be made in a
separate statement entitled ''(insert name and employer identification
number of common parent) hereby certifies under 1.337(d)-1 (e)(3) that
the group of which it is the common parent is applying 1.1502-20T to
all transactions to which that section otherwise applied by it terms.''
The statement must be signed by the common parent and filed with the
group's income tax return for the taxable year of the first disposition
or deconsolidation to which the certification applies. If the separate
statement required under this paragraph (e)(3) is to be filed with a
return the due date (including extensions) of which is before November
16, 1991, the statement may be filed with an amended return for the year
of the disposition or deconsolidation that is filed within 180 days
after September 13, 1991. Any other filings required under 1.1502-20T,
such as the statement required under 1.1502-20T(f)(5), may be made with
the amended return, regardless of whether 1.1502-20T permits such
filing by amended return.
(T.D. 8319, 55 FR 49031, Nov. 26, 1990, as amended by T.D. 8364, 56
FR 47389, Sept. 19, 1991)
1.337(d)-1T (Reserved)
26 CFR 1.337(d)-2 Loss limitation window period.
(a) Loss disallowance -- (1) General rule. No deduction is allowed
for any loss recognized by a member of a consolidated group with respect
to the disposition of stock of a subsidiary.
(2) Definitions. For purposes of this section --
(i) The definitions in 1.1502-1 apply.
(ii) Disposition means any event in which gain or loss is recognized,
in whole or in part.
(3) Coordination with loss deferral and other disallowance rules.
For purposes of this section, the rules of 1.1502-20(a)(3) apply, with
appropriate adjustments to reflect differences between the approach of
this section and that of 1.1502-20.
(b) Basis reduction on deconsolidation -- (1) General rule. If the
basis of a member of a consolidated group in a share of stock of a
subsidiary exceeds its value immediately before a deconsolidation of the
share, the basis of the share is reduced at that time to an amount equal
to its value. If both a disposition and a deconsolidation occur with
respect to a share in the same transaction, paragraph (a) of this
section applies and, to the extent necessary to effectuate the purposes
of this section, this paragraph (b) applies following the application of
paragraph (a) of this section.
(2) Deconsolidation. ''Deconsolidation'' means any event that causes
a share of stock of a subsidiary that remains outstanding to be no
longer owned by a member of any consolidated group of which the
subsidiary is also a member.
(3) Value. Value means fair market value.
(4) Loss within 2 years after basis reduction -- (i) In general. If
a share is deconsolidated and a direct or indirect disposition of the
share occurs within 2 years after the date of the deconsolidation, a
separate statement entitled ''statement pursuant to 1.337(d)-2(b)(4)''
must be filed with the taxpayer's return for the year of disposition.
If the taxpayer fails to file the statement as required, no deduction is
allowed for any loss recognized with respect to the disposition. If the
separate statement is required to be filed with a return the due date
(including extensions) of which is before January 16, 1991, or with a
return due (including extensions) after January 15, 1991 but filed
before that date, the statement may be filed with an amended return for
the year of the disposition or with the taxpayer's first subsequent
return the due date (including extensions) of which is after January 15,
1991. A disposition after the 2-year period described in this paragraph
(b)(4) that is pursuant to an agreement, option, or other arrangement
entered into within the 2-year period is treated as a disposition within
the 2-year period for purposes of this section.
(ii) Contents of statement. The statement required under paragraph
(b)(4)(i) of this section must contain --
(A) The name and employer identification number (E.I.N.) of the
subsidiary.
(B) The amount of prior basis reduction with respect to the stock of
the subsidiary under paragraph (b)(1) of this section.
(C) The basis of the stock of the subsidiary immediately before the
disposition.
(D) The amount realized on the disposition.
(E) The amount of the loss recognized on the disposition.
(c) Allowable loss -- (1) Application. This paragraph (c) applies
with respect to stock of a subsidiary only if --
(i) Before February 1, 1990, the consolidated group either --
(A) Disposes (in one or more transactions) of its entire equity
interest in the subsidiary to persons not related to any member of the
consoldiated group within the meaning of section 267(b) or section
707(b)(1) (substituting ''10 percent'' for ''50 percent'' each place
that it appears); or
(B) Sustains a worthless stock loss under section 165(g); and
(ii) A separate statement entitled ''allowed loss under
1.337(d)-2(c)'' is filed in accordance with paragraph (c)(3) of this
section.
(2) General rule. Loss is not disallowed under paragraph (a)(1) of
this section and basis is not reduced under paragraph (b)(1) of this
section to the extent the taxpayer extablishes that the loss or basis in
not attributable to the recognition of built-in gain on the disposition
of an asset (including stock and securities). Loss or basis may be
attributable to the recognition of built-in gain on the disposition of
an asset by a prior group. For purposes of this section, gain
recognized on the disposition of an asset is built-in gain to the extent
attributable, directly or indirectly, in whole or in part, to any excess
of value over basis that is reflected, before the disposition of the
asset, in the basis of the share, directly or indirectly, in whole or in
part, after applying section 1503(e) and other applicable provisions of
the Code and regulations.
(3) Contents of statement and time of filing. The statement required
under paragraph (c)(1)(ii) of this section must be filed with the
taxpayer's return for the year of the disposition or deconsolidation,
and must contain --
(i) The name and employer identification number (E.I.N.) of the
subsidiary.
(ii) The basis of the stock of the subsidiary immediately before the
disposition or deconsolidation.
(iii) The amount realized on the disposition and the amount of fair
market value on the deconsolidation.
(iv) The amount of the deduction not disallowed under paragraph
(a)(1) of this section by reason of this paragraph (c) and the amount of
basis not reduced under paragraph (b)(1) of this section by reason of
this paragraph (c).
(v) The amount of loss disallowed under paragraph (a)(1) of this
section and the amount of basis reduced under paragraph (b)(1) of this
section.
If the separate statement is required to be filed with a return the
due date (including extensions) of which is before January 16, 1991, or
with a return due (including extensions) after January 15, 1991 but
filed before that date, the statement may be filed with an amended
return for the year of the disposition or deconsolidation or with the
taxpayer's first subsequent return the due date (including extensions)
of which is after January 15, 1991.
(4) Example. The principles of paragraphs (a), (b), and (c) of this
section are illustrated by the examples in 1.337(d)-1(a) and
1.1502-20(a) (other than Examples 3, 4, and 5) and (b), with appropriate
adjustments to reflect differences between the approach of this section
and that of 1.1502-20, and by the following example. For purposes of
the examples in this section, unless otherwise stated, the group files
consolidated returns on a calendar year basis, the facts set forth the
only corporate activity, and all sales and purchases are with unrelated
buyers or sellers. The basis of each asset is the same for determining
earnings and profits adjustments and taxable income. Tax liability and
its effect on basis, value, and earnings and profits are disregarded.
''Investment adjustment system'' means the rules of 1.1502-32 and
1.1502-33(c).
Example. Loss offsetting built-in gain in a prior group. (i) P buys
all the stock of T for $50 in Year 1, and T becomes a member of the P
group. T has 2 assets. Asset 1 has a basis of $50 and a value of $0,
and asset 2 has a basis of $0 and a value of $50. T sells asset 2
during Year 3 for $50, and recognizes a $50 gain. Under the investment
adjustment system, P's basis in the T stock increases to $100 as a
result of the recognition of gain. In year 5, all of the stock of P is
acquired by the P1 group, and the former members of the P group become
members of the P1 group. T then sells asset 1 for $0, and recognizes a
$50 loss. Under the investment adjustment system. P's basis in the T
stock decreases to $50 as a result of the loss. T's assets decline in
value from $50 to $40. P then sells all the stock of T for $40 and
recognizes a $10 loss.
(ii) P's basis in the T stock reflects both T's unrecognized gain and
unrecognized loss with respect to its assets. The gain T recognizes on
the disposition of asset 2 is built-in gain with respect to both the P
and the P1 groups for purposes of paragraph (c)(2) of this section. In
addition, the loss T recognizes on the disposition of asset 2 is
built-in loss with respect to the P and P1 groups for purposes of
paragraph (c)(2) of this section. T's recognition of the built-in loss
while a member of the P1 group offsets the effect on T's stock basis of
T's recognition of the built-in gain while a member of the P group.
Thus, P's $10 loss on the sale of the T stock is not attributable to the
recognition of built-in gain, and the loss is therefore not disallowed
under paragraph (c)(2) of this section.
(iii) The result would be the same if, instead of having a $50
built-in loss in asset 2 when it becomes a member of the P group, T has
a $50 net operating loss carryover and the carryover is used by the P
group.
(d) Successors. For purposes of this section, the rules and examples
of 1.1502-20(d) apply, with appropriate adjustments to reflect
differences between the approach of this section and that of 1.1502-20.
(e) Anti-avoidance rules. For purposes of this section, the rules
and examples of 1.1502-20(e) apply, with appropriate adjustments to
reflect differences between the approach of this section and that of
1.1502-20.
(f) Investment adjustments and earnings and profits. For purposes of
this section, the rules and examples of 1.1502-20 (f) apply, with
appropriate adjustments to reflect differences between the approach of
this section and that of 1.1502-20.
(g) Effective dates -- (1) General rule. Except as otherwise
provided in this paragraph (g), this section applies with respect to
dispositions and deconsolidations on or after November 19, 1990, but
only to the extent the disposition or deconsolidation is not subject to
1.1502-20. For this purpose, dispositions deferred under 1.1502-13,
1.1502-13T, 1.1502-14, and 1.1502-14T are deemed to occur at the time
the deferred gain or loss is taken into account unless the stock was
deconsolidated before November 19, 1990. If stock of a subsidiary
became worthless during a taxable year including November 19, 1990, the
disposition with respect to the stock is treated as occurring on the
date the stock became worthless.
(2) Binding contract rule. For purposes of this paragraph (g), if a
disposition or deconsolidation is pursuant to a binding written contract
entered into before March 9, 1990, and in continuous effect until the
disposition or deconsolidation, the date the contract became binding is
treated as the date of the disposition or deconsolidation.
(3) Application of 1.1502-20T to certain transactions -- (i) In
general. If a group files the certification described in paragraph
(g)(3)(ii) of this section, it may apply 1.1502-20T (as contained in
the CFR edition revised as of April 1, 1990), to all of its members with
respect to all dispositions and deconsolidations by the certifying group
to which 1.1502-20T otherwise applied by its terms occurring --
(A) On or after March 9, 1990 (but only if not pursuant to a binding
contract described in 1.337(d)-1T(e)(2) (as contained in the CFR
edition revised as of April 1, 1990) that was entered into before March
9, 1990); and
(B) Before November 19, 1990 (or thereafter, if pursuant to a binding
contract described in 1.1502-20T(g)(3) that was entered into on or
after March 9, 1990 and before November 19, 1990).
The certification under this paragraph (g)(3)(i) with respect to the
application of 1.1502-20T to any transaction described in this
paragraph (g)(3)(i) may not be withdrawn and, if the certification is
filed, 1.1502-20T must be applied to all such transactions on all
returns (including amended returns) on which such transactions are
included.
(ii) Time and manner of filing certification. The certification
described in paragraph (g)(3)(i) of this section must be made in a
separate statement entitled ''(insert name and employer identification
number of common parent) hereby certifies under 1.337(d)-2(g)(3) that
the group of which it is the common parent is applying 1.1502-20T to
all transactions to which that section otherwise applied by its terms.''
The statement must be signed by the common parent and filed with the
group's income tax return for the taxable year of the first disposition
or deconsolidation to which the certification applies. If the separate
statement required under this paragraph (g)(3) is to be filed with a
return the due date (including extensions) of which is before November
16, 1991, the statement may be filed with an amended return for the year
of the disposition or deconsolidation that is filed within 180 days
after September 13, 1991. Any other filings required under 1.1502-20T,
such as the statement required under 1.1502-20T(f)(5), may be made with
the amended return, regardless of whether 1.1502-20T permits such
filing by amended return.
(T.D. 8364, 56 FR 47390, Sept. 19, 1991)
26 CFR 1.338-1T Elections under section 338(g) of the Internal Revenue
Code of 1954 (temporary).
(a) Scope. This section prescribes rules relating to elections under
section 338, as added by TEFRA and as amended by the Technical
Corrections Act of 1982 and the Tax Reform Act of 1984. This section
also prescribes rules under certain related provisions not included in
the Internal Revenue Code. This section only applies with respect to
acquisitions for which the acquisition date (determined without section
224(d)(5) of TEFRA) occurs after August 31, 1982.
(b) Definitions -- (1) TEFRA. ''TEFRA'' is the Tax Equity and Fiscal
Responsibility Act of 1982.
(2) Acquisition date. The ''acquisition date'' of a corporation is
the first day on which there is a qualified stock purchase of such
corporation. Thus, in the event of a series of stock purchases over a
period of time, the acquisition date is the first day on which the
aggregate of the stock purchases satisfies the requirements of section
338(d)(3).
(3) Common parent. The term ''common parent'' has the same meaning
as in section 1504.
(4) Purchasing corporation. The term ''purchasing corporation'' has
the same meaning as in section 338(d)(1).
(5) Qualified stock purchase. The term ''qualified stock purchase''
has the same meaning as in section 338(d)(3).
(6) Selling group; purchasing group. The ''selling group'' is the
affiliated group (as defined in section 1504) that is eligible to file a
consolidated return that includes the target for the acquisition date
and that does not have a target as common parent for the taxable year
including the acquisition date. See paragraph (f)(3) (i) and (ii) of
this section. The ''purchasing group'' is the affiliated group that
includes the purchasing corporation.
(7) Old target; new target. The ''target'' is the target
corporation as defined in section 338(d)(2). ''Old target'' refers to
the target for periods ending as of the close of the date of the
target's deemed sale of assets. ''New target'' refers to the target for
subsequent periods.
(8) Old target's final return. ''Old target's final return'' is the
income tax return of old target for the taxable year ending at the close
of the acquisition date that includes the deemed sale of assets under
section 338. If the disaffiliation rule of paragraph (f)(3)(i) of this
section applies, target's ''deemed sale return'' is considered old
target's final return.
(9) Cross-reference. The definitions in 1.338-4T (as modified by
1.338-5T(b)(2)) also apply for purposes of this section.
(c) Time and manner of making election -- (1) In general. The
purchasing corporation makes an election under section 338(g) for the
original target only by filing, not later than the 15th day of the 9th
month beginning after the month in which the acquisition date occurs (or
if later, July 15, 1986), a statement of section 338 election in the
Form 8023 filing place. The Form 8023 filing place is:
(i) For a statement of section 338 election that is filed before July
1, 1986, the Internal Revenue Service Center with which the purchasing
corporation files its annual income tax return.
(ii) For a statement of section 338 election that is filed on or
after January 1, 1987, the District Director (Attention: Chief of
Examination) for the internal revenue district in which the purchasing
corporation's income tax return would be filed if 1.6091-2(b) applied
(i.e., the internal revenue district in which is located the principal
place of business or the principal office or agency of the corporation).
(iii) For a statement of section 338 election that is filed on or
after July 1, 1986 and before January 1, 1987, either of the places
described in subdivisions (i) and (ii) of this subparagraph (1).
(2) Additional rules. If the statement of section 338 election for
the original target will cause section 338(a) to apply to other
corporations (''affected targets'') by reason of section 338(f)(1), a
separate statement of section 338 election need not be filed for those
affected targets. See paragraph (e)(1) of this section for requirement
to attach a schedule containing information relating to the original
target and the affected targets. See paragraph (k)(7) of this section
for a required notice to the domestic shareholders of foreign targets in
certain cases. See also paragraph (k) of this section generally for
other special rules applicable to certain foreign corporations and
DISCs. For special rules applicable to certain statements of section
338 election filed on or after December 9, 1985, and on or before July
15, 1986, see paragraph (m) of this section.
(d) Statement of section 338 election -- (1) General rule. The
statement of section 338 election must be made by the purchasing
corporation on Form 8023. If the form is not available, a statement
prepared by the purchasing corporation will be satisfactory. (If Form
8023 is available but does not require all of the information required
by this section to be included in the statement of section 338 election,
the additional information must be added to the form or contained in an
attachment.) The heading of the statement should prominently identify
the statement as an election under section 338. Except as provided in
this paragraph (d) or in paragraphs (j)(2) and (k) (4) and (5) of this
section, the statement must --
(i) Contain the name, address, and employer identification number of
the purchasing corporation and the original target,
(ii) Identify the election as an election under section 338(g) of the
Code.
(iii) For elections filed after May 8, 1984, specify the acquisition
date,
(iv) For elections filed after October 9, 1984, state that the
election is not barred by reason of section 338(f)(2),
(v) For elections filed after February 19, 1986, specify (if the
purchasing corporation or the original target is a foreign corporation)
the country (and, if relevant, the lesser political subdivision) under
the laws of which it is organized, and
(vi) Be signed by a person who states under penalties of perjury that
he or she is authorized to make the election on behalf of the purchasing
corporation.
(2) Signature requirement if common parent is the agent of purchasing
corporation. If the common parent of an affiliated group filing
consolidated returns is the agent of the purchasing corporation under
1.1502-77, then the person authorized to sign the statement of section
338 election pursuant to paragraph (d)(1)(v) of this section is the
person authorized to act on behalf of that common parent.
(3) Qualified stock purchase made by several corporations in the
aggregate. Under section 338(h)(8), stock purchases made by members of
an affiliated group (as defined in section 338(h)(5)) are treated as if
made by one corporation. If two or more corporations make a qualified
stock purchase in the aggregate under this rule, a single statement of
section 338 election must include the name, address, and employer
identification number of each such member and must be signed in
accordance with paragraph (d)(1)(v) of this section by a person
authorized to act on behalf of each such member. A copy of this single
statement of section 338 election must be filed within the time
specified in paragraph (c) of this section in the Form 8023 filing place
(determined under paragraph (c) of this section) of each such member.
(e) Schedule; attachments to target returns -- (1) Schedule of
information relating to certain corporations and persons -- (i) Required
data. A schedule providing the information specified in this paragraph
(e)(1)(i) (''required data'') must be attached to the statement of
section 338 election. That schedule must satisfy the following
requirements:
(A) It must contain the name, address, and employer identification
number each includible affected target, i.e., each corporation that, as
of the day the statement of section 338 election is filed (''day of
filing''), is an affected target subject to that election by reason of
section 338(f)(1). For each includible affected target that is a
foreign corporation, it must also contain the country (and, if relevant,
the lesser political subdivision) under the laws of which it is
organized.
(B) It must disclose the fair market value of the consideration paid
by the purchasing corporation for the stock of each directly acquired
target, i.e., (1) the original target, (2) each includible affected
target, (3) each excludible foreign target affiliate identified under
paragraph (e)(1)(i)(F) of this section, (4) each transitional target
affiliate (that is identified in an attached transitional exclusion
election pursuant to 1.338-5T(j)(8) and that is actually acquired on or
before the day of filing), and (5) each other corporation that, as of
the day of filing, would be a target but for the transitional exclusion
election (if any). For purposes of this subdivision (i), a directly
acquired target does not include a corporation the qualified stock
purchase of which occurs solely by reason of section 338(a)(2) and
(h)(3)(B) (or would so occur if a regular or transitional exclusion
election were not made) (''indirectly acquired corporation'').
(C) It must identify the portion of the consideration paid for the
stock of each directly acquired target that is represented by the
following components: (1) Cash, (2) purchase money debt, and (3) other
components of consideration (with each such other component separately
stated).
(D) It must disclose the liabilities (with any tax liability
resulting from the deemed sale of assets under section 338(a)(1)
separately stated), as of the close of the acquisition date (or as of
the close of the day that would be the acquisition date if a regular or
transitional exclusion election were not made), of each of the
corporations described in paragraph (e)(1)(i)(B) of this section and of
each other corporation that would be so described but for the exception
therein for indirectly acquired corporations.
(E) If an election under section 338(h)(10) is made, it must clearly
identify (such as by a footnote system) each corporation listed on the
schedule that is subject to that election, including corporations
subject to deemed section 338(h)(10) elections under
1.338(h)(10)-1T(h).
(F) If a regular exclusion election under 1.338-5T(c)(2) is made,
the schedule must contain the name, address, and employer identification
number (if any) of, and country (and, if relevant, the lesser the
political subdivision) under the laws of which is organized, each
corporation that, as of the day the schedule is filed, is an excludible
foreign target affiliate, with each such corporation clearly identified
(such as by a footnote system) as an excludible foreign target affiliate
subject to a regular exclusion election.
(G) It must contain the name, address, and identifying number (if
available) of each U.S. person to whom notice of the election must be
sent as of the day the statement of section 338 election is filed (see
paragraph (k)(7) of this section).
(ii) Corrective statements -- (A) Transitional rule. If a statement
of section 338 election filed on or before July 15, 1986, does not
include the schedule with all of the required data, the requirements of
paragraph (e)(1)(i) of this section will be satisfied if, on or before
July 15, 1986, a corrective statement in the form of the schedule
(containing all of the required data, and with a copy of the previously
filed statement of section 338 election attached) is filed in the Form
8023 filing place(s) where a statement of section 338 election would be
filed, under paragraphs (c) and (d) of this section, on the date the
corrective statement is filed.
(B) Regular exclusion election invalidated. If, subsequent to the
making of a regular exclusion election, that exclusion election is
invalidated by reason of an invalidation event described in
1.338-5T(c)(2)(iii) and if, by reason of the invalidation event, a
previously filed schedule under this subparagraph (1) incorrectly
identifies certain corporations as excludible foreign target affiliates
subject to a regular exclusion election, then the requirements of
paragraph (e)(1)(i) of this section will be satisfied if, on or before
the later of July 15, 1986, or the 120th day after the date of the
invalidation event, a corrective statement in the form of an amended
schedule (along with a copy of the previously filed statement of section
338 election) is filed in the Form 8023 filing place(s) where a
statement of section 338 election would be filed, under paragraphs (c)
and (d) of this section, on the date the corrective statement is filed.
(The invalidated regular exclusion statement need not be attached.) The
revised schedule must clearly identify (such as by a footnote system)
the corporations that are no longer treated as excludible foreign target
affiliates subject to a regular exclusion election. The following
declaration (or a substantially similar declaration) must be set forth
on the amended schedule: ''this schedule is amended by reason of the
invalidation under 1.338-5T(c)(2)(iii) of a regular exclusion
election.''
(C) Schedule must be updated. The schedule filed as a corrective
statement under this subdivision (ii) must contain the required data
described in paragraph (e)(1)(i) of this section for each corporation
subject to the statement of section 338 election as of the day the
schedule is filed.
(2) Attachments to target returns; additional filings with certain
Service Centers and District Directors -- (i) Attachments. The items
described in this subdivision (i) (''required items'') must be attached
to old target's final return and to the first return of new target. For
purposes of this subparagraph (2), the term ''target'' refers to the
original target and each affected target subject to the express election
for the original target. The required items are --
(A) A copy of the statement of section 338 election (including a copy
of any election made by filing a separate statement in connection with
the statement of section 338 election) and
(B) The schedule described in paragraph (e)(1)(i) of this section
(''schedule'').
(ii) Corrective statements -- (A) Transitional rule. If all of the
required items (containing all of the information required to be
included in those items) are not attached to a final return of old
target or a first return of new target that is filed on or before July
15, 1986, the requirements of paragraph (e)(2)(i) of this section will
be satisfied if on or before that date a corrective statement consisting
of all of the required items (containing all of the information required
to be included in those items) is filed with the Internal Revenue
Service Center(s) with which the returns to which the required items
should have been attached were filed. A corrective statement that is
filed on or after January 1, 1987, must be attached to an amended
return. Prior to that date, however, attachment to an amended return is
optional.
(B) Special rule if regular exclusion election invalidated. If,
under the circumstances described in paragraph (e)(1)(ii)(B) of this
section (relating to invalidation of regular exclusion election), a
previously filed schedule under this paragraph (e)(2) incorrectly
identifies certain corporations as excludible foreign target affiliates
subject to a regular exclusion election, then the requirements of
paragraph (e)(2)(i) of this section will be satisfied only if, on or
before the 120th day after the date of the invalidation event, a
corrective statement in the form of an amended schedule (containing the
information and attachment required by paragraph (e)(1)(ii)(B) of this
section) is filed with the Internal Revenue Service Center(s) with which
the returns to which the previously filed schedule was attached were
filed. A corrective statement that is filed on or after January 1,
1987, must be attached to an amended return. Prior to that date,
however, attachment to an amended return is optional.
(iii) Additional filings with certain Service Centers and District
Directors. On or before the day on which any return or corrective
statement described in paragraph (e)(2) (i) or (ii) of this section is
filed, the required items also must be filed in the Form 8023 filing
place(s) where a statement of section 338 election would be filed, under
paragraphs (c) and (d) of this section, on the date the return or
corrective statement is filed. If a gain recognition election under
section 338(b)(3) is made in connection with the statement of section
338 election (so that a copy of the gain recognition statement (''GRS'')
under 1.338-4T(j)(2) is a required item pursuant to paragraph
(e)(2)(i)(A) of this section and the required items are filed with a
Service Center under paragraph (c)(1) of this section, then, on or
before the day specified in the preceding sentence, the required items
also must be filed with each other Internal Revenue Service Center with
which each affected P group member (determined as of the day of filing)
files its annual income tax return. For the definition of ''affected P
group member,'' see 1.338-4T(j)(2) Answer 5(ii)(A). The required items
need not, however, be filed with a Service Center or District Director
that already has received the identical required items.
(iv) Schedule and GRS must be updated. The schedule attached to a
return or filed as part of a corrective statement under paragraph (e)(2)
(i) or (ii) of this section (or filed with a Service Center under
paragraph (e)(2)(iii) of this section) must contain the required data
described in paragraph (e)(1)(i) of this section for each corporation
subject to the statement of section 338 election as of the day the
schedule is filed. Similarly, the GRS filed under the circumstances
described in the preceding sentence must include the name, address, and
employer identification number of each corporation that is an affected P
group member as of the day the GRS is filed.
(v) Special rules for returns to which required items must be
attached -- (A) Target subject to section 338(h)(10) election. If a
target is subject to an election under section 338(h)(10), then the
required items specified in paragraph (e)(2)(i) of this section are
considered filed with the last return of old target if they are attached
to the return of the selling consolidated group for the taxable period
that includes the acquisition date. For guidance under section
338(h)(10), see 1.338(h)(10)-1T(d).
(B) Certain returns filed by U.S. persons. Each U.S. person to whom
the purchasing corporation must provide notice under paragraph
(k)(7)(ii)(B) of this section (relating to notice of a section 338
election for a foreign target) must attach the required items specified
in paragraph (e)(2)(i) of this section to its income tax return in which
it is required to report a section 1248 dividend by reason of its sale
of stock in the foreign target to the purchasing corporation.
In addition, each other U.S. person that is required to file an
information return (Form 5471) with respect to the foreign target for a
relevant taxable year of that foreign target must attach the required
items to that return if (1) the purchasing corporation must provide
notice under paragraph (k)(7)(ii)(A) to that U.S. person or (2) that
U.S. person is a member of the affiliated group that includes the
purchasing corporation. A foreign target's relevant taxable years are
its taxable year that includes its acquisition date and its taxable year
that includes the first day thereafter. A U.S. person that receives a
notice pursuant to paragraph (k)(7)(ii) of this section may assume that
the required items received from the purchasing corporation as part of
that notice are accurate for purposes of the attachment requirement.
(C) First return of new foreign target after acquisition date. If a
United States income tax return is not required to be filed for new
foreign target's taxable period that includes the first day after its
acquisition date, then the required items must be attached to the first
United States income tax return filed by that target for a subsequent
taxable year.
(vi) Transitional allocation election statements. A copy of the
transitional allocation election statement prescribed in
1.338(b)-4T(c)(1) is required to be attached to the first return (or
amended return) of the original target (and each affected target) as new
target. A copy of the supplemental transitional allocation election
statement prescribed by 1.338(b)-4T(c)(3) is required to be attached
only to the first return of the new target (or new targets) identified
in that statement.
(3) Consequence of failure to comply with requirements of paragraph
(e) (1) and (2) of this section -- (i) General rule. If the
requirements of paragraph (e) (1) and (2) of this section or of
1.338-5T(c)(2)(vii)(B) (requirement of amended returns if regular
exclusion election invalidated) are not satisfied with respect to the
original target or any affected target, then the waiver rule of
paragraph (h)(1) of this section will not apply to any of those targets.
Failure to comply with those requirements will not invalidate a
statement of section 338 election or any other election under section
338.
(ii) Exception for certain returns. Failure to comply with the
provisions of paragraph (e)(2)(v) of this section will not bar the
application of the waiver rule of paragraph (h)(1) of this section.
(f) Certain consequences of section 338 election -- (1) Exclusion of
old target's deemed sale from purchasing group's consolidated return.
Notwithstanding the provisions of 1.1502-76(b)(5)(i) (relating to
elective inclusion in an affiliated group), old target is not includible
in a consolidated return of the purchasing group with respect to its
deemed sale of assets under section 338.
(2) Old target's final taxable year not otherwise included in
consolidated return of selling group -- (i) General rule. If a valid
election under section 338 is made for a target that is not includible
in any consolidated return for a period that includes the acquisition
date, then a final return must be filed for old target's taxable year
that ends at the close of the acquisition date by reason of the section
338 election. Any tax liability resulting from the deemed sale of
assets under section 338 is reported in that final return and may not be
included in any consolidated return of the purchasing group.
(ii) Old target the common parent of affiliated group or a subsidiary
in a group with a common parent target. If a valid election under
section 338 is made for a target that is the common parent of an
affiliated group, the final return specified in paragraph (f)(2)(i) of
this section may be a consolidated return of that group. If such a
final consolidated return is filed, any tax liability resulting from the
deemed sale of such target, as well as from any deemed sales occurring
on the same date of subsidiaries in target's group, is reported in that
consolidated return (along with any tax liability on other income of the
group for the taxable year ending at the close of the acquisition date)
and may not be included in any consolidated return of the purchasing
group. Thus, the final consolidated return of the common parent target
is also the final return for each subsidiary of such target that is also
a target with the same acquisition date.
(3) Old target's final taxable year otherwise included in
consolidated return of selling group -- (i) General rule. If a valid
election under section 338 is made for a target that is includible in a
consolidated return filed by the selling group for a period that
includes the acquisition date, then old target is disaffiliated from
that group immediately before its deemed sale of assets under section
338 and must file a final return including only the items resulting from
the deemed sale and the carryover items specified in paragraph
(f)(3)(iv) of this section (''deemed sale return''). The deemed sale
occurs at the close of the acquisition date and is the last transaction
of old target. If a ''deemed sale return'' must be filed, then any
transactions of old target occurring on the acquisition date prior to
the deemed sale are reported in the selling group's consolidated return.
A ''deemed sale return'' includes a ''combined return'' as defined in
1.338-4T(k)(6).
(ii) Old target includible in selling group's consolidated return.
Old target is considered to be includible in a consolidated return filed
by the selling group for a period that includes the acquisition date if
target is an includible corporation (within the meaning of section 1504)
with respect to that group at the beginning of the acquisition date and
if the 30-day rule option in 1.1502-76(b)(5)(ii) (relating to elective
exclusion from an affiliated group), is not exercised. For the
definition of ''selling group,'' see paragraph (b)(6) of this section.
(iii) Separate taxable year. The deemed sale of old target reported
in the ''deemed sale return'' under this subparagraph (3) occurs in a
separate taxable year, except that such sale is treated as occurring in
the same taxable year of target as is represented by the selling group's
consolidated return (for the period including the acquisition date) for
purposes of determining the number of years in a carryover or carryback
period.
(iv) Carryover and carryback of tax attributes. Target's attributes
may be carried over to, and carried back from, the ''deemed sale
return'' under the rules applicable to a corporation that ceases to be a
member of an affiliated group during a consolidated return year. See
generally 1.1502-21 and 1.1502-79.
(v) Old target is a component member of purchasing corporation's
controlled group. For purposes of its deemed sale return, target is a
component member of the controlled group of corporations including the
purchasing corporation unless target is treated as an excluded member
under section 1563(b)(2).
(vi) Exception. This subparagraph (3) does not apply if the binding
contract rule of paragraph (l) of this section applies.
(4) EIN not affected. New target shall use the same employer
identification number old target used.
(5) Liquidating target before election. Liquidating target on or
after the acquisition date and before the filing of an election under
section 338 has no effect on the validity of the election. If target
liquidates on the acquisition date, the liquidation will be considered
to occur on the following day and immediately after new target's deemed
purchase of assets.
(6) Due date for old target's final return -- (i) General rule. Old
target's final return (as defined in paragraph (b)(8) of this section)
is due on the 15th day of the third calendar month following the month
in which the acquisition date occurs. If old target is sold by a
selling group, 1.1502-76(c) may be applicable to old target's final
return.
(ii) Exceptions. If the final taxable period of old target is
includible in the consolidated return of the selling group by reason of
the binding contract rule of paragraph (l) of this section, the due date
of that consolidated return controls. For special rules applicable to
certain foreign corporations and DISCs, see paragraph (k)(7) of this
section.
(7) New target's taxable year and method of accounting -- (i)
Selection. Except as otherwise provided in the Code and the Income Tax
Regulations, new target may adopt, without obtaining prior approval from
the Commissioner, any taxable year that meets the requirements of
section 441 and any method of accounting that meets the requirements of
section 446.
(ii) First return due on or before certain time. Notwithstanding
1.441-1(b)(3), a new target may adopt a taxable year for which the first
return is due (not including extensions of time) on or before the date
that is the later of (A) July 15, 1986, or (B) the last day for making
the election under section 338 by filing its first return as new target
for the desired taxable year on or before that date.
(8) Example. The provisions of this paragraph (f) may be illustrated
by the following example. A capital letter refers to a domestic
corporation.
Example. S is the common parent of an affiliated group that includes
T. The S group files calendar year consolidated returns. At the close
of June 30, 1983, P purchases all of the T stock from S. P makes a
timely election under section 338(g), and the tax resulting from T's
deemed sale of assets is triggered to T as of the close of the
acquisition date (June 30). T is considered disaffiliated for purposes
of reporting the deemed sale. Accordingly, T is included in the
consolidated return of the selling group for the acquisition date except
that the tax liability resulting from the deemed sale of assets will be
reported in a separate ''deemed sale return'' of T. The result would be
the same if P purchased the T stock at 10 a.m. on June 30, 1983. See
paragraph (f)(3) (i) and (ii) of this section. Provided that T is not
treated as an excluded member under section 1563(b)(2), T is a component
member of P's controlled group for the taxable year represented by the
deemed sale, and the taxable income bracket amounts available in
calculating tax on the deemed sale return must be limited accordingly.
If the S group does not file consolidated returns and if old T filed on
the calendar year, a separate return must be filed for old T for its
short taxable year beginning on January 1, 1983, and ending on June 30,
1983, which would include the deemed sale.
(9) Cross reference. See 1.338(b)-3T(h) for certain rules relating
to any change in the aggregate deemed sale price of old target's assets.
(g) Revoking election made before March 1, 1983 -- (1) In general.
An election under section 338(g) made before March 1, 1983, that meets
all the requirements of paragraphs (c) and (d) of this section may be
revoked by filing a statement of revocation before March 1, 1983, with
the Internal Revenue Service Center with which the statement of election
was filed. Technical Corrections Act of 1982, section 306(a)(8)(B)(i)
(Pub. L. 97-448; 96 Stat. 2365). (A statement filed with the Internal
Revenue Service that does not meet all the requirements of paragraphs
(c) and (d) of this section is not a valid election and need not be
revoked.) The revocation of an election does not bar a later, timely
election under section 338 with respect to the same acquisition. The
heading of the statement of revocation should prominently identify the
statement as a revocation of section 338 election, and a copy of the
statement of election previously filed must be attached. The statement
of revocation must --
(i) Identify the purchasing corporation and the target by name,
address, and employer identification number,
(ii) Indicate that the previously filed election under section 338 is
revoked, and
(iii) Be signed by a person who states under penalties of perjury
that he or she is authorized to revoke the election on behalf of the
purchasing corporation.
(2) Perfection of revocation. A statement of revocation filed before
March 1, 1983, that sufficiently identifies the prior election and is
signed by a person authorized to revoke the election but does not meet
all of the requirements of paragraph (g)(1) of this section will
nonetheless be considered valid if a statement of perfection is filed
with the appropriate Internal Revenue Service Center not later than May
8, 1984. The statement of perfection must contain the information
omitted from the original statement of revocation and be signed in the
manner required for a statement of revocation. A copy of the previously
filed statement of revocation must be attached to the statement of
perfection.
(h) Waiver: certain additions to tax and times to act, etc. -- (1)
Waiver of certain additions to tax. An addition to tax or additional
amount (addition) under Subchapter A of Chapter 68 arising on or before
the later of July 15, 1986, or the last day for making the election
under section 338, by reason of circumstances that would not exist but
for an election under section 338, is waived if (i) under the particular
statute the addition is excusable upon a showing of reasonable cause and
(ii) corrective action is taken on or before the later of July 15, 1986
or the last day. For the nonapplication of this paragraph (h)(1) for
failure to file certain materials, see paragraph (e)(3) of this section.
The Service should be notified at the time of correction (e.g.,by
attaching a statement to a return that constitutes corrective action)
that the waiver rule of this paragraph (h) is being asserted.
(2) Elections or other actions required to be specified on a timely
filed return -- (i) In general. If the addition to tax for failure to
file a return is waived under paragraph (h)(1) of this section, or if
that addition would have been waived had there been an underpayment of
tax or had paragraph (e)(3) of this section (under which paragraph
(h)(1) of this section does not apply if certain materials are not
filed) not applied, then any election or other action that must be
specified on a timely filed return for the taxable period covered by the
late filed return described in that paragraph (h)(1) will be considered
timely if specified on that late-filed return (filed within the time
prescribed in that paragraph (h)(1) for corrective action).
(ii) New target in purchasing group's consolidated return. If new
target is includible for its first taxable year in a consolidated return
filed by the purchasing group on or before the later of July 15, 1986,
or the last day for making the election under section 338, then any
election or other action that must be specified in a timely filed return
for new target's first taxable year (but which is not specified in the
consolidated return) will be considered timely if specified in an
amended return filed on or before the later of July 15, 1986, or such
last day, with the Internal Revenue Service Center with which the
consolidated return was filed. Before January 1, 1987, if the contents
of the consolidated return itself are not affected by the election or
other action, a separate statement may serve as a substitute for the
amended return. Such separate statement must cite this provision and
must include the name, address, and EIN of the parent corporation of the
purchasing group.
(3) Moot return not required. If a timely election under section 338
is made, then an income tax return need not be filed for the taxable
year of old target which, had an election not been made, would have
included any day after the acquisition date.
(4) Examples. The provisions of this paragraph (h) may be
illustrated by the following examples. A capital letter refers to a
domestic corporation.
Example (1). T is an unaffiliated corporation filing income tax
returns on the basis of a fiscal year ending October 31. At the close
of September 20, 1982, T is acquired by P. P does not file consolidated
returns. P files an election under section 338 on or before July 15,
1986, which causes T's taxable year to end as of the close of September
20, 1982. An income tax return for T's taxable period ending on
September 20, 1982, was due on December 15, 1982. Additions to tax for
failure to file a return and to pay tax shown on a return will not be
imposed if T's return is filed and the tax paid on or before July 15,
1986. (This waiver applies even if the acquisition date coincides with
the last day of T's former taxable year, i.e., October 31, 1982.)
Interest on any underpayment of tax for old T's short taxable year
ending September 20, 1982, will run from December 15, 1982. A statement
indicating that the waiver rule of 1.338-1T(h) is being asserted should
be attached to T's return.
Example (2). Assume the same facts as in Example (1). Assume
further that new T adopts the calendar year. Under paragraph (f)(7)(ii)
of this section, a calendar year will be properly adopted if new T files
its first return on or before July 15, 1986, indicating that a calendar
year is adopted for new T (including the period beginning on September
21, 1982, and ending on December 31, 1982). Any additions to tax or
additional amounts described in this paragraph (h) which arise by reason
of the late filing of a return for the period ending on December 31,
1982, are waived, since they are based on circumstances that would not
exsit but for the section 338 election. Notwithstanding this waiver,
however, the return is still considered due on March 15, 1983, and
interest on any underpayment runs from that date. Although prior to the
election old T had a return due on January 15, 1983, that return need
not be filed since a timely election under section 338 was made. See
paragraph (h)(3) of this section.
(i) (Reserved)
(j) Special rules for acquisitions affected by regulations under
section 338(h)(6)(B -- (1) Target subject to special rules. This
paragraph (j) applies to a target --
(i) That is a foreign corporation, a DISC, a corporation described in
section 934(b), or a corporation to which section 936 applies or
(ii) That has a target affiliate (as defined in paragraph (k)(3)(ii)
of this section) that either (A) is described in paragraph (j)(1)(i) of
this section or (B) owns stock in a foreign corporation or a domestic
corporation that is a DISC or described in section 1248(e).
(2) No additional suspension of time to make election for target
described in this paragraph. Pursuant to paragraph (c) of this section,
the time to make an express election (for an acquisition subject to this
section) does not expire before July 15, 1986. Prior to amendment by
T.D. 8074, this paragraph (j) provided for an indefinite suspension of
time to make an express election for certain targets but permitted an
option to make an express election notwithstanding that suspension.
Rules applicable to this obsolete option are prescribed in paragraph (j)
(3), (4), and (5) of this section.
(3) Declaration required in statement of section 338 election. If,
on or before March 14, 1986, a statement of section 338 election is
filed for a target described in paragraph (j)(1) of this section, and if
a regular exclusion election, transitional exclusion election, or
transitional stock exclusion election (as defined in 1.338-5T (c)(2),
(j)(1), and (j)(7), respectively) is not made in that statement of
section 338 election, then that statement of section 338 election must
include, in addition to the other requirements specified in this
section, the following declaration (or a substantially similar
declaration: ''this election is made pursuant to the option in
1.338-1T(j)(2) to make the section 338 election notwithstanding the
suspension.''
(4) Perfecting procedure -- (i) General rule. If a statement of
section 338 election is required to include the declaration described in
paragraph (j)(3) of this section but does not, the election nonetheless
shall be valid if --
(A) A timely regular exclusion election, transitional exclusion
election, or transitional stock exclusion election is filed or
(B) A timely perfecting declaration is filed.
(ii) Perfecting declaration. A ''perfecting declaration'' is a
statement that contains the declaration described in paragraph (j)(3) of
this section and that is signed by a person who states under penalties
or perjury that he or she is authorized to make the perfecting
declaration on behalf of the purchasing corporation. The perfecting
declaration must be filed on or before July 15, 1986, with the Internal
Revenue Service Center(s) with which the statement of section 338
election is required to be filed under paragraphs (c) and (d) of this
section, and a copy of the previously filed statement of section 338
election must be attached.
(5) Statement of section 338 election filed pursuant to this
paragraph (j) is binding. An election under section 338(g) that is made
pursuant to the option in paragraph (j)(2) of this section is subject to
all of the provisions of section 338 as well as to the provision of
regulations issued or to be issued thereunder, including the regulations
under section 338(h)(6).
(k) Special rules for foreign corporations or DISCs -- (1) Elections
by certain foreign purchasing corporations -- (i) In general. This
subparagraph (1) applies to a statement of section 338 election (or any
other election under section 338) that is filed by a foreign purchasing
corporation that is not required under 1.6012-2(g) (other than
subparagraph (2)(i)(b)(2) thereof) to file a United States income tax
return for its taxable year that includes the acquisition date.
(ii) Place of filing. An election to which this subparagraph (1)
applies that is filed --
(A) Before July 1, 1986 must be filed with the Philadelphia Service
Center, Philadelphia, Pennsylvania 19255.
(B) On or after January 1, 1987, must be filed with the District
Director of the Foreign Operations District (Attention: Chief of
Examination), 1325 K Street, NW., Washington, DC 20225.
(C) On or after July 1, 1986 and before January 1, 1987, may be filed
in either of the places described in (A) or (B) of this subdivision
(ii).
(iii) Special rule. Notwithstanding subdivision (ii) of this
subparagraph (1), the items required (under paragraph (m) of this
section and 1.338(b)-4T(b)) to be filed by such a foreign purchasing
corporation with the District Director shall be filed with the District
Director of the Foreign Operations District (Attention: Chief of
Examination), 1325 K Street, NW., Washington, DC 20225.
(2) Election not required until relevant -- (i) General rule. A
qualifying foreign purchasing corporation is not required to file a
statement of section 338 election for a qualifying foreign target before
the 180th day after the close of the purchasing corporation's taxable
year within which a triggering event occurs. A transitional allocation
election statement under 1.338(b)-4T for a qualifying foreign target
must be filed on or before the last day that the qualifying purchasing
corporation may file a statement of section 338 election.
(ii) Qualifying foreign purchasing corporation. A purchasing
corporation is a ''qualifying foreign purchasing corporation'' only if,
during the acquisition period of a qualifying foreign target, all the
corporations in the purchasing corporation's affiliated group (as
defined in section 338(h)(5)) are foreign corporations that are not
subject to United States tax.
(iii) Qualifying foreign target. A target is a ''qualifying foreign
target'' only if the target and its target affiliates are foreign
corporations that, during the acquisition period of target, are not
subject to United States tax (and will not become subject to United
States tax during such period by reason of a section 338 election). A
target affiliate is taken into account for purposes of the preceding
sentence only if, during the acquisition period of target, it is or
becomes a member of the affiliated group (as defined in section
338(h)(5)) that includes the purchasing corporation of target.
(iv) Triggering event. A triggering event occurs in the taxable year
of the qualifying purchasing corporation in which either that
corporation or any corporation in its affiliated group (as defined in
section 338(h)(5)) becomes subject to United States tax.
(v) Subject to United States tax. For purposes of this paragraph
(k)(2), a foreign corporation is considered ''subject to United States
tax'' --
(A) For the taxable year for which that corporation is required under
1.6012-2(g) (other than subparagraph (2)(i)(b)(2) thereof) to file a
U.S. income tax return and
(B) For the period during which that corporation is a controlled
foreign corporation, a foreign investment company, or a foreign
corporation the stock ownership of which is described in section
552(a)(2).
(3) Definitions. For purposes of this paragraph (k) --
(i) Acquisition period. The ''acquisition period'' is the period
beginning at the end of the day before the first day of the ''12-month
acquisition period'' (as defined in section 338(h)(1)) and ending at the
beginning of the day following the acquisition date.
(ii) Target affiliate. The term, ''target affiliate,'' has the same
meaning as in section 338(h)(6) (applied without section
338(h)(6)(B)(i)).
(4) Statement of section 338 election may be filed by United States
shareholders in certain cases. The United States shareholders (as
defined in section 951(b)) may file a statement of section 338 election
on behalf of a foreign purchasing corporation described in paragraph
(k)(1) of this section if such corporation is also a controlled foreign
corporation (as defined in section 957(a)). The statement of section
338 election must include the name, address, taxpayer identification
number, and stock interest of each United States shareholder. In lieu
of the requirement of paragraph (d)(1)(v) of this section, the statement
must be jointly signed by each United States shareholder, with each such
shareholder stating under penalties of perjury that he or she holds the
stock interest specified for such shareholder in the statement of
section 338 election. (As an alternative to a jointly signed statement
of section 338 election, the shareholder signatures may be contained in
separate statements attached to the statement of section 338 election.)
If a United States shareholder is not an individual or has delegated
authority to sign the statement of section 338 election, the statement
must be signed by a person who states under penalties of perjury that he
or she is authorized to execute the statement on behalf of the United
States shareholder. A copy of the statement of section 338 election
must be attached to the Form 5471 (information return with respect to a
foreign corporation) filed with respect to the purchasing corporation by
each United States shareholder for the purchasing corporation's taxable
year that includes the acquisition date (or, if paragraph (k)(2) of this
section applies to the election, for the purchasing corporation's
taxable year within which it becomes a controlled foreign corporation).
The provisions of 1.964-1(c) (including 1.964-1(c)(7)) do not apply to
an election made by the United States shareholders.
(5) EIN not required for certain corporations. If, without regard to
section 338 or the regulations thereunder, a corporation is not required
to have an employer identification number (EIN) and if such a
corporation does not actually have an EIN, then the requirement that an
EIN be provided in the statement of section 338 election (or in any
other election under section 338) shall not apply to that corporation.
