[Federal Register Volume 62, Number 4 (Tuesday, January 7, 1997)]
[Rules and Regulations]
[Pages 923-941]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-153]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8708]
RIN 1545-AL98
Computation of Foreign Taxes Deemed Paid Under Section 902
Pursuant to a Pooling Mechanism for Undistributed Earnings and Foreign
Taxes
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final income tax regulations relating
to the computation of foreign taxes deemed paid under section 902.
Changes to the applicable law were made by the Tax Reform Act of 1986
and by the Technical and Miscellaneous Revenue Act of 1988 (TAMRA).
These regulations provide guidance needed to comply with these changes
and affect foreign corporations and their United States corporate
shareholders.
DATES: These regulations are effective January 7, 1997.
Applicability: For the specific dates of applicability of these
regulations, see Secs. 1.902-1(g) and 1.902-3(l).
FOR FURTHER INFORMATION CONTACT: Caren S. Shein (202) 622-3850 (not a
toll free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in these final regulations
has been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 15451458. Responses to these collections of information
are required by the IRS to implement the section 902 pooling regime
enacted in the Tax Reform Act of 1986.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.
[[Page 924]]
The burden for the collection of information is reflected in the
burden for Form 1118.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attention: IRS Reports Clearance Officer T:FP,
Washington, DC 20224, and to the Office of Management and Budget,
Attention: Desk Officer for the Department of the Treasury, Office of
Information and Regulatory Affairs, Washington, DC 20503.
Books or records relating to the collections of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
Section 902 (26 CFR part 1) was amended by section 1202(a) of the
Tax Reform Act of 1986 (Public Law 99-514, 100 Stat. 1085), and section
1012(b) of the Technical and Miscellaneous Revenue Act of 1988 (TAMRA)
(Public Law 100-647, 102 Stat. 3242). On January 6, 1995, the IRS
published a notice of proposed rulemaking in the Federal Register (60
FR 2049 [INTL-933-86 (1995-1 C.B. 959)]). The proposed regulations
provide guidance needed to comply with section 902 as amended in 1986
and 1988. No public hearing was requested or held, but numerous written
comments were received. The proposed regulations, with certain changes
made in response to comments, are adopted in this Treasury decision as
final regulations. The principal changes to the regulations, as well as
the major comments and suggestions, are discussed below.
Explanation of Provisions
Section 1.902-1
In the preamble to the proposed regulations, the IRS requested
comments on whether the holding of Revenue Ruling 71-141 (1971-1 C.B.
211) should be expanded to allow taxes paid by a foreign corporation to
be considered deemed paid by domestic corporations that are partners in
domestic limited partnerships or foreign partnerships, shareholders in
limited liability companies, beneficiaries of domestic or foreign
trusts and estates, or interest holders in other pass-through entities.
The revenue ruling held that two 50-percent domestic corporate general
partners of a domestic general partnership that owned 40 percent of a
foreign corporation were entitled to compute an amount of foreign taxes
deemed paid under section 902 with respect to dividends they received
from the foreign corporation through the partnership.
The IRS received numerous comments in response to the request in
the preamble. The commenters uniformly argue that the aggregate theory
of partnerships should apply to allow domestic corporate partners to
compute an amount of foreign taxes deemed paid with respect to
dividends paid to any partnership by a foreign corporation, provided
that the partner owns at least 10 percent of the voting stock of the
foreign corporation through the partnership.
The final regulations do not resolve under what circumstances a
domestic corporate partner may compute an amount of foreign taxes
deemed paid with respect to dividends received from a foreign
corporation by a partnership or other pass-through entity. That issue
will be the subject of a future proposed regulations project. However,
in recognition of the holding in Revenue Ruling 71-141 (1971-1 C.B.