(6) Special rules for due date of old target's final return -- (i)
Old target a foreign corporation required to file U.S. return. The final
return of old target is due on the 15th day of the sixth calendar month
following the month in which the acquisition date occurs if old target
is a foreign corporation that is required under 1.6012-2(g) (other than
subparagraph (2)(i)(b)(2) thereof) to file a U.S. income tax return for
its taxable year that includes its acquisition date but that does not
have an office or fixed place of business in the United States during
such period.
(ii) Old target a foreign corporation not required to file U.S.
return. A final return of old target is not required if old target is a
foreign corporation that is not required under 1.6012-2(g) (other than
subparagraph (2)(i)(b)(2) thereof) to file a U.S. income tax return for
its taxable year that includes its acquisition date.
(iii) Old target a DISC. The final return of old target is due on
the 15th day of the ninth calendar month following the month in which
the acquisition date occurs if old target is a DISC for its taxable year
that includes the acquisition date.
(7) Notice requirement for U.S. persons holding stock in foreign
target -- (i) Scope. This subparagraph (7) provides rules relating to
notice to U.S. persons holding stock in a foreign target. For
additional information that must be included on the schedule required by
1.338-1T(e) if the notice requirement of this subparagraph (7) applies,
see paragraph (e)(1)(i)(G) of this section. For rules applicable to the
recipient of the notice, see paragraph (e)(2)(v)(B) of this section.
(ii) General rule. If a target subject to an express election
(either as the original target or as an affected target) is a foreign
corporation, then the purchasing corporation must deliver written notice
of the election (with a copy of the statement of section 338 election
attached) to --
(A) Each U.S. person (other than a member of the affiliated group
that includes the purchasing corporation (''P group'')) that, on the
acquisition date of the foreign target or at the beginning of the first
day after that acquisition date, holds stock in the foreign target and
(B) Each U.S. person (other than a P group member) that sells stock
in the foreign target to a P group member during so must of the foreign
target's 12-month acquisition period as ends on its acquisition date,
provided that the foreign target was a controlled foreign corporation at
any time during so much of the taxable year within which its acquisition
date occurs as ends on that acquisition date.
(iii) Form of notice. The notice to U.S. persons must be identified
prominently as a notice of section 338 election and must satisfy all of
the following:
(A) The notice must contain the name, address, and employer
identification number (if any) of, and the country (and, if relevant,
the lesser political subdivision) under the laws of which is organized,
the purchasing corporation and the relevant target (i.e., the target the
stock of which the particular U.S. person held or sold under the
circumstances described in paragraph (k)(7)(ii) of this section).
(B) The notice must identify those corporations as the purchasing
corporation and the foreign target corporation, respectively.
(C) The notice must contain the following declaration (or a
substantially similar declaration):
''THIS DOCUMENT SERVES AS NOTICE OF AN ELECTION UNDER SECTION 338 FOR
THE ABOVE CITED FOREIGN TARGET THE STOCK OF WHICH YOU EITHER HELD OR
SOLD UNDER THE CIRCUMSTANCES DESCRIBED IN TREASURY REGULATIONS
1.338-1T(k)(7)(ii). FOR POSSIBLE UNITED STATES FEDERAL INCOME TAX
CONSEQUENCES UNDER SECTION 1248 OF THE INTERNAL REVENUE CODE OF 1954
THAT MAY APPLY TO YOU, SEE TREASURY REGULATIONS 1.338-5T(g). YOU MAY BE
REQUIRED UNDER TREASURY REGULATIONS 1.338-1T(e)(2)(v) TO ATTACH THE
INFORMATION ATTACHED TO THIS NOTICE TO CERTAIN RETURNS.''
(D) The notice must contain (as an attachment) the required times
specified in paragraph (e)(2)(i) of this section.
(iv) Timing of notice. The notice required by this subparagraph (7)
must be delivered to the U.S. person on or before the latest of the
dates specified in this subdivisions (iv). If notice is delivered by
United States mail, the date of the United States postmark is deemed to
be the date of delivery. The dates are as follows:
(A) July 15, 1986,
(B) The 120th day after the acquisition date of the particular
target, or
(C) The day on which the statement of section 338 election is filed.
(v) Consequence of failure to comply. If a statement of section 338
election is filed after July 15, 1986, and if notice under this
subparagraph (7) must be given to one or more U.S. persons on or before
the day on which the statement of section 338 election is filed, then
that statement of section 338 election shall not be valid if timely
notice is not given to any such U.S. person. Failure to give notice to
U.S. persons under circumstances other than those described in the
preceding sentence shall not invalidate the statement of section 338
election, but the waiver rule of paragraph (h)(1) of this section will
not apply to the same extent as if the requirements of paragraph (e) of
this section were not satisfied.
(l) Binding contracts entered into after September 2, 1982, and
before January 13, 1983 -- (1) In general. This paragraph (l) is
prescribed under section 306(a)(8)(A)(ii) of the Technical Corrections
Act of 1982. Notwithstanding the disaffiliation rule of paragraph
(f)(3)(i) of this section, the target's deemed sale of assets is
reported in the selling group's consolidated return for a period
including the acquisition date if --
(i) Any portion of the stock of target that is part of the qualified
stock purchase is acquired by the purchasing corporation pursuant to a
binding contract (the ''contract'') entered into after September 2,
1982, and before January 13, 1983, and
(ii) The purchasing corporation establishes by clear and convincing
evidence that the contract was negotiated on the contemplation that any
tax liability resulting from the target's deemed section 338 sale would
be reported in the selling group's consolidated return.
(2) Clear and convincing evidence -- (i) Requirement considered
satisfied. The purchasing corporation is considered to have satisfied
the clear and convincing evidence requirement of paragraph (l)(1)(ii) of
this section if, in the absence of contradictory evidence --
(A) Language in the contract plainly and unequivocally provides that
the Federal income tax liability resulting from the deemed section 338
sale will be reported in the selling group's consolidated return;
(B) Documents contemporaneous with the negotiation of the contract
plainly and unequivocally provide that the Federal income tax liability
resulting from the deemed section 338 sale will be reported in the
selling group's consolidated return, provided that the provisions of
such documents relating to the selling group's liability were relied
upon by both the buyer and seller in computing the contract selling
price; or
(C) A statement, signed under penalties of perjury by a person
authorized to act on behalf of the common parent of the selling group
that files a consolidated return for a period including the acquisition
date, plainly and unequivocally provides that the contract was
negotiated on the contemplation that the Federal income tax liability
resulting from the deemed section 338 sale would be reported in the
selling group's consolidated return.
(ii) Requirement not considered satisfied. In no event will the
purchasing corporation be considered to have satisfied the clear and
convincing evidence requirement if the stock sale contract (or
collateral documents) requires the purchasing corporation to indemnify
the selling group for any Federal income tax liability resulting from
the deemed section 338 sale in the event that applicable law or
regulations impose that liability on the selling group.
(3) Manner of asserting binding contract rule -- (i) In general. The
purchasing corporation asserts the binding contract rule of this
paragraph (l) by filing a ''binding contract statement'' with the
statement of election under section 338 (or with a copy of a previously
filed statement of election, provided that the binding contract
statement and such copy are filed with the appropriate Internal Revenue
Service Center on or before the due date for making the section 338
election).
(ii) Contents of binding contract statement. The binding contract
statement must --
(A) Contain the name, address, and employer identification number of
the common parent of the selling group;
(B) State that the binding contract rule is asserted;
(C) Indicate the date of entry into the binding contract;
(D) Set forth the facts which demonstrate that the parties
contemplated selling group liability for target's deemed sale of assets;
and
(E) Be signed by a person who states under penalties of perjury that
he or she is authorized to make the binding contract statement on behalf
of the purchasing corporation.
(iii) Notice to common parent or selling corporations. The binding
contract rule does not apply unless, on or before the due date for
filing a statement of election, a copy of the binding contract statement
and the statement of election are provided the common parent of the
selling group or each selling corporation.
(4) Binding contract rule inapplicable if no consolidated return. If
a consolidated return including the target for a period including the
acquisition date is not filed by the selling group (or if such return is
filed but is properly withdrawn), then old target's final return is a
separate return for its year ending on the acquisition date.
(m) Statements of section 338 election filed on or after December 9,
1985, and on or before July 15, 1986 -- (1) General rule. A statement
of section 338 election filed on or after December 9, 1985, and on or
before July 15, 1986, is not effective unless --
(i) It meets the applicable requirements prescribed in paragraph
(m)(2) of this section when it is filed,
(ii) It is perfected by refiling in accordance with paragraph
(m)(4)(ii) of this section, or
(iii) The District Director or his delegate waives, under paragraph
(m)(13) of this section, the applicable requirements contained in
paragraph (m)(2) of this section.
(2) Applicable requirements. The requirements of this subparagraph
(2) are that --
(i) The statement of section 338 election meets the filing,
documentation, and Form 872 requirements of paragraph (m)(4), (5), and
(6) of this section for each relevant taxable year (within the meaning
of paragraph (m)(3) of this section) for which the statute of
limitations on making an assessment is considered under paragraph
(m)(10) of this section to expire after August 15, 1986, and on or
before November 15, 1986,
(ii) The statement of section 338 election meets the filing,
documentation, and closing agreement requirements of paragraph (m)(4),
(5), and (7) of this section for each relevant taxable year (within the
meaning of paragraph (m)(3) of this section) for which the statute of
limitations on making assessment is considered under paragraph (m)(10)
of this section to expire on or before August 15, 1986, and
(iii) The statement of section 338 election meets the filing and
closing agreement requirements of paragraph (m)(4) and (7)(v) of this
section if a deemed sale return is required to be filed and the
acquisition date occurred on or before November 15, 1983.
(3) Relevant taxable year. For purposes of this paragraph (m), a
taxable year is relevant if it is one for which a Federal income tax
return was filed prior to filing the statement of section 338 election,
but only if it is also --
(i) A taxable year of target (or an affected target) which includes
its acquisition date, or
(ii) Any subsequent taxable year of target (or an affected target) or
an affected taxable year of an affected corporation (within the meaning
of paragraph (m)(12) of this section).
(4) Filing procedures -- (i) In general. The statement of section
338 election and any documents, Forms 872, and closing agreements to
which paragraph (m)(2) of this section applies shall all be filed in one
envelope with the District Director (Attention: Chief of Examination)
for the internal revenue district where original target had its
principal place of business or where it principal office or agency was
located on the acquisition date.
(ii) Perfection rule. A statement of section 338 election filed on
or after December 9, 1985, and on or before July 15, 1986, that does not
comply with the applicable procedures prescribed in paragraph (m)(2) of
this section is perfected by refiling in accordance with those
procedures the statement of election on or before July 15, 1986, along
with a copy of the previously filed statement of election.
(5) Documents required under paragraph (m)(2) of this section. The
documents required by this subparagraph (5) for each relevant taxable
year are --
(i) A photocopy of the face page of the income tax return (and of any
amended return or returns) filed for the taxable year, and
(ii) A photocopy of any extension, consent, or other document
previously entered into or filed which extended the statute of
limitations on assessment for the year.
(6) Contents of Form 872 -- (i) In general. For purposes of
paragraph (m)(2)(i) of this section, for each relevant taxable year a
Form 872 must be properly completed and executed in duplicate on behalf
of each target or any affected corporation and must agree to extend
until May 15, 1987, the period for making an assessment with respect to
any tax due as a result of the deemed sale under section 338(a)(1) by
the target. A photocopy of Form 872 (including one on white paper) may
be used instead of a copy supplied by the Internal Revenue Service.
(ii) Restrictive language -- (A) General language. The following
restrictive language shall be inserted as numbered paragraph (4) on the
face page of any Form 872 to which this subparagraph (6) applies:
''THIS CONSENT AND AGREEMENT IS LIMITED TO ANY FEDERAL TAX DUE FROM
TAXPAYER (INCLUDING ACCRUED INTEREST THEREON) AS A RESULT OF THE DEEMED
SALE OF ASSETS UNDER SECTION 338(a)(1) OF THE INTERNAL REVENUE CODE BY
TAXPAYER'' (if taxpayer is not the target, substitute name of target
instead of last word).
(B) Year which includes the acquisition date. If the relevant
taxable year of target includes the acquisition date, the Form 872 for
that relevant taxable year shall contain the following language inserted
as numbered paragraph (5): ''THIS CONSENT AND AGREEMENT COVERS THE
ENTIRE PERIOD ENDING ON THE DATE SET FORTH IN PARAGRAPH (1) OF THIS
AGREEMENT, AS WELL AS ALL SHORT PERIODS WHICH RESULT AS A CONSEQUENCE OF
THE SECTION 338 ELECTION AND WHICH END WITH OR WITHIN THAT ENTIRE
PERIOD''.
(7) Closing agreement -- (i) In general. For purposes of paragraph
(m)(2) (ii) and (iii) of this section, a separate closing agreement
under section 7121 shall be submitted on Form 906 and must be properly
completed and executed on behalf of each target or any affected
corporation. For guidelines on preparation of closing agreements, see
Rev. Proc. 68-16, 1968-1 C.B. 770. A photocopy of Form 906 (including
one on white paper) may be used instead of a copy supplied by the
Internal Revenue Service. In addition, a separate closing agreement
under the provisions of paragraph (m)(2)(ii) of this section must be
executed in triplicate for each relevant taxable year and contain the
applicable language prescribed in paragraph (m)(7) (ii), (iii), and (iv)
of this section. For special rules for applying the provisions of
paragraph (m)(2)(iii) of this section with respect to a deemed sale
return or a combined deemed sale return, see paragraph (m)(7)(v) of this
section.
(ii) Waiver of statute of limitations -- (A) In general. Each
closing agreement required by paragraph (m)(2)(ii) of this section must
contain an express waiver of the statute of limitations on assessment
(under section 6501(a)) and credit (under section 6402(a)) with respect
to any Federal tax (including accrued interest thereon) required to be
reported on any return or claim for refund for the relevant taxable year
of the taxpayer, using the following language: ''TAXPAYER AND
COMMISSIONER AGREE TO WAIVE THE STATUTE OF LIMITATIONS FOR ASSESSMENT
AND CREDIT WHICH (HAS EXPIRED or WILL EXPIRE) ON (insert expiration
date) FOR ANY FEDERAL TAX DUE OR REFUNDABLE (INCLUDING ACCRUED INTEREST
THEREON) AS A RESULT OF THE DEEMED SALE OF ASSETS UNDER SECTION
338(a)(1) OF THE INTERNAL REVENUE CODE BY TAXPAYER'' (if taxpayer is not
the target, substitute name of target instead of last word).
(B) Year which includes the acquisition date. If the relevant
taxable year is a taxable year of target which includes the acquisition
date, the closing agreement for that relevant taxable year shall contain
the following language in addition to the language contained in
subdivision (m)(7)(ii)(A) of this section: ''TAXPAYER ACKNOWLEDGES THAT
THIS CLOSING AGREEMENT COVERS THE ENTIRE PERIOD DESCRIBED IN THE
PRECEDING SENTENCE, AS WELL AS ALL SHORT PERIODS WHICH RESULT AS A
CONSEQUENCE OF THE SECTION 338 ELECTION AND WHICH END WITH OR WITHIN
THAT ENTIRE PERIOD''.
(iii) Amended returns -- (A) In general. Each closing agreement must
contain an express agreement on behalf of the taxpayer to file an
amended Federal income tax return or returns on or before November 3,
1986, for each relevant taxable year, and an acknowledgement that the
statement of section 338 election will not be effective in the event of
a failure to timely file any such amended return, unless the requirement
of filing an amended return is waived by the District Director or his
delegate.
(B) Relevant taxable year which includes acquisition date. For the
relevant taxable year which includes the acquisition date, the following
language shall be inserted in the closing agreement: ''FOR THE RELEVANT
TAXABLE YEAR COVERED BY THIS CLOSING AGREEMENT, TAXPAYER AGREES TO FILE
ON OR BEFORE NOVEMBER 3, 1986 (IF NOT ALREADY FILED), THE FOLLOWING
FEDERAL INCOME TAX RETURNS(S):(1) AN AMENDED RETURN AS OLD TARGET'S
FINAL RETURN, AND (2) AN AMENDED RETURN FOR NEW TARGET'S FIRST TAXABLE
YEAR ENDING ON (insert date). TAXPAYER ACKNOWLEDGES THAT A STATEMENT OF
ELECTION UNDER SECTION 338 WILL NOT BE EFFECTIVE IF THE FEDERAL INCOME
TAX RETURN(S) COVERED BY THIS CLOSING AGREEMENT (IS) (ARE) NOT FILED ON
A TIMELY BASIS, UNLESS SUCH REQUIREMENT IS WAIVED IN WRITING BY THE
DISTRICT DIRECTOR OR HIS DELEGATE.'' If the acquisition date occurs on
the last day of target's relevant taxable year or if new target does not
have a taxable year that terminates within the relevant taxable year,
then the language in (2) of this subdivision (B) shall be omitted. If
new target has more than one taxable year ending within the relevant
taxable year covered by a closing agreement governed by this subdivision
(B), then appropriate language referring to the amended returns for
those years shall be added to the closing agreement, using the format
set forth in this subdivision (B).
(C) Other relevant taxable years. For a relevant taxable year which
does not include the acquisition date, the following language shall be
inserted in the closing agreement. ''TAXPAYER AGREES TO FILE AN AMENDED
FEDERAL INCOME TAX RETURN ON OR BEFORE NOVEMBER 3, 1986, FOR THE
RELEVANT TAXABLE YEAR COVERED BY THIS CLOSING AGREEMENT. TAXPAYER
ACKNOWLEDGES THAT A STATEMENT OF ELECTION UNDER SECTION 338 WILL NOT BE
EFFECTIVE IF ANY FEDERAL INCOME TAX RETURN COVERED BY THIS CLOSING
AGREEMENT IS NOT FILED ON OR BEFORE NOVEMBER 3, 1986, UNLESS SUCH
REQUIREMENT IS WAIVED IN WRITING BY THE DISTRICT DIRECTOR OR HIS
DELEGATE.''
(D) Section 338(h)(10) election. The second quoted sentence in
subdivision (iii) (B) and (C) of this paragraph (m)(7) shall be omitted
from any closing agreement for a relevant taxable year of a selling
group referred to in paragraph (m)(11)(ii)(A) of this section (relating
to section 338(h)(10) election).
(E) Waiver of certain additions to tax and time to act. See
1.338-1T(h) for rules applicable to the waiver of certain additons to
tax and time to act.
(iv) Consent to extend expiration date. Each closing agreement must
contain an express consent to extend until June 15, 1988, the period for
further assessment (under section 6501(a)) or credit (under section
6402(a)) of any tax due or refundable (including accrued interest
thereon) for any relevant taxable year resulting from the deemed sale
under section 338(a)(1), using the following language: ''TAXPAYER AND
COMMISSIONER AGREE TO EXTEND UNTIL JUNE 15, 1988, THE PERIOD FOR MAKING
ANY FURTHER ASSESSMENT OR CLAIMING ANY CREDIT OF ANY FEDERAL TAX DUE OR
REFUNDABLE (INCLUDING ACCURED INTEREST THEREON) AS A RESULT OF THE
DEEMED SALE OF ASSETS UNDER SECTION 338(a)(1) BY TAXPAYER'' (If taxpayer
is not the target, substitute name of target instead of last word).
(v) Special rule for deemed sale return or combined deemed sale
return -- (A) In general. For purposes of paragraph (m)(2)(iii) of this
section, if a target is required to file a deemed sale return (as
defined in paragraph (f)(3)(i) of this section), then a separate closing
agreement with respect to that deemed sale return must be filed in
triplicate in order to make an effective election under section 338.
The closing agreement shall contain the following language: ''TAXPAYER
AGREES TO FILE ON OR BEFORE NOVEMBER 3, 1986 (IF NOT ALREADY FILED), A
DEEMED SALE RETURN REFLECTING THE CONSEQUENCES OF THE DEEMED SALE OF
ASSETS BY TAXPAYER (if taxpayer is not the target, substitute the name
of target instead of last word) UNDER SECTION 338. TAXPAYER
ACKNOWLEDGES THAT A STATEMENT OF ELECTION UNDER SECTION 338 WILL NOT BE
EFFECTIVE IF THE DEEMED SALE RETURN IS NOT FILED ON A TIMELY BASIS,
UNLESS SUCH REQUIREMENT IS WAIVED IN WRITING BY THE DISTRICT DIRECTOR OR
HIS DELEGATE. TAXPAYER FURTHER AGREES THAT THE STATUTE OF LIMITATIONS
ON ASSESSMENT FOR ANY FEDERAL TAX DUE AS A RESULT OF THE DEEMED SALE OF
ASSETS BY TAXPAYER (if taxpayer is not the target, substitute the name
of target instead of last word) UNDER SECTION 338 WILL NOT TERMINATE
PRIOR TO THE EXPIRATION OF THREE YEARS FROM THE DATE THE DEEMED SALE
RETURN IS ACTUALLY FILED.''
(B) Combined deemed sale return. All targets which are eligible to
file a combined deemed sale return (as defined in section 338(h)(15) and
1.338-4T(k)(6)) may join together in a combined deemed sale closing
agreement, instead of filing a separate closing agreement for each
target under paragraph (m)(7)(v)(A) of this section. If a combined
deemed sale closing agreement is filed, then a combined deemed sale
return must be filed. The combined deemed sale closing agreement shall
contain the language prescribed in paragraph (m)(7)(v)(A) of this
section, except that the words ''COMBINED DEEMED SALE RETURN'' shall be
substituted for ''DEEMED SALE RETURN,' the word ''TAXPAYER'' shall be
expressed in the singular or plural (as the case may be), and each
target's name shall be inserted in place of ''TAXPAYER'', if
appropriate. A list containing the name, address, and employer
identification number of each target which is joining in the combined
deemed sale closing agreement shall be included in the text of the
combined deemed sale closing agreement. If the targets included in the
combined deemed sale closing agreement constitute a single affiliated
group within the meaning of section 1504(a), the combined deemed sale
closing agreement shall be signed by an officer of the common parent of
that group. Otherwise, the combined deemed sale closing agreement must
be signed by an officer of each target included in the combined deemed
sale closing agreement.
(8) Execution of Form 872 or Form 906 -- (i) On behalf of
Commissioner. Any Form 872 or Form 906 properly submitted pursuant to
the requirements in this paragraph (m) will be executed on behalf of the
Commissioner of Internal Revenue and an executed copy of each Form 872
and each Form 906 will be returned to the originating party.
(ii) On behalf of target. If target was included on a consolidated
return filed by the purchasing group for a relevant taxable year, the
common parent of the purchasing group shall be the proper party to
execute any Form 872 or Form 906 required by this paragraph (m) for that
year. See 1.1502-77(a).
(9) Exceptions. This paragraph (m) shall not apply --
(i) If the statement of section 338 election has been filed before
December 9, 1985, or after July 15, 1986,
(ii) If there is no relevant taxable year of a target, affected
target, or affected corporation for which the statute of limitations
expires on or before November 15, 1986,
(iii) With respect to the taxable year of a selling group that files
a consolidated return for the period that includes the acquisition date,
if the binding contract rule in paragraph (l) of this section applies,
or
(iv) With respect to the taxable year of a person that includes the
acquisition date of a target, if (A) the target is a DISC, a controlled
foreign corporation, or a domestic corporation described in section 1248
(e) and (B) the person actually transfers the target stock (as
distinguished from being treated under section 338(a)(1) as having sold
it).
(10) Statute of limitations on assessment -- (i) General rule. For
purposes of applying this paragraph (m), the statute of limitations on
assessment is considered to begin to run for a relevant taxable year,
and any short period of target which may result as a consequence of a
section 338 election that ends with or within that relevant taxable
year, on the date target is considered under section 6501(b) to have
filed its return for that relevant taxable year.
(ii) Deemed sale return. If old target's final return is a deemed
sale return (within the meaning of paragraph (f)(3)(i) of this section)
or a combined deemed sale return (within the meaning of section
338(h)(15)), then the period for assessment under section 6501 does not
begin to run until such deemed sale return or combined deemed sale
return is filed.
(11) Section 338(h)(10) -- (i) Scope. This subparagraph (11)
provides rules for applying this paragraph (m) as a condition for
electing to report the consequences of old target's deemed sale of its
assets under section 338(a)(1) on the selling group's consolidated
return under section 338(h)(10).
(ii) Application. If this subparagraph (11) applies, then --
(A) A relevant taxable year under paragraph (m)(3) of this section is
considered to include the period for which a consolidated return of the
selling group is filed that includes the acquisition date.
(B) Any document executed or item submitted by the common parent of
the selling group on behalf of that entire group with respect to that
relevant taxable year is considered to be on behalf of old target (see
1.1502-77(a)).
(12) Affected taxable years of affected corporations. For purposes
of this paragraph (m) --
(i) Affected taxable year. A taxable year is affected by the section
338 election if Federal tax for that year is increased or decreased as a
result of the section 338 election. For example, an affected taxable
year may arise if target originally filed a return for a period which
ended on or after the acquisition date and the deemed sale of assets
results in additional Federal tax due from target for that period, or if
consideration for stock included in a qualified stock purchase is
contingent and receipt of that consideration subsequent to the
acquisition date is reported on new target's return under 1.338
(b)-3T(h).
(ii) Affected corporation. An affected corporation is a corporation
that has a basis in an asset transferred to it by a new target or
another affected corporation that is determined in whole or in part by
reference to the asset's basis in the hands of the transferor.
(13) Discretion of the District Director -- (i) General standard. In
exercising discretion to waive any of the requirements prescribed under
this paragraph (m) for any statement of section 338 election or amended
returns, the District Director or his delegate shall consider all of the
relevant facts and circumstances.
(ii) Time when discretion is exercised. The discretion of the
District Director or his delegate under this paragraph (m) can be
exercised at any time in connection with the examination of any Federal
income tax return which would be affected by a section 338 election.
(14) Applicability of the mitigation provisions. For application of
the mitigation provisions contained in sections 1311-1314, see 1.338-4T
(l)(5).
(15) Examples. The provisions of this paragraph (m) may be
illustrated by the following examples.
Example (1). (i) T is an unaffiliated corporation filing income tax
returns on the basis of a fiscal year ending February 28. At the close
of January 20, 1983, P acquires all of T's stock in a qualified stock
purchase. P does not file consolidated returns. On May 15, 1983, T
timely files an income tax return (without extensions) for its taxable
year beginning on March 1, 1982, and ending February 28, 1983. On May
14, 1986, P files a statement of election under section 338 which (if
effective) would cause T's taxable year ending on February 28, 1983, to
be divided into two periods. The first period for ''old T'' ends on the
close of the acquisition date (January 20, 1983), and the second period
for ''new T'' begins the next day. For T's taxable year ending February
28, 1983, the statute of limitations expires on May 15, 1986. In order
for the section 338 election to be effective, the statement of election
must be filed in accordance with the requirements of paragraph
(m)(2)(ii) of this section. Thus, for example, there must be filed with
the election, in the form prescribed in paragraph (m)(7) of this
section, a closing agreement for T's taxable year ending on February 28,
1983, for which T's return was filed on May 15, 1983, extending the time
within which assessments can be made until June 15, 1988. This closing
agreement will cover the two periods into which that taxable year has
now been divided. Additionally, the closing agreement must provide that
on or before November 3, 1986, T must file old target's final return for
the taxable year ending on January 20, 1983, and an amended return for
the taxable year ending on February 28, 1983. The section 338 election
will be ineffective unless the closing agreement procedures are followed
and T files on or before November 3, 1986, the required returns, unless
the District Director, in his discretion, waives any failure by P or T
to comply with these requirements. However, in order for the waiver
provisions contained in paragraph (h) of this section to apply, the
amended returns must be filed on or before the last day for making an
election under section 338, i.e., July 15, 1986.
(ii) T also timely filed an income tax return (without extensions) on
May 15, 1984, for its taxable year beginning on March 1, 1983, and
ending on February 29, 1984. Since the statute of limitations on
assessment for the income tax return filed on May 15, 1984, expires on
May 15, 1987, which is after November 15, 1986, the provisions contained
in paragraph (m) of this section are not applicable with respect to that
taxable year.
Example (2). Assume the same facts as in Example (1) except that P
files the statement of election on April 1, 1986, and that filing does
not comply with the requirements of paragraph (m)(2)(ii) of this
section. On July 6, 1986, under paragraph (m)(1)(ii) of this section, P
perfects the election by refiling the election in accordance with the
requirements of paragraph (m) (2)(ii) and (4)(ii) of this section. As
long as T timely files on or before November 3, 1986, the returns which
relate to the periods covered by the closing agreement (i.e., T's
taxable years ending on January 20, 1983, and February 28, 1983), the
section 338 election will be valid.
Example (3). Assume the same facts as in Example (2) except that P
does not perfect the election. Under paragraph (m) (1)(iii) and (13) of
this section, the election is ineffective unless the District Director
waives the requirements of paragraph (m)(2) of this section.
Example (4). Assume the same facts as in Example (2) except that T
does not timely file the returns covered by the closing agreement. The
section 338 election is ineffective under paragraph (m)(13) of this
section unless the District Director waives the timely filing
requirement for the amended returns.
Example (5). Assume the same facts as in Example (1) Assume further
that T owns all the stock of T1 and that T1 uses the same taxable year
as T. For the election to be effective, P must also file a closing
agreement for T1 and T1 must file on or before November 3, 1986, the
returns for the periods covered by T1's closing agreement unless those
requirements are waived by District Director.
Example (6). Assume the same facts as in Example (2) except that T
reports its income on the basis of a taxable year ending June 30.
Assume further that on September 15, 1983, T timely filed an income tax
return (without extensions) for its taxable year ending June 30, 1983,
and that the statute of limitations for that year expires on September
15, 1986. In order for the section 338 election to be effective, the
statement of election must be filed in accordance with the requirements
of paragraph (m)(2)(i) of this section. Thus, for example, there must
be filed with the election, in the form prescribed in paragraph (m)(6)
of this section, a Form 872 for T's taxable year ending June 30, 1983,
for which T's return was filed on September 15, 1983, extending the time
within which assessments can be made until May 15, 1987. This Form 872
will cover both periods into which the taxable year has been divided.
However, in order for the waiver provisions contained in 1.338-1T(h) to
apply, T must file the amended returns on or before the last day for
making an election under section 338, i.e., July 15, 1986. In any
event, old target's final return and an amended return for the taxable
year ending June 30, 1983, should be filed on or before May 15, 1987.
Example (7). Assume the same facts as in Example (1) except that T
files its income tax returns on the basis of the calendar year and
actually filed its returns for calendar year 1983 on March 3, 1984. No
Form 872 or closing agreement is required for T's 1983 calendar year if
the statute of limitations for that year expires after November 15,
1986. See paragraph (m)(1) and (9)(ii) of this section. The statute of
limitations for new T's first taxable year and old T's period ending on
the close of the acquisition date (January 20, 1983) did not start to
run until the due date for T's 1983 return (March 15, 1984), and
therefore cannot expire prior to March 15, 1987. See section 6501(b)(1)
and paragraph (m)(10) of this section.
Example (8). (i) Assume the same facts as in Example (1) except that
T, on its first tax return as new T filed on or before July 15, 1986,
adopts a taxable year ending on January 31. The closing agreement
referred to in Example (1) for the taxable year ending on February 28,
1983, will also operate to waive and extend the statute of limitations
on assessment for new T's first taxable year which begins January 21,
1983, and ends on January 31, 1983. If T filed its first tax return as
new T after July 15, 1986, it would not be permitted to adopt a taxable
year different from the year T used before making the section 338
election. See paragraph (f)(7)(ii) of this section.
(ii) The tax consequences of new T's operations for the period that
begins on February 1, 1983, and ends on February 28, 1983, will now have
to be reported on an amended return which should be filed by new T for
its second taxable year which begins on February 1, 1983, and ends on
January 31, 1984. The statute of limitations on assessment for new T's
second taxable year is controlled by the due date of the return T
originally filed (without regard to the section 338 election) on May 15,
1984, for its taxable year ending February 29, 1984, which includes the
last day of new T's second taxable year (i.e., January 31, 1984).
Because the statute of limitations on assessment for the taxable year
ending on February 29, 1984, does not expire until May 15, 1987, the
provisions of paragraph (m) does not apply to new T's second taxable
year.
(iii) The results of this example may be summarized with time lines.
Line A represents taxable years of T for which returns were filed prior
to the time that a section 338 statement of election was filed. Line B
represents taxable years of old T and new T reflecting such election.
Arrows show dates on Line A when T's tax returns were filed, which
started the statute of limitations running for the taxable periods shown
on Line B.
Example (9). Assume the same facts as in Example (1) except that T,
on its first tax return as new T filed on or before July 15, 1986,
adopts a taxable year ending on April 30. The closing agreement
referred to in Example (1) for the taxable year ending on February 28,
1983, will waive and extend the statute of limitations on assessment
only for old T's taxable year ending on January 20, 1983. The tax
consequences of new T's operations for new T's taxable year which begins
on January 20, 1983, and ends on April 30, 1983, will have to be
reported on an amended return filed for that period. The statute of
limitations on assessment for new T's first taxable year is controlled
by the due date of the return T originally filed (without regard to the
section 338 election) on May 15, 1984, for its taxable year ending
February 29, 1984, which includes the last day of new T's first taxable
year, (i.e., April 30, 1983). Because the statute of limitations on
assessment for the taxable year ending on February 29, 1984, does not
expire until May 15, 1987, the provisions of paragraph (m) do not apply
to new T's first taxable year.
Example (10). All of T's stock is owned by S, which is included in a
consolidated return that is filed for the S group on the basis of a
fiscal year ending January 31. At the close November 15, 1982, P
acquired all of T's stock in a qualified stock purchase. P is the
common parent of an affiliated group that files consolidated returns on
the basis of a calendar year. On July 1, 1986, P files a statement of
election under section 338 for T. As a result of the acquisition, the
results of T's operations through the close of business on November 15,
1982, was originally reported on the consolidated return for the S group
which was timely filed on April 15, 1983. The results of T's operations
from November 16, 1982, through December 31, 1982, were originally
reported on the consolidated return for the P group, which was timely
filed on March 15, 1983. Because T must file a deemed sale return
(within the meaning of paragraph (f)(3)(i) of this section) and the
acquisition date occurred on or before November 15, 1983, in order for
the section 338 election to be effective, the closing agreement and
other procedures required by paragraph (m)(2)(iii) and (7)(v) of this
section must be followed and the deemed sale return must be filed on or
before November 3, 1986, unless those requirements are waived by the
District Director.
(Secs. 338 and 7805 of the Internal Revenue Code of 1954 (96 Stat.
324, 26 U.S.C. 338; 68A Stat. 917, 26 U.S.C. 7805))
(T.D. 7942, 49 FR 4725, Feb. 8, 1984. Redesignated and amended by
T.D. 7975, 49 FR 35088, Sept. 6, 1984; T.D. 8021, 50 FR 16428, Apr.
25, 1985; T.D. 8068, 51 FR 748, Jan. 8, 1986; T.D. 8074, 51 FR 5190,
Feb. 12, 1986; T.D. 8072, 51 FR 10621, Mar. 28, 1986; T.D. 8088, 51 FR
17932, May 16, 1986; 51 FR 20274, June 4, 1986; 51 FR 20480, June 5,
1986; T.D. 8092, 51 FR 23739, July 1, 1986; 51 FR 34469, Sept. 23,
1986)
26 CFR 1.338-2T Transitional rule elections (temporary).
(a) In general -- (1) Scope. This section prescribes rules relating
to section 338 ''transitional rule'' elections permitted by reason of
section 224(d)(2) of TEFRA, as amended by section 306(a)(8)(B) of the
Technical Corrections Act of 1982. See also section 224(d) (4) and (5)
of TEFRA as added by such section 306(a)(8)(B). This section also
reflects changes made by the Tax Reform Act of 1984. In general, a
transitional rule election may be made for a corporation for which the
acquisition date occurs after August 31, 1980, and before September 1,
1982.
(2) Definitions. The definitions contained in 1.338-1T(b) also
apply to this section.
(b) Manner of making election. The purchasing corporation makes a
transitional rule election only by filing a statement of election not
later than September 17, 1984, with the Internal Revenue Service Center
with which it files its annual income tax return.
(c) Statement of election -- (1) General rule. The heading of the
statement of election should prominently identify the statement as a
transitional rule election under section 338. Form 8023 is not used for
this purpose. The statement must --
(i) Contain the name, address, and employer identification number of
the purchasing corporation and the target,
(ii) Identify the election as an election under section 338(g) of the
Code that is permitted by section 224(d)(2) of TEFRA, and
(iii) Be signed by a person who states under penalties of perjury
that he or she is authorized to make the election on behalf of the
purchasing corporation.
(2) Purchasing corporation or target a foreign corporation. If the
purchasing corporation or the target is a foreign corporation, then a
statement of transitional rule election filed not later than September
17, 1984, that constitutes a reasonable attempt to comply with the rules
of paragraphs (b) and (c)(1) of this section will be valid.
(3) Purchasing corporation included in consolidated return. If the
purchasing corporation is included in a consolidated return for the
taxable year in which the statement of election is filed, see
1.1502-77.
(d) Attachment to target returns; consequence of failure to attach
-- (1) Attachment. A copy of the statement of transitional rule
election must be attached to old target's final return and to the first
return of new target. If the statement is not attached to a return
filed on or before December 5, 1984, this requirement will be satisfied
if, on or before December 5, 1984, a copy of the statement of
transitional rule election is filed with the Internal Revenue Service
Center with which old target's final return and the first return of new
target are required to be filed. If the target is a foreign corporation
not subject to United States tax (as defined in 1.338-1T(k)(3)(iii)), a
copy of the statement of election must be attached to the return(s)
specified in 1.338-1T(k)(6).
(2) Consequence of failure to comply with the requirement of
paragraph (d)(1) of this section. If the requirement of paragraph
(d)(1) of this section is not satisfied, then the waiver rule of
1.338-1T)h) (1) as applied by paragraph (h) of this section will not
apply. Failure to comply with the requirement of paragraph (d)(1) of
this section, however, will not invalidate a statement of transitional
rule election.
(e) Certain consequences of transitional rule election -- (1) Taxable
year ends at close of selected deemed sale date. Old target's taxable
year ends at the close of the deemed sale date selected under paragraph
(f) of this section. Because that date is never earlier than the day
after the acquisition date, old target's tax liability resulting from
its deemed sale of assets may not be included in the consolidated return
of a selling group but may be included in the consolidated return of the
purchasing group.
(2) EIN not affected. New target shall use the same employer
identification number as old target used.
(3) Rules similar to old section 334(b)(2); certain provisions of
section 338 inapplicable. If a transitional rule election is made, then
--
(i) A rule similar to the last sentence of section 334(b)(2) (as in
effect on August 31, 1982) applies, and
(ii) Section 338 has in effect on July 17, 1984, applies, except that
subsections (e), (f), and (i) of section 338, and paragraphs (4), (6),
(8), and (9) of section 338(h), as in effect on such date do not apply.
(4) Liquidating target before election. Liquidating target on or
after the deemed sale date (or after August 31, 1982, if later) and
before the filing of a transitional rule election under section 338 has
no effect on the validity of the election. If target liquidates on the
deemed sale date, the liquidation will be considered to occur on the
following day and immediately after new target's deemed purchase of
assets.
(5) Due date for old target's final return -- (i) General rule. Old
target's final return is due on the 15th day of the third calendar month
following the month in which the deemed sale date occurs. If old target
is sold by a selling group, 1.1502-76(c) may be applicable to old
target's final return.
(ii) Exceptions. If the final taxable period of old target is
includible in the consolidated return of the purchasing group, the due
date of that consolidated return controls. For special rules applicable
to DISCs and certain foreign corporations, see 1.338-1T(k)(7) (applied
by replacing the phrase, ''acquisition date,'' wherever it occurs, with
the phrase, ''deemed sale date'')
(6) New target's taxable year and method of accounting. The rules of
1.338-1T(f)(7) also apply to transitional rule elections.
(7) Deemed purchase of stock. Stock acquired by ''new'' target in
its deemed purchase of assets under section 338 (a) (2) does not
constitute ''purchased'' stock for purposes of applying the qualified
stock purchase rules of section 338(d)(3). See section 338(h)(3)(B) as
in effect on July 17, 1984, and section 712(k)(9)(A) of the Tax Reform
Act of 1984.
(f) Selection of deemed sale date by purchasing corporation -- (1) In
general. The date of the target's deemed sale of assets under seciton
338(a) is the date selected by the purchasing corporation in the
statement of transitional rule election or in a deemed sale date
statement, rather than the acquisition date specified in section
338(h)(2). For purposes of determining whether the transitional
election rules apply to the particular acquisition and for purposes of
determining when target can be included in the consolidated return filed
by the affiliated group that includes the purchasing corporation, the
acquisition date rather than the selected deemed sale date controls.
(2) Date selected as deemed sale date -- (i) In general. The
purchasing corporation may select any deemed sale date in the statement
of transitional rule election or deemed sale date statement, so long as
such date --
(A) Is after the later of the acquisition date or June 30, 1982, and
(B) Is not later than the earlier of February 28, 1983, or the date
on which the statement of transitional rule election or deemed sale date
statement is filed.
(ii) Unspecified deemed sale date. If a timely filed statement of
transitional rule election does not specify a deemed sale date and a
deemed sale date statement is not filed, the date of filing the election
is considered the selected deemed sale date, except that February 28,
1983, will be treated as the deemed sale date if the statement of
transitional rule of election is filed after that date.
(iii) Conformity of deemed sale dates in certain cases. If, by
reason of the qualified stock purchase of one corporation, the
purchasing corporation is treated, under section 338(h)(3)(B) (as in
effect on July 17, 1984), as purchasing all or a part of the stock of a
second corporation with respect to which a qualified stock purchase is
also made, then a deemed sale date selected for the second corporation
that is different from that selected for the first corporation will be
disregarded and the second corporation will be assigned the first
corporation's deemed sale date. This rule does not apply if the
otherwise applicable rules on selection of a deemed sale date would
prohibit the selection of the first corporation's deemed sale date for
the second corporation.
(iv) Filing date. For purposes of determining the date on which the
deemed sale occurs, the date of mailing a statement, as evidenced by the
postmark date, is considered the date of filing.
(3) Selecting deemed sale date after filing transitional rule
election -- (i) Deemed sale date statement. Except as provided in
paragraph (f)(3)(iii) of this section, a purchasing corporation may
select a deemed sale date after timely filing a valid statement of
transitional rule election, whether or not that election specifies a
deemed sale date, by filing a deemed sale date statement on or before
May 8, 1984, with the Internal Revenue Service Center with which it
filed the election. A copy of the statement of transitional rule
election must be attached. The deemed sale date statement should
contain the name, address, and employer identification number of the
purchasing corporation and the target, identify the deemed sale date,
and be signed by a person who states under penalties of perjury that he
or she is authorized to select a deemed sale date on behalf of the
purchasing corporation. The EIN requirement does not apply for a
corporation that does not have, and is not otherwise required to have,
an EIN.
(ii) Revoking and filing new election. As an alternative to the
deemed sale date statement procedure, the purchasing corporation may
revoke the previously filed election in accordance with paragraph (g) of
this section and file a new election which specifies the desired deemed
sale date. The prior election must be revoked and the new election
filed before March 1, 1983.
(iii) Limited extension of time to file deemed sale date statement.
If a timely filed statement of transitional rule election does not
specify a deemed sale date, such a date may be specified in a deemed
sale date statement filed on or before September 17, 1984.
(g) Revoking election made before March 1, 1983. A timely filed
transitional rule election that meets all the requirements of paragraphs
(b) and (c) of this section may be revoked only in the manner prescribed
in 1.338-1T(g).
(h) Waiver: certain additions to tax and times to act, etc. The
rules of 1.338-1T(h) also apply to transitional rule elections, except
that 1.338-1T(h)(3) is applied by substituting the phrase ''deemed sale
date'' for the phrase ''acquisition date.'' For the non-application of
1.338-1T(h)(1) for failure to file certain materials, see paragraph
(d)(2) of this section.
(i) (Reserved)
(j) Examples. The provisions of this section may be illustrated by
the following examples. In each example, a capital letter refers to a
domestic corporation.
Example (1). (i) S is the common parent of an affiliated group that
includes T. The S group files calendar year consolidated returns. At
the close of May 31, 1982 S sells all of the stock of T to P, a calendar
year corporation, and on November 10, 1982, P files a statement of
transitional rule election with respect to T. The statement of election
meets all the requirements of this section but does not specify a deemed
sale date. P will file a separate return for the 1982 calendar year.
Unless P takes action to specify a different date, the date of filing
the statement of transitional rule election will be considered the
selected deemed sale date. Thus, T's deemed sale occurs and its taxable
year ends at the close of November 10, 1982. T's income from January 1,
1982, through May 31, 1982, is included in the consolidated return of
the S group. Any income tax liability resulting from the deemed sale
under section 338 is reported in old T's return for its final taxable
period which begins on June 1, 1982, and ends on November 10, 1982.
Under paragraph (e)(5)(i) of this section, this return is due on
February 15, 1983. Assuming new T adopts the calendar year, another
return will be required for the period from November 11, 12, through
December 31, 1982, which is T's first taxable period as ''new target.''
Under paragraph (e)(6) of this section, new T may adopt the calendar
year on its first income tax return if that return in filed on or before
July 15, 1986.
(ii) Because a return would not be due on February 15, 1983, but for
the transitional rule election under section 338, additions to tax under
section 6651(a) (1) and (2) are waived if that return is filed and the
tax shown thereon paid on or before July 15, 1986. See paragraph (h) of
this section. If new T adopts the calendar year in accordance with
paragraph (e)(6) of this section, these additions to tax are also waived
with respect to the return of new T due on March 15, 1983. Interest on
any underpayment of tax, however, runs from the due date of these
returns.
(iii) If P files a consolidated return for the 1982 calendar year,
T's income for its final taxable period as old target and for its first
taxable period as new target will be included in P's consolidated
return, to which a copy of the statement of transitional rule election
must be attached. See paragraph (d) of this section. The waiver rule
applies only to additions that would not arise but for the section 338
election.
Example (2). Assume the same facts as in Example (1)(i), except that
P wishes to select a deemed sale date other than November 10, 1982. If
P files a proper deemed sale date statement under paragraph (f) of this
section after February 28, 1983, and on or before September 17, 1984 P
may select as the deemed sale date any date after June 30, 1982, and
before March 1, 1983. If July 1, 1982, is selected as the deemed sale
date and P does not join with T in filing a consolidated return for
1982, any income tax liability resulting from the deemed sale of assets
(occurring at the close of July 1, 1982) is reported in old T's final
return for its taxable period beginning on June 1, 1982, and ending on
July 1, 1982. Under paragraph (e)(5)(i) of this section, that return is
due on October 15, 1982. If that return is filed on or before July 15,
1986, additions to tax for failure to file a return and to pay tax shown
on a return will be waived. Similarly, if new T adopts the calendar
year in accordance with paragraph (e)(6) of this section, those
additions will be waived with respect to its return due on March 15,
1983 (for its taxable period beginning on July 2, 1982, and ending on
December 31, 1982). The return of old T which, had an election not been
made, would have been due on March 15, 1983 (for the period from June 1,
1982, to December 31, 1982) need not be filed. See paragraph (h) of
this section. If P acquired all of the stock of T at the close of June
30, 1982, and selected July 1, 1982, as the deemed sale date, old T's
final return would consist of July 1, 1982 (i.e., only one day).
(Secs. 338 and 7805 of the Internal Revenue Code of 1954 (96 Stat.
324, 26 U.S.C. 338; 68A Stat. 917, 26 U.S.C. 7805))
(T.D. 7942, 49 FR 4729, Feb. 8, 1984; 49 FR 6716, Feb. 23, 1984.
Redesignated and amended at T.D. 7975, 49 FR 35088, 35090, Sept. 6,
1984; 49 FR 39677, Oct. 10, 1984; T.D. 8021, 50 FR 16429, Apr. 25,
1985; T.D. 8088, 51 FR 17936, May 16, 1986)
26 CFR 1.338-3T Miscellaneous rules under section 224 of TEFRA
(temporary).
(a) Date of section 338 election for purposes of the LIFO recapture
rule of the Miscellaneous Revenue Act of 1982 -- (1) In general. Solely
for purposes of section 403(b)(4)(D) of the Crude Oil Windfall Profit
Tax Act of 1980, as added by section 101 of the Miscellaneous Revenue
Act of 1982, an election under section 338(g) that could have been made
during 1982 is considered to have been made during 1982 if an election
under section 338(g) is actually made before the expiration of the time
for making such an election.
(2) Election that could have been made during 1982 -- (i) In general.
Except as provided in paragraph (a)(2)(ii) of this section, an election
is considered one that could have been made during 1982 if the qualified
stock purchase as defined in section 338(d)(3) occurred before January
1, 1983.
(ii) Transitional rule elections. For transitional rule elections,
an election is not considered made in 1982 unless the deemed sale date
occurs in 1982. For selection of deemed sale date, see 1.338-2T(f).
(b) Certain acquisitions of financial institutions -- (1) In general.
The amendments made by section 224 of TEFRA do not apply to the
acquisition of control (within the meaning of section 368(c)) of a
financial institution in certain cases if the purchasing corporation
elects out under section 224(d)(3) of TEFRA.
(2) Manner of electing out. A purchasing corporation is considered
to elect out only if the requirements of section 224(d)(3) of TEFRA are
satisfied and the purchasing corporation files a statement of
election-out within 30 days after adoption of the plan of complete
liquidation of the financial institution specified in section
224(d)(3)(C) (or by May 8, 1984, if later) in the Form 8023 filing
place(s) where a statement of section 338 election would be filed, under
1.338-1T (c) and (d), on the date the statement of election-out is
filed.
(3) Statement of election-out. The heading of the statement of
election-out should prominently identify the statement as an
election-out under section 224(d)(3) of TEFRA. The statement must --
(i) Contain the name, address, and employer identification number of
the purchasing corporation and financial institution,
(ii) Identify the election as an election-out under section 224(d)(3)
of TEFRA,
(iii) Specify the date of entry into the binding contract to acquire
control of the financial institution,
(iv) Specify the date of final approval of the last regulatory
authority granting final approval of the acquisition,
(v) Specify the date of adoption of the plan of complete liquidation
of the financial institution, and
(vi) Be signed by a person who states under penalties of perjury that
he or she is authorized to make the election on behalf of the purchasing
corporation.
(4) Copy of statement of election-out attached to return of
purchasing corporation. A copy of the statement of election-out should
be attached to the income tax return of the purchasing corporation for
its taxable year in which the liquidation begins. Failure to attach the
statement to that return will not invalidate the election-out.
(5) Financial institution. For purposes of this section, a financial
institution is an entity described in section 585 or 593 or a bank
holding company within the meaning of section 2(a) of the Bank Holding
Company Act of 1956.
(6) Adoption of plan of complete liquidation; date of final
approval. The statement of election-out is valid only if a plan of
complete liquidation of the financial institution is adopted within 90
days after the date of final approval of the acquisition by the last
regulatory authority granting approval. The date of final approval by
the last regulatory authority includes, where applicable, the expiration
date of the period under 12 U.S.C. 1849 within which the Attorney
General is authorized to commence an action under the antitrust laws
with respect to the acquisition (provided that no such action is
commenced).
(7) Election-out invalidates prior section 338 election. A valid
election-out invalidates a prior section 338 election made for the
target financial institution. If a prior section 338 election has been
made, the statement of election-out should indicate that such prior
election is invalidated by the election-out.
(Secs. 338 and 7805 of the Internal Revenue Code of 1954 (96 Stat.
324, 26 U.S.C. 338; 68A Stat. 917, 26 U.S.C. 7805))
(T.D. 7942, 49 FR 4731, Feb. 8, 1984. Redesignated and amended at
T.D. 7975, 49 FR 35088, 35091, Sept. 6, 1984; T.D. 8092, 51 FR 23741,
July 1, 1986)
26 CFR 1.338-4T Questions and answers relating to miscellaneous issues
under section 338 (temporary).
(a) Introduction -- (1) Effective date. Except as otherwise provided
in this section, this section applies to stock acquisitions for which
the acquisition date (determined without section 224 (d)(5) of TEFRA)
occurs after August 31, 1982.
(2) Scope of regulations. This section provides guidance on a broad
range of issues under section 338. This section deals principally with
domestic aspects of section 338. For guidance on international aspects
of section 338 and on the extent to which the provisions of this section
apply in that context, see 1.338-5T.
(3) Outline of topics. In order to facilitate the use of this
section, this paragraph (a) (3) lists the paragraphs, subparagraphs, and
subdivisions contained in this section.
(a) Introduction.
(1) Effective date.
(2) Scope of regulations.
(3) Outline of topics.
(4) Cross-reference of Code provisions to provisions in this section.
(b) Nomenclature and definitions.
(1) Nomenclature.
(2) Definitions in section 338(h) and 1.338-1T.
(3) Affected target.
(4) Original target.
(5) Consistency period.
(6) Domestic corporation.
(7) Section 338 election.
(8) Express election.
(9) Deemed election.
(10) Related persons.
(c) Qualified stock purchase and miscellaneous related rules.
(1) Purchase requirement of section 338(h)(3).
(2) Date of purchase from certain related persons.
(3) Qualified stock purchase, deemed election, and acquisition date
for tiered targets.
(4) Effect of redemptions.
(5) Effect of section 304.
(d) Effect of post-acquisition events on eligiblility of T for
section 338 election; requirement of purchasing corporation.
(e) Application of the stock consistency rules of section 338(f).
(f) Application of the asset consistency rule of section 338(e).
(1) Introduction and general operating rules.
(i) Introduction. (ii) General operating rules.
(2) Asset acquisition by P (or another member of the P group) from T
or T's target affiliate.
(3) Exception of section 338(e)(2)(A) for acquisitions in ordinary
course of trade or business.
(4) Exception of section 338(e)(2)(B) for acquisitions in which
transferee's basis in acquired assets is measured wholly by reference to
transferor's basis.
(5) Certain transactions excepted under section 338(e)(2)(D).
(6) Carryover basis election exception under section 338(e)(2)(D) and
(i).
(i) Introduction. (A) Overview. (B) Cross-reference. (ii)
Procedure for making protective carryover election and
affirmative action carryover election.
(iii) Corporations and acquisitions subject to protective or
affirmative action carryover election.
(iv) Consequences of protective or affirmative action carryover
election.
(7) De minimis exception under section 338 (e)(2)(D).
(g) Special consistency rules.
(1) Extension of consistency period and 12-month acquisition period
in certain cases.
(2) Asset or stock acquisition by non-P group member considered an
acquisition by P group member in certain cases.
(h) Determination of section 338(a)(1) deemed sale price.
(1) Introduction.
(2) Definitions.
(i) ADSP. (ii) Elective ADSP formula. (iii) Allocable ADSP
amount. (iv) Recapture gain. (v) Section 338(c)(1) percentage.
(3) Determination of ADSP.
(i) (Reserved)
(j) Determination of basis of target assets after section 338
election.
(1) Introduction.
(2) Determination of adjusted grossed-up basis.
(k) Miscellaneous matters affecting the final return of old T.
(1) Application of section 337 to deemed sale of assets.
(2) Application of section 338(h)(10).
(3) Effect of sections 382(a) and 168(d)(2)(B) on old T's final
return.
(4) Application of 1.1502-76(c) to old T's final return.
(5) Effect on old T's final return of plan to abate section 338(c)(1)
amounts.
(6) Combined deemed sale return under section 338 (h)(15).
(l) Miscellaneous matters affecting new T.
(1) Effect of old T liabilities.
(2) Availability of investment tax credit; recovery deductions.
(3) Effect of acquisition of partnership interest in deemed purchase
under section 338(a)(2).
(4) Employment taxes; employee plans.
(5) Application of mitigation provisions.
(4) Cross-reference of Code provisions to provisions in this section.
The following tables cross-reference provisions of the Code to subunits
of this section in which those Code provisions are dealt with in a
significant manner. A Code provision may be cross-referenced to a
subunit of this section even though that Code provision is not
specifically cited in the section subunit. These tables are not
intended to provide an exhaustive cross-reference of Code provisions.
(b) Nomenclature and definitions. For purposes of this section (and
except as otherwise provided in this section) --
(1) Nomenclature -- (i) P is a domestic corporation that directly
purchases all of the outstanding stock in a second domestic corporation.
(ii) T is the domestic corporation the stock of which is purchased by
P. T has only one class of stock outstanding. Except as otherwise
provided in this section, T is an original target if a qualified stock
purchase is made of its stock.
(iii) P1, P2, etc., are domestic corporations that are members of the
P group.
(iv) The P group is an affiliated group (as defined in section
338(h)(5)) that includes one or more P corporations as members.
(v) T1, T2, etc., are domestic corporations that are target
affiliates of T. Those corporations (T1, T2, etc.) have only one class
of stock outstanding, and also may be targets. None of the stock of
those corporations is owned by T.
(vi) S is a domestic corporation (unrelated to P and B) that owns all
of the outstanding stock of T prior to the purchase of T stock by P. (S
is referred to in cases in which it is appropriate to consider the
effects of having all of the outstanding stock of T owned by a domestic
corporation.)
(vii) A is an individual (unrelated to P and B) who is a U.S.
resident or citizen and who owns all of the outstanding stock of T prior
to the purchase of T stock by P. (A is referred to in cases in which it
is appropriate to consider the effects of having all of the outstanding
stock of T owned by an individual who is a U.S. resident or citizen.
Ownership of the stock of T by A and ownership of the stock of T by S
are mutually exclusive circumstances.)
(viii) B is an individual (unrelated to T, S, and A) who is a U.S.
resident or citizen and who owns all of the outstanding stock of P.
(2) Definitions in section 338 and 1.338-1T. The definitions in
section 338 and 1.338-1T also apply to this section.
(3) Affected target. A corporation is an ''affected target'' if a
deemed election would occur for that corporation in the event of a
section 338 election for T.
(4) Original target. A corporation (''X'') is an ''original target''
if there exists no previously acquired target as to which a section 338
election would cause a deemed election under section 338(f)(1) for X.
If two corporations are acquired at the same time, either corporation
(but not both) may be considered by the purchasing corporation as the
original target.
(5) Consistency period. The ''consistency period'' is the period
described in section 338(h)(4)(A) unless extended pursuant to paragraph
(g)(1) Answer 1 of this section.
(6) Domestic corporation. A ''domestic corporation'' is a
corporation (i) that is created or organized in the United States or
under the law of the United States or of any State and (ii) that is not
a DISC, a corporation described in section 934(b) or 1248(e), or a
corporation to which an election under section 936 applies.
(7) Section 338 election. A ''section 338 election'' is an election
to apply section 338(a) to a target. A section 338 election is either
an express election or a deemed election.
(8) Express election. An ''express election'' is a section 338
election made for the original target by filing a statement of section
338 election (Form 8023) pursuant to 1.338-1T(c).
(9) Deemed election. A ''deemed election'' is a section 338 election
that is not an express election. A deemed election is made under the
authority of section 338 (e), (f), or (i) or under the authority of more
than one of those provisions. If an express election for the original
target causes a section 338 election by reason of section 338(f)(1) for
another target, that other target is considered subject to a deemed
election. A statement of section 338 election (Form 8023) need not be
filed for that other target, but that other target may be required to be
included in a schedule attached to the statement of section 338 election
filed for the original target. See 1.338-1T (c) and (e).
(10) Related persons. Two persons are related to each other if stock
in a corporation owned by one such person would be attributed under
section 318(a) (other than paragraph (4) thereof) to the other, or vice
versa.
(c) Qualified stock purchase and miscellaneous related rules -- (1)
Purchase requirement of section 338(h)(3). The purpose of this
paragraph (c)(1) is to provide guidance on whether particular stock
acquisitions qualify as purchases under section 338(h)(3). It is
assumed in each question and answer that no exception to the purchase
requirement is potentially applicable other than the exception discussed
in the particular question and answer.
Question 1: If P acquires T stock from S solely for cash in a
transaction with respect to which S does not recognize gain or loss
pursuant to section 337, has P acquired that T stock by purchase?
Answer 1: Yes. Such an acquisition of stock is not excepted from the
definition of purchase under the regulatory authority in section
338(h)(3)(A)(ii).
Question 2: If P acquires T stock from S solely for cash in a
transaction with respect to which S recognizes its income under the
installment method, has P acquired that T stock by purchase?
Answer 2: Yes. Such an acquisition of stock is not excepted from the
definition of purchase under the regulatory authority in section
338(h)(3)(A)(ii).
Question 3: If P acquires T stock from S solely for cash and if S is
a foreign person that is not required to pay United States income tax on
the disposition of the T stock, has P acquired that T stock by purchase?
Answer 3: Yes. Such an acquisition of stock is not excepted from the
definition of purchase under the regulatory authority in section
338(h)(3)(A)(ii).
Question 4: Assume that P owns less than 50 percent in value of the
stock of S and that S owns 100 percent of the only class of T stock. If
P acquires all of the T stock from S in a distribution with respect to
P's S stock or in a redemption of P's S stock, has P acquired that T
stock by purchase?
Answer 4: (i) Distribution with respect to which section 311(d)(1)
applies. If P acquires the T stock in a distribution with respect to
which S recognizes gain under section 311(d)(1), then P has acquired
that T stock by purchase.
(ii) Distributions with respect to which section 311(d)(1) does not
apply -- (A) Fair market value of T stock does not exceed its adjusted
basis in the hands of S. If P acquires the T stock in a distribution to
which sections 301-307 apply and if the fair market value of the T stock
does not exceed its adjusted basis in the hands of S (so that section
311(d)(1) does not apply to the distribution), then P has acquired that
T stock by purchase. This result applies even though S realizes but
does not recognize a loss, since such an acquisition of stock is not
excepted from the definition of purchase under the regulatory authority
in section 338(h)(3)(A)(ii).
(B) Fair market value of T stock exceeds its adjusted basis in the
hands of S. Under the authority of section 338(h)(3)(A)(ii), if (1) P
acquires the T stock in a distribution to which sections 301-307 apply,
(2) the fair market value of the T stock exceeds its adjusted basis in
the hands of S, and (3) section 311(d)(1) does not apply to the
distribution, then P has not acquired that T stock by purchase.
Example (1). P owns less than 50 percent in value of the stock of S,
and S owns all of the stock of T. The stock of T has a fair market
value of $1,000, and S's basis in that stock is $400. On November 1,
1986, S distributes all of the stock of T to P in a redemption
qualifying under section 302(a) of the S stock held by P. S recognizes
a gain of $600 on the distribution pursuant to section 311(d)(1).
Accordingly, P has acquired the T stock by purchase under section
338(h)(3).
Example (2). Assume the same facts as in Example (1), except that
S's basis in the T stock is $1,400. The result is the same.
Example (3). Assume the same facts as in Example (1), except that
the distribution is a dividend distribution rather than a distribution
in redemption of S stock. S recognizes a gain of $600 on the
distribution pursuant to section 311(d)(1). Accordingly, P has acquired
the T stock by purchase under section 338(h)(3).
Example (4). Assume the same facts as in Example (3), except that
the distribution occurs on January 1, 1984. S does not recognize a gain
on the distribution under section 311(d)(1). P has not acquired the T
stock by purchase under section 338(h)(3).
(2) Date of purchase from certain related persons.
Question: If T stock acquired by P from a related corporation is
treated as purchased stock by reason of section 338(h)(3)(C) (relating
to certain stock acquisitions from related corporations), what is the
date on which P is considered to have acquired that stock for purposes
of satisfying the requirement of section 338(d)(3) that stock included
in the qualified stock purchase must be acquired during the 12-month
acquisition period?
Answer: If T stock acquired by P from a related corporation (''R'')
is treated as purchased by P by reason of section 338(h)(3)(C), then,
solely for purposes of determining whether the 12-month acquisition
period requirement for a qualified stock purchase is satisfied, to the
extent such T stock is considered owned by P under section 318(a) (other
than paragraph (4) thereof) immediately before the acquisition from R by
reason of P's ownership of stock in R (''attributed T stock''), that
attributed T stock is considered to have been acquired by P on the day
on which P is first considered to own that stock rather than on the day
on which P actually acquires that stock from R. If the date on which
that T stock is considered to have been acquired by P precedes the date
of P's actual purchase by more than 12 months, that stock cannot be
taken into account for purposes of determining whether a qualified stock
purchase has occurred unless, in the particular case, the 12-month
acquisition period is extended pursuant to paragraph (g)(1) Answer 2 of
this section. If shares of attributed T stock owned by R are first
considered to be owned by P on more than one date, then the attributed T
shares purchased by P are deemed to be the T shares that are considered
owned by P on the earliest date first, to the extent thereof, and then
on the next earliest date.
Example (1). (i) On January 1, 1984, P purchases 75 percent in value
of the stock of S. On that date, S owns 4 of the 100 shares of T's only
class of outstanding stock. On June 1, 1984, S acquires an additional
16 shares of T stock. On December 1, 1984, P purchases 70 shares of T
stock from an unrelated person and 12 of the 20 shares of T stock held
by S.
(ii) Of the 12 shares of T stock purchased by P from S on December 1,
1984, 3 of those shares are deemed to have been acquired by P on January
1, 1984, the date on which 3 of the 4 shares of T stock held by S on
that date were first considered owned by P under section 318(a) (other
than paragraph (4) thereof), i.e., 4 .75. Section 338(h) (1) and
(3)(C)(i). The remaining 9 shares of T stock purchased by P from S on
December 1, 1984, are deemed to have been acquired by P on June 1, 1984,
the date on which an additional 12 of the 20 shares of T stock owned by
S on that date were first considered owned by P under section 318 (a)
(other than paragraph (4) thereof), i.e., (20 .75)^3. Because stock
acquisitions by P sufficient for a qualified stock purchase of T occur
within a 12-month period (i.e., 3 shares constructively on January 1,
1984, 9 shares constructively on June 1, 1984, and 70 shares actually on
December 1, 1984), a qualified stock purchase is made on December 1,
1984.
Example (2). (i) On February 1, 1983, P acquires 25 percent in value
of the stock of S from B (the sole shareholder of P). That S stock is
not acquired by purchase. See section 338(h)(3)(A)(iii). On that date,
S owns 4 of the 100 shares of T's only class of outstanding stock. On
June 1, 1983, P purchases an additional 25 percent in value of the stock
of S, and on January 1, 1984, P purchases another 25 percent in value of
the stock of S. On June 1, 1984, S acquires an additional 16 shares of
T stock. On December 1, 1984, P purchases 68 shares of T stock from an
unrelated person and 12 of the 20 shares of T stock held by S.
(ii) Of the 12 shares of T stock purchased by P from S on December 1,
1984, 2 of those shares are deemed to have been acquired by P on June 1,
1983, the date on which 2 of the 4 shares of T stock held by S on that
date were first considered owned by P under section 318(a) (other than
paragraph (4) thereof), i.e., 4 .5. For purposes of this attribution,
the S stock need not be acquired by P by purchase. See section
338(h)(1). (By contrast, the acquisition of T stock by P from S will
not qualify as a purchase unless P has acquired at least 50 percent in
value of S stock by purchase. Section 338(h)(3)(C)(i).) Of the remaining
10 shares of T stock purchased by P from S on December 1, 1984, 1 of
those shares is deemed to have been acquired by P on January 1, 1984,
the date on which an additional 1 share of the 4 shares of T stock held
by S on that date was first considered owned by P under section 318(a)
(other than paragraph (4) thereof), i.e., (4 .75)^2. The remaining 9
shares of T stock purchased by P from S on December 1, 1984, are deemed
to have been acquired by P on June 1, 1984, the date on which an
additional 12 shares of T stock held by S on that date were first
considered owned by P under section 318(a) (other than paragraph (4)
thereof), i.e., (20 .75)^3. Because a qualified stock purchase of T by P
is made on December 1, 1984, only if all 12 shares of T stock purchased
by P from S on that date are considered acquired during a 12-month
period ending on that date (so that, in conjunction with the 68 shares
of T stock P purchased on that date from the unrelated person, 80 of T's
100 shares are acquired by P during a 12-month period) and because 2 of
those 12 shares are considered to have been acquired by P more than 12
months before December 1, 1984 (i.e., on June 1, 1983), a qualified
stock purchase is not made. (In appropriate cases, however, the
12-month period within which the qualified stock purchase must be made
will be extended pursuant to paragraph (g)(1) Answer 2 of this section.)
Example (3). Assume the same facts as in Example (2), except that on
February 1, 1983, P acquires 25 percent in value of the stock of S by
purchase. The result is the same as in Example (2).
(3) Qualified stock purchase, deemed election, and acquisition date
for tiered targets.
Question 1: Assuming that T owns 80 percent of the only class of
outstanding T1 stock, and that P purchases 80 percent of the only class
of outstanding T stock in a qualified stock purchase, will T have made
both a qualified stock purchase of T1 stock and a deemed election for T1
if P makes a valid express election for T?
Answer 1: Yes. By reason of P's express election for T, old T is
deemed to sell T's assets and new T is deemed to purchase those assets.
Under section 338(h)(3)(B), this deemed purchase of 80 percent of the T1
stock by new T is a purchase by new T for purposes of section 338(d)(3),
and thus constitutes a qualified stock purchase of T1 stock.
Accordingly, the express election for T also causes a deemed election
for T1 (a target affiliate of T) under section 338(f)(1) since, under
section 338(h)(8), purchases by members of the same affiliated group
(here P and new T) are treated as if made by one corporation. For
guidance in a case in which a qualified stock purchase of T stock is
effected in part by a redemption by T (on the acquisition date of T) in
which T distributes the stock of its subsidiary, see paragraph (c)(4)
Answer Example (3) of this section.
Question 2: Under the facts of Question 1 of this paragraph (c)(3),
what is the acquisition date of T1?
Answer 2: Under the authority of section 338(h)(3)(B), the
acquisition date of T1 is the same day as the acquisition date of T, the
corporation the stock of which is actually purchased (rather than deemed
purchased pursuant to section 338(h)(3)(B)). However, the deemed sale
and purchase of T1's assets is considered to take place instantaneously
after the deemed sale and purchase of T's assets.
Question 3: Assume the facts of Question 1 of this paragraph (c)(3).
Assume in addition that T1 owns 80 percent of the only class of T2
stock. What is the acquisition date of T2?
Answer 3: Under the principles of Answer 1 of this paragraph (c)(3),
T1 is deemed to make a qualified stock purchase of T2 stock and the
deemed election for T1 under section 338(f)(1) causes a deemed election
for T2 (also under section 338(f)(1)). The acquisition date of T2 is
the same day as the acquisition date of T, the corporation the stock of
which is actually purchased (rather than deemed purchased pursuant to
section 338(h)(3)(B)). However, the deemed sale and purchase of T2's
assets is considered to take place instantaneously after the deemed sale
and purchase of T1's assets.
Example (1). T is the common parent of an affiliated group that
files consolidated returns. The group consists of T, T1, and T2. T
owns 80 percent of the only class of outstanding T1 stock and T1 owns 80
percent of the only class of outstanding T2 stock. On September 10,
1984, P purchases all of the outstanding T stock and makes an express
election for T. Pursuant to Answer (1) of this paragraph (c)(3), new
T's deemed purchase of the stock of T1 constitutes a qualified stock
purchase of T1 stock by new T, and the section 338 election for T also
applies to T1 by reason of section 338(f)(1). Similarly, new T1 is
deemed to have made a qualified stock purchase of T2 stock, for which a
deemed election also is made. The acquisition date of T1 and T2 is
September 10, 1984, i.e., the acquisition date of T, the stock of which
was actually purchased. The T group's final consolidated return for the
period ending at the close of September 10, 1984, will include any items
resulting from the deemed asset sales of old T, old T1, and old T2 (all
of the deemed sales of which are treated as occurring on that date).
See 1.338-1T(f)(2)(ii).
Example (2). A owns all 100 shares of T's only class of outstanding
stock. T owns 50 of the 100 shares of X's only class of outstanding
stock. The other 50 shares of X stock are owned by corporation Y, which
is unrelated to A, T, or P. On January 1, 1985, P acquires all of the
stock of T in a qualified stock purchase and makes an express election
for T. On December 1, 1985, P acquires by purchase the 50 shares of X
stock held by Y. A qualified stock purchase of X stock is made on
December 1, 1985, since the deemed purchase of 50 shares of X stock by
new T by reason of the express election for T and the actual purchase of
50 shares of X stock by P are treated as purchases made by one
corporation. Section 338(h)(8). For purposes of determining whether
those purchases occur within a 12-month acquisition period as required
by section 338(d)(3), the X stock T is deemed to purchase is deemed
purchased on the acquisition date of T, i.e., January 1, 1985.
(4) Effect of redemptions.
Question: May the requirements for a qualified stock purchase under
section 338(d)(3) be satisfied through a combination of T stock
purchases by P and redemptions by T?
Answer: Yes. (i) Redemptions from persons unrelated to P. A
qualified stock purchase is made on the first day on which the
percentage ownership requirements of section 338(d)(3) are satisfied by
reference to T stock that is both (A) held on that day by P and (B)
purchased by P during the 12-month acquisition period ending on that day
(''qualifying target stock''). That day is the ''acquisition date''
within the meaning of section 338(h)(2). T stock redemptions from
persons unrelated to P that occur at any time before the close of the
12-month acquisition period (whether before or after the beginning of
that period and whether before or after the purchase of any T stock by
P) are taken into account as reductions in T's outstanding stock for
purposes of determining whether T stock purchased by P in the 12-month
acquisition period satisfies the percentage ownership requirements of
section 338(d)(3).
(ii) Redemptions from P or related persons during 12-month
acquisition period -- (A) General rule. For purposes of the percentage
ownership requirements of section 338(d)(3), a redemption of T stock
during the 12-month acquisition period from P or from any person related
to P is not taken into account as a reduction in T's outstanding stock.
(B) Exception for certain redemptions from related persons. A
redemption of T stock during the 12-month acquisition period from a
person related to P will be taken into account as a reduction in T's
outstanding stock to the extent of the purchased stock amount. The
''purchased stock amount'' is the portion of the redeemed stock that
could have been purchased by P from the related person on the day of the
redemption (by reason of section 338(h)(3)(C)) and that, in the event of
such a purchase, would have been qualifying target stock with respect to
the 12-month acquisition period. See paragraph (c)(2) of this section.
Example (1). A owns all 100 shares of T's only class of outstanding
stock. On January 1, 1984, P purchases 40 shares of T stock from A. On
July 1, 1984, T redeems 25 shares from A. On December 1, 1984, P
purchases 20 shares of T stock from A. A qualified stock purchase is
made by P on December 1, 1984, since, within a 12-month period ending on
that date, the 60 shares of T stock purchased by P satisfy the
percentage ownership requirements of section 338(d)(3), i.e., 80
percent, 60/75 shares, determined by taking into account the redemption
of 25 shares.
Example (2). Assume the same facts as in Example (1), except that P
purchases 60 shares on January 1, 1984, and none on December 1, 1984. A
qualified stock purchase is made by P on July 1, 1984, since that is the
first day on which T stock purchased by P within the preceding 12-month
period satisfies the percentage ownership requirements of section
338(d)(3), i.e., 80 percent, 60/75 shares, determined by taking into
account the redemption of 25 shares.
Example (3). Assume the same facts as in Example (2). Assume
further that T distributes to A all of the stock of T's wholly-owned
subsidiary, T1, in the redemption on July 1, 1984, and that P makes an
express election with respect to its qualified stock purchase of T
stock. The acquisition date of T is July 1, 1984. Although T held all
of the stock of T1 on that date, a qualified stock purchase and deemed
election are not considered made for T1 by reason of the express
election for T. In order for a deemed election to be made for T1, T
must hold the T1 stock when T's deemed sale of assets occurs pursuant to
section 338(a). The deemed sale of assets is considered the last
transaction of old T at the close of the acquisition date. Accordingly,
T1 stock actually disposed of by T on the acquisition date is not
included in the deemed sale and purchase of assets pursuant to section
338(a). Thus, a qualified stock purchase and deemed election are not
made for T1. See paragraph (c)(3) Answer 1 of this section and
1.338-1T(f).
Example (4). A owns all 100 shares of T's only class of outstanding
stock. On January 1, 1984, T redeems 25 of those shares. On February
1, 1984, P purchases 30 shares of T stock from A, and on January 15,
1985, P purchases another 30 shares. A qualified stock purchase is made
by P on January 15, 1985, since T stock held by P on that date that was
purchased during the preceding 12 months satisfies, on that date, the
percentage ownership requirements of section 338(d)(3), i.e., 80
percent, 60/75 shares, determined by taking into account the redemption
of 25 shares. It is irrelevant that the redemption necessary for this
result occurred before the 12-month acquisition period.
Example (5). Assume the same facts as in Example (4), except that
the redemption occurs on April 1, 1985. Assume further that the
12-month acquisition period is not extended. A qualified stock purchase
is not made by P on April 1, 1985. This result obtains because the
percentage ownership requirements of section 338(d)(3) are not satisfied
on that date by reference to T stock held on that date that was
purchased during the preceding 12 months, since such stock represents
only 40 percent of the T stock, i.e., 30/75 shares, determined by taking
into account the redemption of 25 shares.
Example (6). On December 15, 1983, T redeems 30 percent of its only
class of outstanding stock from P. The redeemed stock was held by P for
several years and constituted the total interest of P in T. On December
1, 1984, P purchases the remaining outstanding stock of T from A. A
qualified stock purchase is not made by P on December 1, 1984, since,
for purposes of the percentage ownership requirements of section
338(d)(3), the redemption on December 15, 1983, is not taken into
account as a reduction in T's outstanding stock.
Example (7). (i) X and T each have outstanding 100 shares of a
single class of stock. On January 1, 1985, P purchases 60 shares of X
stock. On that date, X owns 40 shares of T stock. On April 1, 1985, T
redeems the 40 shares of T stock held by X and P purchases the remaining
60 shares of T stock from an unrelated person. Assume that the 12-month
acquisition period is not extended.
(ii) For purposes of the percentage ownership requirements of section
338(d)(3), the redemption of T stock from X (a person related to P) is
taken into account as a reduction in T's outstanding stock to the extent
of the purchased stock amount. Under these facts, all 40 of the
redeemed shares constitute the purchased stock amount since (A) P could
have acquired those 40 shares from X on the day of the redemption by
purchase (by reason of section 338(h)(3)(C)(i)), and (B) those 40
shares, in the event of such a purchase, would have been qualifying
target stock with respect to the 12-month period ending on April 1,
1985. If P had acquired the 40 shares of T stock from X by purchase on
the day of the redemption, April 1, 1985, then, for purposes of the
12-month acquisition period, 24 of those 40 shares of T stock would have
been considered purchased by P on January 1, 1985, and the remaining 16
shares would have been considered purchased by P on April 1, 1985. See
paragraph (c)(2) of this section. Accordingly, a qualified stock
purchase is made by P on April 1, 1985, since the 60 shares of T stock
purchased by P on that date satisfy, as of that date, the percentage
ownership requirements of section 338(d)(3), i.e., 100 percent, 60/60
shares, determined by taking into account the redemption of 40 shares.
(5) Effect of section 304.
Question: If A, the owner of 20 percent of T's only class of
outstanding stock, transfers that stock to P solely in exchange for all
the stock of P, and if, pursuant to the same transaction, P, solely in
exchange for cash, acquires the remaining 80 percent of T's stock from
the other T shareholder, B, that is unrelated to A, will section
304(a)(1) apply to preclude a qualified stock purchase of T stock by P?
Answer: No. (i) Background -- (A) Operation of section 304(a)(1).
Under section 304(a)(1), if one or more persons that control each of two
corporations transfer stock in one of those corporations (''issuing
corporation'') to the other of those corporations (''acquiring
corporation'') in return for property, then those persons will be
treated as having received that property as a distribution in redemption
of the acquiring corporation's stock. If section 304(a)(1) applies to a
person's transfer of issuing corporation's stock, the acquiring
corporation is treated as receiving that person's issuing corporation
stock as a contribution to the acquiring corporation's capital and,
because the acquiring corporation's basis in the issuing corporation's
stock is determined by reference to the transferor's basis under section
362(a) and 1.304-2(a), the issuing corporation's stock is not
considered purchased (within the meaning of section 338(h)(3)) by the
acquiring corporation. See section 338(h)(3)(A)(i). This result
obtains whether or not section 302 (a) or (d) applies to the person's
section 304(a)(1) deemed distribution in redemption of the acquiring
corporation's stock.
(B) Control requirement in general. Section 304(c)(1) provides that,
for purposes of section 304, control means the ownership of stock
possessing at least 50 percent of the total combined voting power of all
classes of stock entitled to vote or at least 50 percent of the total
value of shares of all classes of stock. Section 304(c)(3) makes
section 318(a) (relating to constructive ownership of stock), as
modified by section 304(c)(3)(B), applicable to section 304 for purposes
of determining control under section 304(c)(1).
(ii) Effect of section 304(c)(2)(B) -- (A) In general. In
determining whether the control test with respect to both the issuing
and acquiring corporations is satisfied, section 304(a)(1) considers
only the person or persons that (1) control the issuing corporation
before the transaction, (2) transfer issuing corporation stock to the
acquiring corporation for property, and (3) control the acquiring
corporation thereafter. Section 317 defines property to include money,
securities, and any other property except stock (or stock rights) in the
distributing corporation. However, section 304(c)(2)(B) provides a
special rule to extend the relevant group of persons to be tested for
control of both the issuing and acquiring corporations to include the
person or persons that do not acquire property, but rather solely stock
from the acquiring corporation in the transaction. Section 304(c)(2)(B)
provides that if two or more persons in control of the issuing
corporation transfer stock of such corporation to the acquiring
corporation, and if the transferors are in control of the acquiring
corporation after the transfer, then the person persons in control of
each corporation will include each of those transferors. Because the
purpose of section 304(c)(2)(B) was to include in the relevant control
group the person or persons that retain or acquire in the transaction
acquiring corporation stock, only the person or persons transferring
stock of the issuing corporation that retain or acquire any proprietary
interest in the acquiring corporation will be taken into account for
purposes of applying section 304(c)(2)(B).
(B) Application of section 304(c)(2)(B) to facts in question. Under
the facts set forth in the question in this paragraph (c)(5), while both
A and B were in control of T (the issuing corporation) before the
transaction and both A and B transferred T stock to P (the acquiring
corporation), section 304 (c)(2)(B) and (a)(1) will not apply to B since
B did not retain or acquire any proprietary interest in P in the
transaction. Section 304(a)(1) also does not apply to A since A (or a
control group of P and T of which A was a member) did not control T
before the transaction. Accordingly, the acquisition by P of the 80
percent stock interest in T constitutes a qualified stock purchase.
(d) Effect of post-acquisition events on eligibility of T for section
338 election; requirement of purchasing corporation.
Question 1: May P make an express or deemed election for T after T
is liquidated, merged into another corporation, or otherwise disposed of
by P?
Answer 1: Yes, provided that, under the facts and circumstances, P
is considered for tax purposes as the purchaser of the T stock.
Example (1). On January 1, 1985, P purchases all of the stock of T
in a qualified stock purchase. On June 1, 1985, P sells all of the
stock of T to an unrelated person. Assuming that P is considered for
tax purposes as the purchaser of the T stock, P remains eligible, after
June 1, 1985, to make a section 338 election for T.
Example (2). On January 1, 1985, P purchases all of the stock of T
in a qualified stock purchase. On that date, T owns all of the stock of
T1. On March 1, 1985, T sells all of the stock of T1 to an unrelated
person. On April 1, 1985, P makes an express election for T.
Notwithstanding that the stock of T1 previously was sold on March 1,
1985, the express election for T on April 1, 1985, results in a
qualified stock purchase by T of T1 on January 1, 1985, and a deemed
election is made for T1 under section 338(f)(1) as a result of P's
express election for T. See paragraph (c)(3) Answer 1 of this section.
The result is the same if P transfers both T and T1 on February 1, 1985,
and whether or not the transfer is characterized as a dividend, a
reorganization under section 368, or a taxable sale, provided that P is
considered for tax purposes as the purchaser of the T stock.
Question 2: May an express or deemed election be made for T after P
is liquidated or merged into another corporation in a transaction
described in section 381(a)?
Answer 2: Yes, provided that, under the facts and circumstances, P
is considered for tax purposes as the purchaser of the T stock. The
acquiring corporation in the section 381(a) transaction may make a
section 338 election for T.
Question 3: Assume that P exchanges cash for all of the stock of new
subsidiary N, N thereafter merges with and into T, and pursuant to the
merger T shareholders receive cash in exchange for all of their T stock.
If, under the circumstances, the step-transaction doctrine properly is
applied to disregard the existence of N for tax purposes, will P be
considered to have made a qualified stock purchase of T stock?
Answer 3: Yes. If the existence of N properly is disregarded for tax
purposes under these circumstances, then P is deemed to have acquired
the T stock directly from the T shareholders for cash. The acquisition
described in this Question 3 and Answer 3, commonly called a ''reverse
subsidiary cash merger,'' will be a qualified stock purchase by P if all
of the requirements of a qualified stock purchase are satisfied. The
result would be the same if P contributed other property (such as P
stock) as well as cash to N, provided that the use of such other
property in the acquisition would not cause the acquisition to qualify
as a reorganization under section 368.
Question 4: May an individual make a qualified stock purchase of T
stock?
Answer 4: No. Section 338(d)(3) requires, as a condition of a
qualified stock purchase, that there be a corporate purchaser of the
stock of T.
Question 5: Assume that individual B contributes cash for all of the
stock of new corporation P and that P thereafter transfers cash to the
shareholders of T for all of the stock of T. If P either merges
downstream into T or liquidates, has a qualified stock purchase of T
stock been made?
Answer 5: Yes, provided that, under the facts and circumstances, P
is considered for tax purposes as the purchaser of the T stock.
(e) Application of the stock consistency rules of section 338(f).
This paragraph (e) provides general guidance on the operation of section
338(f). For special consistency rules issued under the authority of
section 338 (e)(3), (h)(4)(B), and (i), see paragraph (g) of this
section.
Question 1: Assume that S owns directly all of the stock of T and
T1, that P makes a qualified stock purchase of T stock, and that, after
the acquisition date of T but within T's consistency period, P makes a
qualified stock purchase of T1 stock. If no section 338 election has
been made for T so that T1 is not already subject to a deemed election
under section 338(f)(1), may P make an express election for T1?
Answer 1: No. Under section 338(f)(2), the express election must be
made for T, the original target. An express election made for T will
cause a deemed election under section 338(f)(1) for T1. If P makes
qualified stock purchases of the stock of T and T1 at the same time, the
express election may be made for either target (but not both), and that
election will cause a deemed election under section 338(f)(1) for the
other target. For guidance on making the express election and complying
with related requirements (e.g., inclusion of schedule of corporations
subject to the express election by reason of section 338(f)(1),
attachments to T returns, etc.), see 1.338-1T.
Question 2: If P makes qualified stock purchases of the stock of T
and T1 on January 1, 1985, and November 1, 1986, respectively, will T1
be affected by a section 338 election for T (or by the absence of such
an election for T)?
Answer 2: No. The acquisition date of T1 must occur during T's
consistency period in order for T1 to be subject to section 338(f) (1)
and (2) by reason of the status of T. Under section 338(h)(4)(A)(iii),
T's consistency period normally will end at the close of the one-year
period beginning on January 2, 1985 (the day after the acquisition date
of T). It is irrelevent that the beginning of T1's consistency period
overlaps with the end of T's consistency period. Thus, assuming that
T's consistency period is not extended, the section 338 election for T
will not cause a deemed election under section 338(f)(1) for T1, and the
absence of a section 338 election for T will not bar an express election
for T1 by reason of section 338(f)(2).
Question 3: Would the answer to Question 2 of this paragraph (e) be
different if (i) P also makes a qualified stock purchase of T2 stock on
December 15, 1985, (ii) T2 is a target affiliate of T, and (iii) T1 is a
target affiliate of T2?
Answer 3: Yes. T1 will be affected by a section 338 election for T
(or by the absence of such an election for T). This result follows
because T2 is a target affiliate of T and is acquired by P during T's
consistency period. Similarly, T1 is a target affiliate of T2 and is
acquired by P during T2's consistency period. Thus, a section 338
election for T causes a deemed election under section 338(f)(1) for T2,
which in turn causes a deemed election under section 338(f)(1) for T1.
Similarly, under section 338(f)(2), the absence of a section 338
election for T bars an express election for T2, which in turn bars an
express election for T1.
Question 4: Assume that P makes a qualified stock purchase of all of
the stock of T from S and thereafter, within one year, also makes a
qualified stock purchase of all of the stock of X from Y. Assume
further that S and Y are and always have been unrelated corporations
that respectively have held all of the stock of T and X since those
corporations were organized. If P makes a valid section 338 election
for T, is a deemed election under section 338(f)(1) made for X?
Answer 4: No. A deemed election is made for X only if X is a target
affiliate of T. Under section 338(h)(6)(A), X is a target affiliate of
T only if, at any time during so much of T's consistency period as ends
on the acquisition date of T, X and T were members of an affiliated
group that had the same common parent. Even though X and T are both
members of the P group after the acquisition date of X, X is not a
target affiliate of T because X was not a member of the P group during
so much of T's consistency period as ends on the acquisition date of T.
Even if the acquisition date of X were the same as the acquisition date
of T, X would not be a target affiliate of T and T would not be a target
affiliate of X under these facts.
(f) Application of the asset consistency rule of section 338(e) --
(1) Introduction and general operating rules -- (i) Introduction. This
paragraph (f) provides general guidance on the operation of section
338(e). For special consistency rules issued under the authority of
section 338(e)(3), (h)(4)(B), and (i), see paragraph (g) of this
section.
(ii) General operating rules.
Question 1: Under what circumstances will a deemed election under
section 338(e)(1) be made by P with respect to its qualified stock
purchase of T stock?
Answer 1: Under the authority of section 338 (e)(2)( and (i), a
deemed election under section 338(e)(1) will be made by P with respect
to its qualified stock purchase of T stock only if the District Director
determines, in connection with the examination of a return that would be
affected by a deemed election for T, that --
(i) P (or another member of the P group) has acquired an asset of T
(or a target affiliate of T) during T's consistency period in an
acquisition that is described in section 338(e)(1) and that is not
subject to an exception (other than the carryover basis election
exception of paragraph (f)(6) of this section) to section 338(e)(1),
(ii) Neither a section 338 election nor a protective carryover
election under paragraph (f)(6)(ii) Answer 1 of this section is made by
P with respect to T, and
(iii) A deemed election for T, in lieu of the affirmative action
carryover election for T under paragraph (f)(6)(ii) Answer 3 of this
section, is appropriate to carry out the purposes of the consistency
rules of section 338(e), (f), or (i) (see paragraph (f)(6)(i)(A) and
(ii) Answer 3 Example (1)).
Question 2: Will section 338(f)(2) apply to bar the District
Director's determination of a deemed election under section 338(e)(1)
for T1 if --
(i) P makes a qualified stock purchase of T stock,
(ii) After the acquisition date of T but within T's consistency
period, P makes a qualified stock purchase of the stock of T1, a target
affiliate of T,
(iii) No section 338 election has been made for T so that T1 is not
already subject to a deemed election under section 338(f)(1), and
(iv) P acquires an asset from T1 during T1's consistency period but
after the close of T's consistency period in an acquisition that is
described in section 338(e)(1) and that is not subject to an exception
(other than the carryover basis election exception of paragraph (f)(6)
of this section) to section 338(e)(1)?
Answer 2: No. Section 338(f)(2) will not bar the District Director's
determination of a deemed election under section 338(e)(1) for T1.
Question 3: Will the District Director's determination of a deemed
election under section 338(e)(1) for T1 under the facts described in
Question 2 of this paragraph (f)(1)(ii) cause a deemed election for T?
Answer 3: Yes. Under the authority of section 338 (f)(1) and (i), T
will be subject to a deemed election whenever the District Director
determines that a deemed election under section 338(e)(1) is made for a
later-acquired target (i.e., a target acquired by the P group subsequent
to the P group's acquisition of T), provided that a deemed election
under section 338(f)(1) would be considered made for the later-acquired
target if a section 338 election were made for T. It is irrelevant, for
purposes of this Answer 3, whether the asset acquisition occurs before
or after the period within which to make an express election for T or
before or after the close of T's consistency period.
(2) Asset acquisition by P (or another member of the P group) from T
or T's target affiliate.
Question 1: Is an asset acquisition by a future or a former member
of the P group considered an asset acquisition by a member of the P
group for purposes of section 338(e)(1)?
Answer 1: No, provided that the acquisition is not treated as made
by a member of the P group under paragraph (g)(2) of this section.
Question 2: Is an asset acquisition by T after the acquisition date
of T and while T is a member of the P group considered an asset
acquisition by a member of the P group for purposes of section
338(e)(1)?
Answer 2: Yes. For purposes of determining whether an asset
acquisition is made by a P group member, T is treated like any other P
group member once it joins that group.
(3) Exception of section 338(e)(2)(A) for acquisitions in ordinary
course of trade or business.
Question: Under what circumstances will an asset sale by T (or a
target affiliate of T) (''selling corporation'') to P (or another member
of the P group) be subject to the exception to section 338(e)(1)
provided by section 338(e)(2)(A) (relating to sales in the ordinary
course of the selling corporation's trade or business)?
Answer: (i) General rule. An asset sale will be subject to the
exception of section 338(e)(2)(A) if the sale is either customary for
the selling corporation or a normal incident to the conduct of the trade
or business in which that selling corporation is engaged. For purposes
of applying this exception, all sales made by a selling corporation to
members of the P group during T's consistency period will be aggregated
and treated as a single sale by that selling corporation if, on the
basis of all of the facts and circumstances, it appears that such sales
were separated for the purpose of satisfying the ordinary course of
trade or business exception. In addition, all sales by all of the
selling corporations to members of the P group during the consistency
period will be aggregated and treated as a single sale by each selling
corporation for purposes of applying the ordinary course of trade or
business exception to each such selling corporation if, on the basis of
all of the facts and circumstances, it appears that some or all of the
assets sold were dispersed among T and its target affiliates for the
purpose of satisfying the ordinary course of trade or business
exception.
(ii) Customary for selling corporation. The determination whether
the sale is customary for the selling corporation is based on all of the
facts and circumstances of the particular sale in light of the selling
corporation's customary practice. Factors that must be considered in
determining customary practice include the frequency and magnitude (both
in terms of quantity and value) of prior sales of such property as well
as the circumstances under which such prior sales occurred.
(iii) Normal incident to trade or business. In general, a sale is
considered a normal incident to the conduct of the trade or business in
which the selling corporation is engaged if, taking into consideration
all of the facts and circumstances of the particular sale, it is one
that reasonably would occur in the context of the ongoing business
operations of a similarly situated company engaged in the same trade or
business as the selling corporation.
Example (1). On January 1, 1985, P acquires all of the stock of T in
a qualified stock purchase. T is a corporation engaged in the
manufacture and sale of steel products. On April 1, 1985, P purchases
steel girders from T for use in P's construction business. P makes no
additional purchases from T (or from a target affiliate of T) during T's
consistency period. T customarily sells girders in its business, and
the magnitude of P's purchase is not unusual. The ordinary course of
trade or business exception applies.
Example (2). (i) Assume the same facts as in Example (1). Assume in
addition that T owns several tractor-trailers used to deliver its steel
products. T has owned and operated these vehicles for four years. It
is a general practice in T's industry to replace such vehicles after
three or four years. T sells the tractor-trailers to P1 pursuant to T's
standard procedure for disposing of and replacing used equipment. T
promptly purchases new tractor-trailers and continues in the business of
delivering steel products. In terms of both the sales price of the used
equipment and the quantity, the sale to P1 is unexceptional.
(ii) While T may not be engaged in the business of selling
tractor-trailers, the sale of the tractor-trailers to P1 is customary in
its business. Accordingly, the ordinary course of trade or business
exception applies.
Example (3). Assume the same facts as in Example (1). Assume in
addition that a fire at one of T's plants destroys uninsured machinery
used in T's business, and that T sells the machinery to P as scrap for
cash in an amount that exceeds T's adjusted basis in the machinery.
Such a sale reasonably would occur in T's industry in the context of
ongoing business operations in the event of a fire. Accordingly, the
ordinary course of trade or business exception applies.
(4) Exception of section 338(e)(2)(B) for acquisitions in which
transferee's basis in acquired assets is measured wholly by reference to
transferor's basis.
Question 1: Does the exception to section 338 (e) (1) provided by
section 338(e)(2)(B) apply if P (or any other member of the P group)
acquires assets from T (or a target affiliate of T) in a reorganization
as defined in section 368 under which the transferee P group member's
basis in the transferred assets is governed by section 362(b)?