211) that a general partner of a domestic general partnership may
compute an amount of foreign taxes deemed paid with respect to a
dividend distribution from a foreign corporation to the partnership,
Sec. 1.902-1(a)(1) is amended to define a domestic shareholder as a
domestic corporation that ``owns'' the requisite voting stock in a
foreign corporation rather than one that ``owns directly'' the voting
stock. The IRS is still considering under what other circumstances the
revenue ruling should apply.
Section 1.902-1(a)(8) is amended to clarify under what
circumstances the pool of post-1986 foreign income taxes must be
reduced to account for distributions made in prior post-1986 taxable
years. The regulations require a reduction in the taxes pool for taxes
attributable to earnings distributed to shareholders ineligible for the
deemed paid credit (for example, a foreign shareholder, a U.S.
individual shareholder, or a domestic corporate shareholder that owns
less than 10 percent of the foreign corporation's voting stock) and to
shareholders that are eligible for the credit but that choose to deduct
foreign taxes under section 164(a) in the year of the distribution
rather than claim a credit.
The IRS understands that some taxpayers have taken the position,
contrary to the position taken in Sec. 1.902-1(a)(8) of the proposed
regulations, that although post-1986 undistributed earnings must be
reduced to account for all distributions out of current or accumulated
earnings and profits, post-1986 foreign income taxes should be reduced
only to account for taxes attributable to distributions with respect to
which a shareholder both is eligible to claim a credit for foreign
taxes deemed paid under section 902(a) and in fact elects to credit
foreign taxes for the taxable year under section 901(a). These
taxpayers argue that only in those circumstances are foreign taxes
``deemed paid'' and thus required to be removed from the taxes pool
under a literal reading of sections 902(a) and 902(c)(2)(B).
The IRS has not changed its position as reflected in Sec. 1.902-
1(a)(8)(i) of the proposed regulations that the foreign taxes pool must
be reduced to account for foreign taxes attributable to all
distributions and deemed distributions or inclusions to all
shareholders. However, the text of the final regulations has been
amended to clarify the rule. The requirement that the foreign taxes
pool must be reduced proportionately as the earnings pool is reduced is
consistent with the legislative history of the Tax Reform Act of 1986
(Public Law 99-514). The House Report states that under the pooling
regime, ``[a] dividend or subpart F inclusion is considered to bring
with it a pro rata share of the accumulated foreign taxes paid by the
subsidiary.'' H.R. Rep. No. 426, 99th Cong., 1st Sess. 357 (1985). In
addition, removing taxes attributable to distributions to ineligible
shareholders and eligible shareholders that choose to deduct foreign
taxes is supported by the general matching principles of section 902,
which presume that a dividend distribution will carry with it a ratable
share of the foreign corporation's taxes. If taxes paid with respect to
distributed earnings remained in the pool, eligible shareholders
eventually could receive credits for more than their ratable share of
the foreign corporation's taxes, a result at odds with the statutory
scheme.
Section 1.902-1(a)(8)(i) is amended to correct an oversight in the
proposed regulation. In the case of a distribution out of current
earnings and profits that is treated as a ``nimble'' dividend under
section 316(a)(2) when there is a deficit in accumulated earnings and
profits, post-1986 foreign income taxes are not reduced. This rule is
not inconsistent with the general rule of paragraph (a)(8)(i) that the
foreign taxes pool must be reduced to account for taxes attributable to
all distributions and deemed distributions out of post-1986
undistributed earnings. Rather, it reflects the fact that under section
902 and these regulations, no taxes are deemed paid with respect to a
nimble
[[Page 925]]
dividend under section 316(a)(2) because the post-1986 undistributed
earnings pool is zero or less than zero.
Section 1.902-1(a)(9), defining post-1986 undistributed earnings,
is amended to clarify that the earnings pool is reduced only to account
for distributions or deemed distributions that reduce earnings and
profits and inclusions that result in previously-taxed amounts
described in sections 959(c)(1) and (c)(2) or 1293(c). Thus, for
example, in the case of a controlled foreign corporation owned 60
percent by a domestic corporate shareholder and 40 percent by a foreign
shareholder, the earnings and taxes pools are reduced only to account
for 60 percent of the foreign corporation's subpart F income.