Answer 1: Yes, provided that the transferee's basis under section
362(b) in the transferred assets is determined wholly by reference to
the adjusted basis of that property in the hands of the transferor.
Thus, if the transferor recognizes gain on the transfer by reason of the
receipt of property not permitted to be received without recognition of
gain, the exception of section 338(e)(2)(B) will not apply to the
acquisition.
Question 2: Does the exception to section 338(e)(1) provided by
section 338(e)(2)(B) apply if P (or any other member of the P group)
acquires assets from T (or a target affiliate of T) in a liquidation to
which section 334(b)(1) applies?
Answer 2: Yes. The transferee of assets in a liquidation subject to
section 334(b)(1) takes as its basis in the transferred assets the
transferor's basis in those assets. Accordingly, the exception of
section 338(e)(2)(B) applies.
Question 3: Does the exception to section 338(e)(1) provided by
section 338(e)(2)(B) apply if P (or any other member of the P group)
receives money or other property as a dividend distribution from T (or a
target affiliate of T)?
Answer 3: (i) Receipt of money in dividend distribution. The
exception of section 338(e)(2)(B) applies to the receipt of money (not
including foreign currency) in a dividend distribution from T (or a
target affiliate of T).
(ii) Receipt of other property in dividend distribution -- (A) Fair
market value not greater than distributor's basis. Although the
exception of section 338(e)(2)(B) may not apply, an exception to section
338(e)(1) applies under the authority of section 338(e)(2)(D) to the
receipt of property in a dividend distribution if the fair market value
of that property is not greater than the distributing corporation's
basis in that property.
(B) Fair market value exceeds distributor's basis. The exception of
section 338(e)(2)(B) does not apply if the distributee's basis in
property received in a dividend distribution exceeds the distributing
corporation's basis in that property immediately before the
distribution. The distributing corporation's basis will be exceeded,
for example, if (1) section 311(d)(1), as amended by the Tax Reform Act
of 1984 (Pub. L. No. 98-369; 96 Stat. 568), applies to the distribution
or (2) the distributing corporation otherwise recognizes gain on the
distribution (e.g., under section 311 (b) or (c)). On the other hand,
the distributee corporation's basis will not exceed the distributing
corporation's basis, for example, if section 311(d)(1), as amended by
the Tax Reform Act of 1984, does not apply to the distribution and the
distributing corporation does not otherwise recognize gain on the
distribution. In such a case, the exception of section 338(e)(2)(B)
applies to the distribution.
Example. On January 1, 1985, P acquires all of the stock of T in a
qualified stock purchase. P and T, which are calendar year taxpayers,
do not join in a consolidated return for calendar year 1985. On June 1,
1985, T makes a divided distribution to P of raw land (held for
investment) with a fair market value of $100,000 and a basis to T of
$10,000. T recognizes a gain of $90,000 on the distribution pursuant to
section 311(d)(1), as amended by the Tax Reform Act of 1984. Pursuant
to section 301(d)(2), P's basis in the land is $100,000. Because P's
basis exceeds T's basis in the land immediately before the distribution,
the exception of section 338(e)(2)(B) does not apply.
Question 4: Does the exception to section 338(e)(1) provided by
section 338(e)(2)(B) apply if (i) P (or any other member of the P group)
(''acquiring member'') acquires an asset from T (or a target affiliate
of T) in exchange for an asset of that acquiring member (''exchanged
asset'') and (ii) pursuant to section 1031(d), the acquiring member's
basis in the acquired asset is determined by reference to that acquiring
member's basis in the exchanged asset?
Answer 4: No. Section 338(e)(2)(B) requires that the acquiring P
group member's basis in the asset acquired from T (or a target affiliate
of T) be determined wholly by reference to the adjusted basis of that
asset in the hands of the transferor.
(5) Certain transactions excepted under section 338(e)(2)(D).
Question: What acquisitions by P (or any other member of the P
group) from T (or a target affiliate of T) or what arrangements between
P (or any other member of the P group) and T (or a target affiliate of
T) are subject to an exception to section 338(e)(1) under the authority
of section 338(e)(2)(D)?
Answer: (i) No step-up property. The acquisition of property is
subject to an exception to section 338(e)(1) under the authority of
section 338(e)(2)(D) if the transferee's basis in that property is not
greater than the transferor's basis immediately before the transfer.
(ii) Target affiliate stock. The acquisition of stock in a target
affiliate of T is subject to an exception to section 338(e)(1) under the
authority of section 338(e)(2)(D).
(iii) T or target affiliate debt or other instruments. The
acquisition of debt of T or a target affiliate of T or the acquisition
of a call option or warrant to acquire the stock or debt of T or a
target affiliate of T is subject to an exception to section 338(e)(1)
under the authority of section 338(e)(2)(D).
(iv) Covenant not to compete. A covenant not to compete that is
separately allocable from other assets is subject to an exception to
section 338(e)(1) under the authority of section 338(e)(2)(D).
(v) Lease or license of tangible or intangible property. The lease
or license of tangible or intangible property is subject to an exception
to section 338(e)(1) under the authority of section 338(e)(2)(D),
provided that the transaction is not actually a sale for tax purposes of
either the underlying property or the leasehold or license interest with
respect to the property.
(vi) Property acquired by T after T's acquisition date. The
acquisition by P of property from T is subject to an exception to
section 338(e)(1) under the authority of section 338(e)(2)(D) if (A) T
acquired that property after T's acquisition date from a person other
than a target affiliate of T and (B) T's basis in that property was not
determined in whole or in part by reference to the adjusted basis of an
asset held by T (or a target affiliate of T) on T's acquisition date.
Example (1). On January 1, 1985, P purchases all of the stock of T
in a qualified stock purchase. On January 15, 1985, T purchases, for
$60,000 in cash, a machine for use in its trade or business. On
December 1, 1985, P purchases that machine from T for $65,000 in cash.
P's acquisition of the machine from T is subject to the exception to
section 338(e)(1) provided in this Answer (vi) under the authority of
section 338(e)(2)(D).
Example (2). On January 1, 1985, P purchases all of the stock of T
in a qualified stock purchase. On December 1, 1985, P purchases a
storage tank from T for $65,000 in cash. The cost of the storage tank
to T was $50,000. Of that $50,000, $32,000 represented the price paid
by T for raw materials used in constructing the storage tank. Those raw
materials were held by T on T's acquisition date. The remaining $18,000
of T's $50,000 cost in the storage tank represented labor and other
production costs. Assume that the exception of section 338(e)(2)(A),
relating to sales in the ordinary course of the selling corporation's
trade or business, does not apply. P's acquisition of the storage tank
is not subject to the exception to section 338(e)(1) provided in the
Answer (vi) under the authority of section 338(e)(2)(D), since T's basis
in the property was determined in part by reference to the adjusted
basis of assets (i.e., the raw materials) held by T on T's acquisition
date.
(vii) Property subject to timely disposition (A) General rule. The
acquisition of property is subject to an exception to section 338(e)(1)
under the authority of section 338(e)(2)(D) if, on or before the
required disposition date, (1) the P group disposes of that property to
an unrelated person that is not a target affiliate of T or of an
affected target or (2) the P group member holding the property ceases to
be a member of the P group and ceases to be related to any member of the
P group. A P group member is not treated as ceasing to be a member of
the P group for purposes of this subdivision (A) if it ceases to exist
by reason of a transaction described in section 381(a) and if the
acquiring corporation (within the meaning of section 381(a)) is a member
of the P group.
(B) Required disposition date. The ''required disposition date'' is
the latest of the following three dates: (1) March 15, 1986, (2) the
90th day after the date on which a P group member acquires the property,
or (3) the 90th day after the acquisition date of T.
(viii) Other transactions. The Internal Revenue Service may treat
other transactions as subject to an exception to section 338(e)(1) under
the authority of section 338(e)(2)(D).
(6) Carryover basis election exception under section 338(e)(2)(D) and
(i) -- (i) Introduction -- (A) Overview. If P makes a qualified stock
purchase of T stock and, in lieu of an express election, makes a
protective carryover basis election for T under this paragraph (f)(6)
(''protective carryover election''), then a tainted asset acquisition
with respect to T or any affected target will in no case cause a deemed
election under section 338(e)(1) for T or any affected target. A
''tainted asset acquisition'' occurs with respect to T (or with respect
to an affected target) if an express election is not made and if, during
the consistency period of T (or of the affected target), a P group
member acquires an asset of T or its target affiliate (or of the
affected target or its target affiliate) in an acquisition that is
described in section 338(e)(1) and that is not subject to an exception
(other than the carryover basis election exception of this paragraph
(f)(6)) to section 338(e)(1). The protective carryover election is
irrevocable and bars an express election for T and the affected targets.
If the P group makes a tainted asset acquisition but does not make a
protective carryover election for T, then the tainted asset acquisition
will cause a carryover basis election by affirmative action
(''affirmative action carryover election'') as of the later of the day
of the tainted asset acquistion or the expiration of the period within
which to make the protective carryover election for T. Pursuant to
paragraph (f)(1)(ii) Answer 1 of this section, however, the District
Director in appropriate cases may cause a deemed election under section
338(e)(1) in lieu of the otherwise applicable affimative action
carryover election. Thus, the only certain way for the P group to avoid
a deemed election under section 338(e)(1) in the event of a tainted
asset acquisition is to make a timely protective carryover election.
Apart from the District Director's authority to override an affirmative
action carryover election and impose a deemed election under section
338(e)(1) in lieu thereof, the consequences of a protective carryover
election and an affirmative action carryover election are identical,
except that an offset prohibition election under this paragraph (f)(6)
and the special increase in basis of transferee member stock under
paragraph (f)(6)(iv) Answer 1(i)(B) of this section are available only
if a protective carryover election is made. (For a special limitation
on the application of the offset prohibition election, see
1.338-5T(d)(1).) Unless otherwise indicated, any reference in this
section to the carryover basis election exception of this paragraph
(f)(6) is a reference to either the protective carryover election or the
affirmative action carryover election.
(B) Cross-references. Subdivision (ii) of this paragraph (f)(6)
explains how the protective carryover election and the affirmative
action carryover election are made, subdivision (iii) of this paragraph
(f)(6) describes the corporations and acquisitions to which those
elections apply, and subdivision (iv) of this paragraph (f)(6) describes
the consequences of those elections.
(ii) Procedure for making protective carryover election and
affirmative action carryover election.
Question 1: How is the protective carryover election made for T?
Answer 1: (i) Filing procedure. The protective carryover election
is made in the form of a statement of protective carryover election
(''protective carryover election statement'') filed within the period
during which an express election may be made for T. A protective
carryover election statement that is filed before July 1, 1986 must be
filed with each Internal Revenue Service Center with which a corporation
required to join in making the protective carryover election files its
annual income tax return. A protective carryover election statement
that is filed on or after January 1, 1987, must be filed with the
District Director (Attention: Chief of Examination) for each internal
revenue district in which a corporation required to join in making the
protective carryover election would file its income tax return if
1.6091-2 (b) applied. A protective carryover election statement that is
filed on or after July 1, 1986 and before January 1, 1987, may be filed
in either of the places described in the preceding two sentences. For
place to file in certain cases if the purchasing corporation is a
foreign corporation, see 1.338-1T (k)(1).
(ii) Corporations required to join in making protective carryover
election -- (A) General rule. Subject to two exceptions, each
corporation included in the P group at any time during so much of T's
consistency period as ends on the day the protective carryover election
statement is filed is required to join in making the protective
carryover election.
(B) Exception for certain prior P group members. A corporation that
ceases to be a P group member prior to the day on which the protective
carryover election statement is filed is not required to join in making
the protective carryover election if it did not make a tainted asset
acquisition while a member of the P group. (Caution should be exercised
when relying on this exception, since it is not always clear whether an
asset acquisition is a tainted asset acquisition.)
(C) Certain foreign P group members. A foreign P group member is not
required to join in making the protective carryover election unless (1)
it is subject to United States tax (within the meaning of
1.338-1T(k)(2)(v)) for its taxable year in which the protective
carryover election statement is filed or for any prior taxable year any
day of which occurs during the consistency period, (2) it purchases any
of the stock included in the qualified stock purchase of T or of an
affected target, or (3) it directly or indirectly (in the manner
described in section 958(a)) holds stock in a foreign P group member
that satisfies one or both of the two preceding conditions. A foreign P
group member that is not required to join in making the protective
carryover election (''nonjoining member'') nonetheless must be
identified in that election as if it were so required (such as by a
footnote system). In addition, tainted asset acquisitions by a
nonjoining member shall be treated as asset acquisitions subject to an
affirmative action carryover election unless that member actually joins
in making the election, i.e., unless a representative of that member
signs the election on that member's behalf. The District Director shall
not have authority, however, to impose a deemed election under section
338(e)(1) in the event of a tainted asset acquisition by a nonjoining
member that is treated as subject to an affirmative action carryover
basis election pursuant to the preceding sentence.
(D) U.S. shareholders of CFC P group member may act on its behalf. A
P group member that is a controlled foreign corporation will be
considered to have joined in making the protective carryover election if
its U.S. shareholders sign the protective carryover election statement
in its behalf. For purposes of this subdivision (D), the principles of
1.338-1T(k)(4) (section 338 election made by U.S. shareholders) apply.
(iii) Contents of protective carryover election statement -- (A)
General rule. The protective carryover election statement must be
identified prominently as a protective carryover election under
1.338-4T(f)(6) and must contain the name, address, and employer
identification number of T and of each other corporation required to
join in making the election. A protective carryover election statement
that is filed on or after July 31, 1986 also must identify the
purchaser(s) of T. In addition, the protective carryover election
statement must contain the following declaration (or a substantially
similar declaration):
''EACH CORPORATION MAKING THIS ELECTION AGREES, WITH RESPECT TO ASSET
ACQUISITIONS SUBJECT TO THE PROTECTIVE CARRYOVER ELECTION, TO BE BOUND
BY THE TERMS AND CONDITIONS IMPOSED BY 1.338-4T(f)(6) NOTWITHSTANDING
ANY OTHER PROVISION OF THE INTERNAL REVENUE CODE (OR OTHER APPLICABLE
STATUTE) OR THE REGULATIONS ISSUED THEREUNDER. EACH SUCH CORPORATION
FURTHER AGREES TO CAUSE SUBSEQUENT P GROUP MEMBERS ACQUIRED DURING THE
CONSISTENCY PERIOD OF ANY AFFECTED TARGET TO FILE A SUPPLEMENTAL
STATEMENT.''
Finally, the protective carryover election statement must be signed,
in the manner prescribed in 1.338-1T(d)(1)(v) (for a statement of
section 338 election), by a person authorized to make the protective
carryover election on behalf of each corporation required to join in
making the election.
(B) Additional contents required for offset prohibition election. If
the P group wishes to make an offset prohibition election for T, the
protective carryover election statement must contain, in addition to the
material described in subdivision (iii)(A) of this Answer 1, a statement
indicating that an offset prohibition election is made for T. For the
consequences of an offset prohibition election, see Answer 2 (ii) and
Answer 3 (iv) of paragraph (f)(6)(iv) of this section.
(C) Schedule of information relating to corporations subject to
protective carryover election A schedule providing the information
specified in this subdivision (C) (''required data'') must be attached
to the protective carryover election statement. Failure to attach the
schedule, however, will not invalidate the protective carryover
election. The schedule must satisfy the following requirements:
(1) It must contain the name, address, and employer identification
number (if any) of, and (for a foreign corporation) the country (and
further political subdivision, if relevant) under the laws of which is
organized, each corporation that, as of the day the protective carryover
election statement is filed, is an affected target (''includible
affected target'').
(2) It must disclose the fair market value of the consideration paid
by the purchasing corporation for the stock of each directly acquired
target, i.e., the original target and each includible affected target
(other than an includible affected target for which a qualified stock
purchase would occur solely by reason of section 338 (a)(2) and
(h)(3)(B)).
(3) It must identify the portion of the consideration paid for the
stock of each directly acquired target that is represented by cash,
purchase money debt, and other components of consideration (with each
such other component separately stated).
(4) It must disclose the liabilities of the original target and each
includible affected target (whether or not a directly acquired target)
as of the close of the acquisition date (or as of the close of the day
that would be the acquisition date if an express election were made).
Question 2: What is the procedure for filing the supplemental
statement referred to in Answer 1 (iii)(A) of this paragraph (f)(6)(ii)?
Answer 2: (i) Who must file. The supplemental statement must be
filed for any P group member that becomes a member during the
consistency period of any affected target and after a protective
carryover election statement for the P group has been filed. Failure to
file the supplemental statement, however, will not invalidate the
protective carryover election.
(ii) Filing procedure. The supplemental statement is filed in the
place(s) where a protective carryover election statement would be filed,
under Answer 1 (i) of this paragraph (f)(6)(ii), on the date the
supplemental statement is filed. The supplemental statement must be
filed on or before the 15th day of the 9th calendar month beginning
after the month in which the P group member for which the supplemental
statement is made joined the P group.
(iii) Contents of supplemental statement. The supplemental statement
must be identified prominently as a supplemental statement under
1.338-4T(f)(6) and must contain the name, address, and employer
identification number of the target for which the protective carryover
election was made and of the P group member for which the supplemental
statement is made. In addition, the supplemental statement must contain
the declaration described in Answer 1 (iii)(A) of this paragraph
(f)(6)(ii) and must indicate that a copy of the previously filed
protective carryover election statement is attached to and incorporated
by reference as a part of the supplemental statement. Finally, the
supplemental statement must be signed, in the manner prescribed in
1.338-1T(d)(1)(v) (for a statement of section 338 election), by a person
authorized to make the supplemental statement for the P group member for
which the supplemental statement is made. A copy of the protective
carryover election statement (and, if applicable, the schedule described
in subdivision (iv) of this Answer 2) must be attached to the
supplemental statement.
(iv) Schedule of information relating to targets subject to
protective carryover election. The schedule described in Answer 1
(iii)(C) of this paragraph (f)(6)(ii) must be attached to the
supplemental statement. That schedule must include the required data
for T and for each corporation that is an affected target as of the day
the supplemental statement is filed. The schedule need not be attached
to the supplemental statement if it would be identical to a schedule
already received by each Service Center or District Director with which
the supplemental statement is required to be filed.
Question 3: Under what circumstances is the affirmative action
carryover election made for T?
Answer 3: (i) General rule. An affirmative action carryover
election is made for T on the first day on which all of the following
three requirements are satisfied:
(A) A P group member made a tainted asset acquisition.
(B) Neither a section 338 election nor a protective carryover
election is made by P with respect to T.
(C) The time to make a protective carryover election for T has
expired.
(ii) Offset prohibition election and special increase in basis of
transferee member stock inapplicable. An offset prohibition election
under this paragraph (f)(6) cannot be made and the special increase in
basis of transferee member stock under this paragraph (f)(6)(iv) Answer
1 (i)(B) is not available in connection with an affirmative action
carryover election.
(iii) Discretion of District Director to impose deemed election under
section 338(e)(1) in lieu of affirmative action carryover election.
Under the circumstances described in paragraph (f)(1)(ii) Answer 1 of
this section, the District Director may override the affirmative action
carryover election and impose a deemed election under section 338(e)(1)
in lieu of that affirmative action carryover election.
Example (1). On January 1, 1985, P purchases all of the stock of T
in a qualified stock purchase. P makes neither a section 338 election
nor a protective carryover election for T. On December 15, 1985, P
purchases an asset from T for cash in a tainted asset acquisition.
Accordingly, an affirmative action carryover election is made for T on
December 15, 1985. Under the circumstances described in paragraph
(f)(1)(ii) Answer 1 of this section, however, a deemed election under
section 338(e)(1) will be made for T in lieu of the affirmative action
carryover election if the District Director determines that such a
deemed election is appropriate to carry out the purposes of the
consistency rules of section 338 (e), (f), or (i).
Example (2). Assume the same facts as in Example (1), except that
the asset acquisition on December 15, 1985, is subject to an exception
(other than the carryover basis election exception of this paragraph
(f)(6)) to section 338(e)(1) (e.g., the de minimis exception of
paragraph (f)(7) of this section). An affirmative action carryover
election is not made for T on December 15, 1985.
(iii) Corporations and acquisitions subject to protective or
affirmative action carryover election.
Question 1: What targets and other P group members are subject to a
protective or an affirmative action carryover election for T?
Answer 1: (i) Targets subject to protective or affirmative action
carryover election. A protective or an affirmative action carryover
election for T also applies to all affected targets.
(ii) Other P group members subject to protective or affirmative
action carryover election. All other members of the P group, including
members that join the group after the protective or affirmative action
carryover election is made, are subject to the election.
Example. (i) T, T1, and T2 are wholly-owned, first-tier subsidiaries
of S. On January 1, 1985, P purchases all of the stock of T in a
qualified stock purchase. On April 1, 1985, S acquires a new
wholly-owned subsidiary, Z. On June 15, 1985, P purchases all of the
stock of T1 in a qualified stock purchase. On July 15, 1985, P
purchases all of the stock of Z in a qualified stock purchase. On
September 1, 1985, a protective carryover election is made for T. On
August 1, 1986, P purchases all of the stock of T2 in a qualified stock
purchase. All members of the P group are included in a single
consolidated return.
(ii) The protective carryover election made for T also applies to T1
and Z, since T1 and Z are affected targets. Although Z is not a target
affiliate of T and therefore would not directly be subject to a deemed
election under section 338(f)(1) in the event of a section 338 election
for T, Z is subject to the protective carryover election because a
section 338 election for T indirectly would cause a deemed election for
Z: A section 338 election for T would cause a deemed election under
section 338(f)(1) for T1, and, since Z is a target affiliate of T1 and
was acquired during T1's consistency period, the deemed election for T1
would cause a deemed election for Z. Assuming that the consistency
periods for the targets are not extended pursuant to paragraph (g)(1) of
this section, T2 is not subject to the protective carryover election,
since a section 338 election for T would not cause a deemed election for
T2.
Question 2: What asset acquisitions are subject to a protective or
an affirmative action carryover election for T?
Answer 2: (i) General rule. An asset acquisition is subject to a
protective or an affirmative action carryover election for T (i.e., to
the carryover basis election exception) and therefore to the
consequences imposed by this paragraph (f)(6), if --
(A) The asset is acquired by P (or another member of the P group)
from T, an affected target, a target affiliate of T, or a target
affiliate of an affected target, and
(B) With respect to T or any affected target, the acquisition is a
tainted asset acquisition.
(ii) Coordination with de minimis exception. Notwithstanding that an
asset acquisition is subject to the de minimis exception to section
338(e)(1) under paragraph (f)(7) of this section, that acquisition is
subject to a protective or an affirmative action carryover election for
T (and therefore to the consequences imposed by this paragraph (f)(6)).
(iv) Consequences of protective or affirmative action carryover
election.
Question 1: What are the consequences of an unincluded company asset
acquisition (''UCA acquisition''), i.e., the acquisition of an asset by
a P group member (''acquiring member'') from T or a target affiliate of
T (''U'') in a case in which the acquisition (i) is subject to a
protective or an affirmative action carryover election and (ii) occurs
while U is not a member of the P group?
Answer 1: (i) General rule -- (A) Carryover basis to acquiring
member. For all purposes of the Code, the acquiring member's basis in
an asset acquired in a UCA acquisition (''UCA asset'') is the adjusted
basis of that asset in the hands of U immediately before the transfer.
(B) Special increase in basis of transferee member stock. If the
acquiring member in a UCA acquisition transfers the UCA asset to T or
any other P group member (''transferee member'') within the permissible
transfer period (1) in a transaction to which section 351 applies, (2)
as paid-in surplus, or (3) as a contribution to capital, then that
acquiring member's basis in transferee member stock will be increased by
the special adjustment amount. The ''special adjustment amount'' is the
excess (if any) of the basis the acquiring member would have taken in
the UCA asset absent subdivision (i)(A) of this Answer 1 over the
transferee member's basis in the asset immediately after the transfer.
This increase for the special adjustment amount is made in addition to
any other adjustment to the acquiring member's basis in its transferee
member stock that (without this subdivision (i)(B)) results from the
transfer to the transferee member.
(C) Permissible transfer period. The stock basis increase for the
special adjustment amount is permitted only if the transfer to the
transferee member occurs on or before the latest of the following three
dates: (1) July 15, 1986, (2) the 90th day after the date on which the
acquiring member acquires the UCA asset, or (3) the 15th day of the 9th
month beginning after the month in which the acquisition date of the
original target occurs.
(D) Special increase in basis of transferee member stock applicable
only if protective carryover election made. The stock basis increase
for the special adjustment amount is permitted only if the UCA
acquisition is subject to a protective carryover election.
(ii) Exception for transfer of UCA asset prior to U's acquisition
date in certain cases. If the UCA acquisition occurs in a taxable year
of U that ends after U's acquisition date, then subdivision (i) of this
Answer 1 does not apply to that UCA acquisition, the UCA asset is
considered an INA asset subject to Answer 2 of this paragraph
(f)(6)(iv), and gain on the transfer is considered INA gain subject to
that Answer 2.
Example (1). (i) On January 1, 1985, P acquires all of the stock of
T from S in a qualified stock purchase for $100,000. P makes a
protective carryover election for T. On December 31, 1985, P purchases
a machine from S in an asset acquisition that is subject to the
protective carryover election. P pays $1,000 in cash for the machine
and assumes a liability of $600 that encumbers the machine. S had an
adjusted basis for the machine immediately before the transfer of $250.
P immediately transfers the machine to T in a transaction governed by
sections 351 and 357(c).
(ii) Pursuant to the protective carryover election, P's basis in the
machine is $250, the adjusted basis of the machine in the hands of S. P
recognizes a gain of $350 under section 357(c) on the transfer of the
machine to T, i.e., the excess of the $600 liability assumed over P's
$250 basis in the machine. Thus, T's basis in the machine after the
transfer is $600, i.e., P's $250 basis in the machine plus P's $350 gain
on the transfer to T. Section 362(a). Because P transfers the machine
to T within the permissible transfer period, P's adjusted basis in T
stock is increased by the special adjustment amount. The special
adjustment amount is $1,000, since the basis P would have taken in the
machine absent the protective carryover election ($1,600, i.e., $1,000
cash paid plus the $600 liability assumed) exceeds by $1,000 T's basis
in the machine immediately after the transfer ($600). Under these
facts, no adjustment to P's basis in T stock other than the increase for
the special adjustment amount is permitted. (Under section 358(a)(1),
P's basis in T stock is increased by zero, i.e., P's basis in the
transferred machine ($250), plus P's recognized gain ($350), minus the
liability assumed ($600).) Accordingly P's adjusted basis in T stock
after the transfer to T is $101,000, i.e., $100,000+$1,000.
Example (2). Assume the same facts as in Example (1). Assume in
addition that, immediately after P's transfer of the machine to T, T
transfers the machine to its wholly-owned subsidiary, T1. No special
increase in T's basis in T1 stock is permitted since T was not the
acquiring member in the UCA acquisition within the meaning of this
Answer 1.
Question 2: What are the consequences of an intercompany
non-consolidated asset acquisition (''INA acquisition''), i.e., the
acquisition of an asset by a P group member (''acquiring member'') from
T or a target affiliate of T (''N'') in a case in which the acquisition
(i) is subject to a protective or an affirmative action carryover
election and (ii) occurs while N is a member of the P group and during a
taxable year for which N is not included in a consolidated return with
the acquiring member?
Answer 2: (i) Carryover basis to acquiring member. For all purposes
of the Code, the acquiring member's basis in an asset acquired in an INA
acquisition (''INA asset'') is the adjusted basis of that asset in the
hands of N immediately before the transfer.
(ii) Exception if INA acquisition is subject to offset prohibition
election -- (A) Offset prohibition for INA gain; carryover basis rule
inapplicable. For purposes of determining N's taxable income, gain
recognized by N in an INA acquisition (''INA gain'') may not be offset
by any deductions of N for the taxable year if an offset prohibition
election was made in a timely filed protective carryover election for T
and if subdivision (iii) of this Answer 2 does not apply (''offset
prohibition''). The offset prohibition does not apply for purposes of
calculating the earnings and profits of N (other than the earnings and
profits reduction for N's tax liability). If INA gain is subject to the
offset prohibition, then the INA acquisition to which that INA gain
relates is not subject to the carryover basis rule of subdivision (i) of
this Answer 2.
(B) Limitation on application of certain credits. For purposes of
determining the amount of a restricted credit permitted as a credit
against N's tax liability for N's taxable year in which there is INA
gain subject to the offset prohibition, N's pre-credit tax liability is
calculated as if that INA gain were not income to N. ''Restricted
credits'' are credits against tax described in part IV (other than
subparts A and C thereof and section 27(a)) of subchapter A of chapter 1
of the Code (i.e., sections 27(b), 28-30, and 38-41). For a separate
restriction applicable to the foreign tax credit and for a special rule
coordinating that restriction with this subdivision (B), see
1.338-5T(d)(2).
(C) Character and timing of INA gain. INA gain subject to the offset
prohibition is ordinary income if the INA asset to which it relates is
of a character that is subject to the allowance for depreciation,
amortization, or depletion in the hands of the acquiring member. In
addition, INA gain subject to the offset prohibition may not be
recognized under the installment method.
(iii) Subdivision (ii) inapplicable if gain realized by N is not
required to be recognized. If, pursuant to any provision of the Code
(or other applicable statute) or the regulations thereunder (other than
provisions relating to recognition of income under the installment
method), all or a portion of the gain realized by N in an INA
acquisition is not required to be recognized by N at the time of the
acquisition, then --
(A) The carryover basis rule of subdivision (i) of this Answer 2
applies to that INA acquisition notwithstanding an otherwise applicable
offset prohibition election, and
(B) Subdivision (ii) of this Answer 2 does not apply to that INA
acquisition.
Question 3: What are the consequences of an intercompany
consolidated asset acquisition (''ICA acquisition''), i.e., the
acquisition of an asset by a P group member (''acquiring member'') from
T or a target affiliate of T (''C'') in a case in which the acquisition
(i) is subject to a protective or an affirmative action carryover
election and (ii) occurs while C is a member of the P group and during a
taxable year for which C is included in a consolidated return with the
acquiring member?
Answer 3: (i) Consolidated return intercompany transaction rules
generally apply. Subject to the limitations of this Answer 3,
1.1502-13 of the consolidated return regulations (relating to
intercompany transactions) applies to an ICA acquisition.
(ii) Periodic restoration limitation for property subject to
depreciation, etc. -- (A) General rule. Under the periodic restoration
limitation --
(1) The annual disregarded ICA gain amount is not taken into account
as income in determining the separate taxable income of C (or of any
other P group member) under 1.1502-12 and
(2) The annual disregarded ICA deduction is not taken into account as
a deduction in determining the separate taxable income of the acquiring
member (or of any other P group member) under 1.1502-12.
(B) Annual disregarded ICA gain amount; annual disregarded ICA
deduction. The ''annual disregarded ICA gain amount'' is the deferred
gain in an ICA acquisition that, absent this Answer 3, would be restored
during the taxable year to C's income under 1.1502-13(d) (relating to
periodic restoration of deferred gain for property subject to
depreciation, etc.). The ''annual disregarded ICA deduction'' is so much
of the acquiring member's depreciation, amortization, or depletion
deduction for the ICA asset as does not exceed the annual disregarded
ICA gain amount with respect to that ICA asset.
(C) Exceptions. The periodic restoration limitation does not apply
for purposes of calculating --
(1) The earnings and profits of P group members (other than the
earnings and profits reduction for tax liability);
(2) The remaining balance of C's deferred gain in the ICA
acquisition; and
(3) The acquiring member's adjusted basis in the asset acquired in
the ICA acquisition.
(iii) Limitations if C ceases to be a member and offset prohibition
election does not apply -- (A) In general. The consequences of an ICA
acquisition if C ceases to be a member of the P group are governed by
this subdivision (iii) if an offset prohibition election was not made
for T.
(B) Application of periodic restoration limitation. For the
consolidated return year in which C ceases to be a member of the P
group, the periodic restoration limitation of subdivision (ii) of this
Answer 3 applies to C and the acquiring member to the extent that there
is an annual disregarded ICA gain amount for that taxable year.
(C) Reduction in basis of ICA asset by amount of remaining ICA gain
amount. For all purposes of the Code, the acquiring member's basis in
an asset acquired in an ICA acquisition (''ICA asset'') is reduced by
the remaining ICA gain amount. The ''remaining ICA gain amount'' is C's
deferred gain with respect to the ICA asset that is restored to C's
income by reason of 1.1502-13(f)(1)(iii) because C ceases to be a
member of the group.
(iv) Limitations if C ceases to be a member and offset prohibition
election applies -- (A) In general. The consequences of an ICA
acquisition if C ceases to be a member of the P group are governed by
this subdivision (iv) if an offset prohibition election was made in a
timely filed protective carryover election for T.
(B) Application of periodic restoration limitation. Subdivision
(iii)(B) of this Answer 3 (relating to the application of the periodic
restoration limitation for the taxable year in which C ceases to be a
member of the P group) also applies to an ICA acquisition that is
subject to this subdivision (iv).
(C) Offset prohibition for remaining ICA gain amount; reduction in
basis rule inapplicable. For purposes of determining the P group's
consolidated taxable income, the remaining ICA gain amount (as defined
in subdivision (iii)(C) of this Answer 3) may not be offset by any
deductions of any P group members for the taxable year if an offset
prohibition election was made in a timely filed protective carryover
election for T (''offset prohibition''). The offset prohibition does
not apply for purposes of calculating the earnings and profits of P
group members (other than the earnings and profits reduction for tax
liability). If a remaining ICA gain amount is subject to the offset
prohibition, then the ICA acquisition to which that remaining ICA gain
amount relates is not subject to the reduction in basis rule of
subdivision (iii)(C) of this Answer 3.
(D) Limitation on application of certain credits. For purposes of
determining the amount of a restricted credit permitted as a credit
against the P group's consolidated tax liability for a taxable year in
which there is a remaining ICA gain amount subject to the offset
prohibition, the P group's pre-credit consolidated tax liability is
calculated as if that remaining ICA gain amount were not income to the P
group. ''Restricted credits'' are credits against tax described in part
IV (other than subparts A and C thereof and section 27(a)) of subchapter
A of chapter 1 of the Code (i.e., sections 27(b), 28-30, and 38-41).
For a separate restriction applicable to the foreign tax credit and for
a special rule coordinating that restriction with this subdivision (D),
see 1.338-5T(d)(2).
(E) Character of remaining ICA gain amount. A remaining ICA gain
amount subject to the offset prohibition is ordinary income if the ICA
asset to which it relates is of a character that is subject to the
allowance for depreciation, amortization, or depletion in the hands of
the acquiring member.
(F) Remaining ICA gain amount not considered C's income for purposes
of loss or credit carryovers from separate return limitation years. For
purposes of determining the amount of a loss or credit of C arising in a
separate return limitation year of C (or of a predecessor of C) that may
be included in the consolidated carryover of such losses or credits to
the consolidated return year in which there is a remaining ICA gain
amount subject to the offset prohibition, that remaining ICA gain amount
is considered an item of income of a P group member other than C.
(G) Recapture of investment tax credit on ICA asset. For purposes of
investment tax credit recapture under 1.1502-3(f)(2), the P group
member acquiring an ICA asset from C is deemed to dispose of that asset
not later than the day on which the remaining ICA gain amount with
respect to that ICA asset is restored to C's income if that remaining
ICA gain amount is subject to the offset prohibition.
(v) Gain on ICA acquisition that is restored pursuant to
1.1502-13(f)(1)(vii) considered a remaining ICA gain amount. If C's
deferred gain in an ICA acquisition is restored to C's income under
1.1502-13(f)(1)(vii) because the P group files consolidated returns for
fewer than three consecutive taxable years immediately preceding a
separate return year of the common parent of the P group, then that
restored deferred gain is considered a remaining ICA gain amount for
purposes of applying this Answer 3.
(vi) Limitations when gain in an ICA acquisition is not deferred --
(A) General rule. If gain in an ICA acquisition is not deferred under
1.1502-13 (e.g., by reason of an election under 1.1502-13(c)(3) not to
defer gain on deferred intercompany transactions), then the provisions
of Answer 2 of this paragraph (f)(6)(iv) apply as if C were not included
in a consolidated return with the acquiring member for the taxable year
in which the asset acquisition occurs.
(B) Recapture of investment tax credit when gain in an ICA
acquisition is not deferred. For purposes of investment tax credit
recapture under 1.1502-3(f)(2) in the case of an ICA acquisition with
respect to which gain is not deferred under 1.1502-13, the P group
member acquiring the ICA asset from C is deemed to dispose of that asset
not later than the day on which C ceases to be a member of the P group,
provided that C ceases to be a member under circumstances that would
cause the restoration of deferred gain under 1.1502-13(f)(1)(iii) (had
there been deferred gain subject to that restoration rule).
Example (1). (i) In 1984, C, a calendar year corporation, sustains a
$450 net operating loss that is not a net operating loss carryback to
any preceding taxable year. On January 1, 1985, C purchases for $20,000
an item of intangible property with a remaining useful life as of that
date of five years. The property has no salvage value. In its 1985
return, C reports an allowance for depreciation on the intangible
property of $4,000 under the straight line method (i.e., $20,000/5),
thereby reducing its adjusted basis to $16,000. C's 1985 taxable income
before the net operating loss deduction is $50. Accordingly, $50 of the
1984 net operating loss is allowed as a net operating loss carryover to
1985.
(ii) P, a calendar year common parent of an affiliated group that
files consolidated returns, purchases all of the stock of C in a
qualified stock purchase at the close of December 31, 1985, and makes a
protective carryover election for C. An offset prohibition election is
not made in the protective carryover election statement. See Answer 1
(iii)(B) of paragraph (f)(6)(ii) of this section. On January 1, 1986, P
purchases the intangible property from C in an ICA acquisition for
$22,000. The ICA acquisition is a deferred intercompany transaction
under 1.1502-13, and C's $6,000 gain on the ICA acquisition (i.e.,
$22,000^$16,000) is a deferred gain. Absent this Answer 3, P would
report, in the 1986 consolidated return, an allowance for depreciation
on the intangible property (''ICA asset'') of $5,500 under the straight
line method, assuming a remaining useful life as of January 1, 1986, of
four years and no salvage value, i.e., $22,000/4. Similarly, absent this
Answer 3, $1,500 of C's $6,000 deferred gain would be restored to C's
income (as ordinary income) in 1986 by reason of P's $5,500 deduction,
i.e., $6,000 $5,500/$22,000. See 1.1502-13(c)(4)(ii) and (d)(1).
Assume that, absent this Answer 3, C's separate taxable income under
1.1502-12 for 1986 would be $1,500.
(iii) Pursuant to subdivision (ii)(A)(1) of this Answer 3, the $1,500
of deferred gain that, absent this Answer 3, would be restored to C's
income in 1986 pursuant to 1.1502-13(d)(1) is an annual disregarded ICA
gain amount that is not taken into account as income in determining C's
separate taxable income under 1.1502-12 for 1986. Thus, T's separate
taxable income for 1986 is $0. In addition, under subdivision
(ii)(A)(2) of this Answer 3, P's $5,500 deduction that, absent this
Answer 3, would have caused the annual disregarded ICA gain amount of
$1,500 to be restored to C's income in 1986 is not taken into account as
a deduction in determining P's separate taxable income under 1.1502-12
for 1986 to the extent of the annual disregarded ICA deduction of
$1,500, i.e., so much of the total $5,500 depreciation allowance as does
not exceed the annual disregarded ICA gain amount of $1,500. Thus, P
reports a deduction in 1986 with respect to the ICA asset of $4,000,
i.e., $5,500^$1,500. P's adjusted basis in the ICA asset, however, is
reduced by the entire $5,500 from $22,000 to $16,500. Because C's
separate taxable income for 1986 is $0, none of C's net operating loss
incurred in 1984, a separate return limitation year, can be a carryover
to 1986, since C does not make a contribution to the P group's
consolidated taxable income in 1986. See 1.1502-21(c)(2). At the
beginning of the following taxable year, the remaining balance of C's
deferred gain in the ICA acquisition is $4,500, i.e., $6,000^$1,500.
Example (2) (i) Assume the same facts as in Example (1). Assume in
addition that on January 1, 1987, an individual purchases all of the
stock of C from P. Accordingly, all of C's remaining deferred gain in
the ICA acquisition ($4,500) is restored to C's income in the P group's
1987 consolidated return by reason of 1.1502-13(f)(1)(iii). Assume
that C has no other items of income or deduction while a member of the P
group during 1987. Thus, C's only item of income or loss for that
period is the restored deferred gain of $4,500. Assume in addition
that, absent this Answer 3, P's separate taxable income for 1987 would
be a loss of $4,500, reflecting a deduction of $5,500 for the ICA asset,
i.e., $16,500/3. All other P group members break even for the year.
(ii) The $4,500 of deferred gain that is restored to C's income in
1987 by reason of 1.1502-13(f)(1)(iii) is a remaining ICA gain amount.
Because the ICA acquisition is not subject to an offset prohibition
election, P must reduce its basis in the ICA asset by $4,500 (i.e., by
the remaining ICA gain amount) as of January 1, 1987. See subdivision
(iii)(C) of this Answer 3. Accordingly, P's deduction in 1987 for the
ICA asset is reduced by $1,500 from $5,500 to $4,000, i.e.,
($16,500^$4,500)/3. P's separate taxable income for 1987, as adjusted
for the basis adjustment, therefore is a loss of $3,000, i.e., the loss
of $4,500 (P's separate taxable income for 1987 absent this Answer 3),
reduced by $1,500. The remaining ICA gain amount of $4,500 is income
reported in the P group's 1987 consolidated return. Accordingly, the
P's group's consolidated taxable income for 1987 (computed without the
consolidated net operating loss deduction) is $1,500, i.e., C's income
of $4,500 minus P's loss of $3,000.
(iii) Since C's limitation under 1.1502-21(c) exceeds $400, all of
C's $400 net operating loss incurred in 1984, a separate return
limitation year, may be included in the P group's consolidated net
operating loss carryover to 1987. Assuming that no other net operating
losses are available for inclusion in that carryover, the P group's
consolidated taxable income for 1987 after reduction for that carryover
is $1,100, i.e., $1,500 minus $400.
Example (3). (i) Assume the same facts as in Example (2), except
that the ICA acquisition is subject to an offset prohibition election.
All of the consequences described in Example (1) and Example (2) apply,
except that P's adjusted basis in the ICA asset is not reduced as of
January 1, 1987, by the remaining ICA gain amount and, as explained
below, none of C's 1984 net operating loss is a carryover to 1987. In
addition, four other potential consequences attend the ICA acquisition.
(ii) First, the remaining ICA gain amount of $4,500 is ordinary
income to the P group that may not be offset by any deductions of C or
any other P group member for 1987 (including C's $400 remaining portion
of the net operating loss incurred in 1984). Thus, notwithstanding that
the aggregate of taxable income and loss of P group members in 1987 is
$0 (i.e., C's income of $4,500 minus P's loss of $4,500), the P group is
considered to have a consolidated taxable income in 1987 of $4,500 (the
remaining ICA gain amount). See subdivision (iv)(C) of this Answer 3.
In addition, however, the P group is considered to incur a consolidated
net operating loss in 1987 of $4,500, i.e., P's loss in 1987 of $4,500
that may not be used to offset C's remaining ICA gain amount of $4,500
because of the offset prohibition election. That consolidated net
operating loss may be applied to reduce income in other taxable years
pursuant the applicable carryover and carryback rules.
(iii) Second, for purposes of determining the amount of any
restricted credit (as defined in subdivision(iv)(D) of this Answer 3)
permitted as a credit against the P group's consolidated tax liability
for 1987, the pre-credit consolidated tax ability is calculated as if
the remaining ICA gain amount of $4,500 were not income to the P group
has no income (and therefore no pre-credit tax liability) in 1987 absent
the remaining ICA gain amount. Thus, the P group's 1987 tax liability
may not be reduced by restricted credits. Credits that, by reason of
this Answer 3, cannot be applied to reduce the P group's consolidated
tax liability in a taxable year in which there is a remaining ICA gain
amount subject to the offset prohibition nevertheless may be applied to
reduce tax liability in other taxable years pursuant to the applicable
carryover and carryback rules for the particular credit.
(iv) Third, the remaining ICA gain amount is considered an item of
income of a P group member other than C for purposes of determining the
amount of a loss or credit of C arising in a separate return
limitationyear that may be included in the consolidated carryover of
such a loss or credit to 1987. This rule is irrelevant under the facts
of this Example (3), however, since the P group's entire consolidated
taxable income for 1987, $4,500, may be offset by no deductions
otherwise available to the P group and since the P group's consolidated
tax liability before restricted credits is a negative amount for
purposes of restricted credit carryovers.
(v) Fourth, if the ICA asset were tangible property eligible for the
investment tax credit, investment tax credit recapture could occur in
1987.
(7) De minimis exception under section 338(e)(2)(D).
Question 1: Does an exception to section 338(e)(1) apply under the
authority of section 338(e)(2)(D) if P (or any other member of the P
group) acquires a de minimis amount of assets from T (or a target
affiliate of T)?
Answer 1: Yes.
Question 2: When does the de minimis exception apply?
Answer 2: (i) General rule. The de minimis exception applies only
if the de minimis amount equals or exceeds the aggregate gross fair
market value of all assets acquired in acquisitions that, with respect
to T or any affected target, are described in section 338(e)(1) and are
not subject to an exception to section 338(e)(1) (other than the
carryover basis election exception of paragraph (f)(6) of this section
or this de minimis exception). The ''gross fair market value'' of an
asset is the fair market value of that asset without regard to
liabilities. For the effect of a protective or an affirmative action
carryover election on the de minimis exception, see paragraph
(f)(6)(iii) Answer 2 (ii) of this section.
(ii) De minimis amount. The ''de minimis amount'' is the lesser of
(A) the sum of the five percent amounts for T and all affected targets
or (B) $50,000. The ''five percent amount'' for a target (i.e., either
T or an affected target) is an amount equal to five percent of the sum
of (A) the target's grossed-up stock basis and (B) the target's
liabilities on the acquisition date (not including tax liabilities that
would arise if a section 338 election were made for the target). The
target's grossed-up stock basis for this purpose is the amount
determined under section 338(b)(1) (applied as if the basis of
nonrecently purchased target stock were determined under section
338(b)(3)(B)).
Example (1). (i) On December 31, 1985, T and T1 are wholly-owned
subsidiaries of S. On January 1, 1986, P acquires all of the stock of T
in a qualified stock purchase. On June 1, 1986, P acquires all of the
stock of T1 in a qualified stock purchase. On December 1, 1986, P
acquires all of the stock of X from S in a qualified stock purchase. S
previously acquired X on April 1, 1986, i.e., after T was sold by S but
before T1 was sold by S. P makes neither an express election nor a
protective carryover election for T. On May 1, 1986, P purchases an
asset from T (''T asset''). The T asset has a fair market value of
$30,000 and is subject to a liability of $10,000. On August 1, 1987, P
purchases an asset from X (''X asset''). The X asset has a fair market
value of $25,000 and is subject to no liabilities. Assume that both
asset acquisitions are described in section 338(e)(1) and are not
subject to an exception to section 338(e)(1) (other than the carryover
basis election exception of paragraph (f)(6) of this section or this de
minimis exception). Assume in addition that the five percent amount for
each of the targets (i.e., T, T1, and X) exceeds $50,000.
(ii) T1 and X are affected targets with respect to T, since a deemed
election would occur for those corporations in the event of a section
338 election for T. (Note that X is an affected target with respect to
T even though X is not a target affiliate of T.) The de minimis amount
is $50,000, i.e., the lesser of the sum of the five percent amounts for
T, T1, and X or $50,000. The May 1, 1986, asset acquisition, standing
alone, does not exceed the de minimis amount under these facts, since it
does not exceed $50,000. By reason of the August 1, 1987, asset
acquisition from X, however, the de minimis amount is exceeded, since
the gross fair market value of the T and X assets exceeds $50,000, i.e.,
$55,000 ($30,000+$25,000). As a result, neither asset acquisition is
subject to the de minimis exception. Note that T is thereby affected by
P's acquisition of the X asset even though that acquisition occurs after
T's consistency period (assuming that period is not extended pursuant to
paragraph (g)(1) Answer 1 of this section) and even though P acquires
the asset from a corporation that is not a target affiliate of T.
Example (2). (i) Assume the same facts as in Example (1), except
that (A) the August 1, 1987, asset acquisition does not occur and (B)
the five percent amounts for T, T1, and X are $15,000, $10,000, and
$40,000, respectively.
(ii) The May 1, 1986, asset acquisition exceeds the de minimis amount
as of that day, since the $30,000 gross fair market value of the T asset
exceeds the de minimis amount (as of that day) of $15,000, i.e., the
lesser of the five percent amount for T or $50,000. As of May, 1, 1986,
the de minimis exception therefore does not apply to the asset
acquisition. The qualified stock purchase of the stock of T1 does not
change this result, since the qualified stock purchase increases the de
minimis amount only to $25,000 (i.e., the lesser of the five percent
amounts for T and T1 or $50,000), which is less than the $30,000 gross
fair market value of the T asset. By reason of the qualified stock
purchase of the stock of X on December 1, 1986, however, the May 1,
1986, asset acquisition does not exceed the de minimis amount, which, as
of December 1, 1986, is $50,000, i.e., the lesser of the five percent
amounts for T, T1, and X or $50,000. Accordingly, the May 1, 1986,
asset acquisition is subject to the de minimis exception.
(g) Special consistency rules -- (1) Extension of consistency period
and 12-month acquisition period in certain cases.
Question 1: Under what circumstances is T's consistency period
extended under section 338(h)(4)(B) beyond the period specified in
section 338(h)(4)(A) (''normal consistency period'')?
Answer 1: (i) Extension to period preceding normal consistency
period. T's consistency period extends beyond the normal consistency
period to include the day preceding that period on which a member of the
P group acquires an asset in a triggering asset acquisition, provided
that the Commissioner determines (on the basis of all of the facts and
circumstances) that a P group member had a plan in effect at the close
of the day of the triggering asset acquisition to make a qualified stock
purchase of T and that such plan remained in effect through T's
acquisition date.
(ii) Extension to period following normal consistency period. T's
consistency period extends beyond the normal consistency period to
include the later of the day following that period on which a P group
member either makes a qualified stock purchase of the stock of a target
affiliate of T or makes a triggering asset acquisition, provided that
the Commissioner determines (on the basis of all of the facts and
circumstances) that a P group member had a plan in effect at the close
of the normal consistency period to make such qualified stock purchase
or triggering asset acquisition, and that such plan remained in effect
through the subsequent qualified stock purchase or triggering asset
acquisition.
(iii) Triggering asset acquisition. An asset acquisition is a
''triggering asset acquisition'' if, had it occurred during the normal
consistency period, it would have been described in section 338(e)(1)
and would not have been subject to an exception (other than the
carryover basis election exception of paragraph (f)(6) of this section)
to section 338(e)(1).
Question 2: Under what circumstances is the 12-month acquisition
period extended beyond 12 months?
Answer 2: Under the authority of section 338(e)(3) and (i), the
12-month acquisition period is extended beyond 12 months if (i) pursuant
to a plan of the P group (as determined by the Commissioner on the basis
of all of the facts and circumstances), T stock purchased by P satisfies
the percentage ownership requirements of section 338(d)(3) by reference
to a period of time that exceeds 12 months (''extended period'') and
(ii) an extension of the 12-month acquisition period is necessary to
carry out the purposes of the consistency rules of section 338(e), (f),
or (i). If the requirements of the preceding sentence are satisfied,
the extended period is considered the ''12-month acquisition period.''
(2) Asset or stock acquisition by non-P group member considered an
acquisition by P group member in certain cases.
Question: Under what circumstances may the Commissioner treat an
acquisition by a person other than a P group member (''X'') of --
(i) an asset of T (or of a target affiliate of T) as an acquisition
of an asset of T (or of a target affiliate of T) by a P group member, or
(ii) stock in T (or in a target affiliate of T) as a purchase of
stock in T (or in a target affiliate of T) by a P group member?
Answer (i) Acquisition of an asset of T or its target affiliate. For
purposes of applying the consistency rules of section 338 (e), (f), and
(i), the Commissioner may treat the acquisition of an asset of T (or of
a target affiliate of T) by X as the acquisition of an asset of T (or of
a target affiliate of T) by a P group member if --
(A) P makes a qualified stock purchase of T stock,
(B) X acquires the asset of T (or of a target affiliate of T) during
T's consistency period,
(C) X transfers the asset to a P group member, or becomes a member of
the P group, during T's consistency period, and
(D) If X is not related to a P group member at the time it acquires
the asset, the Commissioner determines (on the basis of all of the facts
and circumstances) that the requirements described in subdivisions (B)
and (C) of this Answer (i) were satisfied pursuant to a single plan of
the P group.
(ii) Acquisition of stock in T (or its target affiliate). For
purposes of applying the consistency rules of section 338 (e), (f), and
(i), the Commissioner may treat a P group member as having acquired
stock in Y (i.e., T or a target affiliate of T) by purchase either on
the day a P group member acquires Y stock from X or on the day that X,
while holding Y stock, becomes a member of the P group if --
(A) X acquired the Y stock under such circumstances that, if X
(whether or not a corporation) were treated as a P group member at the
time X acquired that Y stock, a qualified stock purchase of the Y stock
(''hypothetical Y stock purchase'') would be made by the P group (on or
after the day X acquired that Y stock, and wholly or in part by reason
of X's acquisition of that Y stock),
(B) Either (1) a deemed election would be made for Y by the P group
(or could be made for Y by reason of section 338(e)(1) at the discretion
of the District Director) if the hypothetical Y stock purchase were an
actual qualified stock purchase of Y stock by the P group, or (2) a
section 338 election actually is made by the P group for any target that
would have been an affected target (''hypothetical affected target'') if
a section 338 election applied with respect to the P group's
hypothetical Y stock purchase,
(C) X transfers the Y stock to a P group member or becomes a member
of the P group during either (1) Y's consistency period (determined as
if the hypothetical Y stock purchase were an actual qualified stock
purchase of Y by the P group) or (2) the consistency period of a
hypothetical affected target for which a section 338 election actually
is made, and
(D) In the event that X is not related to a P group member at the
time it acquires the Y stock, the Commissioner determines (on the basis
of all of the facts and circumstances) that the requirements described
in subdivisions (A), (B), and (C) of this Answer (ii) were satisfied
pursuant to a single plan of the P group.
(iii) Other acquisitions. The Internal Revenue Service may treat any
indirect acquisition of an asset of T (or of a target affiliate of T) or
of stock in T (or in a target affiliate of T) as a direct acquisition of
such an asset or as a purchase of such stock by a P group member if such
treatment is appropriate to carry out the purposes of the consistency
rules of section 338 (e), (f), or (i). An indirect acquisition
includes, for example, the acquisition of such asset or stock by an
intermediary, such as a partnership or trust, in which a P group member
has an interest.
(iv) Operating rules for subdivision (ii) of this Answer -- (A)
Application of section 338(f). Under the authority of section 338 (f)
and (i), the P group is considered to have made a deemed election with
respect to its qualified stock purchase of the stock of Y if --
(1) That qualified stock purchase occurs in whole or in part by
reason of the operation of subdivision (ii) of this Answer,
(2) Subdivision (ii) of this Answer applies to Y by reason of an
actual section 338 election for a hypothetical affected target, and
(3) The acquisition date of that hypothetical affected target occurs
after the acquisition date of Y.
(B) Aggregation rule. In the event that acquisitions by two or more
persons in the aggregate would satisfy the requirements of subdivision
(ii) of this Answer, then all such persons shall be treated as a single
person for purposes of applying that subdivision.
(v) Special extension of consistency period and 12-month acquisition
period in appropriate cases. Under the authority of section 338 (e),
(f), (h)(4) (B), and (i), the consistency period and 12-month
acquisition period of any corporation affected by the provisions of this
Answer may be extended by the Internal Revenue Service whenever
appropriate to carry out the purposes of those provisions.
Example (1). On January 1, 1985, D, an individual unrelated to P,
acquires an asset of S for cash (''S asset''). On December 1, 1985, P
acquires all of the stock of T from S in a qualified stock purchase. P
makes neither an express election nor a protective carryover election
for T. On October 1, 1986 (i.e., during T's consistency period), P
acquires the S asset from D. Assume that the Commissioner determines,
on the basis of all of the facts and circumstances, that D's acquisition
of the S asset and D's subsequent transfer of the S asset to P occurred
pursuant to a single plan of the P group. For purposes of applying the
consistency rules of section 338 (e), (f), and (i), the Commissioner may
treat P as having acquired an asset of S.
Example (2). (i) On May 1, 1985, P acquires all of the stock of T
from S in a qualified stock purchase and makes an express election for
T. On June 1, 1985, B, an individual that is the sole shareholder of P,
acquires for cash from S all of the stock of Y, a target affiliate of T.
On December 1, 1985, B transfers the stock of Y to P.
(ii) For purposes of applying the consistency rules of section 338
(e), (f), and (i), the Commissioner may treat P as having acquired the Y
stock by purchase, since the three applicable requirements of
subdivision (ii) of this Answer are satisfied. First, if B were treated
as a corporation that was a member of the P group at the time of B's
acquisition of the Y stock, then a qualified stock purchase of Y stock
would be made by the P group on June 1, 1985. Accordingly, the
hypothetical Y stock purchase requirement is satisified. Second, had
the hypothetical Y stock purchase actually occurred, a deemed election
under section 338(f)(1) would be made for Y by reason of the P group's
express election for T. Third, B transfers the Y stock to P during Y's
consistency period (determined as if the hypothetical Y stock purchase
were an actual qualified stock purchase of Y by the P group). If the
Commissioner treats P as having acquired the Y stock by purchase under
these facts, then a P group member is considered to acquire all of the Y
stock in a qualified stock purchase on December 1, 1985, notwithstanding
that P acquires the stock from B, a person described in section
338(h)(3)(A)(iii), and therefore would not be considered to have
purchased that stock absent this Answer. If, pursuant to this Answer, P
is considered to have made a qualified stock purchase of the stock of Y,
then the express election for T causes a deemed election under section
338(f) (1) for Y, since Y is a target affiliate of T and was acquired
during the consistency period of T.
Example (3). Assume the same facts as in Example (2), except that B
is a corporation and that, on December 1, 1985, B does not transfer the
Y stock to a P group member but rather becomes a member of the P group.
The result is the same as in Example (2).
Example (4). (i) Assume the same facts as in Example (2), except
that (A) on June 1, 1985, B acquires for cash from S only 40 of the 100
shares of Y's only class of outstanding stock, and (B) on April 1, 1986,
P purchases for cash the remaining 60 shares of Y's stock.
(ii) If B were considered a corporation that was a member of the P
group at the time of B's acquisition of the Y stock, then a qualified
stock purchase of Y stock would be made by the P group on April 1, 1986.
(Note that the hypothetical Y stock purchase requirement is satisified
by reason of an event (P's purchase of 60 shares of Y stock on April 1,
1986) that occurs after B transfers the 40 shares of Y stock to P.)
Thus, the result is the same as in Example (2), except that the
qualified stock purchase of Y stock by the P group occurs on April 1,
1986 (assuming that the Commissioner determines under subdivision (ii)
of this Answer that the P group should be treated as having acquired the
Y stock from B by purchase) rather than on December 1, 1985.
Example (5). (i) On January 1, 1985, S holds all of the stock of Y
and T. At the close of that date, B, an individual that is the sole
shareholder of P, acquires for cash from S all of the stock of Y. On
February 1, 1985, P acquires all of the stock of T from S in a qualified
stock purchase and makes an express election for T. On May 1, 1985, B
transfers the stock of Y to P.
(ii) For purposes of applying the consistency rules of section
338(e), (f), and (i), the Commissioner may treat P as having acquired
the Y stock by purchase, since the three applicable requirements of
subdivision (ii) of this Answer are satisfied. First, if B were treated
as a corporation that was a member of the P group at the time of B's
acquisition of the Y stock, then a qualified stock purchase of Y stock
would be made by the P group on January 1, 1985. Accordingly, the
hypothetical Y stock purchase requirement is satisfied. Second, an
express election actually is made by the P group for a target (T) that
is a hypothetical affected target. Third, B transfers the Y stock to P
during the consistency period of a hypothetical affected target (T) for
which a section 338 election actually is made. If, pursuant to this
Answer, P is considered to have made a qualified stock purchase of the
stock of Y, then the express election for T causes a deemed election
under section 338 (f)(1) for Y, since Y is a target affiliate of T and
was acquired during the consistency period of T.
Example (6). Assume the same facts as in Example (5), except that P
acquires all of the stock of T from S in a qualified stock purchase on
September 1, 1985. The result is the same as in Example (5). Assuming
that P is treated under subdivision (ii) of this Answer as having
acquired the stock of Y in a qualified stock purchase, a deemed election
is made for Y by reason of subdivision (iv)(A) of this Answer. This
result follows because (i) the qualified stock purchase of Y occurs
under subdivision (ii) of this Answer by reason of the actual section
338 election for T, a hypothetical affected target, and (ii) the
acquisition date of T occurs after the acquisition date of Y. Note that
the express election for T properly is made even though, as a result of
that express election, there may exist a target, Y, that, as between Y
and T, is the original target. See paragraph (e) of this section.
Example (7). (i) On May 1, 1985, B, an individual that is the sole
shareholder of P, acquires for cash from S all of the stock of T. On
September 1, 1985, P acquires an asset of S. On January 1, 1986, B
transfers the stock of T to P.
(ii) Under these facts, the hypothetical Y stock purchase requirement
is satisfied. If, under the circumstances, a deemed election under
section 338(e)(1) with respect to the P group's hypothetical Y stock
purchase could be made at the discretion of the District Director by
reason of the asset acquisition on September 1, 1985, then the
Commissioner may treat B's transfer of the Y stock to P on January 1,
1986, as a purchase by P of that Y stock on that date, since the
transfer occurs during the consistency period of Y (determined as if the
hypothetical Y stock purchase were an actual qualified stock purchase of
Y stock by the P group).
(h) Determination of section 338(a)(1) deemed sale price -- (1)
Introduction. The price at which old T is treated as selling its assets
in the section 338(a)(1) deemed sale must be determined in order to
measure the gain or loss recognized by T in the deemed sale. The
questions and answers in this paragraph (h) provide guidance on the
determination of the aggregate deemed sale price. For purposes of
applying this paragraph (h), T stock is considered purchased or held by
P if it is purchased or held by any member of the P group. See section
338(h)(8). This paragraph (h) does not apply if an election under
section 338(h)(10) is made. For the effect of old T's tax liabilities,
as determined under this paragraph (h), on the basis of new T's assets,
see paragraph (j) of this section. See 1.338(b)-3T(h) and (j) for
certain rules and examples relating to any change in the aggregate
deemed sale price of old target's assets.
(2) Definitions -- (i) ADSP. The ''ADSP'' is the aggregate deemed
sale price, i.e., the price at which T is deemed to have sold all of its
assets in the deemed sale under section 338(a)(1). In the absence of a
subscript, ''ADSP'' refers to ADSP for Class III assets only. See
1.338(b)-2T(b).
(ii) Elective ADSP formula. The ''elective ADSP formula'' is an
elective formula prescribed under the authority of section 338(h)(11)
for determining the ADSP.
(iii) Allocable ADSP amount. The ''allocable ADSP amount'' is the
portion of the ADSP as calculated under the elective ADSP formula that
is allocable to a particular T asset. Except as provided in section
7701(g) (relating to fair market value in the case of nonrecourse
indebtedness), and unless a transitional allocation election under
1.338 (b)-4T is made, the ADSP is allocated among T assets for this
purpose in accordance with the rules in 1.338 (b)-2T (without regard to
1.338 (b)-2T (c) (2)). If a transitional allocation election under
1.338 (b)-4T is made, the ADSP is allocated among T assets for this
purpose in accordance with the rules in 1.338 (b)-4T (e). Recapture
gain on a T asset under the elective ADSP formula is computed by
reference to the allocable ADSP amount for that asset.
(iv) Recapture gain. ''Recapture gain'' is gain that is recognized
in the section 338(a)(1) deemed sale notwithstanding the application of
section 337 to the deemed sale. Examples of recapture gain include
depreciation and LIFO recapture, section 338(c)(1) amounts, and tax
benefit items.
(v) Section 338(c)(1) percentage. The ''section 338(c)(1)
percentage'' is 100 percent minus the maximum percentage specified in
section 338(c)(1). Items of gain or loss that are realized in the
deemed sale but that would not be recognized in an actual sale under
section 337 are multiplied by the section 338(c)(1) percentage to arrive
at the section 338(c)(1) gain (or loss) recognized in the deemed sale.
(vi) Classes of assets. The four classes of assets are defined in
1.338(b)-2T(b). Examples of each class are: Class I, cash; Class II,
marketable securities; Class III, assets other than Classes I, II, and
IV; and Class IV, goodwill and going concern value.
(3) Determination of ADSP.
Question 1: How is the ADSP determined?
Answer 1: (i) General rule. The ADSP is the aggregate of the fair
market values of all of old T's assets at the close of the acquisition
date. Section 338(a)(1). Except as provided in section 7701(g)
(relating to fair market value in the case of nonrecourse indebtedness),
for assets other than Class IV assets (i.e., goodwill and going concern
value), the same fair market values shall be used for purposes of this
paragraph (h) (old T's aggregate deemed sale price) and for purposes of
1.338(b)-2T (b) and (c)(1) or (c)(3) (allocating new T's adjusted
grossed-up basis to its assets). If the elective ADSP formula is not
used, a proper appraisal of Class IV assets will be considered evidence
of their fair market value.
(ii) Elective ADSP formula for determining ADSP -- (A) General rule.
Under the authority of section 338(h)(11), the ADSP may be determined
under the elective ADSP formula, which takes into account liabilities
and other relevant items.
(B) Procedure for electing elective ADSP formula and for revoking
election. The election to apply the elective ADSP formula (''formula
election'') is made by attaching to the final return of old T (including
an amended final return) a statement containing the following
declaration (or a substantially similar declaration): ''this return
reflects a formula election for t under section 338 and
1.338-4T(h)(3).'' The formula election is revoked by attaching to an
amended final return of old T a statement containing the following
declaration (or a substantially similar declaration): ''this return not
reflect a formula election for t under section 338 and
1.338-4T(h)(3).'' In addition, a formula election may be made or revoked
in connection with the examination of the final return of old T. A
formula election made for T also applies to all affected targets, as
does the revocation of a formula election for T. A formula election may
not be made or revoked if the period within which to make an assessment
of tax has expired for any return that would be affected by the election
or the revocation. For this purpose, a return would be affected by the
election (or revocation) if the election (or revocation) would have the
effect, directly or indirectly, of increasing the tax liability reported
in that return.
Question 2: How is the ADSP determined under the elective ADSP
formula?
Answer 2: (i) Introduction. The ADSP under the elective ADSP
formula is the sum of (A) the grossed-up basis to P's recently purchased
T stock (as defined in section 338(b)(6)(A)), (B) the liabilities of T
(including any tax liability resulting from the deemed sale), and (C)
other relevant items. If T is acquired in a true bargain purchase
(i.e., if the cost of the stock acquisition of P is less than the
aggregate fair market value of the assets of T), the ADSP as determined
under the elective ADSP formula will reflect that bargain element. This
result follows because the elective ADSP formula takes into account the
actual price paid by P for T stock. If the elective ADSP formula is not
used in such a case, recapture gain items measured by reference to the
ADSP will be disproportionately high as compared to the price P actually
paid for the T stock and the basis of new T's assets.
(ii) Grossed-up basis of P's recently purchased T stock. The
grossed-up basis of P's recently purchased T stock is an amount equal to
P's basis in recently purchased T stock, divided by the percentage of T
stock (by value) attributable to that recently purchased T stock. If T
has a single class of outstanding stock, the grossed-up basis of P's
recently purchased T stock for purposes of the elective ADSP formula
reflects the total price P would have paid for all outstanding T stock
had it purchased all such stock for a price per share equal to the
average price per share that it paid for the recently purchased T stock.
(iii) Tax liability resulting from the deemed sale. The elective
ADSP formula takes into account both tax credit recapture liability
arising by reason of the deemed sale and the tax liability on recapture
gain. The elective ADSP formula reflects the fact that recapture gain
both increases the ADSP (by creating a tax liability) and is computed by
reference to the ADSP.
(iv) Calculation of recapture gain with respect to certain property.
Section 1245 depreciation recapture gain on a T asset under the elective
ADSP formula is the amount by which (A) the lesser of the recomputed
basis of that asset or the allocable ADSP amount for that asset exceeds
(B) the adjusted basis of that asset. Proper use of recomputed basis
for items of section 1245 property results in the lowest ADSP. When a
large number of items subject to section 1245 depreciation recapture
must be included in the elective ADSP formula, the determination as to
which of those assets should be measured by reference to recomputed
basis to arrive at the lowest ADSP requiries a very large number of
trial and error computations. Similar rules apply to other classes of
property with respect to which recapture gain is properly determined by
reference to the lesser of the allocable ADSP amount or some other
amount.
(v) Other applicable rules apply in elective ADSP formula. The
elective ADSP formula may not be applied in such a way as to contravene
other applicable rules. Thus, for example, a capital loss under section
338(c)(1) cannot be applied in the elective ADSP formula to reduce
ordinary income recapture gain.
(vi) Sample elective ADSP formula. The sample ADSP formula shown
below takes into account the existence of recapture gain arising under
sections 1245 and 338(c)(1). For illustrative purposes, Examples (1)
through (3) of this subdivision (vi) assume that the target has only
Class III assets (e.g., property other than certain cash items, certain
securities, and goodwill, etc.). For examples illustrating the effect on
the elective ADSP formula of Class I, II, or IV assets, see Examples (4)
through (9) of this subdivision (vi). In Examples (1) through (9) of
this subdivision (vi) it is assumed that a transitional allocation
election under 1.338 (b)-4T is not made. The sample formula is as
follows:
ADSP=G+L+tR ((Lesser of R or (ADSP F))^B)+C tR ((ADSP F)^Cb)
For purposes of this sample formula --
(A) ''G'' is the grossed-up basis of P's recently purchased T stock
(as determined under subdivision (ii) of this Answer 2).
(B) ''L'' is the sum of T's liabilities other than T's tax liability
for recapture gain amounts determined by reference to the ADSP.
(Investment tax credit recapture under section 47 that results from the
deemed sale of T's assets is included in L, for example, since that
liability is not determined by reference to the ADSP.)
(C) ''tR'' is the tax rate applicable to the recapture gain item
represented by the bracketed material immediately following this symbol.
In the sample formula, the bracketed material following the first use
of the ''tR'' symbol represents section 1245 depreciation recapture gain
on an asset. (If there is more than one asset subject to section 1245
depreciation recapture, the recapture gain for each asset is separately
computed in the elective ADSP formula.) The bracketed material following
the second use of the ''tR'' symbol in the sample formula represents
section 338(c) (1) gain on an asset.
(D) ''R'' is the recomputed basis (as defined in section 1245(a)(2))
of an item of section 1245 property.
(E) ''F'' is a fraction the numerator of which is the fair market
value of a T asset on T's acquisition date and the denominator of which
is the aggregate fair market value of all T assets on T's acquisition
date. This fraction is multiplied by the ADSP to arrive at the
allocable ADSP amount for a T asset.
(F) (Reserved)
(G) ''B'' is the adjusted basis of a T asset on the acquistion date.
(H) ''C'' is the section 338(c)(1) percentage (as defined in
paragraph (h) (2)(v) of this section).
(I) ''Cb'' is the basis of an asset for purposes of determining the
section 338(c)(1) gain or loss on that asset. An item of section 1245
property, for example, is taken into account for purposes of determining
section 338(c)(1) gain only if the recomputed basis of that item (rather
than the allocable ADSP amount for that item) is the measure of section
1245 depreciation recapture gain on that asset, since only in that case
is there realized gain on the item that, absent section 338(c)(1), would
not be recognized by reason of section 337. In such a case, the
recomputed basis is the ''Cb'' amount.
Example (1). (i) T is a calendar year taxpayer that files separate
returns and that has no loss or tax credit carryovers to 1985. As of
July 1, 1985, T's only asset, which T has held for more than one year,
is an item of section 1245 property with an adjusted basis to T of
$50,400, a recomputed basis of $80,000, and a fair market value of
$100,000. On July 1, 1985, P purchases all of the stock of T for
$75,000 and makes an express election for T. Assume that T has no
liabilities other than a tax liability resulting from the deemed sale of
assets. Assume in addition that T's marginal tax rate for any ordinary
income resulting from the deemed sale of assets is 46 percent.
(ii) Section 1245 depreciation recapture gain on the item of section
1245 property is determined under the elective ADSP formula by reference
to the lesser of the recomputed basis of that item ($80,000) or the
allocable ADSP amount for that item. The elective ADSP formula as
applied to these facts is as follows:
ADSP=G+L+tR ((Lesser of R or ADSP)^B)
ADSP=($75,000/1)+$0+.46 ((Lesser of $80,000 or ADSP)^$50,400)
ADSP -- Recomputed basis measurement:
ADSP=$75,000+.46 ($80,000^$50,400)
ADSP=$88,616
ADSP -- ADSP measurement:
ADSP=$75,000+.46 (ADSP^$50,400)
ADSP=$75,000+(.46 ADSP)^23,184
ADSP=$51,816+.46ADSP
ADSP^.46ADSP=$51,816
.54ADSP/.54=$51,816/.54
ADSP=$95,955.56
Accordingly, the ADSP of T is $88,616, i.e., the recomputed basis
measurement ($88,616), which is less than the ADSP measurement
($95,955.56). Since the ADSP for T ($88,616) does not exceed the fair
market value of T's one asset ($100,000), a Class III asset, its entire
ADSP is allocated to that asset. See 1.338(b)-2T(c)(1) (relating to
fair market value limitation).
Example (2). Assume the same facts as in Example (1), except that on
July 1, 1985, P purchases only 80 of the 100 outstanding shares of T's
only class of stock for $60,000. Assume in addition that those 80
shares represent, at all times during the one-year period beginning on
July 1, 1985 (the acquisition date of T), 80 percent of the value of all
T stock and that P purchases no additional T stock during that one-year
period. Accordingly, the section 338(c)(1) percentage under paragraph
(h)(2)(v) of this section is 20 percent, i.e., 100 percent minus 80
percent. Assume that any net capital gain resulting from the deemed
sale will be taxed at the 28 percent rate. The elective ADSP formula as
applied to these facts is as follows:
ADSP=G+L+tR ((Lesser of R or ADSP)^B)+C tR (ADSP^Cb)
ADSP=($60,000/.8)+$0+.46 ((Lesser of $80,000 or ADSP)^50,400)+.20
.28 (ADSP^(Lesser of $80,000 or ADSP))*
*For an item of section 1245 property, section 338(c)(1) gain exists
under the formula only if the recomputed basis of $80,000 rather than
the allocable ADSP amount is the measure of section 1245 depreciation
recapture gain. The section 338(c)(1) gain in that case is the
allocable ADSP amount, reduced by $80,000. Whenever section 1245
depreciation recapture gain for an item is calculated by reference to
the allocable ADSP amount for that item, the section 338(c)(1)
calculation may be omitted for that item.
ADSP -- Recomputed basis measurement:
ADSP=($60,000/.8)+.46 ($80,000^ $50,400)+.20 .28 (ADSP^$80,000)
ADSP=$75,000+$13,616+ (.056 ADSP)^$4,480
ADSP=$84,136+.056ADSP
ADSP^.056ADSP=$84,136
.944ADSP/.944=$84,136/.944
ADSP=$89,127.12
ADSP -- ADSP measurement:
ADSP=($60,000/.8)+.46 (ADSP^$50,400)
ADSP=$75,000+(.46 ADSP)^$23,184
ADSP=$51,816+.46ADSP
ADSP^.46ADSP=$51,816
.54ADSP/.54=$51,816/.54
ADSP=$95,955.56
Accordingly, the ADSP of T is $89,127.12, i.e., the recomputed basis
measurement ($89,127.12), which is less than the ADSP measurement
($95,955.56). Since the ADSP for T ($89,127.12) does not exceed the fair
market value of T's one asset ($100,000), a Class III asset, its entire
ADSP is allocated to that asset. See 1.338(b)-2T(c)(1) (relating to
fair market value limitation).
Example (3). T is a calendar year taxpayer that files separate
returns and that has no loss or tax credit carryovers to 1985. On July
1, 1985, P purchases 80 of the 100 outstanding shares of T's only class
of stock for $80,000 and makes an express election for T. Assume that
those 80 shares represent, at all times during the one-year period
beginning on July 1, 1985 (the acquisition date of T), 80 percent of the
value of all T stock and that P purchases no additional T stock during
that one-year period. Accordingly, the section 338(c)(1) percentage
under paragraph (h)(2)(v) of this section is 20 percent, i.e., 100
percent minus 80 percent. Assume in addition that T's marginal tax rate
for any ordinary income resulting from the deemed sale of assets will be
46 percent, and that any net capital gain resulting from the deemed sale
of assets will be taxed at the 28 percent rate. T does not inventory
goods under the LIFO method, so there is no LIFO recapture gain in the
deemed sale. T's assets, all of which have been held by T for more than
one year, are as follows:
T has liabilities (not including the tax liability for recapture gain
on its assets) of $50,000. The elective ADSP formula as applied to
these facts is as follows (the subscript numerals in the formula
correspond to the number assigned each asset in the above table and
indicate which asset is being referred to):
ADSP=G+L+tR ((Lesser of R3 or (ADSP F3))^B3+(Lesser of R4 or (ADSP
F4))^B4)+C tR ((ADSP (F1+F3+F4))^(Cb1*+Cb3**+Cb4***))
+C tR ((ADSP F2)^Cb2****)
*Equal to B1.
**Equal to the lesser of R3 or (ADSP F3).
***Equal to the lesser of R4 or (ADSP F4).
****Equal to B2.
ADSP=$80,000/.8+$50,000+.46 ((Lesser of $80,000 or (ADSP
.372093))^$5,000+
(Lesser of $20,000 or
(ADSP .4186046)^$10,000)+.2 .28 ((ADSP (97674+.372093+.4186046)^$5,000^
(Lesser of $80,000 or (ADSP .372093))^(Lesser of $20,000 or (ADSP
.4186046))+.2 .46 ((ADSP .1395348)^$10,000)
In this case, the recomputed basis is less than the allocable ADSP
amount for Asset 4 but not for Asset 3. The elective ADSP formula
computation, as applied on these assumptions, is as follows:
ADSP=$100,000+$50,000+
.46 ((.372093ADSP^$5,000)+($20,000^$10,000))+ .2 .28 (.860465ADSP^
$5,000^.372093ADSP^$20,000)+ .2 .46 (.1395348ADSP^$10,000)
ADSP=$150,000+.46
(.372093ADSP+$5,000)+.056 (.488372ADSP^$25,000)+.092
(.1395348ADSP^$10,000)
ADSP=$150,000+.1711627ADSP+
$2,300+.0273488ADSP^$1,400+ .0128372ADSP^$920
ADSP=$150,000+.2113487ADSP^$20
ADSP=$149,980+.2113487ADSP
ADSP=.2113487ADSP=$149,980
.7886513ADSP/.7886513=$149,980/.7886513
ADSP=$190,172.76
Since the ADSP for T ($190,172.76) does not exceed the sum of the
fair market values of all of T's assets ($215,000), and those assets are
all Class III assets, its entire ADSP is allocated to those assets. See
1.338(b)-2T(c)(1) (relating to fair market value limitation). The
following table breaks the ADSP of $190,173 down to the deemed sale
price, section 1245 depreciation recapture gain (and resulting tax) and
section 338(c)(1) gain (and resulting tax) allocable to each asset:
Summary of calculation
Example (4). Assume the same facts as in Example (1), except that P
purchases all of the stock of T for $85,000 and that T has $10,000 of
cash, a Class I asset. The sample elective ADSP formula as applied to
these facts is modified by referring to the amount of the Class I assets
as ''I''. This modified formula is as follows:
ADSP=G^I+L+tR ((Lesser of R or ADSP)^B)
ADSP=($85,000/1)^$10,000+$0+.46 ((Lesser of $80,000 or ADSP)^$50,400)
ADSP=$75,000+0+.46 ((Lesser of $80,000 or ADSP)^$50,400)
The remainder of the calculation and result are the same as in
Example (1).
Example (5). Assume the same facts as in Example (2), except that P
purchases the 80 shares for $68,000 and that T has $10,000 of cash, a
Class I asset. The elective ADSP formula used in Example (4) as applied
to these facts is as follows:
ADSP=G^I+L+tR ((Lesser of R or ADSP)^B)+C tR (ADSP^Cb)
ADSP=($68,000/.8)^$10,000+0+.46 ((Lesser of $80,000 or
ADSP)^$50,400)+.20 .28 (ADSP^(Lesser of $80,000 or ADSP))
ADSP=$85,000^$10,000+.46 ((Lesser of $80,000 or ADSP)^$50,400)+.20
.28 (ADSP^(Lesser of $80,000 or ADSP))
ADSP=$75,000+.46 ((Lesser of $80,000 or ADSP)^$50,400)+.20 .28
(ADSP^(Lesser of $80,000 or ADSP))
The remainder of the calculation and result are the same as in
Example (2).
Example (6). Assume the same facts as in Example (5), except that T
does not hold any cash. Assume further that T holds marketable
securities, a Class II asset, it acquired 10 years ago having a fair
market value of $10,000 and a basis of $4,000. The sample elective ADSP
formula as applied to these facts is modified by referring to the fair
market value of the Class II asset as ''II'' and the basis of that asset
as ''BII.'' This modified formula for calculating the ADSP of the
section 1245 property is as follows:
ADSP=G^II+L+tR ((Lesser of R or ADSP)^B)+C tR ((ADSP^Cb)+(II^BII))
ADSP=($68,000/.8)^$10,000+0+.46 ((Lesser of $80,000 or
ADSP)^$50,400)+.20 .28 ((ADSP^(Lesser of $80,000 or
ADSP))+($10,000^$4,000))
In this case, assume that for the item of section 1245 property, the
recomputed basis is less than the allocable ADSP amount for that item.
The elective ADSP formula computation, as applied to this assumption, is
as follows:
ADSP=$85,000^$10,000+.46
($80,000^$50,400)+.056 ((ADSP^$80,000)+($6,000))
ADSP=$75,000+(.46 29,600)+.056ADSP^$4,480+$336
ADSP=$75,000+$13,616+.056ADSP
^$4,480+$336
ADSP^.056ADSP=$84,472
.944ADSP/.944=$84,472/.944
ADSP=$89,483.05
Since the ADSP for T's Class III asset ($89,483.05) does not exceed
its fair market value, its entire ADSP for its Class III assets is
allocated to its one asset in the class. See 1.338(b)-2T (b) and
(c)(1). The deemed selling price for the marketable securities (Class
II assets) is their fair market value ($10,000).
Example (7). Assume the same facts as in Example (1), except that T
has goodwill with an appraised value $10,000. The result is the same as
in Example (1) when the elective ADSP formula is used because the
appraised value of goodwill is not taken into account under the formula,
and, so long as the ADSP for T's Class III asset does not exceed its
fair market value, goodwill does not arise under the formula.
Example (8). Assume the same facts as in Example (7), except that P
purchases all of the stock of T for $100,000 and the recomputed basis of
the section 1245 property is $210,000. The elective ADSP formula as
applied to these facts is as follows:
ADSP=G+L+tR ((Lesser of R or ADSP)^B)
ADSP=($100,000/1)+$0+.46 ((Lesser of $210,000 or ADSP)^$50,400)
ADSP -- Recomputed basis measurement:
ADSP=$100,000+.46 ($210,000^$50,400)
ADSP=$173,416
ADSP -- ADSP measurement:
ADSP=$100,000+.46 (ADSP ^$50,400)
ADSP=$100,000+(.46 ADSP)^$23,184
ADSP=$76,816+.46 ADSP
ADSP^.46 ADSP=$76,816
.54ADSP/.54=$76,816/.54
ADSP=$142,251.85
Accordingly, under the elective ADSP formula, as initially applied,
the ADSP of T would be $142,251.85, i.e., the ADSP measurement
($142,251.85) which is less than the recomputed basis measurement
($173,416). Since this ADSP for T ($142,251.85) exceeds the fair market
value of T's Class III asset ($100,000), ADSP allocated to that asset is
limited to the asset's fair market value under 1.338 (b)-2T(c)(1).
Thus, the elective ADSP formula must be applied to compute the ADSP for
T's Class IV property (e.g., goodwill). The sample ADSP formula as
applied to this computation is modified by using III to refer to the
fair market value of the Class III asset (i.e., the section 1245
property) and ADSPIV to refer to the ADSP for Class IV property. This
modified formula is as follows:
ADSPIV=G^III+L+tR ((Lesser of R or III)^B)
ADSPIV=$100,000^$100,000+$0+.46
((Lesser of $210,000 or $100,000)^$50,400)
ADSPIV=.46 ($100,000^$50,400)
ADSPIV=$22,816
Thus, the ADSP for the Class IV property is $22,816. Note that the
appraised value of the goodwill is irrelevant.
Example (9). Assume the same facts as in Example (8), except that P
purchases only 80 of the 100 outstanding shares of T's only class of
stock for $96,000. Assume further that T's assets, all of which have
been held for more than one year, are as follows:
The elective ADSP formula as applied to these facts is modified by
referring to items for a class of property by using Roman subscripts.
(Since there is only one asset in each class, subscripts as used in
Example (3) are not necessary.) The modified formula is as follows:
ADSP=G^I^II+L+tR ((Lesser R or ADSP)^BIII)+C tR ((ASDP^
CbIII)+(II^BII))
ADSP=($96,000/.8)^$10,000^$10,000+0+.46 ((Lesser $210,000 or
ADSP)^$50,400)+.20 .28 ((ADSP^(Lesser of $210,000 or
ADSP))+($10,000^$4,000))
In this case, the allocable ADSP amount for the one Class III asset
is less than its recomputed basis. The modified elective ADSP formula,
based on these assumptions, is applied as follows:
ADSP=$120,000^$20,000+.46
(ADSP^$50,400)+.20 .28 ($10,000^$4,000)
Section 338(c)(1) gain does not exist in this case since the measure
of section 1245 depreciation recapture is the ADSP measure. See the
footnote in Example (2).
ADSP=$100,000+.46ADSP^
$23,184+.056 ($6,000)
ADSP=$100,000+.46ADSP^$23,184+$336
ADSP^.46ADSP=$77,152
.54ADSP/.54=$77,152/.54
ADSP=$142,874.07
Accordingly, under the modified elective ADSP formula, as initially
applied, the ADSP of T would be $142,874.07, an amount that exceeds the
fair market value of T's one Class III asset ($100,000). Thus, ADSP
allocated to that asset cannot exceed $100,000 under 1.338(b)-2T(c)(1).
It follows that the elective ADSP formula must be applied to compute the
ADSP for T's Class IV property (e.g., goodwill). The modified ADSP
formula, as used initially in this example, is further modified in the
manner shown in Example (8). In this example, the application of this
further modified formula assumes that the measure of section 1245
depreciation recapture is fair market value so that section 338(c)(1)
gain cannot exist. (See the preceding footnote.) This further modified
formula is as follows:
ADSPIV=G^I^II^III+L+tR (III^BIII)+C tR ((II^BII)+(ADSPIV^Biv))
ADSPIV=$120,000^$10,000 ^$10,000^$100,000+0+.46 ($100,000^$50,40.20
.28 (($10,000^$4,000)+(ADSPIV^$3,000))
ADSPIV=.46 $49,600+.056 ($6,000+ADSPIV^$3,000)
ADSPIV=$22,816+$336+.056ADSPIV^$168
ADSPIV^.056ADSPIV=$22,984
.944ADSPIV/.944=$22,984/.944
ADSPIV=$24,347.46
Thus, the ADSP for the Class IV property is $24,347.46. Note that the
appraised value for the goodwill is irrelevant.
Summary of calculation:
*.056 x ($24,347.46^$3,000).
Question 3: Assume that T owns all of the stock of T1 at the close
of T's acquisition date and that P makes a qualified stock purchase of
and express election for T. For purposes of applying the elective ADSP
formula to T1, what is T's basis in the T1 stock that T is deemed to
sell and purchase under section 338(a)?
Answer 3: T's basis in recently purchased T1 stock is the allocable
ADSP amount for the T1 stock that is deemed purchased by T, treating the
T1 stock in the same manner as any other asset of T to which the ADSP of
T is allocated under the elective ADSP formula.
Example: (i) Assume the facts of Example (3) of Answer 2 of this
paragraph (h), except that Asset 2 is all of the stock of T1 rather
than inventory. T1 is a calendar year taxpayer that files separate
returns and that has no loss or tax credit carryovers to 1985. As of
July 1, 1985, T1's only asset, which T1 has held for more than one year,
is an item of section 1245 property with an adjusted basis to T1 of
$18,000 and a recomputed basis of $25,000. Under these facts, the
express election for T causes a deemed election under section 338(f)(1)
for T1. The fair market value of T1's asset is $30,000. Assume that T1
has no liabilities other than a tax liability resulting from section
1245 depreciation recapture gain in the deemed sale of assets. Assume
in addition that T1's marginal tax rate for any ordinary income
resulting from its deemed sale of assets is 46 percent.
(ii) The ADSP of T under the elective ADSP formula is computed as
follows (the assumptions regarding the application of recomputed basis
in the elective ADSP formula are the same as in Example (3)):
)
ADSP=G+L+tR (((ADSP F3)^B3)+(R4^B4))+C t)
*The total ADSP is taken into account in determining the long term
capital gain realized in the deemed sale of T since long-term capital
gain potentially is realized with respect to all four assets held by T.
Because section 1245 depreciation recapture gain on Asset 3 is
calculated by reference to the allocable ADSP amount, however, no
long-term capital gain is actually realized with respect to Asset 3,
i.e., all gain on Asset 3 is treated as section 1245 depreciation
recapture gain.
+
ADSP=$100,000+$50,000+.46 ((.372093ADSP^.2 .28 (ADSP^($5,000+$10,000+.3
72093ADSP+$20,000))
ADSP=$150,000+.46 (.372093ADSP+$5,000)+.056 (.627907ADSP^$35,000)
ADSP=$150,000+.1711627ADSP+$2,300+.0351627ADSP^$1,960
ADSP=$150,340+.2063254ADSP
ADSP^.2063254ADSP=$150,340
.7936746ADSP/.7936746=$150,340/.7936746
ADSP=$189,442.71
The ADSP in this Example is less than the ADSP in Example (3) of
Answer 2 of this paragraph (h)(3) because the gain on Asset 2 ( the T1
stock) that is recognized in the deemed sale (by reason of section
338(c)(1)) is taxed at the 28 percent rate rather than at the 46 percent
rate. Since the ADSP for T ($189,422.71) does not exceed the sum of the
fair market values of all of T's assets ($215,000), and those assets are
all Class III assets, its entire ADSP is allocated to those assets in
proportion to their fair market values. See 1.338(b)-2T(c)(1)
(relating to fair market value limitation).
(iii) For purposes of applying the elective ADSP formula to T1, T's
basis in recently purchased T1 stock is equal to the allocable ADSP
amount for the item of T property represented by the T1 stock. The
allocable ADSP amount for the T1 stock is $26,431.06,i.e., $189,422.71
.1395348. No P group members other than T hold recently purchased T1
stock. Thus, the elective ADSP formula as applied to T1 is as follows:
ADSP=G+L+tR ((Lesser of R or ADSP)^B)
ADSP=$26,431/1+$0+.46 ((Lesser of $25,000 or ADSP)^$18,000)
ADSP -- Recomputed basis measurement:
ADSP=$26,431+.46 ($25,000^$18,000)
ADSP=$29,651
ADSP -- ADSP measurement:
ADSP=$26,431+.46 (ADSP^$18,000)
ADSP=$26,431+(.46 ADSP)^$8,280
ADSP=$18,151+.46ADSP
ADSP^.46ADSP=$18,151
.54ADSP/.54=$18,151/.54
ADSP=$33,612.96
Because the recomputed basis measurement ($29,651) is less than the
ADSP measurement ($33,613), the ADSP of T1 is $29,651. Since the ADSP
for T1 ($29,651) does not exceed the fair market value of T1's only
asset ($30,000), its entire ADSP is allocated to that asset.
Question 4: How is the elective ADSP formula affected by an increase
in the maximum percentage (by value) of T stock held by P during the
one-year period following T's acquisition date?
Answer 4: The section 338(c)(1) percentage used in the elective ADSP
formula is determined by reference to the maximum percentage (by value)
of T stock held by P during the one-year period following T's
acquisition date. See paragraph (h)(2)(v) of this section. Thus, the
ADSP as calculated under the ADSP formula cannot be determined with
certainty until that one-year period has elapsed. See paragraph (k)(5)
of this section.
(i) (Reserved)
(j) Determination of basis of target assets after section 338
election -- (1) Introduction. The questions and answers in this
paragraph (j) provide guidance under section 338(b) on the determination
of the total sum (''adjusted grossed-up basis'') to be allocated as
basis to the assets of new T. These questions and answers do not
specifically deal with the manner in which the adjusted grossed-up basis
is allocated among T's assets. Rules relating to allocation of adjusted
grossed-up basis among T's assets are provided in 1.338(b)-2T and
1.338(b)-3T. For purposes of applying this paragraph (j), T stock is
considered purchased or held by P if it is purchased or held by any
member of the P group. See section 338(h)(8).
(2) Determination of adjusted grossed-up basis.
Question 1: How is the adjusted grossed-up basis determined?
Answer 1: (i) General rule. The adjusted grossed-up basis is the
sum of (A) P's grossed-up basis in recently purchased T stock, (B) P's
basis in nonrecently purchased T stock, (C) the liabilities of T
(including tax liabilities computed under paragraph (h) of this
section), and (D) other relevant items.
(ii) P's grossed-up basis in recently purchased T stock. P's
grossed-up basis in recently purchased T stock is the product of P's
basis in recently purchased T stock (as defined in section
338(b)(6)(A)), multiplied by the fraction described in section
338(b)(4). If T has a single class of outstanding stock, P's grossed-up
basis in recently purchased T stock reflects the total price P would
have paid for all outstanding T stock (other than P's nonrecently
purchased T stock, as defined in section 338(b)(6)(B)) had P purchased
all such stock (other than such nonrecently purchased T stock) for a
price per share equal to the average price per share that P paid for the
recently purchased T stock. Note that P's grossed-up basis in recently
purchased T stock as calculated for purposes of the adjusted grossed-up
basis differs from the ''grossed-up basis of P's recently purchased T
stock'' as calculated in the elective ADSP formula. The elective ADSP
formula treats P's nonrecently purchased T stock in the same manner as T
stock not held by P. See Answer 2 (ii) of paragraph (h)(3) of this
section.
(iii) P's basis in nonrecently purchased T stock. In the absence of
an election under section 338(b)(3) (''gain recognition election''), P's
basis in nonrecently purchased T stock is P's historic basis in that
stock.
Question 2: What is the effect of a gain recognition election under
section 338(b)(3)?
Answer 2: If P makes a gain recognition election, then, for all
purposes of the Code and regulations, (i) P is treated as if it sold on
the acquisition date the nonrecently purchased T stock for the basis
amount determined under section 338(b)(3)(B), and (ii) P's basis on the
acquisition date in nonrecently purchased T stock is the basis amount.
If T has a single class of outstanding stock, P's basis in each share of
nonrecently purchased T stock after the gain recognition election is
equal to the average price per share of P's recently purchased T stock.
In such a case, the sum of P's grossed-up basis in recently purchased T
stock and P's basis in nonrecently purchased T stock will be equal to
the ''grossed-up basis of P's recently purchased T stock'' as calculated
in the elective ADSP formula. See Answer 2 (ii) of paragraph (h)(3) of
this section. Absent a gain recognition election, the adjusted
grossed-up basis will differ from the ADSP as calculated under the
elective ADSP formula whenever P holds nonrecently purchased T stock at
a basis that differs from P's basis in recently purchased T stock.
Question 3: May losses on nonrecently purchased T stock be
recognized in the deemed sale of such stock under section 338(b)(3)?
Answer 3: No. Only gains (unreduced by losses) on the nonrecently
purchased T stock are recognized.
Question 4: If P makes a gain recognition election for T, what stock
held by P is subject to that election?