The rules precluding special allocations of earnings and taxes in
Sec. 1.902-1(a)(9)(iv) and (10)(ii) of the proposed regulations have
been retained in the final regulations. These regulations are intended
to reverse the result in Vulcan v. Commissioner, 96 T.C. 410 (1991),
aff'd per curiam, 959 F.2d 973 (11th Cir. 1992), nonacq. 1995-1 C.B. 1,
for post-1986 taxable years. Several commenters argued that the Vulcan
decision was correct and should be applied to both pre-1987 and post-
1986 taxable years, and the regulations should be revised to reflect
the decision. For the reasons stated in the preamble to the proposed
regulations, the IRS declines to do so.
Commenters also argued that the rule precluding special allocations
of earnings and taxes is inconsistent with Sec. 1.904-6(a)(2). Section
1.904-6(a)(2) is an anti-abuse rule designed to prevent the use of
accommodation parties to improve a United States taxpayer's foreign tax
credit position. The rule states that if a taxpayer receives or accrues
a dividend from a noncontrolled section 902 corporation and the
Commissioner establishes the existence of an express or implied
agreement that the dividend is paid out of the foreign corporation's
passive or high withholding tax interest earnings, then only taxes
imposed on passive or high withholding tax interest earnings will be
considered related to the dividend. The IRS may invoke this rule to
prevent a shareholder from sheltering investment income from tax by
investing it through a noncontrolled section 902 corporation that
distributes only the investment earnings to the shareholder, which then
treats the distribution as a dividend sheltered by taxes paid on the
corporation's hightaxed active business income. The IRS believes that
this narrowly defined anti-abuse rule is an appropriate exception to
the general rule of Sec. 1.902-1(a)(9)(iv) and (a)(10)(ii) barring
special allocations of earnings and taxes.
Section 1.902-1(a)(11) has been amended to clarify that the
definition of a dividend in section 316(a) applies for purposes of
section 902, and that the section 902 definition of a dividend also
includes deemed dividends under sections 551 and 1248. Deemed
inclusions under sections 951(a) and 1293 are not dividends for
purposes of section 902. However, sections 960(a)(1) and 1293(f)
provide that deemed paid taxes with respect to inclusions under
sections 951(a) and 1293 are determined under section 902 in the same
manner as if a dividend was paid.
Paragraph (a)(11) also has been amended to add a crossreference to
section 1291 and Sec. 1.1291-5 of the proposed regulations, which
provide special rules for computing foreign taxes deemed paid with
respect to distributions from section 1291 funds. These distributions
are treated as dividends solely for foreign tax credit purposes, but
the general section 902 computational rules do not apply.
A commenter correctly pointed out that the regulation's inclusion
of deemed distributions under section 551 as dividends for purposes of
section 902 is contrary to the holding in Revenue Ruling 74-59 (1974-1
C.B. 183) that an amount includible in gross income under section 551
is not considered a dividend received for purposes of the allowance of
a foreign tax credit under section 902. The holding of the revenue
ruling is based on language in the 1937 legislative history of the
foreign personal holding company provisions. The Report of the Joint
Committee on Tax Evasion and Avoidance of the Congress of the United
States, H.R. Doc. No. 337, 75th Cong., 1st Sess. 18 (1937), recommended
that shareholders of foreign personal holding companies not be allowed
a credit for foreign income taxes paid by the foreign corporation with
respect to amounts deemed distributed. The Report goes on to state that
the committee recommended against allowing a credit because ``it is not
administratively feasible, although it might seem equitable under the
circumstances.''
Section 551(b) provides that amounts required to be included in the
gross income of a U.S. shareholder under section 551(a) are treated as
dividends, and under current law it is administratively feasible to
allow deemed paid taxes to be computed with respect to deemed
dividends. In addition, the Code now includes other anti-deferral
regimes, e.g., the subpart F and passive foreign investment company
provisions, the application of which may overlap with the foreign
personal holding company rules. Shareholders are permitted to compute
deemed paid taxes with respect to subpart F and passive foreign
investment company inclusions.
The IRS, therefore, has concluded the revenue ruling is not
supported by current law. A shareholder of a foreign personal holding
company should be entitled to compute deemed paid taxes with respect to
amounts required to be included in gross income as dividends under
section 551(a). Revenue Ruling 74-59 (1974-1 C.B. 183) is hereby
revoked effective as of the date these regulations are published in the
Federal Register.
A commenter argued that the rule in Sec. 1.902-1(b)(4), providing
that no taxes are deemed paid with respect to dividends out of current
earnings and profits when the foreign corporation has no post-1986
undistributed earnings and no accumulated earnings and profits (so-
called ``nimble'' dividends) conflicts with the general purpose of the
foreign tax credit to prevent double taxation. The rule is retained in
the final regulations for two reasons. First, the legislative history
of the Tax Reform Act of 1986 (Public Law 99-514) clearly indicates
that Congress was aware of the issue and agreed with the position
stated in the regulation. See S. Rep. No. 313, 99th Cong., 2d Sess. 321
(1986). Second, because no taxes can be deemed paid under the
computational rules of section 902 when post-1986 undistributed
earnings are zero or less than zero, no taxes are removed from the
post-1986 foreign income taxes pool. Thus, all of the foreign
corporation's taxes remain in its post-1986 foreign income taxes pool
and are available to be credited if the corporation pays another
dividend in a later year in which the post-1986 undistributed earnings
pool is positive.
Section 1.902-1(c)(8) of the proposed regulations reserved on the
application of section 902 in section 304 exchanges. Commenters
suggested that the regulations should address this area by
incorporating the holdings in Revenue Ruling 91-5 (1991-1 C.B. 114),
and Revenue Ruling 92-86 (1992-1 C.B. 199). In addition, the commenters
argued that the regulations should state that a deemed paid credit is
available in a section 304 exchange involving a foreign parent
corporation. The IRS is still studying the area and the regulations
thus continue to reserve on the application of section 902 in a section
304 exchange.
Section 1.902-1(c)(9) of the proposed regulations is reserved in
these final regulations. The proposed regulation
[[Page 926]]
provided a cross-reference to regulations under section 905(c) with
respect to adjustments to post-1986 undistributed earnings and taxes
that result from a section 482 allocation of income. There currently
are no regulations under section 905(c) addressing section 482
allocations and the IRS, therefore, has reserved this paragraph pending
issuance of final regulations under section 905(c).
Section 1.902-1(d)(3) (ii) through (iv) of the proposed regulations
is not included in the final regulations. Paragraph (d)(3) set out
rules and examples exercising a grant of regulatory authority under the
last sentence of section 904(d)(2)(E)(i) to limit beyond the statute
the circumstances under which a dividend paid to a new U.S. shareholder
by a controlled foreign corporation out of earnings accumulated while
it was a controlled foreign corporation will be treated as dividends
from a noncontrolled section 902 corporation. Identical rules were
proposed in 1992 under section 904(d). See Sec. 1.904-4(g)(3) (ii)
through (iv) of the proposed regulations. The rules address the
character of a dividend distribution under section 904(d) and are more
appropriately placed in the regulations under that section. After
considering the comments received, the rule will be finalized as part
of the section 904 regulations.
Section 1.902-2
A commenter suggested that the deficit carryback rules in
Sec. 1.902-2(a)(1) should be amended to provide that a deficit in post-
1986 undistributed earnings will not be carried back to pre-1987 years
on a return of capital or capital gain distribution. The rule states
that a deficit will be carried back when ``* * * a corporation makes a
distribution to shareholders that is a dividend or would be a dividend
if there were current or accumulated earnings and profits, * * * .''