Answer 4: All T stock held by P (or other members of the P group) on
T's acquisition date that is not recently purchased T stock is subject
to the election. In addition, stock in an affected target held by P
group members on the affected target's acquisition date also is subject
to the gain recognition election for T if such stock is not recently
purchased affected target stock.
Example. (i) Assume the same facts as in Example (2) of Answer 2 of
paragraph (h)(3) of this section, except that on June 1, 1984 (i.e.,
more than 12 months before July 1, 1985, the acquisition date of T), P
purchases 10 of the 100 outstanding shares of T's only class of stock
for $5,000. Those 10 shares constitute nonrecently purchased T stock
with respect to P's qualified stock purchase of T stock on July 1, 1985.
Assume that the 90 shares of T stock thus held by P on July 1, 1985,
represent, at all times during the one-year period beginning on that
date (the acquisition date of T) 90 percent of the value of all T stock,
and that P purchases no additional T stock during that one year period.
Accordingly, the section 338(c)(1) percentage under paragraph (h)(2)(v)
of this section is 10 percent, i.e., 100 percent minus 90 percent. The
elective ADSP formula as applied to these facts is as follows:
ADSP=G+L+tR ((Lesser of R or ADSP)^B)+C tR (ADSP^Cb)
ADSP=($60,000/.8)+$0+.46 ((Lesser of $80,000 or ADSP)^50,400)+.10 .28
(ADSP^(Lesser of $80,000 or ADSP))*
*Section 338(c)(1) gain exists under the formula only if the
recomputed basis of $80,000 rather than the allocable ADSP amount (as
defined in paragraph(h)(2)(iii) of this section) is the measure of
section 1245 depreciation recapture gain. The section 338(c)(1) gain in
that case is the allocable ADSP amount, reduced by $80,000. Whenever
section 1245 depreciation recapture gain for an item is calculated by
reference to the allocable ADSP amount for that item, the section
338(c)(1) calculation may be omitted for that item.
ADSP -- Recomputed basis measurement:
ADSP=($60,000/.8)+.46 ($80,000^$50, 400)+.10 .28 (ADSP^$80,000)
ADSP=$75,000+$13,616+ (.028 ADSP)^$2,240
ADSP=$86,376+.028ADSP
ADSP^.028ADSP=$86,376
.972ADSP/.972=$86,376/.972
ADSP=$88,864.20
ADSP -- ADSP measurement:
ADSP=($60,000/.8)+.46 (ADSP^$50,400)
ADSP=$75,000+(.46 ADSP)^$23,184
ADSP=$51,816+.46ADSP
ADSP^.46ADSP=$51,816
.54ADSP/.54=$51,816/.54
ADSP=$95,955.56
Accordingly, the ADSP of T is $88,864.20, i.e., the recomputed basis
measurement ($88,864.20), which is less than the ADSP measurement
($95,955.56). This ADSP differs from the ADSP in Example (2) of Answer 2
of paragraph (h)(3) of this section because the section 338(c)(1)
percentage in this Example is 10 percent rather than 20 percent. The
existence of nonrecently purchased T stock is irrelevant for purposes of
the elective ADSP formula, since that formula treats P's nonrecently
purchased T stock in the same manner as T stock not held by P. See
Answer 2 (ii) of paragraph (h)(3) of this section.
(ii) The total tax liability resulting from T's deemed sale of
assets, as calculated under the ADSP formula, is $13,864.20, determined
as follows:
(iii) The adjusted grossed-up basis of new T's assets is determined
on the basis of the following formula:
AGUB=GRP+BNP+L
For purposes of this formula --
(A) ''GRP'' is P's grossed-up basis in recently purchased T stock,
i.e., the product of P's basis in recently purchased T stock multiplied
by a fraction the numerator of which is 100 percent minus the percentage
of T stock (by value) attributable to P's nonrecently purchased T stock
and the denominator of which is the percentage of T stock (by value)
attributable to P's recently purchased T stock. See section 338(b)(4).
(B) ''BNP'' is P's basis in nonrecently purchased T stock. If P
makes a gain recognition election under section 338(b)(3), P's basis in
nonrecently purchased T stock is the basis amount determined under
section 338(b)(3)(B). (The basis amount is equal to the GRP multiplied
by a fraction the numerator of which is the percentage of T stock (by
value) attributable to P's nonrecently purchased T stock and the
denominator of which is 100 percent minus the numerator amount.) The sum
of the GRP and the BNP in the event of a gain recognition election may
be stated in a simplified manner: That sum is equal to P's basis in
recently purchased T stock, divided by the percentage of T stock (by
value) attributable to that recently purchased T stock. Note that this
formulation is identical to the formulation used in calculating the
''grossed-up basis of P's recently purchased T stock'' in the elective
ADSP formula.
(C) ''L'' is the sum of T's liabilities (including tax liabilities
computed under paragraph (h) of this section).
(iv) If P does not make a gain recognition election, the adjusted
grossed-up basis of new T's assets under the formula described in
subdivision (iii) of this Example is $86,364.20, determined as follows:
AGUB=$60,000 ((1^.1)/.8)+$5,000+$13,864.20
AGUB=$86,364.20
(v) If P makes a gain recognition election, the adjusted grossed-up
basis of new T's assets under the formula described in subdivision (iii)
of this Example is $88,864.20, determined as follows:
AGUB=$60,000 ((1^.1)/.8)+$60,000 ((1^.1)/.8) (.1/(1^.1)+$13,864.20
AGUB=$88,864.20
The calculation of adjusted grossed-up basis if P makes a gain
recognition election may be simplified as follows (see subdivision
(iii)(B) of this Answer):
AGUB=$60,000/.8+$13,864.20
AGUB=$88,864.20
(vi) As a result of the gain recognition election, P's basis in its
nonrecently purchased T stock is increased from $5,000 to $7,500, i.e.,
$60,000 ((1^.1)/.8) (.1/(1^.1)). Accordingly, P's basis in each of its
10 shares of nonrecently purchased T stock after the gain recognition
election is $750, i.e., $7,500/10. P's basis in each share of
nonrecently purchased T stock before the gain recognition election was
$500, i.e., $5,000/10. Thus, P recognizes a gain in 1985 with respect to
its nonrecently purchased T stock of $2,500, i.e., 10 (750^$500).
Question 5: How is the gain recognition election under section
338(b)(3) made?
Answer 5: (i) Attachment to statement of section 338 election. The
gain recognition election is made in the form of a gain recognition
statement (''GRS'') that is attached to a timely filed statement of
section 338 election (Form 8023) for T. In order for the gain
recognition election to be valid, the statement of section 338 election
(with the GRS attached) must be filed within the time specified in
1.338-1T(c) in the Form 8023 filing place(s) designated in 1.338-1T (c)
and (d). The gain recognition election is irrevocable. For certain
additional filing requirements if a gain recognition election is made,
see 1.338-1T (e) (2).
(ii) Contents of GRS. The GRS must be identified as a gain
recognition election under section 338(b)(3) and 1.338-4T(j). In
addition, the GRS must --
(A) Contain the name, address, and employer identification number of
each corporation (1) that is a P group member on the acquisition date of
T and that holds nonrecently purchased T stock on that date or (2) that
is a P group member on the acquisition date of an affected target
(provided that such acquisition date occurs on or before the day on
which the statement of section 338 election is filed) and that holds
nonrecently purchased stock in that affected target on that acquisition
date (''affected P group member'');
(B) Contain the following declaration (or a substantially similar
declaration):
''EACH CORPORATION HOLDING STOCK SUBJECT TO THIS GAIN RECOGNITION
ELECTION AGREES TO REPORT ANY GAIN PURSUANT TO THE GAIN RECOGNITION
ELECTION IN ITS FEDERAL INCOME TAX RETURN (INCLUDING AN AMENDED RETURN,
IF NECESSARY) FOR ITS TAXABLE YEAR IN WHICH THE ACQUISITION DATE OF T OR
ANY AFFECTED TARGET OCCURS'';
and
(C) Be signed (in the manner prescribed in 1.338-1T(d)(1)(v)) by a
person authorized to act on behalf of each affected P group member.
(iii) Transitional rules. Notwithstanding subdivision (i) of this
Answer 5 --
(A) If the statement of section 338 election with the GRS attachment
is filed with a Service Center under 1.338-1T (c)(1), then the gain
recognition election will not be valid unless copies of the GRS are also
filed with each other Service Center with which each affected P group
members (as defined in this Answer 5 (ii)(A)) files its annual income
tax return.
(B) If a statement of section 338 election is filed on or before July
15, 1986, without the GRS attachment, the P group may make a valid gain
recognition election by filing the GRS (with a copy of the previously
filed statement of section 338 election attached) on or before that day
at the place(s) specified in subdivision (i) of this Answer 5 and, if
applicable, subdivision (A) of this subdivision (iii).
Question 6: Assume that T owns all of the stock of T1 at the close
of T's acquisition date and that P makes a qualified stock purchase of
and express election for T. For purposes of determining the adjusted
grossed-up basis of T1, what is T's basis in the T1 stock that T is
deemed to sell and purchase under section 338(a)?
Answer 6: T's basis in recently purchased T1 stock for purposes of
determining the adjusted grossed-up basis of T1 is new T's basis in the
T1 stock. See also 1.338(b)-lT(d)(2).
(k) Miscellaneous matters affecting the final return of old T -- (1)
Application of section 337 to deemed sale of assets.
Question 1: If a section 338 election is made for T, will the deemed
sale of T's assets under section 338(a)(1) be governed by section 337,
notwithstanding section 337 (c)(1)(A) or (c)(2) (relating to collapsible
corporations and liquidations subject to section 332, respectively)?
Answer 1: Yes. Section 337 will not apply to T's deemed sale of
assets, however, to the extent that another section of the Internal
Revenue Code overrides (in whole or in part) the operation of section
337. Thus, for example, if old T is a ''consenting corporation'' within
the meaning of section 341(f) and if old T holds ''subsection (f)
assets'' on the acquisition date, section 337 will not apply to the
deemed sale to the extent that gain realized on the deemed sale of the
subsection (f) assets is required to be recognized under section
341(f)(2). See also section 897(d)(2), under which a foreign target
will be required to recognize gain or loss with respect to its deemed
sale of a United States real property interest notwithstanding section
337.
Question 2: Does the LIFO recapture rule of section 337(f) (rather
than section 336(b)) apply to T's deemed sale of assets?
Answer 2: Yes.
Question 3: How does section 337 operate in the context of section
338(h)(12), under which, for purposes of section 337, T is treated as
having distributed all of its assets at the close of the acquisition
date?
Answer 3: (i) General rule. Section 338(h)(12) provides that, for
purposes of section 337 and provisions that relate to section 337, T is
treated as distributing all of its assets as of the close of its
acquisition date if (A) T adopts a plan of complete liquidation during
the 12-month period ending on the acquisition date, (B) the plan is not
rescinded before the close of the acquisition date, and (C) a section
338 election is made for T. Section 337(a) provides that no gain or
loss shall be recognized to a corporation from the sale or exchange of
property (as defined in section 337(b)) during the 12-month period
beginning on the date on which that corporation adopts a plan of
complete liquidation, provided that, within such 12-month period, the
corporation distributes all of its assets in complete liquidation (less
assets retained to meet claims). Accordingly, if the requirements of
section 338(h)(12) are satisfied, T does not recognize gain or loss from
its sale or exchange of property during so much of such 12-month period
as ends on T's acquisition date if the nonrecognition rule of section
337 would have applied to such sale or exchange had T hypothetically
distributed all of its assets on the acquisition date. However, if
section 332 would have applied to a distribution of all of T's assets in
a hypothetical complete liquidation immediately after the plan of
complete liquidation was adopted, then section 337(c)(2) will apply to
bar the operation of section 337 through section 338(h)(12) unless each
corporation that would have been a distributee corporation (within the
meaning of section 337(c)(3)(B)(i)) with respect to that hypothetical
liquidation also is completely liquidated under the circumstances
described in section 337(c)(3). The restrictions normally applicable to
section 337 (e.g., the limitation on collapsible corporations) also
apply to the operation of section 337 in the section 338(h)(12) context.
(ii) Exception for section 338(c)(1) percentage. Gain or loss on
actual asset sales pursuant to the plan of complete liquidation that are
subject to the nonrecognition rule of section 337 by reason of section
338(h)(12) nevertheless is recognized to the extent of the section
338(c)(1) percentage (as defined in paragraph (h)(3)(v) of this
section). Section 338(c)(1) applies to such gain or loss in the same
manner as it applies to gain or loss arising in the deemed sale of
assets under section 338(a)(1).
Example. (i) A owns all 100 shares of the only class of outstanding
stock of T, a calendar year taxpayer. On January 1, 1985, T adopts a
plan of complete liquidation which is not rescinded before the close of
June 1, 1985. On April 1, 1985, T sells land held for investment and
realizes a long-term capital gain of $2,000. On June 1, 1985, P
purchases 90 of T's 100 shares from A and makes an express election for
T. Assume that those 90 shares represent, at all times during the
one-year period beginning on June 1, 1985 (the acquisition date of T),
90 percent of the value of all T stock and that P purchases no
additional T stock during the one-year period beginning on June 1, 1985.
Accordingly, the section 338 (c)(1) percentage is 10 percent.
(ii) Because T satisfies all of the requirements of section
338(h)(12), the nonrecognition rule of section 337 applies to T's asset
sale on April 1, 1985, assuming that such nonrecognition rule would have
applied to that sale had T hypothetically distributed all of its assets
on June 1, 1985, i.e., on T's acquisition date. By reason of section
338(c)(1), however, the capital gain of $2,000 is recognized to the
extent of the section 338(c)(1) percentage of 10 percent. Accordingly,
T recognizes a capital gain of $200 (i.e., $2,000 .10) that must be
reported in old T's final return. (The section 338(c)(1) percentage
also may cause the recognition of gain or loss in T's deemed sale of
assets on June 1, 1985.)
Question 4: How does section 341 apply to A and T if --
(i) At all relevant times, T is a collapsible corporation (as defined
in section 341(b)(1)),
(ii) On January 1, 1985, A causes T to adopt a plan of complete
liquidation,
(iii) On June 30, 1985, T sells property (other than property
described in section 337(b)(1)) to an unrelated person for cash,
(iv) T immediately distributes that cash to A in exchange for T stock
owned by A,
(v) On December 31, 1985, A sells all of its remaining T stock to P,
(vi) Rather than completing the liquidation of T, P makes a section
338 election for T, and
(vii) All of the requirements of section 338(h)(12) are satisfied?
Answer 4: (i) Application of section 341(e)(4) to T's sale of
property. Section 337(c)(1)(A) bars the application of the
nonrecognition rule of section 337 to T's sale of property on June 30,
1985, unless section 341(e)(4) applies with respect to that sale. For
purposes of determining whether the requirement of section 341(e)(4)(B)
is satisfied, T is treated as selling at the close of T's acquisition
date all of the properties held by T on that date.
(ii) Application of section 341(a)(2) to A's gain on the cash
distribution to A. To the extent that A's gain on the cash distribution
from T in exchange for T stock owned by A would be considered (but for
section 341(a)(2)) as gain from the sale or exchange of a capital asset
held for more than six months, such gain is recharacterized under
section 341(a)(2) as ordinary income unless section 341(a) is made
inapplicable to A by reason of section 341 (d) or (e)(2). For purposes
of determining under section 341(e)(2) whether the requirement of
section 341(e)(4)(B) is satisfied, T is treated as selling at the close
of T's acquisition date all of the properties held by T on that date.
(iii) Application of section 341(a)(1) to A's gain on the stock sale.
To the extent that A's gain on the December 31, 1985, sale of T stock
would be considered (but for section 341(a)(1)) as gain from the sale or
exchange of a capital asset held for more than six months, such gain is
recharacterized under section 341(a)(1) as ordinary income unless
section 341(a) is made inapplicable to A by reason of section 341 (d),
(e)(1), or (f).
Question 5: How do sections 453B(d)(2) and 453(h) apply with respect
to the distribution of an installment note (''note'') by T to A, the
sole shareholder of T at the time of the distribution, if --
(i) On January 1, 1985, A causes T to adopt a plan of complete
liquidation,
(ii) On June 30, 1985, T acquires the note in consideration for the
sale of non-depreciable property (other than property described in
section 337(b)(1)(A)),
(iii) T immediately distributes the note to A in exchange for T stock
owned by A,
(iv) On December 31, 1985, A sells all of its remaining T stock to P,
(v) Rather than completing the liquidation of T, P makes a section
338 election for T, and
(vi) The nonrecognition rule of section 337 would have applied by
reason of section 338(h)(12) had T sold or exchanged the note on the day
it distributed that note to A?
Answer 5: Pursuant to section 453B(d)(2) (and subject to the
limitations described therein), no gain or loss is recognized by T on
the distribution of the note to A. Pursuant to section 453(h), the
receipt by A of payments under the note (and not the receipt of that
note in the distribution) is treated as the receipt of payment by A for
the T stock transferred to T in exchange for the installment note.
(2) Application of section 338(h)(10).
Question 1: Is a section 338 election a prerequisite to a section
338(h)(10) election?
Answer 1: Yes.
Question 2: May an election under section 338(h)(10) be made prior
to issuance of a Treasury decision containing regulations under section
338(h)(10)?
Answer 2: No.
Question 3: After a Treasury decision containing regulations under
section 338(h)(10) is published, will an election under section
338(h)(10) be permitted retroactively for a qualified stock purchase
that occurred prior to publication of that Treasury decision?
Answer 3: Yes. After a Treasury decision containing regulations
under section 338(h)(10) is published, a section 338(h)(10) election may
be made for stock sales included in a qualified stock purchase with
respect to which the acquisition date occurs after January 12, 1983.
(January 12, 1983, is the date of enactment of the Technical Corrections
Act of 1982, which added section 338(h)(10).)
(3) Effect of sections 382(a) and 168(d)(2)(B) on old T's final
return.
Question 1: Does section 382(a) (as in effect for taxable years
beginning before January 1, 1986) apply solely by reason of the
operation of section 338 to bar a net operating loss carryover to old
T's final return?
Answer 1: No.
Question 2: Does section 168(d)(2)(B) operate to bar a recovery
deduction for the taxable period represented by old T's final return?
Answer 2: (i) General rule. Subject to certain exceptions, section
168(d)(2)(B) bars a recovery deduction for the taxable period
represented by old T's final return since, by reason of the operation of
section 338(a)(1), all of old T's assets are disposed of during that
taxable period.
(ii) Effect of deemed sale return. The general rule of this Answer 2
applies only if the final return of old T is not a deemed sale return
(within the meaning of 1.338-1T(f)(3)(i)). If a deemed sale return is
filed, the operation of section 338 does not prevent T from taking a
recovery deduction for T's taxable period that ends immediately before
the deemed sale of assets, since T's assets are not considered disposed
of by reason of section 338(a)(1) during that taxable period. (That
taxable period is included in the consolidated return of the selling
group. See 1.338-1T(f)(3).) Although the rule of section 168(d)(2)(B)
technically applies to the deemed sale return, it is of no consequence
since a recovery deduction could not be taken for that taxable period in
any case.
Example (1). T is a calendar year taxpayer that files separate
returns. On November 1, 1985, P purchases all of the stock of T from S
in a qualified stock purchase and makes an express election for T. T is
denied a recovery deduction by reason of section 168(d)(2)(B) for the
ten-month period that ends at the close of November 1, 1985.
Example (2). Assume the same facts as in Example (1), except that T
is included in consolidated returns of the S group and therefore is
required, by reason of the express election made by P for T, to file a
deemed sale return under 1.338-1T(f)(3). T is not denied a recovery
deduction by reason of section 168(d)(2)(B) for the ten-month period
that ends immediately before T's deemed sale of assets at the close of
November 1, 1985. Such a recovery deduction is reported in the
consolidated return of the S group for 1985.
(4) Application of 1.1502-76(c) to old T's final return.
Question: How does 1.1502-76(c) apply to old T's final return if,
immediately before T's deemed sale of assets at the close of the
acquisition date, old T was a member of an affiliated group (''selling
group'') that did not file consolidated returns for taxable years of the
common parent of that group that precede the taxable year that includes
old T's acquisition date?
Answer: (i) General rule. Under 1.338-1T(f)(6)(i), old T's final
return is due on the 15th day of the third calendar month following the
month in which the acquisition date occurs (''final return due date'').
Under 1.1502-76(c)(2), a choice is permitted as to the taxable period
included in old T's final return if, on or before the final return due
date (including extensions), the selling group has not filed a
consolidated return that would include old T's taxable period that ends
on the acquisition date. On or before the final return due date
(including extensions), T may either (i) file a deemed sale return (as
defined in 1.338-1T(f)(3)(i)), on the assumption that the selling group
will file the consolidated return, or (ii) file a return for so much of
old T's taxable period as ends at the close of the acquisition date, on
the assumption that the consolidated return will not be filed. For
purposes of applying 1.1502-76(c)(2), an extension of time to file old
T's final return is considered to be in effect for the period during
which the waiver rule of 1.338-1T(h)(1) applies.
(ii) Consequence of erroneous filing of deemed sale return. If,
pursuant to subdivision (i) of this Answer, T files a deemed sale return
but the selling group does not file a consolidated return, then T must
file a substituted return for old T not later than the due date
(including extensions) for the return of the common parent with which
old T would have been included in the consolidated return. The
substituted return is for so much of old T's taxable year as ends at the
close of the acquisition date. Under 1.1502-76(c)(2), the deemed sale
return is not considered a return for purposes of section 6011 (relating
to the general requirement of filing a return) if a substituted return
must be filed.
(iii) Consequence of erroneous filing of return for regular tax year.
If, pursuant to subdivision (i) of this Answer, T files a return for so
much of old T's regular taxable year as ends at the close of the
acquisition date but the selling group also files a consolidated return,
T must file an amended return for old T not later than the due date
(including extensions) for the selling group's consolidated return.
(The amended return will be a deemed sale return.)
(iv) Last date for payment of tax. If either a substituted or
amended final return of old T is filed pursuant to this Answer, the last
date prescribed for payment of tax is the final return due date (as
defined in subdivision (i) of this Answer).
(5) Effect on old T's final return of plan to abate section 338(c)(1)
amounts.
Question: If, at the time old T's final return is filed, old T is
liable for tax by reason of section 338(c)(1) gain but there is a plan
in effect to abate such gain by reason of a purchase or redemption of T
stock, must such gain nonetheless be reported in old T's final return?
Answer: Yes. T must file old T's final return and pay tax based on
the facts as they exist at the time of filing. If the tax payment
reflects section 338(c)(1) amounts that are later abated, an amended
return should be filed.
(6) Combined deemed sale return under section 338(h)(15).
Question 1: What targets are included in a combined deemed sale
return (''combined return'') under section 338(h)(15)?
Answer 1: The combined return must include all of the targets (i)
that are acquired by the P group from a single selling consolidated
group (as defined in section 338(h)(10)(B)) and (ii) that would be
required to file separate deemed sale returns for the same acquisition
date if a combined return were not filed. All such targets must be
included in the combined return even though, as between those targets,
no one such target is a common parent corporation. Thus, for example, T
and T1 may be included in a combined return if (i) T and T1 are directly
owned subsidiaries of S, (ii) P, on a single day, acquires from S all of
the stock of both T and T1 in qualified stock purchases, and (iii) under
the circumstances, T and T1 would be required to file separate deemed
sale returns if a combined return were not filed.
Question 2: If a combined return is filed, will the losses of one
target included in that return offset the gains of another target, and
will a similar rule apply to tax credits?
Answer 2: Yes. Gains and losses recognized on the deemed sale of
assets by targets included in a combined return are treated as the gains
and losses of a single target. In addition, loss carryovers of a target
that were not subject to the separate return limitation year
restrictions (''SRLY restrictions'') of the consolidated return
regulations while that target was a member of the selling consolidated
group may be applied without limitation to the gains of other targets
included in the combined return. If, however, a target has loss
carryovers that were subject to the SRLY restrictions while that target
was a member of the selling consolidated group, the use of those losses
in the combined return will continue to be subject to those
restrictions, applied in the same manner as if the combined return were
a consolidated return. A similar rule will apply to tax credits. For
SRLY restrictions, see, e.g., 1.1502-1(f), 1.1502-3(c), 1.1502-4(f),
1.1502-21(c), and 1.1502-22(c).
Question 3: How is the combined return made?
Answer 3: The combined return is made by filing a single corporation
income tax return in lieu of separate deemed sale returns for all of the
targets required to be included in the combined return. The combined
return reflects the deemed sales of all of the targets required to be
included in the combined return. If the targets included in the
combined return constitute a single affiliated group within the meaning
of section 1504(a), the income tax return is signed by an officer of the
common parent of that group. Otherwise, the return must be signed by an
officer of each target included in the combined return. Rules similar
to the rules in 1.1502-75(j) apply for purposes of preparing the
combined return. The combined return must include an attachment
prominently identified as an ''Election to file a combined return under
section 338(h)(15).'' The attachment must --
(i) Contain the name, address, and employer identification number of
each target required to be included in the combined return,
(ii) Contain the following declaration (or a substantially similar
declaration): ''each target identified in this election to file a
combined return consents to the filing of a combined return,'' and
(iii) Be signed (in the manner prescribed in 1.338-1T(d)(1)(v)) by a
person authorized to act on behalf of each of those targets.
(l) Miscellaneous matters affecting new T -- (1) Effect of old T
liabilities.
Question: Is new T liable for old T's tax liabilities, including tax
liabilities resulting from the deemed sale?
Answer: Yes. For purposes of subtitle F of the Internal Revenue
Code, new T is treated as a continuation of old T. Thus, new T will be
liable for old T's tax liabilities. The shareholders of old T also will
be liable, however, for those tax liabilities of old T tax that are
attributable to taxable years in which those shareholders and old T
joined in a consolidated return. See 1.1502-6(a).
(2) Availability of investment tax credit; recovery deductions.
Question 1: Is new T entitled to the investment tax credit for
property it is deemed to purchase under section 338(a)(2)?
Answer 1: Yes, provided that the property would qualify for the
investment tax credit if new T acquired it in an actual purchase. The
property acquired by new T in the deemed purchase generally will be
subject to the used property limitations of section 48(c)(2).
Notwithstanding 1.338-1T(f)(3)(v), old T and new T are not considered
component members of the same controlled group for purposes of applying
section 179(d)(2)(B) to section 48(c)(1) (relating to the related party
limitation on the definition of ''used section 38 property'').
Question 2: Is new T entitled to recovery deductions under section
168(a) for property it is deemed to purchase under section 338(a)(2)?
Answer 2: Yes. New T generally is permitted to take recovery
deductions on recovery property acquired in the deemed purchase of
assets, and may make new elections under section 168 without regard to
the elections made by old T. For purposes of the ''anti-churning'' rule
of section 168(e)(4) and the rule of section 168(f)(10) (under which the
transferee of property is treated as the transferor in certain cases for
purposes of applying section 168(a)), old T is not a related person with
respect to new T.
(3) Effect of acquisition of partnership interest in deemed purchase
under section 338(a)(2).
Question: If one of the assets held by old T at the close of the
acquisition date is an interest in a partnership with respect to which
an election under section 754 applies, then may new T's deemed purchase
of that partnership interest cause an adjustment under section 743(b) to
the basis of partnership property (with respect to new T only)?
Answer: Yes. The provisions of subchapter K of the Code (relating to
partners and partnerships) apply as if the deemed sale and purchase
under section 338(a) were an actual sale and purchase.
(4) Employment taxes; employee plans.
Question 1: May wages earned by the employees of old T be considered
wages earned by such employees from new T for purposes of sections 3101
and 3111 (Federal Insurance Contributions Act) and section 3301 (Federal
Unemployment Tax Act)?
Answer 1: Yes.
Question 2: For purposes of applying the rules applicable to
employee benefit plans (including, for example, those plans described in
sections 79, 104, 105, 120, 124, 125, 127, and 129), qualified pension,
profit-sharing, stock bonus and annuity plans (sections 401(a) and
403(a)), simiplified employee pensions (section 408(k)), and tax
qualified stock option plans (sections 422A and 423), are old T and new
T to be treated as a single employer?
Answer 2: Yes.
(5) Application of mitigation provisions.
Question: For purposes of applying sections 1311-1314 (relating to
the mitigation of the effect of limitations), in the absence of a
section 338(h)(10) election, are old T and new T to be treated as being
the same taxpayer?
Answer: Yes.
(T.D. 8021, 50 FR 16405, Apr. 25, 1985, as amended by T.D. 8068, 51
FR 749, Jan. 8, 1986; T.D. 8074, 51 FR 5193, Feb. 12, 1986; 51 FR
6219, Feb. 21, 1986; T.D. 8072, 51 FR 10621, Mar. 28, 1986; T.D.
8088, 51 FR 17938, May 16, 1986; T.D. 8092, 51 FR 23741, July 1, 1986)
26 CFR 1.338-5T International aspects of section 338 (Temporary).
(a) Introduction -- (1) Effective date. Except as otherwise provided
in this section, this section applies to stock acquisitions for which
the acquisition date (determined without section 224(d)(5) of TEFRA)
occurs after August 31, 1982.
(2) Outline of topics. In order to facilitate the use of this
section, this subparagraph (2) lists the paragraphs, subparagraphs and
subdivisons contained in this section.
(a) Introduction.
(1) Effective date.
(2) Outline of topics.
(3) Application of 1.338-4T to foreign persons and certain domestic
corporations.
(4) Procedural rules.
(b) Nomenclature and definitions.
(1) Nomenclature.
(i) Corporations.
(ii) Individuals.
(2) Definitions.
(c) Application of section 338 to corporations and stock described in
section 338(h)(6)(B).
(1) General rule.
(2) Elective exclusion of foreign corporations from target affiliate
status.
(i) General rule.
(ii) Excludible foreign target affiliate.
(iii) Regular exclusion election not available in certain cases.
(A) General rule.
(B) Controlled foreign corporation directly acquired.
(C) Excludible foreign target affiliate holds stock in domestic
corporation.
(D) Exception when statute of limitations has expired.
(iv) Special rule if original target is a foreign corporation.
(A) General rule.
(B) Foreign target as original target.
(C) Qualifying domestic target affiliate.
(D) Special rule inapplicable if express election for original
foreign target filed.
(E) Effect of invalidation event.
(F) Coordination with protective carryover election.
(v) Procedure for making regular exclusion election.
(A) General rule.
(B) Contents of regular exclusion statement.
(C) Transitional rule.
(vi) Annotation on required schedule.
(vii) Procedure if regular exclusion election invalidated subsequent
to filing.
(A) Required schedule must be amended.
(B) Filing of amended returns.
(3) Effect of regular exclusion election on basis in excludible
foreign target affiliate stock.
(i) General rule.
(ii) Excess basis amount eliminated.
(iii) Subject to section 1248(f)(1).
(iv) Special rules if foreign target treated as domestic.
(v) Cross-reference.
(4) Special asset consistency rule if regular exclusion election
made.
(i) General rule.
(ii) Deemed election not imposed.
(iii) Relevant target.
(5) Certain foreign corporations treated as domestic corporations.
(i) General rule.
(ii) Event year.
(iii) Exception.
(6) Examples.
(d) Special rules applicable to offset prohibition election.
(1) Offset prohibition election inapplicable to certain transfers
(i) General rule.
(ii) Exception for certain foreign transferors.
(2) Limit on crediting foreign tax against U.S. tax on offset
prohibition gain.
(i) Definitions.
(A) Offset prohibition gain.
(B) Offset prohibition foreign taxes.
(C) Otherwise applicable section 904 limitation.
(ii) One-way special foreign tax credit limitation for offset
prohibition foreign taxes.
(iii) Excess special limitation disregarded for purposes of section
904(c).
(iv) Special rule for creditability of offset prohibition foreign
taxes in excess of special limitation.
(v) Coordination with restricted credit provisions of
1.338-4T(f)(6)(iv).
(3) Examples.
(e) Certain transactions subject to an exception to section 338(e)(1)
under the authority of section 338(e)(2)(D).
(1) Basis step-up attributable to gain recognized under section 367.
(2) Acquisition of foreign currency.
(i) General rule.
(ii) No inference regarding character of gain or loss.
(f) Effect of section 338 on foreign target.
(g) Operation of section 1248 if section 338 election made.
(1) Scope.
(2) General rules.
(i) Transfer of CFCT on or before acquisition date.
(ii) Effect of gain recognition election.
(iii) Carryover CFCT stock.
(iv) Special rule for determining status as controlled foreign
corporation.
(v) Section 1248(c)(2) subsidiary.
(vi) Special deemed stock sale rule.
(3) Enhanced earnings and profits amount if stock transferred on
CFCT's acquisition date.
(4) Enhanced earnings and profits amount if stock transferred before
CFCT's acquisition date.
(i) General rule.
(ii) Affected taxable year of CFCT.
(iii) CFCT's recapture earnings and profits.
(iv) Recapture amount.
(v) Exception to enhancement rule of paragraph (g)(4)(i) for
transitional period stock transfer.
(vi) Section 1248(c)(2) subsidiary with same taxable year as CFCT.
(A) Recapture amounts for subsidiaries.
(B) Earnings and profits of subsidiaries.
(C) Recapture earnings and profits for block.
(D) Application of general rule.
(vii) Section 1248(c)(2) subsidiary with taxable year different from
CFCT's.
(5) Section 338(c)(1) inapplicable.
(6) Carryover of old CFCT earnings and profits for purposes of
carryover CFCT stock.
(i) General rule.
(ii) Cap on carryover of earnings and profits.
(iii) Section 1248 amount for stock other than section 338(c)(1)
stock.
(iv) Section 1248 amount for section 338(c)(1) stock.
(v) Section 338(c)(1) stock.
(vi) Section 338(c)(1) amount.
(vii) Old CFCT earnings and profits unaffected by post-aquisition
date deficits.
(viii) Character of CFCT stock as carryover CFCT stock eliminated
upon disposition.
(7) Application of principles of this paragraph to section 1246.
(8) Examples.
(h) Treatment of gain in deemed sale of assets as income effectively
connected with the conduct of a trade or business within the United
States and as from sources within the United States.
(1) Foreign target.
(2) Domestic target.
(3) Measurement period.
(4) No inference regarding transactions not described.
(i) Reserved.
(j) Transitional rules for corporations and stock described in
section 339(h)(6)(B).
(1) Transitional elective exclusion from target affiliate status.
(2) Transitional target affiliate.
(i) General rule.
(ii) Acquired on or before March 15, 1986.
(iii) Hypothetical acquisition date of transitional target affiliate.
(3) Special rule for certain original targets described in section
338(h)(6)(B)(i).
(i) General rule.
(ii) Transitional excludible original target.
(iii) Qualifying target affiliate.
(A) General rule.
(B) Excepted target.
(iv) Coordination with protective carryover election.
(4) Examples.
(5) Relationship between transitional exclusion election and regular
exclusion election.
(i) In general.
(ii) Special rule for application of regular exclusion election.
(iii) Limitation on application of paragraph (c)(3) of this section.
(iv) Limitation on application of paragraph (c)(4) of this section.
(v) Overlap between paragraphs (c)(2)(iv) and (j)(3) of this section.
(A) In general.
(B) Illustrative factual situation.
(C) Express election for transitional excludible original target or
qualifying target affiliate.
(D) Express election for qualifying domestic target affiliate.
(E) Express election for FT3 bars regular exclusion election.
(F) FT3 is DT3.
(G) FT1 is DT1.
(H) FT2 is DT2.
(I) Effect of invalidation event after express election filed for
DT5.
(vi) Examples.
(6) Transitional asset consistency rules for corporations described
in section 338(h)(6)(B)(i).
(i) General rule.
(ii) Definitions.
(A) Transitional asset acquisition.
(B) Acquisition made on or before March 15, 1986.
(C) Excluded transferor.
(iii) Special asset consistency rule for acquisition from excluded
transferor.
(A) General rule.
(B) Deemed election not imposed.
(iv) Examples.
(7) Treatment of stock described in section 338(h)(6)(B)(ii).
(i) Transitional stock exclusion election.
(ii) Section 338(h)(6)(B)(ii) stock.
(iii) Eligible target.
(iv) Effect of exclusion from operation of section 338.
(v) Effect of difference between carryover basis amount and regular
basis amount.
(vi) Tacking of old eligible target's holding period.
(vii) Examples.
(8) Transitional section 338(h)(6)(B) election procedures.
(i) General rule.
(ii) Special procedure if express election filed on or before July
15, 1986.
(iii) Amendment procedure if transitional statement filed on or
before July 15, 1986.
(iv) Acquisition date of transitional target affiliate or eligible
target occurs after transitional section 338(h)(6)(B) statement filed.
(v) Contents of transitional section 338(h)(6)(B) statement.
(3) Application of 1.338-4T to foreign persons and certain domestic
corporations. Except as otherwise provided in this section, the
provisions of 1.338-4T apply to --
(i) Foreign corporations.
(ii) Domestic corporations described in section 338(h)(6)(B), and
(iii) Individuals that are not U.S. residents or citizens.
(4) Procedural rules. For additional procedural rules, see
1.338-1T.
(b) Nomenclature and definitions -- (1) Nomenclature. The
nomenclature in 1.338-4T(b)(1) also applies to this section except as
follows:
(i) Corporations. Each term used in 1.338-4T(b)(1) to refer to a
corporation (e.g., ''T'') is preceded in this section either by the
letter ''D,'' connoting a domestic corporation, the letter ''F,''
connoting a foreign corporation (as defined in section 7701(a)(5)), or
the letters ''CFC,'' connoting a controlled foreign corporation (as
defined in section 957). (''CFC'' is used rather than ''F'' only when
the corporation's status as a controlled foreign corporation is
significant.) However, the term ''P'' is used without a prefix when the
purchasing corporation's status as a foreign or domestic corporation is
not significant. (All terms used in 1.338-4T to refer to corporations
are references to domestic corporations.)
(ii) Individuals. Each term used in 1.338-4T(b)(1) to refer to an
individual (i.e., ''A'' and ''B'') is preceded in this section either by
the letter ''D,'' connoting a U.S. resident or citizen, or ''F,''
connoting an individual other than a U.S. resident or citizen. (All
terms used in 1.338-4T to refer to individuals are references to U.S.
residents or citizens.)
(2) Definitions. The definitions in 1.338-4T also apply to this
section, except that the definition of a domestic corporation in
1.338-4T(b)(6) is applied without the exclusion therein for DISCs,
corporations described in section 934(b) or 1248(e), and corporations to
which and election under section 936 applies.
(c) Application of section 338 to corporations and stock described in
section 338(h)(6)(B) -- (1) General rule. Except as otherwise provided
in this paragraph (c) and in paragraph (j) of this section (relating to
transitional rules) --
(i) A corporation that would be a target affiliate within the meaning
of section 338(h)(6)(A) but for section 338 (h)(6)(B)(i) shall be
considered a target affiliate for all purposes of section 338 and
(ii) Stock held by a target affiliate in a foreign corporation or in
a domestic corporation that is a DISC or that is described in section
1248(e) shall not be excluded from the operation of section 338.
(2) Elective exclusion of foreign corporations from target affiliate
status -- (i) General rule. If P files an express election for DT, an
original target, then, solely for purposes of the stock consistency rule
of section 338(f)(1), P also may elect (in the manner prescribed in
paragraph (c)(2)(v) of this section) to exclude all excludible foreign
target affiliates from the status of target affiliate (''regular
exclusion election''). If the regular exclusion election is not or
cannot be made (e.g., because DT is FT or because a section 338 election
is not filed for DT), then none of the excludible foreign target
affiliates may be excluded from the status of a target affiliate. A
section 338 election cannot be made for any excludible foreign target
affiliate that is subject to a regular exclusion election. For a
special stock basis rule that applies when a regular exclusion election
is made, see paragraph (c)(3) of this section. For a special asset
consistency rule that applies when a regular exclusion election is made,
see paragraph (c)(4) of this section. For treatment of certain foreign
corporations as domestic corporations, see paragraph (c)(5) of this
section. For transitional rules, see paragraph (j) of this section.
(ii) Excludible foreign target affiliate. An ''excludible foreign
target affiliate'' is a foreign corporation that meets two conditions.
The first condition is that, absent section 338(h)(6)(B), it would be
subject to a deemed election under section 338(f)(1) by reason of the
express election for DT. The second condition is that it must not be a
transitional target affiliate within the meaning of paragraph (j)(2) of
this section, i.e., its acquisition date must not occur on or before
March 15, 1986 (or after March 15, 1986, but pursuant to a binding
contract in effect on February 19, 1986. See Examples (1) and (2) in
paragraph (c)(6) of this section.
(iii) Regular exclusion election not available in certain cases --
(A) General rule. Except as provided in paragraph (c)(2)(iii)(D) of
this section (relating to effect of statute of limitations), a regular
exclusion election cannot be made (or is retroactively invalidated) if
an invalidation event described in this subdivision (iii) occurs and is
not disregarded by the District Director. An invalidation event shall
be disregarded only if the District Director determines, in connection
with the examination of a return that would be affected by the
invalidation event, that (1) a principal purpose for the transaction
that constitutes the invalidation event is avoidance of the regular
exclusion election and (2) the principles underlying this subdivision
(iii) would not be significantly compromised by disregarding the
invalidation event. The invalidation event shall be given full effect
pursuant to the provisions of this subdivision (iii) unless and until
these determinations are made by the District Director.
(B) Controlled foreign corporation directly acquired. An
invalidation event occurs if, during the consistency period, P (or any
other member of the P group) directly acquires (other than by reason of
a deemed purchase under section 338(a)(2)) any stock in (1) an
excludible foreign target affiliate that was a controlled foreign
corporation at any time during so much of that excludible foreign target
affiliate's taxable year within which its acquisition date occurs (or
would occur if a valid regular exclusion election were not made in the
express election) as ends on that acquisition date or (2) a domestic
target described in section 1248(e) that is subject to a section 338
election and that holds stock in an excludible foreign target affiliate
described in (1) of this subdivision (B). For purposes of determining
whether the excludible foreign target affiliate is a controlled foreign
corporation during the relevant period, the special rule of paragraph
(g)(2)(iv) of this section applies. For purposes of determining whether
P directly acquires any stock, the special deemed stock sale rule of
paragraph (g)(2)(vi) of this section applies. See Examples (3), (5),
and (8) in paragraph (c)(6) of this section.
(C) Excludible foreign target affiliate holds stock in domestic
corporation. An invalidation event occurs if one or more excludible
foreign target affiliates hold stock in a domestic corporation and that
domestic corporation would be subject to a section 338 election only if
the regular exclusion election did not apply. See Examples (9) through
(13) in paragraph (c)(6) of this section.
(D) Exception when statute of limitations has expired. If a regular
exclusion election is retroactively invalidated by reason of a
subsequent invalidation event, and if, as of the day of the invalidation
event, the period within which to make an assessment of tax has expired
for any return (of any person) that would be affected by treating a
particular excludible foreign target affiliate as not subject to the
previously made regular exclusion election (''barred target''), then,
notwithstanding the invalidation event, the barred target will continue
to be treated as subject to a regular exclusion election. Because of
the invalidation event, however, excludible foreign target affiliates
(other than barred targets) will not be treated as subject to a regular
exclusion election. For purposes of this subdivision (D), a return
would be affected by treating an excludible foreign target affiliate as
not subject to a previously made regular exclusion election if such
treatment would have the effect, directly or indirectly, of increasing
the tax liability reported in that return.
(iv) Special rule if original target is a foreign corporation -- (A)
General rule. This subdivision (iv) applies if the original target is a
foreign corporation other than a transitional excludible original target
within the meaning of paragraph (j)(3)(ii) of this section, i.e., other
than an original target with an acquisition date that occurs on or
before March 15, 1986 (or after March 15, 1986, but pursuant to a
binding contract in effect on February 19, 1986. If, subsequent to its
qualified stock purchase of the stock of such a foreign original target,
P (or another member of the P group) makes a qualified stock purchase of
the stock of a qualifying domestic target affiliate, then an express
election may be made for the qualifying domestic target affiliate as if
it were the original target, provided that a regular exclusion election
is made in that express election. If the express election and regular
exclusion election are made, then the foreign original target and all
other foreign corporations that would have been subject to a deemed
election under section 338(f)(1) by reason of an express election for
that foreign original target will be treated as excludible foreign
target affiliates subject to a regular exclusion election. Caution
should be exercised when applying this subdivision (iv), since a
subsequently acquired domestic target affiliate will not be considered a
qualifying domestic target affiliate under paragraph (c)(2)(iv)(C) of
this section if, under the hypothetical circumstances described therein,
an invalidation event occurs before an express election for that
domestic target affiliate (as a deemed original target) is filed. In
such a case, the express election may be made only for the foreign
original target. If the time to make that express election has expired,
then, by reason of section 338(f)(2), the subsequently acquired domestic
target affiliate cannot be made subject to section 338. If, by contrast,
the invalidation event occurs after the express election is filed for
the subsequently acquired domestic target affiliate, then that express
election will be valid but the otherwise excluded foreign targets also
will be subject to that express election. See paragraph (c)(2)(iv)(E) of
this section. See also examples (7), (8), and (13) in paragraph (c)(6)
of this section. For a similar rule applicable to a trasitional
excludible original target, see paragraph (j)(3) of this section. For
rules governing cases in which the provisions of this subdivision (iv)
and paragraph (j)(3) of this section overlap, see paragraph (j)(5)(v) of
this section.
(B) Foreign target as original target. Pursuant to the definition in
1.338-4T(b)(4), a foreign target is an original target if there exists
no previously acquired target as to which a section 338 election would
cause a deemed election under section 338(f)(1) for the foreign target.
For purposes of applying this definition, the section 338 election
referred to therein should be considered one with respect to which a
regular exclusion election is not made.
(C) Qualifying domestic target affiliate. A domestic target is a
''qualifying domestic target affiliate'' if four conditions are
satisfied. The first condition is that the domestic target must be a
corporation that would have been subject to a deemed election under
section 338(f)(1) had an express election been made for the foreign
original target. The second condition is that the qualified stock
purchase of the domestic target's stock must not occur by reason of a
deemed purchase under section 338(a)(2). The third condition is that a
regular exclusion election could have been made in an express election
filed for that domesic target had it been the original target, had the
foreign original target been a target affiliate of that domestic target,
and had the acquisition date of the foreign original target occurred
during the consistency period of that domestic target. For purposes of
the third condition, an invalidation event occurring after the express
election is filed is disregarded. The fourth condition is that there
must be no other domestic target that satisfies the first three
conditions and that has an earlier acquisition date. If two or more
domestic corporations with the same acquisition date satisfy the first
three conditions, then P may select any one of them to be the qualifying
domestic target affiliate. The selection is made by filing an express
election that names one such domestic corporation as the original
target. See Examples (7), (8), and (13) in paragraph (c)(6) of this
section.
(D) Special rule inapplicable if express election for original
foreign target filed. An express election for a qualifying domestic
target affiliate cannot be made if an express election already has been
made for the original foreign target.
(E) Effect of invalidation event. If an invalidation event occurs
after the express election and regular exclusion election are filed,
then, subject to the barred target rule of paragraph (c)(2)(iii)(D) of
this section, the original foreign target will be treated as subject to
a deemed election under section 338(f)(1) by reason of the express
election and no corporation will be excluded from the status of a target
affiliate pursuant to the previously filed regular exclusion election.
(F) Coordination with protective carryover election. If P wishes to
make a protective carryover election under 1.338-4T(f)(6) in lieu of an
express election and if an express election could have been made for a
target other than the actual original target pursuant to this
subdivision (iv) or paragraph (j)(3) of this section, then the
protective carryover election need not be filed before the close of the
period within which an express election could have been made for a
target other than the original target. For all purposes of the
protective carryover election other than the time for filing that
election, the actual original target is treated as the original target
(e.g., for purposes of identifying the original target in the protective
carryover election statement).
(v) Procedure for making regular exclusion election -- (A) General
rule. The regular exclusion election is made on the Form 8023 filed for
DT in the manner shown on the form. If the revised Form 8023 showing
the manner for making this election is not available, a statement
(''regular exclusion statement'') must be attached to the Form 8023.
The regular exclusion election, once made, is treated as an integral
part of the Form 8023, e.g., for purposes of 1.338-1T(e)(2)(i)
(requiring that the Form 8023 be attached to certain returns). The
regular exclusion election is irrevocable.
(B) Contents of regular exclusion statement. The regular exclusion
statement must be identified prominently as a regular exclusion election
under 1.338-5T(c)(2) and must contain the following declaration (or a
substantially similar declaration): ''the regular exclusion election is
hereby made for all excludible foreign target affiliates (as defined in
1.338-5T(c)(2) (ii) and (iv)).'' The regular exclusion statement must be
signed (in the manner prescribed in 1.338-1T(d)(1)(v)) by a person
authorized to act on behalf of P.
(C) Transitional rule. If a regular exclusion election is not made
in an express election filed on or before July 15, 1986, a regular
exclusion election nonetheless may be made if, on or before July 15,
1986, a copy of the previously filed express election (generally Form
8023), with a copy of the regular exclusion statement attached, is filed
in the Form 8023 filing place(s) where a statement of section 338
election would be filed, under 1.338-1T (c) and (d), on the date of the
regular exclusion election is made.
(vi) Annotation on required schedule. For additional information
that must be included on the schedule required by 1.338-1T(e) if a
regular exclusion election is made, see 1.338-1T(e)(1)(i)(F).
(vii) Procedure if regular exclusion election invalidated subsequent
to filing -- (A) Required schedule must be amended. If, subsequent to
the making of a regular exclusion election, that exclusion election is
invalidated by reason of an invalidation event described in paragraph
(c)(2)(iii) of this section, then the schedule required by 1.338-1T(e)
must be amended pursuant to 1.338-1T (e)(1)(ii)(B) and (e)(2)(ii)(B).
See Examples (3) and (11) in paragraph (c)(6) of this section.
(B) Filing of amended returns. If any returns of P group members
(determined as of the day of the invalidation event) need to be amended
as a result of an invalidation event, then the penalty prescribed in
1.338-1T(e)(3)(i) (inapplicability of the waiver rule of 1.338-1T(h))
applies unless appropriate amended returns (with a copy of the
previously filed Form 8023 and the revised schedule attached) are filed
on or before the 120th day after the date of the invalidation event.
(3) Effect of regular exclusion election on basis in excludible
foreign target affiliate stock -- (i) General rule. If a domestic
target (i.e., DT or a domestic affected target) is subject to section
1248(f)((1) on its deemed sale under section 338(a)(1) of stock in an
excludible foreign target affiliate to which a regular exclusion
election applies (''EFTA stock''), then the basis of that EFTA stock in
the hands of that domestic target, as new domestic target, shall be the
lesser of --
(A) The basis amount that, absent this subparagraph (3), is allocable
to that EFTA stock under section 338(b) (''regular basis amount'') or
(B) Old domestic target's basis in that EFTA stock immediately before
its deemed sale of assets under section 338(a)(1), increased by the
dividend (if any) included in old domestic target's gross income under
section 1248(f)(1) as a result of its deemed sale of that EFTA stock
(''special basis amount'').
(ii) Excess basis amount eliminated. If new domestic target's basis
in EFTA stock is determined under this subparagraph (3), then the excess
(if any) of the regular basis amount over the special basis amount is
eliminated. For purposes of allocating new domestic target's adjusted
grossed-up basis among the other assets of new domestic target, however,
such excess is treated as if it were an amount allocated to the EFTA
stock.
(iii) Subject to section 1248(f)(1). A domestic target is considered
''subject to section 1248(f)(1)'' on its deemed sale of EFTA stock if
all of the following three requirements are satisfied:
(A) That target recognizes a section 1248(f) dividend as a result of
such deemed sale (or would have recognized such a dividend if the
excludible foreign target affiliate had earnings and profits).
(B) The section 1248(f) dividend (if any) actually recognized by that
target is less than the gain it is deemed to realize on such deemed
sale.
(C) If earnings and profits hypothetically would arise had the
regular exclusion election not been made (whether or not they would
actually arise), they would increase the section 1248(f) dividend
recognized by that target on its deemed sale of that EFTA stock.
(iv) Special rules if foreign target treated as domestic. This
subdivision (iv) applies if three conditions are satisfied. The first
condition is that a domestic target (i.e., DT or a domestic affected
target) must be subject to section 1248(f)(1) on its deemed sale under
section 338(a)(1) of stock in a foreign target that is treated as a
domestic target under paragraph (c)(5) of this section (an ''FDT''). (A
domestic corporation described in section 1248(e) is considered an FDT
for purposes of this subdivision (iv).) For purposes of applying the
definition of paragraph (c)(3)(iii) of this section, stock in an FDT is
considered EFTA stock. The second condition is that such FDT (''FDT1'')
must, at the close if its aquisition date, directly or indirectly
(through one or more other FDTs (''intermediate FDTs'')) hold EFTA
stock. The third condition is that, if deemed sale earnings and profits
of the excludible foreign target affiliate hypothetically would arise
had the regular exclusion election not been made, they would increase
the section 1248(f) dividend recognized by the domestic target on its
deemed sale of FDT1 stock. If the three conditions are satisfied, then
the following consequences apply:
(A) The basis of the domestic target, as new domestic target, in FDT1
stock shall be determined under paragraph (c)(3)(i) of this section as
if FDT1 were an excludible foreign target affiliate.
(B) The basis of FDT1, as new FDT1, in directly held EFTA stock shall
be the lesser of the following two amounts: The first amount is the
regular basis amount (within the meaning of paragraph (c)(3)(i)(A) of
this section). The second amount is the basis of old FDT1 in the EFTA
stock, increased by an amount equal to the excess of the section 1248(f)
dividend (if any) actually recognized by the domestic target on its
deemed sale of FDT1 stock over the amount that dividend would have been
had (1) FDT1 not held the stock of EFTA and (2) the gain realized on the
deemed sale of the FDT1 stock were not affected by (1) of this
subdivision (B).
(C) The basis of FDT1 in the stock of an intermediate FDT, and the
basis of each intermediate FDT in the stock of another intermediate FDT
or in EFTA stock, shall be determined in the same manner as under
paragraph (c)(3)(iv)(B) of this section.
(v) Cross-reference. For nonapplication of this subparagraph (3)
during a transitional period, see paragraph (j)(5)(iii) of this section.
For examples of this subparagraph (3), see Examples (15) through (18)
in paragraph (c)(6) of this section.
(4) Special asset consistency rule if regular exclusion election made
-- (i) General rule. A P group member must take a carryover basis in an
asset acquired from an excludible foreign target affiliate or from a
foreign target affiliate of a relevant target as if the asset
acquisition were subject to an affirmative action carryover election if
(A) a regular exclusion election is made and (B) in the absence of an
express election, the asset acquisition would be considered a tainted
asset acquisition (as defined in 1.338-4T(f)(6)(ii)) with respect to
any relevant target. See Examples (19) through (21) in paragraph (c)(6)
of this section. For guidance on the affirmative action carryover
election, see 1.338-4T(f)(6). For a limitation on the rule of this
subparagraph (4) in the transitional context, see paragraph (j)(5)(iv)
of this section. Except as provided in this subparagraph (4) or in
paragraph (j)(6)(iii) of this section (relating to a transitional rule),
no asset acquisition shall be treated as a tainted asset acquisition if
an express election is made.
(ii) Deemed election not imposed. In no event shall the District
Director impose a deemed election under section 338(e)(1) for any
excludible foreign target affiliate as a result of an asset acquisition
described in this subparagraph (4).
(iii) Relevant target. A ''relevant target'' is the actual original
target (and not a target deemed to be the original target in the express
election actually filed) or any other corporation that, absent section
338(h)(6)(B), would be subject to a deemed election under section
338(f)(1) by reason of an express election for that original target.
(5) Certain foreign corporations treated as domestic corporations --
(i) General rule. A foreign original target is treated as a domestic
corporation for purposes of this paragraph (c) if 50 percent or more of
its gross income from all sources for the 3-year period ending with the
close of its taxable year that precedes its event year (or for so much
of that 3-year period as that foreign corporation has been in existence)
is effectively connected with the conduct by that corporation of a trade
or business in the United States. This 50 percent gross income test
also applies to a foreign corporation that otherwise would be an
excludible foreign target affiliate (including by reason of the
treatment of a foreign original target as a domestic original target
pursuant to the preceding sentence). The 50 percent test of this
subdivision (i) shall be applied in the same manner as the 50 percent
test of section 861(a)(2)(B) (relating to source of certain dividends)
except that the Commissioner may exclude any transactions of a foreign
corporation during the last year of this 3-year period from gross income
for purposes of this 50 percent test if he determines (on the basis of
all the facts and circumstances) that the transactions were entered into
pursuant to a plan to treat or avoid treating a foreign corporation as a
domestic corporation. See Examples (4), (6), and (9) through (13) in
paragraph (c)(6) of this section.
(ii) Event year. The ''event year'' of a foreign corporation is the
taxable year of that corporation in which its acquisition date occurs
(or would occur, absent a regular exclusion election, in the event of an
express election for the original target).
(iii) Exception. If, during the consistency period, P (or any other
member of the P group) directly acquires (other than by reason of a
deemed purchase under section 338(a)(2)) any stock in a foreign target
(including a foreign corporation that would be a target only if a
regular exclusion election were not made in the express election), then
that foreign target will in no case be treated as a domestic corporation
if (A) it was a controlled foreign corporation at any time during so
much of the taxable year within which its acquisition date occurs (or
would occur if a regular exclusion election were not made in the express
election) as ends on that acquisition date and (B) it holds stock in a
corporation that would be an excludible foreign target affiliate if the
foreign corporation were treated as a domestic corporation. For
purposes of determining whether the corporation is a controlled foreign
corporation during the relevant period, the special rule of paragraph
(g)(2)(iv) of this section applies. See Examples (4) through (6) and
(18) in paragraph (c)(6) of this section.
(6) Examples. The provisions of this paragraph (c) may be
illustrated by the following examples. In each example, assume unless
otherwise expressly indicated that all of the corporations are calendar
year corporations and that none of the foreign corporations are treated
as domestic corporations under paragraph (c)(5) of this section. Assume
also that DS (or FS) has held all of the stock of the corporations it
sells to P since those corporations were organized. Finally, assume
that none of the invalidation events described in the following examples
are subsequently disregarded pursuant to paragraph (c)(2)(iii)(A) of
this section.
Example (1). On July 31, 1986, P purchases from DS all of the stock
of DT in a qualified stock purchase. DT holds all of the stock of FT1,
FT1 holds all of the stock of FT2, and FT2 holds all of the stock of
FT3. Because a section 338 election for DT would cause deemed elections
under section 338(f)(1) for FT1, FT2, and FT3 in the absence of section
338(h)(6)(B), those foreign corporations are excludible foreign target
affiliates under paragraph (c)(2)(ii) of this section. If P makes a
regular exclusion election in an express election filed for DT, then
that express election will not cause deemed elections under section
338(f)(1) for FT1, FT2, and FT3, since those corporations will not be
considered target affiliates for purposes of the stock consistency rule
of section 338(f)(1).
Example (2). Assume the same facts as in Example (1). Assume in
addition that on August 31, 1986, P also purchases from DS all of the
stock of DT4, a domestic corporation, in a qualified stock purchase.
DT4 holds all of the stock of FT5. Because a section 338 election for
DT would cause a deemed election under section 338(f)(1) for FT5 in the
absence of section 338(h)(6)(B), FT5 is an excludible foreign target
affiliate under paragraph (c)(2)(ii) of this section. If P makes a
regular exclusion election in an express election filed for DT, then
that express election will cause a deemed election under section
338(f)(1) for DT4 but not for FT1, FT2, FT3, and FT5. If a regular
exclusion election is not made in the express election filed for DT,
then that express election will cause deemed elections for FT1, FT2,
FT3, and FT5, as well as for DT4.
Example (3). Assume the same facts as in Example (2), except that
DT4 is FT4, a foreign corporation. Because a section 338 election for
DT would cause a deemed election under section 338(f)(1) for FT4 in the
absence of a regular exclusion election, FT4 is an excludible foreign
target affiliate under paragraph (c)(2)(ii) of this section. Because DS
is a domestic corporation, FT4 was a controlled foreign corporation
during the period beginning on January 1, 1986, and ending on August 31,
1986. Accordingly, that acquisition is an invalidation event and a
valid regular exclusion election cannot be made in an express election
filed for DT. See paragraph (c)(2)(iii)(B) of this section. (If a Form
8023 purporting to make a regular exclusion election already has been
filed, then that regular exclusion election is retroactively invalidated
by the qualified stock purchase of FT4 and the procedures described in
paragraph (c)(2)(vii) of this section apply.)
Example (4). (i) Assume the same facts an in Example (3), except
that FT4 satisfies the 50 percent gross income test of paragraph
(c)(5)(i) of this section for the 3-year period preceding 1986. None of
the other foreign corporations satisfy the 50 percent gross income test.
(ii) FT4 is not treated as a domestic corporation even though the 50
percent gross income test is satisfied, however, since the exception of
paragraph (c)(5)(iii) of this section applies, i.e., FT4 was directly
acquired by P (other than by reason of a deemed purchase under section
338(a)(2)), FT4 was a controlled foreign corporation during the period
beginning on January 1, 1986, and ending on August 31, 1986, and FT4
holds the stock of a corporation, FT5, that would be an excludible
foreign target affiliate if FT4 were treated as a domestic corporation.
Accordingly, the result is the same as in Example (3).
Example (5). Assume the same facts as in Example (3), except that DS
is FS. FS is not a controlled foreign corporation. Under these facts,
FT4 is not a controlled foreign corporation at any time during the
period beginning on January 1, 1986, and ending on August 31, 1986.
Because the acquisition of FT4 therefore is not described in paragraph
(c)(2)(iii)(B) of this section, P may make a regular exclusion election
in an express election filed for DT, and that regular exclusion election
will apply to FT1, FT2, FT3, FT4, and FT5.
Example (6). (i) Assume the same facts as in Example (1), except
that DT is FT. FT satisfies the 50 percent gross income test of
paragraph (c)(5)(i) of this section for the 3-year period preceding
1986. None of the other foreign corporations satisfy the 50 percent
gross income test.
(ii) A regular exclusion election cannot be made in an express
election filed for FT, since FT is not a domestic original target. See
paragraph (c)(2)(i) of this section. FT cannot satisfy the requirements
for domestic corporation status under paragraph (c)(5) of this section,
since the exception of paragraph (c)(5)(iii) of this section applies,
i.e., FT was directly acquired by P (other than by reason of a deemed
purchase under section 338(a)(2)), FT was a controlled foreign
corporation during the period beginning on January 1, 1986, and ending
on July 31, 1986, and FT holds the stock of a corporation, FT1, that
would be an excludible foreign target affiliate if FT were treated as a
domestic corporation. Because a regular exclusion election cannot be
made in an express election for FT, such an express election will cause
deemed elections under section 338(f)(1) for FT1, FT2, and FT3.
Example (7). (i) Assume the same facts as in Example (6). Assume in
addition that on August 31, 1986, P also purchases the stock of DT4 from
DS in a qualified stock purchase. DT4 holds all of the stock of FT5.
(ii) Because a regular exclusion election cannot be made in an
express election for FT, such an express election will cause deemed
elections under section 338(f)(1) for DT4 and FT5 as well as for FT1,
FT2, and FT3.
(iii) An express election cannot be made for DT4 under paragraph
(c)(2)(iv) of this section because DT4 is not a qualifying domestic
target affiliate within the meaning of paragraph (c)(2)(iv)(C) of this
section. DT4 is not a qualifying domestic target affiliate within the
meaning of paragraph (c)(2)(iv)(C) of this section because a regular
exclusion election could not have been made in an express election for
DT4 had DT4 been the original target, had FT been a target affiliate of
DT4, and had the acquisition date of FT occurred during the consistency
period of DT4. (Under those hypothetical circumstances, P's direct
acquisition of FT from DS is an invalidation event under paragraph
(c)(2)(iii)(B) of this section, since FT is a controlled foreign
corporation during the relevant period.)
Example (8). (i) Assume the same facts as in Example (6), except
that DS is FS and FT does not satisfy the 50 percent gross income test
of paragraph (c)(5)(i) of this section for the 3-year period preceding
1986. FS is not a controlled foreign corporation. Assume in addition
that on August 31, 1986, P also purchases the stock of DT4 from FS in a
qualified stock purchase. DT4 holds all of the stock of FT5.
(ii) FT is an original foreign target within the meaning of paragraph
(c)(2)(iv)(B) of this section. In addition, DT4 is a qualifying
domestic target affiliate within the meaning of paragraph (c)(2)(iv)(C)
of the section. DT4 is a qualifying domestic target affiliate because
it would be subject to a deemed election under section 338(f)(1) if an
express election were made for FT and because a regular exclusion
election could have been made in an express election for DT4 had DT4
been the original target, had FT been a target affiliate of DT4, and had
the acquisition date of FT occurred during the consistency period of
DT4. (Under those hypothetical circumstances, P's direct acquisition of
FT is not an invalidation event under paragraph (c)(2)(iii)(B) of this
section, since FT is not a controlled foreign corporation during the
relevant period.) Accordingly, the special rule of paragraph (c)(2)(iv)
of this section applies and an express election may be made for DT4
rather than for FT, provided that a regular exclusion election is made
in that express election. If such an express election is made, FT, FT1,
FT2, FT3, and FT5 will be treated as excludible target affiliates
subject to that regular exclusion election.
Example (9). (i) Assume the same facts as in Example (1), except
that FT2 satisfies the 50 percent gross income test of paragraph (c)(5)
of this section for the 3-year period preceding 1986 and therefore is
treated as a domestic corporation for purposes of this paragraph (c).
(1986 is the taxable year of FT 2 in which its acquisition date would
occur, absent a regular exclusion election, in the event of an express
election for DT. See paragraph (c)(5)(ii) of this section.) (The
exception of paragraph (c)(5)(iii) of this section is inapplicable
because P did not directly acquire any of the stock of FT2.) None of the
other foreign corporations satisfy the 50 percent gross income test.
(ii) A valid regular exclusion election cannot be made in an express
election filed for DT, since an excludible foreign target affiliate,
FT1, holds stock in a ''domestic'' corporation, FT2, that would be
subject to a section 338 election only if the regular exclusion election
did not apply. See paragraph (c)(2)(iii)(C) of this section.
Example (10). (i) Assume the same facts as in Example (1), except
that both FT1 and FT2 satisfy the 50 percent gross income test of
paragraph (c)(5) of this section and therefore are treated as domestic
corporations for purposes of this paragraph (c). None of the other
foreign corporations satisfy the 50 percent gross income test.
(ii) A regular exclusion election (applicable to FT3 only) may be
made in the express election filed for DT, since both FT1 and FT2 are
considered domestic corporations under paragraph (c)(5) of this section
(and therefore are no excludible foreign target affiliates).
Accordingly, there exists no excludible foreign target affiliate that
holds stock in a domestic corporation.
Example (11). (i) Assume the same facts as in Example (2), except
that FT5 holds all of the stock of FT6 and that FT6 satisfies the 50
percent gross income test of paragraph (c)(5) of this section for the
3-year period preceding 1986 (and therefore is treated as a domestic
corporation for purposes of this paragraph (c)). None of the other
foreign corporations satisfy the 50 percent gross income test.
(ii) Since an excludible foreign target affiliate, FT5, holds stock
in a ''domestic'' corporation, FT6, that would be subject to a section
338 election only if the regular exclusion election did not apply, the
acquisition of DT4 is an invalidation event and a valid regular
exclusion election cannot be made in the express election filed for DT4.
See paragraph (c)(2)(iii)(C) of this section. (If a Form 8023
purporting to make a regular exclusion election already has been filed,
then that regular exclusion election is retroactively invalidated by the
acquisition of DT4 and the procedures described in paragraph (c)(2)(vii)
of this section apply.)
Example (12). Assume the same facts as in Example (9), except that
FT1 holds only 10 percent of FT2's only class of outstanding stock while
a wholly-owned domestic subsidiary of DT holds the remaining 90 percent.
A regular exclusion election (applicable to FT1 and FT3) may be made in
the section 338 election filed for DT, since FT2, a ''domestic''
corporation, will be subject to a section 338 election even though the
regular exclusion election is made. See paragraph (c)(2)(iii)(C) of
this section.
Example (13). (i) Assume the same facts as in Example (8), except
that FT2 satisfies the 50 percent gross income test of paragraph (c)(5)
of this section for the 3-year period preceding 1986 and therefore is
treated as a domestic corporation for purposes of this paragraph (c).
None of the other foreign corporations satisfy the 50 percent gross
income test.
(ii) An express election cannot be made for DT4 under the special
rule of paragraph (c)(2)(iv) of this section, since a regular exclusion
election could not have been made in an express election for DT4 had DT4
been the original target, had FT been a target affiliate of DT4, and had
the acquisition date of FT occurred during the consistency period of
DT4. Although P's direct acquisition of FT is not an invalidation event
under those hypothetical circumstances, since FT is not a controlled
foreign corporation for the relevant period, an invalidation event
nonetheless occurs because FT1, an excludible foreign target affiliate,
holds stock in a ''domestic'' corporation, FT2. See paragraph
(c)(2)(iii)(C) of this section.
(iii) Because the invalidation event occurs before an express
election for DT4 could be filed, DT4 is not a qualifying domestic target
affiliate within the meaning of paragraph (c)(2)(iv)(C) of this section.
Accordingly, the express election can be made only for FT, and a
regular exclusion election cannot be made in that express election.
Example (14). Assume that P makes a regular exclusion election under
the facts described in Example (2). Notwithstanding that, by reason of
section 338(h)(3)(B), new DT and new DT4 are considered to have made
qualified stock purchases of FT1 and FT5, respectively, a separate
section 338 election cannot be made for either or both of those
corporations. See paragraph (c)(2)(i) of this section.
Example (15). (i) Assume that P makes a regular exclusion election
under the facts described in Example (1). Assume in addition that old
DT4s basis in FT1 stock immediately before old DT's deemed sale of
assets is $20,000, that old DT realizes gain of $80,000 on the deemed
sale of FT1 stock (at a deemed sale price of $100,000), and that old DTD
must include $55,000 in gross income as a dividend under section
1248(f)(1) as a result of that deemed sale. (That $55,000 does not
include a $10,000 dividend under section 78.) Finally, assume that new
DT's basis in FT1 absent this paragraph (c) would be $100,000.
(ii) The special stock basis rule of paragraph (c)(3)(i) of this
section applies. Old DT is subject to section 1248(f)(1) (within the
meaning of paragraph (c)(3)(iii) of this section) on its deemed sale of
FT1 stock because (A) DT recognizes a section 1248(f) dividend on that
deemed sale, (B) that dividend is less than the gain realized by DT in
that deemed sale, and (C) earnings and profits that would have arisen
had the regular exclusion election not been made would have increased
the section 1248(f) dividend recognized by old DT. (Any earnings and
profits that would have accured to FT1, FT2, or FT3 had section 338
applied to those foreign corporations would have increased old DT's
section 1248 (f) dividend since each of those corporations is a
controlled foreign corporation for the taxable year within which such
earnings and profits would have been triggered. See paragraph (g) of
this section.)
(iii) New DT's basis in FT1 stock is $75,000, the lesser of the
regular basis amount of $100,000 or the special basis amount of $75,000,
i.e., $20,000+$55,000. See paragraph (c)(3)(i) of this sectdion. The
$25,000 excess of the regular basis amount over the special basis amount
is eliminated for income tax purposes except that, in allocating basis
among the other assets of new DT, that $25,000 excess is treated as if
it were an amount allocated to the FT1 stock. See paragraph (c)(3)(ii)
of this section.
Example (16). (i) Assume the same facts as in Example (15), except
that FT1 satisfies the 50 percent gross income test of paragraph (c)(5)
of this section for the 3-year period preceding 1986 and therefore is
treated as a domestic corporation for purposes of this paragraph (c).
None of the other foreign corporations satisfy the 50 percent gross
income test. Thus, DT and FT1 are subject to elections under section
338 while FT2 and FT3 are excludible foreign target affiliates subject
to the regular exclusion election. Assume further the following: Old
DT's section 1248(f)(1) dividend increases from $55,000 to $60,000 as a
result of the deemed sale earnings and profits triggered by FT1's deemed
sale of assets. Old FT1's basis in FT2 stock is $10,000. Absent
paragraph (c)(3) of this section, new FT1's basis in FT2 stock would be
$90,000. The earnings and profits of FT2 and FT3 that are attributable
to the FT1 stock under section 1248(c)(2) are $15,000 and $20,000,
respectively.
(ii) Under these circumstances, the special basis rule of paragraph
(c)(3)(iv) of this section applies. Accordingly, DT's basis in FT1
stock is determined under paragraph (c)(3) (i) and (iv)(A) of this
section even though FT1 is not an excludible foreign target affiliate.
Thus, new DT's basis in FT1 is $80,000 (i.e., $20,000+$60,000), an
amount less than the regular basis amount of $100,000. In addition, new
FT1's basis in FT2 stock is the lesser of (A) the regular basis amount
of $90,000 or (B) old FT1's $10,000 basis in the FT2 stock, increased by
$35,000, i.e., the excess of the section 1248(f) dividend actually
recognized by DT, $60,000, over the amount that dividend would have been
had FT1 not held the FT2 stock, $25,000 (i.e., $60,000 --
($15,000+$20,000)). (Had FT1 not held the FT2 stock, the earnings and
profits of both FT2 and FT3 would have been disregarded for purposes of
calculating the amount of DT's section 1248 (f) dividend.)
Example (17). (i) Assume the same facts as in Example (16), except
that FT2 also satisfies the 50 percent gross income test of paragraph
(c)(5) of this section for the 3-year period preceding 1986 and
therefore is treated as a domestic corporation for purposes of this
paragraph (c). FT3 does not satisfy the 50 percent gross income test.
Thus, DT, FT1, and FT2 are subject to elections under section 338 while
FT3 is an excludible foreign target affiliate subject to the regular
exclusion election. Assume further that, as a result of FT2's deemed
sale of assets, its earnings and profits that are attributable to the
FT1 stock under section 1248(c)(2) increase by $2,000, i.e., from
$15,000 to $17,000. (FT3's attributable earnings and profits are the
same as in Example (16).) Thus, old DT's section 1248(f)(1) dividend
increases from $60,000 to $62,000. Finally, assume that old FT2's basis
in FT3 stock is $5,000, and that, absent paragraph (c)(3) of this
section, new FT2's basis in FT3 stock would be $30,000.
(ii) New DT's basis in FT1 stock is determined in the same manner as
in Example (16). Thus, new DT basis in FT1's is $82,000 (i.e.,
$20,000+$62,000), an amount less than the regular basis amount of
$100,000.
(iii) New FT1's basis in FT2 stock is the lesser of (A) the regular
basis amount of $90,000 or (B) old FT1's $10,000 basis in the FT2 stock,
increased $37,000, i.e., the excess of the section 1248(f) dividend
actually recognized by DT, $62,000, over the amount that dividend would
have been had FT1 not held the FT2 stock, $25,000 (i.e. $62,000 --
($17,000+$20,000)).
(iv) New FT2's basis in FT3 stock is the lesser of (A) the regular
basis amount of $30,000 or (B) old FT2's $5,000 basis in the FT3 stock,
increased by $20,000, i.e., the excess of the section 1248(f) dividend
actually recognized by DT ($62,000) over the amount that dividend would
have been had FT2 not held the FT3 stock, $42,000 i.e.,
$62,000-$20,000).
Example (18). (i) Assume the same facts as in Example (16), except
that DT holds only 80 of the 100 outstanding shares of FT1's only class
of stock and that on July 31, 1986, P purchases the remaining 20 shares
of FT1 stock from DS.
(ii) FT1 cannot be treated as a domestic corporation since the
exception of paragraph (c)(5)(iii) of this section applies, i.e., 20
shares of FT1 stock were directly acquired by P (other than by reason of
a deemed purchase under section 338(a)(2)), FT1 was a controlled foreign
corporation for the relevant period, and FT1 holds the stock of a
corporation, FT2, that would be an excludible foreign target affiliate
if FT1 were treated as a domestic corporation. Thus, FT1 also is an
excludible foreign target affiliate and P's direct acquisition of its
stock is an invalidation event under paragraph (c)(2)(iii)(B) of this
section. Accordingly, a valid regular exclusion election cannot be made
in an express election for DT, and such an express election will cause
deemed elections for FT1, FT2, and FT3.
Example (19). Assume that P makes a regular exclusion election under
the facts described in Example (2). Assume in addition that on
September 10, 1986, P purchases an asset from FT1 in an acquisition
that, absent an express election for DT, would be considered a tainted
asset acquisition (as defined in 1.338-4T(f)(6)(i)). Under paragraph
(c)(4) of this section, P is required to take a carryover basis in the
acquired asset as if the acquisition were subject to an affirmative
action carryover election. The result is the same if the asset is
acquired by DT, FT2, FT3, DT4, of FT5.
Example (20). Assume the same facts as in Example (19), except that
DS is FS, a foreign corporation, and that P purchases the asset from FS.
The result is the same as in Example (19).
Example (21). Assume the same facts as in Example (19), except that
P purchases the asset from DT. Because paragraph (c)(4) of this section
does not apply to asset acquisitions from targets that are subject to
the express election, P's basis in the asset is determined under section
1012. The result is the same if P acquires the asset from DT4.
(d) Special rules applicable to offset prohibition election -- (1)
Offset prohibition election inapplicable to certain transfers -- (i)
General rule. The consequences of an offset prohibition election under
1.338-4T(f)(6)(iv) do not apply to a tainted asset acquisition if --
(A) The transferor is a foreign corporation, a corporation described
in section 934(b), or a corporation to which an election under section
936 applies or
(B) The transfer is a transaction to which the pricing rules of
section 994 (relating to DISC) or section 925 (relating to FSC) apply.
(ii) Exception for certain foreign transferors. Paragraph (d)(1)(i)
of this section does not apply to an asset transfer by a foreign
corporation if the gain recognized by that foreign corporation on the
transfer is effectively connected with the conduct by that corporation
of a trade or business within the United States.
(2) Limit on crediting foreign tax against U.S. tax on offset
prohibition gain -- (i) Definitions -- (A) Offset prohibition gain.
''Offset prohibition gain'' is INA gain (or a remaining ICA gain amount)
that is subject to an offset prohibition election under
1.338-4T(f)(6)(iv).
(B) Offset prohibition foreign taxes. ''Offset prohibition foreign
taxes'' are foreign income taxes paid or accrued with respect to offset
prohibition gain, as determined under the principles of 1.904-4(d)(2).
(C) Otherwise applicable section 904 limitation. The ''otherwise
applicable section 904 limitation'' is the limitation described in
section 904(d)(1) or 907 (b) (prior to amendment by section 211(c)(1) of
TEFRA) that would have applied to the offset prohibition gain but for
this subparagraph (2).
(ii) One-way special foreign tax credit limitation for offset
prohibition foreign taxes. A special foreign tax credit limitation
applies to offset prohibition gain (''special limitation'') in lieu of
the otherwise applicable section 904 limitation. The special limitation
is the limitation in section 904(a), computed by taking into account as
foreign source income only offset prohibition gain from sources without
the United States.
(iii) Excess special limitation disregarded for purposes of section
904(c). For purposes of carryback or carryover of excess foreign taxes
under section 904(c) to the taxable year in which there is offset
prohibition gain, any excess special limitation for that taxable year is
disregarded. ''Excess special limitation'' is the special limitation
for a taxable year in excess of offset prohibition foreign taxes paid or
accrued in that year.
(iv) Special rule for creditability of offset prohibition foreign
taxes in excess of special limitation. Offset prohibition foreign taxes
in excess of the special limitation for the taxable year in which those
taxes are paid or accrued nonetheless are creditable in that year if the
otherwise applicable section 904 limitation (determined without regard
to offset prohibition gain) exceeds the foreign taxes (not including
offset prohibition foreign taxes) that are paid or accrued in that year
and that are creditable under the otherwise applicable section 904
limitation in that year. Any remaining offset prohibition foreign taxes
carry back or carry over to other taxable years as foreign taxes subject
to the otherwise applicable section 904 limitation.
(v) Coordination with restricted credit provisions of
1.338-4T(f)(6)(iv). Answer 2 (ii)(B) and Answer 3 (iv)(D) of
1.338-4T(f)(6)(iv) each impose a special limitation on the amount of a
restricted credit (as defined therein) allowable as a credit against the
tax liability of a corporation (or of an affiliated group filing
consolidated returns) for the taxable year in which that corporation (or
group) recognizes offset prohibition gain. (The foreign tax credit is
not defined as a restricted credit.) The tax liability taken into
account for purposes of determining the amount of certain restricted
credits (e.g., the investment credit under section 46) is required by
statute to be reduced by the foreign tax credit allowed for the year.
See section 38(c)(2). Solely for purposes of that reduction, the
portion of the foreign tax credit allowed for the year that is
creditable under the special limitation of paragraph (d)(2)(ii) of this
section is disregarded.
(3) Examples. The provisions of paragraph (d)(2) of this section may
be illustrated by the following examples:
Example (1). (i) On December 31, 1984, P acquires all of the stock
of DT in a qualified stock purchase and timely files a protective
carryover election pursuant to 1.338-4T(f)(6)(ii). P makes an offset
prohibition election in the protective carryover election. P and DT
file separate calendar year returns. On June 1, 1985, P purchases an
asset from DT's foreign branch in a tainted asset acquisition subject to
the offset prohibition election. See 1.338-4T(f)(6)(iv) Answer 2 (ii).
For 1985, DT recognizes a foreign source offset prohibition gain of
$40,000 as a result of the asset transfer and also recognizes $60,000 of
other foreign source income. It is assumed for the sake of simplicity
that T has no deductions allocable to foreign source income. Absent
paragraph (d)(2) of this section, all $100,000 of DT's foreign source
income would be subject to the section 904 limitation for income
described in section 904(d)(1)(E). A foreign income tax of $20,000 is
specifically allocable to the $40,000 offset prohibition gain, and a
foreign income tax of $24,000 is specifically allocable to the remaining
$60,000 of foreign source income. DT's total taxable income for 1985
from all sources is $200,000, all of which is ordinary income. The
United States income tax (before the foreign tax credit) is $81,875.
(This tax reflects an equal division of the taxable income bracket
amounts between P and DT.) DT has no excess foreign taxes available as a
carryover to 1985 under section 904(c).
(ii) DT makes the following foreign tax credit calculations for 1985:
The remaining offset prohibition foreign tax, $3,062, will carryback
or carryover to other taxable years as a foreign tax allocable to income
described in section 904(d)(1)(E). Had the offset prohibition foreign
tax been less than the separate limitation for offset prohibition gain,
the excess limitation would have been disregarded for purposes of
carrying unused foreign taxes to 1985.
Example (2). (i) Assume the same facts as in Example (1), except
that a foreign income tax of $15,375 is specifically allocable to the
$40,000 offset prohibition gain and a foreign income tax of $25,563 is
specifically allocable to the remaining $60,000 of foreign source
income.
(ii) DT makes the following foreign tax credit calculations for 1985:
Example (3). (i) Assume the same facts as in Example (1), except
that foreign taxes paid in 1985 ($44,000) cannot be specifically
allocated between the offset prohibition gain and other foreign source
income.
(ii) Under the principles of 1.904-4(d) (2) (ii), $17,600 of the
total foreign income tax of $44,000 is allocated to offset prohibition
gain (i.e., $44,000 x $40,000/$100,000) and the remainder, $26,400, is
allocated to the other foreign source income (i.e., $44,000 x
$60,000/$100,000). DT makes the following foreign tax credit
calculations for 1985:
Example (4). (i) Assume the same facts as in Example (1). Assume in
addition that for 1985 DT's current year investment credit earned (as
calculated before application of the limitation based on amount of tax
under section 38(c)) is $24,000. Assume also that DT's pre-credit tax
liability would be $63,475 if the offset prohibition gain of $40,000
were disregarded.
(ii) DT's investment credit is a restricted credit. Accordingly, for
purposes of determining the amount of that credit allowable as a credit
against DT's tax in 1985, DT's pre-credit tax liability is calculated as
if the offset prohibition gain were not income to DT. See
1.338-4T(f)(6)(iv) Answer 2(ii)(B). Because the tax liability taken
into account for purposes of determining the amount of the investment
credit is required under section 38(c) to be reduced by the foreign tax
credit, the special rule of paragraph (d)(2)(v) of this section applies.
Accordingly, DT must make the following computations:
(e) Certain transactions subject to an exception to section 338(e)(1)
under the authority of section 338(e)(2)(D) -- (1) Basis step-up
attributable to gain recognized under section 367. The acquisition of
property is subject to an exception to section 338(e)(1) under the
authority of section 338(e)(2)(D) if, solely be reason of the
transferor's recognition of gain under section 367(a), the transferee's
basis in the transferred asset exceeds the transferor's basis in that
asset immediately before the transfer.
(2) Acquisition of foreign currency -- (i) General rule. The
acquisition of foreign currency is subject to an exception to section
338(e)(1) under the authority of section 338(e)(2)(D) if the acquisition
occurs in the ordinary course of the transferor's trade or business (as
determined under principles similar to those in 1.338-4T(f)(3)). Solely
for purposes of this subparagraph (2), a transferor is considered to act
in the ordinary course of its trade or business when it --
(A) Pays interest or principal on an obligation denominated in
foreign currency,
(B) Makes a loan denominated in foreign currency, or
(C) Pays a dividend denominated in foreign currency.
(ii) No inference regarding character of gain or loss. No inference
should be drawn regarding the character of exchange gain or loss
realized on transactions described in this paragraph (e)(2).
(f) Effect of section 338 on foreign target. If, for its taxable
year that includes its acquisition date and for any other relevant
taxable year, a foreign target for which a section 338 election is made
has no items of income for which it is taxable under chapter 1 of the
Code (including an item of income resulting from the section 338
election), then, in general, the section 338 election results in
potential United States tax consequences only for domestic shareholders
of that foreign target. Thus, for example, the adjustment to the
foreign target's earnings and profits that results from the section 338
election may affect the amount of a distribution that is treated as a
dividend for the domestic shareholders. Similarly, if the foreign
target is a controlled foreign corporation, section 338 may affect the
amount included in the gross income of certain domestic shareholders
under section 951 or 1248.
(g) Operation of section 1248 if section 338 election made -- (1)
Scope. This paragraph (g) applies section 1248 to the shareholders of a
target that is a controlled foreign corporation and that is subject to a
section 338 election (''CFCT''). The principles of this paragraph (g)
also apply if a domestic corporation described in section 1248(e) is
involved.
(2) General rules -- (i) Transfer of CFCT stock on or before
acquisition date. If a person transfers a block of CFCT stock on or
before CFCT's acquisition date but during CFCT's 12-month acquisition
period, then, for purposes of determining the amount (if any) treated as
a dividend to the transferor under section 1248, old CFCT's earnings and
profits attributable to the block is the enhanced earnings and profits
amount as determined under paragraph (g) (3) or (4) of this section (as
the case may be).
(ii) Effect of gain recognition election. If P makes a gain
recognition election under 1.338-4T(j)(2) of the nonrecently purchased
CFCT stock, then paragraph (g)(2)(i) of this section shall apply to the
gain recognized by P under section 338(b)(3)(A) as if the nonrecently
purchased CFCT stock were actually sold at the close of CFCT's
acquisition date.
(iii) Carryover CFCT stock. If on the close of CFCT's acquisition
date a non-P group member holds CFCT stock (or if a P group member holds
nonrecently purchased CFCT stock that is not subject to a gain
recognition election under 1.338-4T(j)(2)) (''carryover CFCT stock''),
then, solely for purposes of that carryover CFCT stock, old CFCT's
earnings and profits (adjusted to reflect deemed sale of assets under
section 338) and the foreign taxes attributable to those earnings and
profits shall carry over (in their annual layers) to new CFCT, subject
to the special rules and limitations prescribed in paragraph (g)(6) of
this section.
(iv) Special rule for determining status as controlled foreign
corporation. If a foreign target ceases to be a controlled foreign
corporation solely by reason of one or more purchases of its stock that
constitutes a qualified stock purchase, then all of its stock that is
included in that qualified stock purchase is deemed to have been
acquired by the purchasing corporation on that foreign target's
acquisition date for purposes of determining under this paragraph (g)
the period during which that foreign target (and all of its section
1248(c)(2) subsidiaries) are controlled foreign corporations.
(v) Section 1248(c)(2) subsidiary. For purposes of this paragraph
(g), a ''section 1248(c)(2) subsidiary'' with respect to a foreign
target is any corporation whose earnings and profits may be deemed under
section 1248(c)(2) to be included with the earnings and profits of that
foreign target.
(vi) Special deemed stock sale rule. For all purposes of the Code, a
transferor of stock in a controlled foreign corporation is deemed to
sell the stock directly to P or a P group member on the transferee's
acquisition date if (A) a member of the S group transfers the stock to a
domestic member of the S group that becomes a target for which a section
338 election applies, (B) the transfer takes place on or before the
transferee's acquisition date and during the consistency period of the
original target or an affected target, and (C) the controlled foreign
corporation becomes an affected target. The transferor shall not be
deemed to sell stock under this subdivision (vi) if it is demonstrated
that the transfer was not in anticipation of, or pursuant to a plan to
make, a direct or indirect transfer of the transferee's stock to P or a
P group member. Thus, for example, there will not be a deemed sale of
the stock of a controlled foreign corporation to P or a P group member
if, prior to the time the controlled foreign corporation becomes an
affected target, section 351(a) applies to the transfer by an S group
member of the stock of the controlled foreign corporation to a domestic
member of the S group. The Internal Revenue Service may treat a
transfer to a foreign member as subject to this subdivision (vi) if such
treatment is appropriate to carry out the purposes of this subdivision
(vi).
(3) Enhanced earnings and profits amount if stock transferred on
CFCT's acquisition date. For a block of CFCT stock actually or deemed
transferred on CFCT's acquisition date, the enhanced earnings and profit
amount is the earnings and profits of CFCT (and any section 1248(c)(2)
subsidiary) attributable to the block under the applicable section 1248
regulations. For purposes of this subparagraph (3), earnings and
profits of CFCT (and of each section 1248(c)(2) subsidiary) shall be
deemed to include the gains and other income amounts that each would
have recognized in the deemed sale of assets under section 338(a)(1) had
each been a domestic corporation.
(4) Enhanced earnings and profits amount if stock transferred before
CFCT's acquisition date -- (i) General rule. For a block of CFCT stock
actually or deemed transferred beofore CFCT's acquisition date, the
enhanced earnings and profits amount is the sum of the following
amounts:
(A) Old CFCT's earnings and profits attributable to the block under
the applicable section 1248 regulations, applied however by not
including in CFCT's earnings and profits (accumulated for the taxable
year of CFCT in which that stock transfer occurs) the recapture earnings
and profits for that year, and
(B) CFCT's recapture earnings and profits for each affected taxable
year of CFCT that would have been attributable to the block under the
applicable section 1248 regulations had that block been transferred on
CFCT's acquisition date.
(ii) Affected taxable year of CFCT. An affected taxable year of CFCT
is the taxable year of CFCT in which the CFCT stock is transferred and
each subsequent taxable year of CFCT up to and including its taxable
year that includes CFCT's acquisition date.
(iii) CFCT's recapture earnings and profits. CFCT's recapture
earnings and profits for an affected taxable year are an amount (not
less than zero) equal to (A) CFCT's earnings and profits accumulated for
that taxable year, minus (B) such earnings and profits as redetermined
by disregarding recapture amounts for that taxable year. The recapture
earnings and profits for a taxable year may not, however, exceed the
earnings and profits of CFCT accumulated for that taxable year.
(iv) Recapture amount. A ''recapture amount'' for an affected
taxable year is --
(A) The amount of gain realized as a result of an actual sale or
exchange of an asset during that year, to the extent that such amount
would have been recognized by CFCT in the deemed sale of assets under
section 338(a)(1) had CFCT been a domestic corporation that held that
asset on its acquisition date and had the deemed sale price of that
asset been equal to the actual amount realized on the sale or exchange
of that asset, and
(B) For the affected taxable year in which the deemed sale of assets
under section 338(a)(1) occurs, the gains and other income amounts that
would have been recognized by CFCT in the deemed sale of assets had CFCT
been a domestic corporation.
(v) Exception to enhancement rule of paragraph (g)(4)(i) for
transitional period stock transfer. Paragraph (g)(4)(i) of this section
does not apply to a stock transfer occurring on or before February 12,
1986 or after that date but pursuant to a contract of sale that is
binding on both the acquiring P group member and the seller as of that
date. Nevertheless, if such a transfer occurs during old CFCT's final
taxable year, then the transferor's ratable share of old CFCT's earnings
and profits accumulated for that year under the applicable section 1248
regulations will reflect the earnings and profits resulting from the
deemed sale of assets under section 338(a)(1) (pro-rated on a daily
basis for the period during which the transferor held the CFCT stock).
(iv) Section 1248(c)(2) subsidiary with same taxable year as CFCT.
For a block of CFCT stock with respect to which there are one or more
section 1248(c)(2) subsidiaries, all of which have the same taxable year
as CFCT, the provisions of paragra (g)(4)(i)-(iv) of this section shall
apply in the following manner:
(A) Recapture amounts for subsidiaries. First, for each affected
taxable year, (1) determine separately the recapture amounts of CFCT and
of each section 1248(c)(2) subsidiary, (2) under the applicable section
1248 regulations attribute to the block the amount for CFCT, (3) under
the principles of section 1248(c)(2) attribute to block the amounts for
each such subsidiary, and (4) determine for the block the sum of the
amount attributed from CFCT and the amounts attributed from the
subsidiaries.
(B) Earnings and profits of subsidiaries. Second, the earnings and
profits accumulated for each affected taxable year of CFCT and of each
section 1248(c)(2) subsidiary shall be determined and, under the
applicable principles, attributed for that year to the block.
(C) Recapture earnings and profits for block. Third, compute the
recapture earnings and profits for each affected taxable year for the
block as an amount (not less than zero) equal to (1) the sum of earnings
and profits accumulated for that year of CFCT attributed to the block
and of each section 1248(c)(2) subsidiary attributed under (B) of this
subdivision (vi) to the block, minus (2) such sum as redetermined by
disregarding recapture amounts for that year of CFCT and its section
1248(c)(2) subsidiaries. Recapture earnings and profits for a taxable
year for the block may not, however, exceed the amount in (1) of this
subdivision (C).
(D) Application of general rule. Fourth, apply the general rule in
paragraph (g)(4)(i) of this section by using amounts attributed to the
block under paragraph (g)(4)(vi) (B) and (C) of this section instead of
the amounts determined solely for CFCT.
(vii) Section 1248(c)(2) subsidiary with taxable year different from
CFCT's. The principles of paragraph (g)(4)(vi) of this section shall
apply if one or more section 1248(c)(2) subsidiaries have a different
taxable year than CFCT.
(5) Section 338(c)(1) inapplicable. The enhanced earnings and
profits amounts under paragraph (g) (3) and (4) of this section are
determined without regard to section 338(c)(1) (relating to surrogate
tax). For an exception applicable to certain carryover CFCT stock, see
paragraph (g)(6)(iv) of this section.
(6) Carryover of old CFCT earnings and profits for purposes of
carryover CFCT stock -- (i) General rule. The earnings and profits (and
attributable foreign taxes) attributable to old CFCT stock carry over to
new CFCT stock under paragraph (g)(2)(iii) of this section solely for
purposes of (A) characterizing an actual distribution with respect to a
share of carryover CFCT stock as a dividend, (B) characterizing gain on
a post-acquisition date transfer of a share of carryover CFCT stock as a
dividend under section 1248, and (C) determining the foreign taxes
deemed paid under section 902 with respect to the amount thereby treated
as a dividend.
(ii) Cap on carryover of earnings and profits. The earnings and
profits of old CFCT are taken into account with respect to a share of
carryover CFCT stock only to the extent of the section 1248 amount for
that share.
(iii) Section 1248 amount for stock other than section 338(c)(1)
stock. The section 1248 amount for a share of carryover CFCT stock
other than section 338(c)(1) stock is the amount (if any) of the gain
that, under the enhanced earnings and profits provisions of paragraph
(g)(3) of this section, would have been included in the shareholder's
gross income as a dividend under section 1248 had the shareholder
transferred that share to P on CFCT's acquisition date for a
consideration equal to the fair market value of that share on that date
(or, with respect to nonrecently purchased CFCT stock treated as
carryover CFCT stock, had a gain recognition election under section
338(b)(3)(A) applied to that share).