The commenter suggests that the rule in the proposed regulation can
result in ``locked-in'' taxes when earnings attributable to one or more
pre-1987 years are eliminated by the deficit carryback. If the deficit
stays in the post-1986 pool there is a chance it can be absorbed by
future earnings, leaving the pre-1987 earnings and taxes intact. In
support of its position, the commenter argues that section 902
establishes rules that minimize double taxation by allowing a taxpayer
to compute a deemed paid credit on a taxable dividend. The legislative
history indicates that the pooling provisions of section 902 are to
apply solely for purposes of computing the deemed paid credit. Because
a return of capital or capital gain distribution is not a taxable
dividend and no section 902 credit is allowable, the commenter argues
that the pooling rules (including the deficit carryback rules) should
not apply.
The IRS declines to adopt the commenter's suggestion. When an
amount is distributed in a post-1986 taxable year and there is a
deficit in post-1986 undistributed earnings, the deficit must be
carried back and reduce earnings and profits in pre-1987 years to
determine whether any earnings remain to support treatment of the
distribution as a dividend. To the extent there are earnings remaining
in one or more pre-1987 years after a deficit is carried back, the
distribution is a dividend. Any remaining amount is a return of capital
and capital gain. It would be incongruous to adopt a rule providing a
different result if a single dollar of pre-1987 accumulated profits
remains in a pre-1987 year after a post-1986 deficit is carried back
than if the deficit carryback eliminated all pre-1987 accumulated
profits and the entire distribution were treated as a return of
capital.
Another commenter argued that the interplay among Sec. 1.902-
2(b)(1) (pre-1987 accumulated deficit carries over to become the
opening balance of post-1986 undistributed earnings pool) and
Sec. 1.902-1(b)(4) (no taxes deemed paid if a dividend is a nimble
dividend) of the proposed regulations, and section 960 (incorporating
the section 902 rules with respect to deemed inclusions under subpart
F) results in a denial of deemed paid taxes to a U.S. shareholder if a
controlled foreign corporation has both a pre-1987 accumulated deficit
and post-1986 earnings and profits that are entirely subpart F income.
The commenter suggests that regulations be issued under section 960 to
provide, solely for purposes of that section, that accumulated deficits
in pre-1987 accumulated profits will not carry over into the post-1986
pool.
The IRS cannot adopt the rule the commenter suggests. Congress
amended sections 902 and 960 in 1986 specifically to eliminate
different earnings and profits and deemed paid taxes computations for
purposes of sections 902 and 960. Further, in the situation the
commenter posits, the credits are deferred but not permanently
disallowed. If the controlled foreign corporation earns enough post-
1986 income to eliminate the accumulated deficit, any distribution or
deemed distribution will carry with it a ratable share of post-1986
foreign income taxes.
A commenter argued that Sec. 1.902-2(b)(2) and (3), Example 1, are
incorrect because they imply that annual deficits in pre-1987
accumulated profits were required to be carried back under pre-1987
section 902 regardless of how foreign income taxes were determined. The
commenter argues that pre-1987 section 902 requires a ``correlation''
between accumulated profits as determined under U.S. law and the
foreign law method by which foreign taxes were determined.
The IRS disagrees with the comment and the proposed regulation has
not been amended. The regulation reflects the IRS' longstanding
position that in the case of a deficit in accumulated profits of a
foreign corporation for a particular pre-1987 year, the deficit first
reduces prior years' accumulated profits on a LIFO basis to the extent
thereof, and then the remaining deficit reduces accumulated profits in
subsequent years. That rule applies regardless of whether foreign law
permits or requires the carryback or carryforward of losses. See
Revenue Ruling 74-550 (1974-2 C.B. 209) and Revenue Ruling 87-72 (1987-
2 C.B. 170).
Effect on Other Documents
The following revenue ruling is revoked as of January 7, 1997:
Revenue Ruling 74-59, 1974-1 C.B. 183.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the notice of proposed
rulemaking preceding the regulations was issued prior to March 29,
1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding these regulations was submitted
to the Small Business Administration for comment on its impact on small
business.