(iv) Section 1248 amount for section 338(c)(1) stock. The section
1248 amount for a share of section 338(c)(1) stock is determined in the
same manner as for other carryover CFCT stock, except that the earnings
and profits attributable to a share of section 338(c)(1) stock for each
taxable year of old CFCT under the principles of paragraph (g)(3) of
this section (i.e., without regard to section 338(c)(1)) are increased
or decreased by the section 338(c)(1) amount for that share for that
year.
(v) Section 338(c)(1) stock. For purposes of this paragraph (g)(6),
''section 338(c)(1) stock'' is carryover CFCT stock (other than
nonrecently purchased CFCT stock) that is neither --
(A) Purchased by a P group member at any time during the one-year
period beginning on CFCT's acquisition date nor
(B) Redeemed by CFCT in a transaction described in section 338
(h)(7)(B) during that 1-year period.
(vi) Section 338(c)(1) amount. The ''section 338(c)(1) amount'' for
a share of section 338(c)(1) stock is a positive (or negative) amount
equal to the net section 338(c)(1) gain or loss of old CFCT for its
taxable year, divided by the total number of shares of section 338(c)(1)
stock. For purposes of this subparagraph (6), the net section 338(c)(1)
amount for a share takes into account the net section 338(c)(1) gain or
loss for each section 1248(c)(2) subsidiary that is attributed under the
principles of section 1248(c)(2) to the share. (If convenient, the
section 338(c)(1) amount may be computed with respect to a block of
stock.) Section 338(c)(1) gains or losses are gains or losses that, had
CFCT (or the section 1248(c)(2) subsidiary) been a domestic corporation,
would have been recognized by it under section 338(c)(1) --
(A) As a result of its deemed sale of assets under section 338(c)(1)
or
(B) As a result of its actual sale of assets under the circumstances
described in section 338(h)(12) and 1.338-4T(k)(1) Answer 3 (ii).
(vii) Old CFCT earnings and profits unaffected by post-acquisition
date deficits. Notwithstanding that new CFCT incurs deficits in
earnings and profits, a post-acquisition date distribution with respect
to a share of carryover CFCT stock (or gain recognized in a
post-acquisition date transfer of a share of carryover CFCT stock when
that transfer is governed by section 1248) shall be treated as a
dividend at least to the extent of the section 1248 amount for that
share, reduced by prior post-acquisition date distributions with respect
to that share out of the earnings and profits of old CFCT. Thus, for
example, the first distribution by new CFCT with respect to a share of
carryover CFCT stock is treated as a dividend by the distributee to the
extent of the section 1248 amount for that share, notwithstanding that
new CFCT's losses exceed old CFCT's earnings and profits at the close of
the acquisition date. A distribution considered made out of old CFCT's
earnings and profits pursuant to this subparagraph (6) has no effect on
the earnings and profits of new CFCT.
(viii) Character of CFCT stock as carryover CFCT stock eliminated
upon disposition. A share of CFCT stock is not considered carryover
CFCT stock after it is disposed of in a transaction described in section
1248 (a)(1) or (f)(1)(B) by the person holding such stock on the close
of CFCT's acquisition date, provided that all gain realized on the
transfer is recognized at the time of the transfer, or that, if less
than all of the realized gain is recognized, the recognized amount
equals or exceeds the remaining section 1248 amount for that share.
(7) Application of principles of this paragraph to section 1246. The
principles of this paragraph (g) also apply to shareholders of a foreign
target that are subject to section 1246.
(8) Examples. The provisions of this paragraph (g) may be
illustrated by the following examples:
Example (1). (i) CFCT is a calendar year foreign corporation. DA, a
United States person, has owned 90 of the 100 shares of CFCT's only
class of outstanding stock since CFCT was organized on March 13, 1977.
P has held the remaining 10 shares of CFCT since CFCT was organized.
(Those 10 shares constitute nonrecently purchased CFCT stock in P's
hands within the meaning of section 338(b)(6)(B).) On November 1, 1986,
P purchases all 90 shares of CFCT stock held by DA for $90,000 in cash
and makes an express election for CFCT. Thus, for United States tax
purposes, CFCT has a short taxable year ending at the close of November
1, 1986. Assume DA recognizes gain of $81,000 on the sale of the CFCT
stock. All 90 shares of CFCT stock constitute a block of stock in DA's
hands within the meaning of 1.1248-2(b) and the conditions of
1.1248-2(c) are satisfied with respect to that block of stock. CFCT has
no earnings and profits accumulated (or deficit) for any taxable year
prior to 1986. Assume that, if CFCT were a domestic corporation, it
would recognize gain of $20,000 on November 1, 1986, by reason of its
deemed sale of assets under section 338(a)(1). CFCT's earnings and
profits accumulated for its short 1986 taxable year ending on November
1, 1986, without taking into account that $20,000 of gain, total
$50,000. P also makes a gain recognition election for CFCT under
section 338(b)(3)(A) and 1.338-4T(j)(2).
(ii) DA's sale of CFCT stock to P on November 1, 1986, is a transfer
to which section 1248 and paragraph (g) (2)(i) and (3) of this section
apply. For purposes of applying section 1248(a) to DA, the earnings and
profits accumulated by CFCT for its short taxable year ending on
November 1, 1986, are $70,000, i.e., the earnings and profits
accumulated for that taxable year as determined under 1.1248-2(b),
taking into account the gain of $20,000 that CFCT would have recognized
in the deemed sale of assets under section 338(a)(1) had CFCT been a
domestic corporation ($50,000+$20,000). See paragraph (g)(3) of this
section. Pursuant to 1.1248-2(e), $63,000 of the $70,000 of earnings
and profits accumulated for 1986 are attributable to the block of CFCT
stock sold by DA on November 1, 1986 (i.e., $70,000 90/100), since that
block (A) was held for the entire taxable year ending on November 1,
1986, and (B) includes 90 of the 100 shares of outstanding CFCT stock.
Accordingly, $63,000 of DA's gain of $81,000 on the sale of CFCT stock
is included under section 1248(a) in DA's gross income as a dividend.
(iii) Assume that P recognizes a gain of $9,000 with respect to the
10 shares of nonrecently purchased CFCT stock by reason of the gain
recognition election, which causes a hypothetical acquisition date sale
of nonrecently purchased stock. Under paragraph (g) (2)(ii) and (3) of
this section, that hypothetical sale is treated as a transfer of CFCT
stock by a U.S. person to P on CFCT's acquisition date in a transfer to
which section 1248 applies. Thus, under 1.1248-2(e), $7,000 of the
$70,000 of earnings and profits accumulated for 1986 are attributable to
the block of 10 shares of CFCT stock hypothetically sold by P at the
close of November 1, 1986 (i.e., $70,000 10/100), since that block (A)
was held for the entire taxable year ending on November 1, 1986, and (B)
includes 10 of the 100 shares of outstanding CFCT stock. Accordingly,
$7,000 of P's gain of $9,000 on the hypothetical sale of 10 shares of
CFCT stock is included under section 1248(a) in P's gross income as a
dividend.
Example (2). (i) Assume the same facts as in Example (1), except
that P does not make a gain recognition election.
(ii) The nonrecently purchased CFCT stock held by P (i.e., the 10
shares owned by P since CFCT was organized) is carryover CFCT stock (and
not section 338(c)(1) stock). See paragraph (g)(2)(iii) of this
section. Accordingly, the earnings and profits (and attributable
foreign taxes) of old CFCT carry over to new CFCT solely for purposes of
that block of 10 shares. However, the amount of old CFCT's earnings and
profits taken into account with respect to that block in the event of a
distribution by new CFCT with respect that block (or in the event of P's
sale of that block in a transaction governed by section 1248) may not
exceed the section 1248 amount for that block. The section 1248 amount
for that block is the amount of the section 1248 dividend P would have
recognized with respect to that block had it made a gain recognition
election under section 338(b)(3)(A). Under the facts of Example
(1)(iii), P would have recognized a gain of $9,000 with respect to that
block, and $7,000 of that amount would have been a section 1248
dividend, i.e., $70,000 10/100. Accordingly, the section 1248 amount for
the block of 10 shares of nonrecently purchased CFCT stock is $7,000.
Example (3). (i) CFCT is a calendar year foreign corporation. DA, a
United States person, has owned all 100 shares of CFCT's only class of
outstanding stock since CFCT was organized on March 13, 1977. On August
7, 1986, P purchases 40 of the 100 shares of CFCT stock held by DA for
cash. On May 26, 1987, P purchases the remaining 60 shares of CFCT
stock from DA for cash and makes an express election for CFCT. Thus,
for United States tax purposes, CFCT has a short taxable year ending on
May 26, 1987. Assume that gain recognized by DA is $80,000 on the
August 7, 1986, sale and $130,000 on the May 26, 1987, sale. The 40
shares and 60 shares of CFCT stock sold by DA constitute two blocks of
stock in DA's hands within the meaning of 1.1248-2(b). The conditions
of 1.1248-2(c) are satisified with respect to each block. CFCT has no
earnings and profits accumulated (or deficit) for any taxable year prior
to 1986. In 1986, CFCT recognizes gain of $30,000 on the sale of used
machinery. All of that gain would have been recognized by CFCT in the
deemed sale of assets under section 338 as depreciation recapture under
section 1245 had CFCT been a domestic corporation that held the
machinery on the acquisition date. CFCT's earnings and profits
accumulated for 1986 are $120,000 if that $30,000 gain is taken into
account. (Accordingly, CFCT's earnings and profits accumulated for
1986, as determined without that $30,000, are $90,000.) If CFCT were a
domestic corporation, it would recognize a gain of $20,000 on May 26,
1987, by reason of its deemed sale of assets under section 338(a)(1).
CFCT's earnings and profits accumulated for its short 1987 taxable year
ending on May 26, 1987, are $80,000 if that $20,000 gain is taken into
account. (Accordingly, CFCT's earnings and profits accumulated for
1987, as determined without that $20,000, are $60,000.)
(ii) DA's sales of the blocks of CFCT stock to P are transfers to
which section 1248 and paragraph (g)(2)(i), (3), and (4) of this section
apply. Under paragraph (g)(4)(ii) of this section, CFCT's 1986 and 1987
taxable years are affected taxable years of CFCT for which CFCT's
recapture earnings and profits must be determined. For 1986, CFCT has a
recapture amount of $30,000, i.e., the $30,000 of gain recognized by
CFCT on the sale of machinery in 1986. See paragraph (g)(4)(iv)(A) of
this section. Accordingly, under paragraph (g)(4)(iii) of this section,
CFCT's recapture earnings and profits for 1986 are $30,000, i.e.,
$120,000^$90,000. For 1987, CFCT has a recapture amount of $20,000,
i.e., the $20,000 of gain hypothetically recognized by CFCT in its
deemed sale of assets under section 338(a)(1)) and, accordingly,
recapture earnings and profits of $20,000, i.e., $80,000^$60,000.
(iii) The enhanced earnings and profits of CFCT attributable to the
block of 40 shares of CFTC stock sold on August 7, 1986, are determined
under paragraph (g)(4) of this section and the applicable section 1248
regulations as follows:
Accordingly, $41,600 of DA's $80,000 gain on the sale of the 40
shares of CFCT stock is included under section 1248(a) in DA's gross
income as a dividend.
(iv) The enhanced earnings and profits of CFCT attributable to the
block of 60 shares of CFCT stock sold on May 26, 1987, are determined as
follows under paragraph (g)(3) of this section and the applicable
section 1248 regulations:
Accordingly, $120,000 of DA's $130,000 gain on the sale of 60 shares
of CFCT stock on May 26, 1987, is included in DA's gross income as a
dividend.
Example (4). (i) Assume the same facts as in Example (1), except
that the 10 shares of CFCT stock not purchased by P from DA on November
1, 1986, are held by DB, a U.S. person, rather than by P. DBhas held
those shares, at an aggregate basis of $1,000 since CFCT was organized.
New CFTC makes no actual distributions to DB. On December 15, 1987, P
purchases those 10 shares of CFTC stock from DBfor $12,000 in cash, and
DBrecognizes a gain of $11,000. Assume that the fair market value of
those 10 shares on November 1, 1986, is $10,000. Assume in addition
that, had CFCT been a domestic corporation, it would have recognized an
additional $1,000 of gain in its deemed sale of assets under section
338(a)(1) on November 1, 1986, by reason of section 338(c)(1), for a
total deemed sale gain of $21,000. Finally, assume that new CFCT incurs
a $100,000 net operating loss for its short taxable year ending on
December 31, 1986, and a $50,000 net operating loss for 1987.
(ii) The tax consequences to DA are the same as in example (1), since
deemed sale gain under section 338(c)(1) is disregarded for purposes of
determining the earnings and profits attributable to CFCT stock sold
during the 12-month acquisition period ending on CFCT's acquisition
date. See paragraph (g)(5) of this section.
(iii) The CFCT stock held by DB, a non-P group member, on the close
of CFCT's acquisition date is carryover CFCT stock. See paragraph
(g)(2)(iii) and (6) of this section. Accordingly, the earnings and
profits (and foreign taxes attributable to such earnings and profits)
carryover to new CFCT solely for purposes of the CFCT stock held by DB.
(Under these facts, DBholds all of the carryover CFCT stock.) In
addition, DB's sale of the CFCT stock to P on December 15, 1987, is a
transfer to which section 1248 applies. DB's shares of CFCT stock
constitute a block of stock in DB's hands within the meaning of
1.1248-2(b) and the conditions of 1.1248-2(c) are satisfied with
respect to that block.
(iv) Because of the deficits incurred by new CFCT, DB's gain of
$11,000 on the sale of its CFCT stock to P on December 15, 1987, is
characterized as a section 1248 dividend only to the extent of the
section 1248 amount. See paragraph (g)(6)(vii) of this section.
Because the 10 shares held by DBconstitute section 338(c)(1) stock (as
defined in paragraph (g)(6)(v) of this section), the section 1248 amount
is determined under paragraph (g)(6)(iv) of this section. Since each of
the 10 shares has the same basis and holding period in DB's hands, it is
convenient to do the necessary calculations for the block of 10 shares
rather than for each share.
(v) The first step in determining the section 1248 amount is to
calculate the gain DBwould have recognized had it sold its CFCT stock to
P on CFCT's acquisition date for a consideration equal to the fair
market value of the stock on that day (''hypothetical stock sale
gain''). The fair market value of the 10 shares on that date is assumed
to be $10,000. Thus, DB's hypothetical stock sale gain is $9,000, i.e.,
$10,000-$1,000.
(vi) The second step in determining the section 1248 amount is to
calculate the protion of the hypothetical stock sale gain that would
have been a section 1248 dividend. This calculation also involves two
steps. First, the earnings and profits attributable to the block for
each relevant taxable year of old CFCT must be determined under
paragraph (g)(3) of this section. The only relevant year under these
facts is the short taxable year ending on November 1, 1986. The
earnings and profits attributable to the block for that short year under
such paragraph (g)(3) are $7,000, i.e., $70,000 x 10/100. Note that the
earnings and profits taken into account under such paragraph (g)(3) do
not reflect the $1,000 gain under section 338(c)(1). The second step,
in calculating the portion of the hypothetical stock sale gain that
would have been a section 1248 dividend, is to increase (or decrease)
that $7,000 by the section 338(c)(1) amount attributable to the block.
Under these facts, there is a single section 338(c)(1) gain of $1,000.
Because the block of stock at issue constitutes the entire amount of
section 338(c)(1) stock, the entire $1,000 is the section 338(c)(1)
amount attributable to the block. The portion of the hypothetical stock
sale gain that would have been a section 1248 dividend therefore is
$8,000, i.e., the lesser of the attributable earnings and profits of
$8,000 (i.e., $7,000+$1,000) or the hypothetical stock sale gain of
$9,000. Thus, the section 1248 amount for the block of stock sold by
DBon December 15, 1987, is $8,000. Accordingly, $8,000 of DB's $11,000
gain on the actual December 15, 1987, stock sale is a section 1248
dividend.
(vii) If DBwere a corporation it would be eligible for an indirect
foreign tax credit on the section 1248 dividend it receives, since
foreign taxes attributable to old CFCT's earnings and profits also
carryover to new CFCT for purposes of the carryover CFCT stock. (Such
deemed paid taxes would be treated as a dividend under section 78.)
Example (5). On December 31, 1986, P purchases from DS all of the
stock of DT in a qualified stock purchase. For many years, DT has held
as one block all of the stock of CFCTl and CFCTl has held all of the
stock of CFCT2. All corporations use the calendar year as the taxable
year and have no earnings and profits (or deficit) accumulated for any
taxable year prior to 1986. P makes an express election for DT. A
regular exclusion election under paragraph (c)(2) of this section is not
made, so that CFCT1, and CFCT2 are subject to deemed elections under
section 338(f)(1) as a result of the express election for DT. Pursuant
to 1.338-4T(c)(3), the acquisition date of DT and of each of its two
subsidiaries is December 31, 1986. For purposes of calculating the
amount of the section 1248(f) dividend recognized by DT as a result of
its deemed sale of the block of CFCT1 stock, the enhanced earnings and
profits attributable to the block are calculated under paragraph (g)(3)
of this section in the table below, based upon the facts assumed:
Example (6). Assume the same facts as in Example (5) except that
CFCT1 holds only 80 percent of the single class of outstanding stock of
CFCT2. For purposes of calculating the amount of the section 1248 (f)
dividend recognized by DT as a result of its deemed sale of the block of
CFCT1 stock, the enhanced earnings and profits attributable to the block
are calculated under paragraph (g)(3) of this section in the table
below:
(h) Treatment of gain in deemed sale of assets as income effectively
connected with the conduct of a trade or business within the United
States and as from sources within the United States -- (1) Foreign
target. If, during the measurement period, more than 50 percent of the
gross income derived by old FT from an item of property is effectively
connected with the conduct of a trade or business within the United
States, then the gain that old FT would recognize with respect to that
item of property in the deemed sale of assets under section 338(a)(1) if
it were a domestic target is treated --
(i) As income that is effectively connected with the conduct of a
trade or business within the United States and
(ii) As income from sources within the United States.
(2) Domestic target. If, during the measurement period, more than 50
percent of the gross income derived by old DT from an item of property
is treated as income from sources within the United States, then the
gain that old DT recognizes with respect to that item of property in the
deemed sale of assets under section 338(a)(1) is treated as income from
sources within the United States.
(3) Measurement period. The ''measurement period'' is the 3-year
period ending with the close of the taxable year that precedes old
target's final taxable year (or so much of that 3-year period as that
target held the particular item of property).
(4) No inference regarding transactions not described . No inference
should be drawn regarding either the source of or the United States tax
with respect to gain arising in the deemed sale of property not
described in paragraph (h) (1) or (2) of this section.
(i) (Reserved)
(j) Transitional rules for corporations and stock described in
section 338(h)(6)(B) -- (1) Transitional elective exclusion from target
affiliate status. If P files an express election for any original
target, then, solely for purposes of the stock consistency rule of
section 338(f)(1), P also may elect (in the manner prescribed in
paragraph (j)(8) of this section) to exclude some or all of the
transitional target affiliates from the status of target affiliate
(''transitional exclusion election''). If a transitional exclusion
election is not made, then none of the transitional target affiliates
may be excluded from the status of a target affiliate. A Section 338
election cannot be made for any transitional target affiliate that is
subject to a transitional exclusion election.
(2) Transitional target affiliate -- (i) General rule. A
''transitional target affiliate'' is any corporation described in
section 338(h)(6)(B)(i) that is acquired on or before March 15, 1986,
and that, absent section 338(h)(6)(B), would be subject to a deemed
election under section 338(f)(1) by reason of the express election for
the original target. (Under the second condition of paragraph
(c)(2)(ii) of this section, status as a transitional target affiliate
precludes status as an excludible foreign target affiliate.)
(ii) Acquired on or before March 15, 1986. A corporation is
considered acquired on or before March 15, 1986, if its acquisition date
(or hypothetical acquisition date) occurs on or before March 15, 1986,
or after that date but pursuant to a contract of sale that is binding on
both the acquiring P group member and the seller as of February 19,
1986. A corporation that is not considered acquired on or before March
15, 1986, is considered acquired after that date.
(iii) Hypothetical acquisition date of transitional target affiliate.
If the acquisition date of a transitional target affiliate actually
would occur only if the transitional exclusion election were not made
(i.e., by reason of the operation of section 338(h)(3)(B) and (f)(1)),
then that hypothetical acquisition date is treated as the acquisition
date for the purposes of applying this subparagraph (2).
(3) Special rules for certain original targets described in section
338(h)(6)(B)(i) -- (i) General rule. If the original target is a
transitional excludible original target, then the following consequences
apply:
(A) An express election may be made for the transitional excludible
original target or for any qualifying target affiliate.
(B) Only the corporation for which the express election is made is
deemed to be the original target.
(C) An express election for a qualifying target affiliate is valid
only if a transitional exclusion election also is made for the following
corporations (which are treated as transitional target affiliates under
these circumstances): (1) the transitional excludible original target
and (2) each qualifying target affiliate with an acquisition date
occurring before the acquisition date of the qualifying target affiliate
for which the express election is made.
(ii) Transitional excludible original target. A ''transitional
excludible original target'' is a corporation described in section
338(h)(6)(B)(i) that is an original target acquired on or before March
15, 1986 (within the meaning of paragraph (j)(2)(ii) of this section).
For purposes of applying 1.338-4T(b)(4) (definition of original target)
to this subdivision (ii), the section 338 election referred to therein
is considered one with respect to which a transitional exclusion
election is not made.
(iii) Qualifying target affiliate -- (A) General rule. A corporation
is a qualifying target affiliate if it is a potential qualifying target
affiliate that is not an excepted target. A corporation is a potential
qualifying target affiliate if (1) it is a target even in the absence of
a section 338 election and (2) it would be subject to a deemed election
under section 338(f)(1) if an express election (and no transitional
exclusion election) were made for the transitional excludible original
target.
(B) Excepted target. A potential qualifying target affiliate is an
excepted target and thus is not a qualifying target affiliate if its
acquisition date occurs after the acquisition date of a potential
qualifying target affiliate that is not a transitional target affiliate.
The determination of transitional target affiliate status is made
without regard to the provisions of this subparagraph (3).
(iv) Coordination with protective carryover election. For guidance
in a case in which P wishes to make a protective carryover election
under 1.338-4T(f)(6) instead of an express election, see paragraph
(c)(2)(iv)(F) of this section.
(4) Examples. The provisions of paragraph (j) (1) through (3) of
this section may be illustrated by the following examples.
Example (1). On December 31, 1984, P purchases from DS all of the
stock of DT in a qualified stock purchase. DT holds all of the stock of
FT1, FT1 holds all of the stock of FT2, and FT2 holds all of the stock
of FT3. FT1, FT2, and FT3 are transitional target affiliates, since an
express election from DT would cause deemed elections under section
338(f)(1) for FT1, FT2, and FT3, and since each of those three
corporations is acquired on or before March 15, 1986 (within the meaning
of paragraph (j)(2)(ii) of this section). Accordingly, P may elect to
exclude FT1, FT2, and/or FT3 from the status of a target affiliate in a
transitional exclusion election filed in connection with an express
election for DT. Note that a transitional exclusion election for FT1
need not also specify FT2 and FT3, since the benefit of excluding FT1
from the status of a target affiliate (avoidance of a section 338
election for FT1) automatically will apply to FT2 and FT3. (A qualified
stock purchase and section 338 election cannot occur for FT2 unless FT1
is deemed to sell its FT2 stock pursuant to an election under section
338. Similarly, a qualified stock purchase and section 338 election
cannot occur for FT3 unless FT2 is deemed to sell its FT3 stock pursuant
to an election under section 338. See section 338(a)(1) and (h)(3)(B).)
Example (2). (i) Assume the same facts as in Example (1), except
that DT is FT. Assume also that P acquires the stock of FT4, FT5, DT6
and FT7 from DS in qualified stock purchases on January 31, 1985, April
1, 1985, June 1, 1985, and July 1, 1985, respectively. Assume in
addition that FT4, FT5, DT6, and FT7 were members of the DS group on
December 31, 1984. Finally, assume that DT6, is a domestic corporation
that is not described in section 338(h)(6)(B)(i).
(ii) FT is a transitional excludible original target within the
meaning of paragraph (j)(3)(ii) of this section. FT1, FT2, and FT3 are
not qualifying target affiliates because they are not targets in the
absence of a section 338 election. See paragraph (j)(3)(iii)(A)(l) of
this section. (Such corporations would be targets only by reason of the
deemed purchase of stock under section 338(a)(1). See section
338(h)(3)(B).) FT4, FT5, and DT6 are qualifying target affiliates within
the meaning of paragraph (j)(3)(iii) of this section, since (A) they are
targets even in the absence of a section 338 election, (B) they would be
subject to deemed elections under section 338(f)(l) if an express
election (and no transitional exclusion election) were made for the
transitional excludible original target, and (C) they are not excepted
targets. FT7 is not a qualifying target affiliate because it is an
excepted target, i.e., its acquisition date occurs after the acquisition
date of DT6, a qualifying target affiliate that would not be a
transitional target affiliate if an express election were made for FT.
See paragraph (j)(3)(iii)(B) of this section.
(iii) Under these facts, an express election may be made for FT or,
pursuant to paragraph (j) (3) of this section, FT4, FT5, or DT6. The
express election cannot be made for FT7, since it is not a qualifying
target affiliate. If, for example, P wishes to make an express election
for FT4, then that express election will be valid only if a transitional
exclusion election is made for FT, the transitional excludible original
target that is treated as a transitional target affiliate under these
circumstances. If the express election is made for FT4, then, at P's
option, a transitional exclusion election may be made for FT5 and/or
FT7. The transitional exclusion election cannot be made for DT6, since
DT6 is not a transitional target affiliate. If P wishes to make an
express election for FT5, then that express election will be valid only
if transitional exclusion elections are made for FT and FT4. At P's
option under these circumstances, a transitional exclusion election may
be made for FT7.
(5) Relationship between transitional exclusion election and regular
exclusion election -- (i) In general. A transitional exclusion election
applies only to transitional target affiliates. If a transitional
exclusion election is or could be made in connection with an express
election, then, in the absence of an invalidation event (within the
meaning of paragraph (c)(2)(iii) of this section), a separate regular
exclusion election also may be made for all of the excludible foreign
target affiliates.
(ii) Special rule for application of regular exclusion election.
Under paragraph (c)(2)(i) of this section, a domestic original target is
a prerequisite for a regular exclusion election. If the express
election is made for a foreign original target with an acquisition date
that occurs on or before March 15, 1986 (within the meaning of paragraph
(j)(2)(ii) of this section), however, that foreign corporation will be
treated as if it were a domestic original target for purposes of
applying such paragraph (c)(2)(i).
(iii) Limitation on application of paragraph (c)(3) of this section.
The special basis rules of paragraph (c)(3) of this section do not apply
if the acquisition date of the domestic target occurs on or before March
15, 1986 (within the meaning of paragraph (j)(2)(ii) of this section).
(iv) Limitation on application of paragraph (c)(4) of this section.
If the acquisition date of the actual (as opposed to a deemed) original
target occurs on or before March 15, 1986 (within the meaning of
paragraph (j)(2)(ii) of this section) and if a valid regular exclusion
election is made, then paragraph (c)(4) of this section (relating to
carryover basis in certain asset acquisitions) applies only to asset
acquisitions from excludible foreign target affiliates and not from
nontarget foreign target affiliates. For transitional asset consistency
rules, see paragraph (j)(6) of this section.
(v) Overlap between paragraphs (c)(2)(iv) and (j)(3) of this section
-- (A) In general. This subdivision (v) provides rules for cases in
which there is an overlap between the provisions of paragraphs
(c)(2)(iv) and (j)(3) of this section. Those provisions provide
prospective and transitional rules, respectively, for making an express
election for a corporation other than the original target. In a case in
which there are both transitional target affiliates and excludible
foreign target affiliates, an express election may be made for (A) the
transitional excludible original target, (B) a qualifying target
affiliate pursuant to paragraph (j)(3) of this section, or (C) the
qualifying domestic target affiliate pursuant to paragraph (c)(2)(iv) of
this section, as modified by this subdivision (v).
(B) Illustrative factual situation. The rules of this subdivision
(v) are set out in the context of the following factual situation:
Assume that on April 1, 1985, FS owns all of the stock of FT1, FT2, FT3,
FT4, and DT5. Assume in addition that P acquires the stock of those
corporations in qualified stock purchases from FS on the dates indicated
in the following table (the post-March 15, 1986, acquisitions are not
made pursuant to a binding contract in effect on February 19, 1986:
(C) Express election for transitional excludible original target or
qualifying target affiliate. Under paragraph (j)(3) of this section, an
express election may be made for FT1, the transitional excludible
original target, or for FT2 or FT3, both of which are qualifying target
affiliates. An express election is not permitted under paragraph (j)(3)
of this section for FT4 or DT5, since those corporations are excepted
targets within the meaning of paragraph (j)(3)(iii)(B) of this section.
FT4 and DT5 are excepted targets because their acquisition dates occur
after the acquisition date of a potential qualifying target affiliate,
FT3, that is not a transitional target affiliate. An express election
for FT3, for example, is valid only if transitional exclusion elections
also are made for FT1 and FT2, which are considered transitional target
affiliates under these circumstances. See paragraph (j)(3)(i)(C) of
this section.
(D) Express election for qualifying domestic target affiliate.
Because one of the qualifying target affiliates for which an express
election could be made under paragraph (j)(3) of this section (FT3), is
a foreign target acquired after March 15, 1986 (within the meaning of
paragraph (j)(2)(ii) of this section), this subdivision (v) also permits
P to make the express election for DT5 (as the qualifying domestic
target affiliate) rather than for FT1, FT2, or FT3 if three conditions
are satisfied. The first condition is that DT5 must be a corporation
that would have been a qualifying domestic target affiliate under
paragraph (c)(2)(iv)(C) of this section had FT3 (i.e., a foreign
corporation that is a qualifying target affiliate acquired after March
15, 1986) been the actual original target. The second condition is that
a valid regular exclusion election under paragraph (c)(2)(iv) of this
section must be made in connection with the express election for DT5 in
the same manner as if FT3 were the actual original target. (Pursuant to
paragraph (c)(2)(iv) of this section, that regular exclusion election
applies to FT3 and FT4.) The third condition is that transitional
exclusion elections must be made as if the express election had been
made for FT3, i.e., transitional exclusion elections must be made for
FT1 and FT2. See paragraph (j)(3)(i)(C) of this section.
(E) Express election for FT3 bars regular exclusion election. An
express election under paragraph (j)(3) of this section for FT3, a
foreign corporation acquired after March 15, 1986, bars a regular
exclusion election. (Subject to the transitional rule of paragraph
(j)(5)(ii) of this section, which is inapplicable on these facts, a
regular exclusion election cannot be made if the original target for
which the express election is made is a foreign corporation.) Thus, FT4
could not be excluded from the status of a target affiliate if an
express election were made for FT3. If, however, an express election
under paragraph (j)(3) of this section is made for FT2, a foreign
corporation acquired on or before March 15, 1986, then the transitional
rule of paragraph (j)(5)(ii) of this section applies and a regular
exclusion election may be made (and will not be invalidated
retroactively) unless an invalidation event under paragraph (c)(2)(iii)
of this section occurs with respect to one of the excludible foreign
target affiliates, i.e., FT3 or FT4.
(F) FT3 is DT3. If FT3 were DT3, then (whether or not DT3 was
described in section 338(h)(6)(B)(i)) an express election could be made
only for FT1 or, pursuant to paragraph (j)(3) of this section, FT2 or
DT3. An express election could not be made for DT5 on these facts
because none of the qualifying target affiliates is a foreign
corporation acquired after March 15, 1986. See paragraph (j)(5)(v)(D)
of this section.
(G) FT1 is DT1. If FT1 were DT1, a domestic corporation not
described in section 338(h)(6)(B)(i), then the express election could be
made only for DT1 since the original target would not be a transitional
excludible original target under paragraph (j)(3)(ii) of this section.
(H) FT2 is DT2. If FT2 were DT2, a domestic corporation not
described in section 338(h)(6)(B)(i), then the express election could be
made only for FT1 or DT2, since no corporation acquired after the
acquisition date of DT2 is a qualifying target affiliate. See paragraph
(j)(3)(iii)(B) of this section.
(I) Effect of invalidation event after express election filed for
DT5. If an invalidation event occurs after an express election is made
for DT5 (e.g., the P group acquires an excludible foreign target
affiliate that holds stock in a domestic corporation under the
circumstances described in paragraph (c)(2)(iii)(C) of this section),
then, subject to the barred target rule of paragraph (c)(2)(iii)(D) of
this section, FT3 and FT4 will be subject to deemed elections under
section 338(f)(1) by reason of the express election for DT5. See
paragraph (c)(2)(iv)(E) of this section. FT1 and FT2 will not be
affected by the invalidation event since they are not excludible foreign
target affiliates. Accordingly, FT1 and FT2 will not be subject to
deemed elections under section 338(f)(1) by reason of the invalidation
event.
(vi) Examples. The provisions of this subparagraph (5) may be
illustrated by the following examples.
Example (1). (i) Assume the same facts as in Example (2) of
paragraph (j)(4) of this section, except that the acquisition dates of
FT5, DT6, and FT7 occur on June 1, 1985, April 1, 1986, and May 1, 1986,
respectively. Assume in addition that a binding contract to acquire DT6
and FT7 is not in effect on February 19, 1986.
(ii) The result is the same as in Example (2) of paragraph (j)(4) of
this section, except that FT7 is not a transitional target affiliate and
therefore cannot be excluded from the status of a target affiliate
pursuant to a transitional exclusion election. In addition, FT7 cannot
be excluded from the status of a target affiliate pursuant to a regular
exclusion election made in connection with an express election for FT,
FT4, FT5, or DT6. A regular exclusion election cannot be made (or is
retroactively invalidated) because P's acquisition of FT7 is an
invalidation event under paragraph (c)(2)(iii)(B) of this section.
(That acquisition is an invalidation event because FT7 was a controlled
foreign corporation during the relevant period.)
Example (2). Assume the same facts as in Example (1), except that DS
is FS. Assume further that FS is not a controlled foreign corporation
and that FT7 does not hold stock of a domestic corporation under the
circumstances described in paragraph (c)(2)(iii)(C) of this section.
Under these facts, FT7 is not a controlled foreign corporation during
the relevant period and P's direct acquisition of its stock is not an
invalidation event. Accordingly, the results are the same as in Example
(1), except that a regular exclusion election (applicable to FT7) may be
made in connection with the express election for FT, FT4, FT5, or DT6.
(6) Transitional asset consistency rules for corporations described
in section 338(h)(6)(B)(i) -- (i) General rule. A transitional asset
acquisition from a corporation that is described in section
338(h)(6)(B)(i) and that is not an excluded transferor shall in no case
be treated as a tainted asset acquisition (within the meaning of
1.338-4T(f)(6)(i)) with respect to any target. Accordingly, such an
asset acquisition cannot cause an affirmative action carryover election
and will not be subject to an otherwise applicable affirmative action or
protective carryover election.
(ii) Definitions -- (A) Transitional asset acquisition. A
''transitional asset acquisition'' is any asset acquisition made by P
(or another member of the P group) on or before March 15, 1986 that is
not subject to the special asset consistency rule of paragraph (c)(4)(i)
of this section (applicable in the case of a regular exclusion election)
.
(B) Acquisition made on or before March 15, 1986. An asset
acquisition is considered made on or before March 15, 1986, if the asset
actually is acquired on or before March 15, 1986, or if it is acquired
after that date but pursuant to a contract of sale that is binding on
both the acquiring P group member and the transferor as of February 19,
1986.
(C) Excluded transferor. An ''excluded transferor'' is a corporation
that is either (1) a transitional target affiliate subject to a
transitional exclusion election made in connection with an express
election or (2) any other corporation that, but for the transitional
exclusion election, would be subject to a deemed election under section
338(f)(1) by reason of the express election.
(iii) Special asset consistency rule for acquisition for excluded
transferor -- (A) General rule. A P group member must take a carryover
basis in an asset acquired from an excluded transferor as if the asset
acquisition were subject to an affirmative action carryover election if,
in the absence of an express election, the asset acquisition would be
considered a tainted asset acquisition (as defined in
1.338-4T(f)(6)(i)) with respect to any relevant target (as defined in
paragraph(c)(4)(iii) of this section). For guidance on the affirmative
action carryover election, see 1.338-4T (f) (6). Except as provided in
this subdivision (iii) or in paragraph (c)(4) of this section (which
contains a similar prospective rule), no asset acquisition shall be
treated as a tainted asset acquisition if an express election is made.
(B) Deemed election not imposed. In no event shall the District
Director impose a deemed election under section 338(e)(1) as a result of
an asset acquisition from any excluded transferor.
(iv) Examples. The provisions of this subparagraph (6) may be
illustrated by the following examples.
Example (1). Assume the same facts as in Example (1) of paragraph
(j)(4) of this section. Assume in addition that P makes a protective
carryover election for DT in lieu of an express election,and that on
January 1, 1985, P purchases for cash an asset from FT1, DT's wholly
owned subsidiary. Because the asset is acquired in a transitional asset
acquisition, it will in no case be considered a tainted asset
acquisition subject to the protective carryover election. Accordingly,
P's basis in the asset will be determined under section 1012. (The
result is the same if P does not make a protective carryover election.)
Example (2). Assume that P makes an express election for DT under
the facts of Example (1) of paragraph (j)(4) of this section. Assume in
addition that P makes a transitional exclusion election for FT2 in that
express election, and that on January 1, 1985, P purchases an asset from
FT2 in a transaction that would be a tainted asset acquisition if an
express election were not made. Because FT2 is an excluded transferor
within the meaning of paragraph (j)(6)(ii)(C) of this section, P must
take a carryover basis in the acquired asset as if the acquisition were
subject to an affirmative action carrover, election.
Example (3). Assume the same facts as in Example (2), except that
the asset is acquired from FT3. Although a transitional exclusion
election was not made for FT3, FT3 is a corporation that would have been
subject to a deemed election under section 338(f)(1) by reason of the
express election for DT had the transitional exclusion election for FT2
not been made. Thus, FT3 is an excluded transferor and the result is
the same as in Example (2).
Example (4). Assume the same facts as in Example (2), except that
the asset is acquired from FT1. FT1, a transitional target affiliate
that is not subject to the transitional exclusion election, is not an
excluded transferor. (FT1 is subject to a deemed election under section
338(f)(1) by reason of the express election for DT.) Accordingly, P does
not take a carrover basis in the asset under paragraph (j)(6) (iii) of
this section but rather takes a basis determined under section 1012.
(7) Treatment of stock described in section 338(h)(6)(B)(ii) -- (i)
Transitional stock exclusion election. If P makes a transitional stock
exclusion election in the manner prescribed in paragraph (j)(8) of this
section for one or more eligible targets, then the following stock held
by such an eligible target at the close of its acquisition date
(''affected stock'') shall be excluded from the operation of section
338:
(A) All section 338(h)(6)(B)(ii) stock other than stock in a
transitional target affiliate (as defined in paragraph (j)(2) of this
section) and
(B) All section 338(h)(6)(B)(ii) stock that is stock in a
transitional target affiliate for which a transitional exclusion
election is made under paragraph (j)(1) of this section.
(ii) Section 338(h)(6)(B)(ii) stock. ''Section 338(h)(6)(B)(ii)
stock'' is stock in a foreign corporation or a domestic corporation that
is a DISC or that is described in section 1248(e), whether or not the
corporation is a target or a target affiliate.
(iii) Eligible target. An ''eligible target'' is a target that is
subject to a deemed election under section 338(f)(1) and which is
acquired on or before February 12, 1986 or pursuant to a binding
contract in effect on that date.
(iv) Effect of exclusion from operation of section 338. If a
transitional stock exclusion election is made for an eligible target,
then --
(A) that eligible target is not deemed under section 338(a) to sell
and purchase the affected stock it holds at the close of its acquisition
date and
(B) that eligible target's basis as new target in that affected stock
is the same as its basis in that stock as old target immediately before
its deemed sale of assets under section 338(a)(1) (''carryover basis
amount'').
(v) Effect of difference between carryover basis amount and regular
basis amount. If the carryover basis amount for affected stock held by
an eligible target (as new eligible target) is less than the basis
amount that, absent paragraph (j)(7)(iv) of this section, would be
allocable to that stock (''regular basis amount''), then the difference
is eliminated. Whether or not the carryover basis amount is less than
or exceeds the regular basis amount, however, that regular basis amount
is treated as the total amount allocated to the affected stock for
purposes of allocating new eligible target's adjusted grossed-up basis
among the other assets of new eligible target.
(vi) Tacking of old eligible target's holding period. If a
transitional stock exclusion election is made for an eligible target and
if, subsequent to its acquisition date, the eligible target disposes of
affected stock, then, for purposes of applying section 1248 to that
disposition, the holding period of new eligible target for that affected
stock includes the holding period of old eligible target for that stock.
(vii) Examples. The provisions of this paragraph (j)(7) may be
illustrated by the following examples. In each example, assume that all
of the corporations are calendar year corporations.
Example (1). On December 31, 1984, P purchases all of the stock of
DT from DS in a qualified stock purchase and makes an express election
for DT. DT holds 20 of the 100 shares of FX's only class of outstanding
stock, and DS holds the remaining 80 shares. (Since all of the stock of
FX is held by U.S. shareholders, FX is a controlled foreign
corporation.) Although the stock of FX is affected stock within the
meaning of paragraph (j)(7)(i) of this section and although the
acquisition date of DT occurs on or before February 12, 1986, a
transitional stock exclusion election applicable to DT cannot be made.
An original target (i.e., a target that is not subject to a deemed
election under section 338(f)(1)) cannot be an eligible target. See
paragraph (j)(7)(iii) of this section.
Example (2). (i) Assume the same facts as in Example (1), except
that DT's wholly owned subsidiary, DT1, holds the 20 shares of FX stock.
Assume in addition that old DT1's basis in that FX stock is $70 and
that, absent paragraph (j)(7)(iv) of this section, new DT1's basis in
the FX stock would be $100. Finally assume that DT1 sells the 20 shares
of FX stock on January 15, 1985, for $90.
(ii) A transitional stock exclusion election applicable to DT1 (and
thus to the FX stock held by DT1) may be made, since DT1 is an eligible
target. DT1 is an eligible target because its acquisition date occurs
on or before February 12, 1986, and it is subject to a deemed election
under section 338 (f)(1) by reason of P's express election for DT. If a
transitional stock exclusion election is made for DT1, then old DT1 will
not include in its gross income a section 1248(f) dividend as a result
of its deemed sale of assets, since it will not be deemed to sell the FX
stock it holds. See paragraph (j)(7)(iv)(A) of this section. In
addition, new DT1's basis in FX stock (e.g., for purposes of DT1's sale
of that FX stock on January 15, 1985) shall be the same as old DT1's
basis in such stock immediately before DT1's deemed sale of assets,
i.e., $70. See paragraph (j)(7)(iv)(B) of this section. For purposes of
allocating new DT1's adjusted grossed-up basis among the other assets of
new DT1, however, the amount that, absent this paragraph (j)(7), would
have been allocated to the FX stock held by DT1, (i.e., $100) shall be
deemed to be the amount actually allocated to that stock.
(iii) Accordingly, DT1's gain on the January 15, 1985, sale of FX
stock is $20, i.e., the difference between the selling price ($90) and
DT1's carryover basis in the FX stock ($70). For purposes of applying
section 1248 to that sale, new DT1's holding period in the stock of FX
includes old DT1's holding period. Thus, the earnings and profits of FX
that accrued during the period while old DT1 held the FX stock must be
taken into account under the principles of section 1248 in determining
new DT1's section 1248 divided (if any) on the January 15, 1985, sale.
Example (3). Assume the same facts as in Example (2), except that
the 80 shares of FX stock are held by DT2, another wholly owned
subsidiary of DT, rather than by DS. Thus, DT1 and DT2 are eligible
targets and FX is a transitional target affiliate. Accordingly, a
transitional stock exclusion election made for DT1 and/or DT2 will not
apply to the stock of FX unless a transitional exclusion election is
made for FX.
Example (4). Assume the same facts as in Example (2), except that
the 80 shares of FX stock are held by an individual. Accordingly, FX is
not a target affiliate of DT or DT1. The result is the same as in
Example (2), since affected stock need not be stock in a target
affiliate.
(8) Transitional section 338(h)(6)(B) election procedures -- (i)
General rule. This subparagraph (8) prescribes procedures for making
the transitional exclusion election and the transitional stock exclusion
election under paragraph (j) (1) and (7) of this section, respectively
(''transitional elections''). The transitional elections are made by
attaching a transitional section 338(h)(6)(B) statement to the express
election (Form 8023) filed for the original target (including a
qualifying target affiliate treated as the original target under
paragraph (j)(3) of this section). The transitional section
338(h)(6)(B) statement, once filed, is treated as an integral part of
the Form 8023 (e.g., for purposes of 1.338-1T(e)(2)(i) (requiring that
the Form 8023 be attached to certain returns)). The transitional
elections are irrevocable.
(ii) Special procedure if express election filed on or before July
15, 1986. If a transitional section 338(h)(6)(B) statement is not
attached to an express election filed on or before July 15, 1986, a
transitional eelection(s) nonetheless may be made if, on or before that
date, a copy of the previously filed express election, with a copy of
the transitional section 338(h)(6)(B) statement attached, is filed in
the Form 8023 filing place(s) where a statement of section 338 election
wold be filed, under 1.338-1T (c) and (d), on the date the transitional
election is made.
(iii) Amendment procedure if transitional statement filed on or
before July 15, 1986. A transitional section 338(h)(6)(B) statement
filed on or before July 15, 1986, may be amended on or before that date
for two purposes. First, if only one transitional election was made in
the previously filed statement, then an amended statement may be made to
include both transitional elections. Second, the previously filed
statement may be amended to make additional corporations subject to a
transitional election already made. The amended statement is filed
pursuant to the procedure described in paragraph (j)(8)(ii) of this
section, and a copy of the previously filed section 338(h)(6)(B)
statement must be attached.
(iv) Acquisition date of transitional target affiliate or eligible
target occurs after transitional section 338(h)(6)(B) statement filed.
A transitional target affiliate or an eligible target will be subject to
a transitional exclusion election or transitional stock exclusion
election, respectively, only if such a corporation is named in the
transitional section 338(h)(6)(B) statement (including an amended
statement), notwithstanding that the acquisition date of such a
corporation occurs after that statement is filed. The failure of the P
group to actually acquire a corporation named in the transitional
section 338(h)(6)(B) statement pursuant to this subdivision (iv) shall
have no effect on the validity of that statement.
(v) Contents of transitional section 338(h)(6)(B) statement. The
transitional section 338(h)(6)(B) statement must --
(A) Be identified prominently as a transitional exclusion election
under 1.338-5T(j)(1), as a transitional stock exclusion election under
1.338-5T(j)(7), or both.
(B) Where applicable, indicate that it is an amended statement.
(C) Contain the following declaration (or a substantially similar
declaration) if a transitional exclusion election is made: ''the
transitional exclusion election permitted by 1.338-5T(j)(1) is hereby
made for the transitional target affiliates identified herein''.
(D) Contain the following declaration (or a substantially similar
declaration) if a transitional stock exclusion election is made: ''the
transitional stock exclusion election permitted by 1.338-5T(j)(7) is
hereby made for the eligible targets identified herein''.
(E) For each of the following corporations contain the name, address,
employer identification number (if any), and, for a foreign corporation,
the country (and, if relevant, the lesser political subdivision) under
the laws of which it is organized. The following corporations are: (1)
Each transitional target affiliate for which a transitional exclusion
election is made, with corporations included pursuant to paragraph
(j)(8)(iv) of this section so identified (such as by a footnote system),
(2) each eligible target for which a transitional stock exclusion
election is made, with corporations included pursuant to paragraph
(j)(8)(iv) of this section so identified, and (3) if determinable as of
the day of filing, each other corporation that would be subject to the
express election absent the transitional elections.
(F) Be signed (in the manner prescribed in 1.338-1T(d)(1)(v)) by a
person authorized to act on behalf of P.
(T.D. 8074, 51 FR 5173, Feb. 12, 1986; 51 FR 6219, Feb. 21, 1986;
51 FR 11017, Apr. 1, 1986; T.D. 8088, 51 FR 17936, May 16, 1986; T.D.
8092, 51 FR 23742, July 1, 1986)