Drafting Information
The principal author of these final regulations is Caren Silver
Shein of the Office of Associate Chief Counsel (International), within
the Office of Chief Counsel, IRS. However, other personnel from the IRS
and Treasury Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
[[Page 927]]
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.902-1 also issued under 26 U.S.C. 902(c)(7).
Section 1.902-2 also issued under 26 U.S.C. 902(c)(7). * * *
Secs. 1.902-1 and 1.902-2 [Redesignated Secs. 1.902-3 and 1.902-4]
Par. 2. Sections 1.902-1 and 1.902-2 are redesignated Secs. 1.902-3
and 1.902-4, respectively.
Par. 3. Sections 1.902-0, 1.902-1 and 1.902-2 are added to read as
follows:
Sec. 1.902-0 Outline of regulations provisions for section 902.
This section lists the provisions under section 902.
Sec. 1.902-1 Credit for domestic corporate shareholder of a
foreign corporation for foreign income taxes paid by the foreign
corporation.
(a) Definitions and special effective date.
(1) Domestic shareholder.
(2) First-tier corporation.
(3) Second-tier corporation.
(4) Third-tier corporation.
(5) Example.
(6) Upper- and lower-tier corporations.
(7) Foreign income taxes.
(8) Post-1986 foreign income taxes.
(i) In general.
(ii) Distributions out of earnings and profits accumulated by a
lower-tier corporation in its taxable years beginning before January
1, 1987, and included in the gross income of an upper-tier
corporation in its taxable year beginning after December 31, 1986.
(iii) Foreign income taxes paid or accrued with respect to high
withholding tax interest.
(9) Post-1986 undistributed earnings.
(i) In general.
(ii) Distributions out of earnings and profits accumulated by a
lower-tier corporation in its taxable years beginning before January
1, 1987, and included in the gross income of an upper-tier
corporation in its taxable year beginning after December 31, 1986.
(iii) Reduction for foreign income taxes paid or accrued.
(iv) Special allocations.
(10) Pre-1987 accumulated profits.
(i) Definition.
(ii) Computation of pre-1987 accumulated profits.
(iii) Foreign income taxes attributable to pre-1987 accumulated
profits.
(11) Dividend.
(12) Dividend received.
(13) Special effective date.
(i) Rule.
(ii) Example.
(b) Computation of foreign income taxes deemed paid by a domestic
shareholder, first-tier corporation, and second-tier corporation.
(1) General rule.
(2) Allocation rule for dividends attributable to post-1986
undistributed earnings and pre-1987 accumulated profits.
(i) Portion of dividend out of post-1986 undistributed earnings.
(ii) Portion of dividend out of pre-1987 accumulated profits.
(3) Dividends paid out of pre-1987 accumulated profits.
(4) Deficits in accumulated earnings and profits.
(5) Examples.
(c) Special rules.
(1) Separate computations required for dividends from each
first-tier and lower-tier corporation.
(i) Rule.
(ii) Example.
(2) Section 78 gross-up.
(i) Foreign income taxes deemed paid by a domestic shareholder.
(ii) Foreign income taxes deemed paid by an upper-tier
corporation.
(iii) Example.
(3) Creditable foreign income taxes.
(4) Foreign mineral income.
(5) Foreign taxes paid or accrued in connection with the
purchase or sale of certain oil and gas.
(6) Foreign oil and gas extraction income.
(7) United States shareholders of controlled foreign
corporations.
(8) Credit for foreign taxes deemed paid in a section 304
transaction.
(9) Effect of section 482 adjustments on post-1986 foreign
income taxes and post-1986 undistributed earnings.
(d) Dividends from controlled foreign corporations.
(1) General rule.
(2) Look-through.
(i) Dividends.
(ii) Coordination with section 960.
(3) Dividends distributed out of earnings accumulated before a
controlled foreign corporation became a controlled foreign
corporation.
(i) General rule.
(ii) Dividend distributions out of earnings and profits for a
year during which a shareholder that is currently a more-than-90-
percent United States shareholder of a controlled foreign
corporation was not a United States shareholder of the controlled
foreign corporation.
(e) Information to be furnished.
(f) Examples.
(g) Effective date.
Sec. 1.902-2 Treatment of deficits in post-1986 undistributed
earnings and pre-1987 accumulated profits of a first-, second-, or
third-tier corporation for purposes of computing an amount of
foreign taxes deemed paid Sec. 1.902-1.
(a) Carryback of deficits in post-1986 undistributed earnings of a
first-, second-, or third-tier corporation to pre-effective date
taxable years.
(1) Rule.
(2) Examples.
(b) Carryforward of deficits in pre-1987 accumulated profits of a
first-, second-, or third-tier corporation to post-1986
undistributed earnings for purposes of section 902.
(1) General rule.
(2) Effect of pre-effective date deficit.
(3) Examples.
Sec. 1.902-3 Credit for domestic corporate shareholder of a
foreign corporation for foreign income taxes paid with respect to
accumulated profits of taxable years of the foreign corporation
beginning before January 1, 1987.
(a) Definitions.
(1) Domestic shareholder.
(2) First-tier corporation.
(3) Second-tier corporation.
(4) Third-tier corporation.
(5) Foreign income taxes.
(6) Dividend.
(7) Dividend received.
(b) Domestic shareholder owning stock in a first-tier corporation.
(1) In general.
(2) Amount of foreign taxes deemed paid by a domestic
shareholder.
(c) First-tier corporation owning stock in a second-tier
corporation.
(1) In general.
(2) Amount of foreign taxes deemed paid by a first-tier
corporation.
(d) Second-tier corporation owning stock in a third-tier
corporation.
(1) In general.
(2) Amount of foreign taxes deemed paid by a second-tier
corporation.
(e) Determination of accumulated profits of a foreign corporation.
(f) Taxes paid on or with respect to accumulated profits of a
foreign corporation.
(g) Determination of earnings and profits of a foreign corporation.
(1) Taxable year to which section 963 does not apply.
(2) Taxable year to which section 963 applies.
(3) Time and manner of making choice.
(4) Determination by district director.
(h) Source of income from first-tier corporation and country to
which tax is deemed paid.
(1) Source of income.
(2) Country to which taxes deemed paid.
(i) United Kingdom income taxes paid with respect to royalties.
(j) Information to be furnished.
(k) Illustrations.
(l) Effective date.
[[Page 928]]
Sec. 1.902-4 Rules for distributions attributable to accumulated
profits for taxable years in which a first-tier corporation was a
less developed country corporation.
(a) In general.
(b) Combined distributions.
(c) Distributions of a first-tier corporation attributable to
certain distributions from second- or third-tier corporations.
(d) Illustrations.
Sec. 1.902-1 Credit for domestic corporate shareholder of a foreign
corporation for foreign income taxes paid by the foreign corporation.
(a) Definitions and special effective date. For purposes of section
902, this section, and Sec. 1.902-2, the definitions provided in
paragraphs (a) (1) through (12) of this section and the special
effective date of paragraph (a)(13) of this section apply.
(1) Domestic shareholder. In the case of dividends received by a
domestic corporation from a foreign corporation after December 31,
1986, the term domestic shareholder means a domestic corporation, other
than an S corporation as defined in section 1361(a), that owns at least
10 percent of the voting stock of the foreign corporation at the time
the domestic corporation receives a dividend from that foreign
corporation.
(2) First-tier corporation. In the case of dividends received by a
domestic shareholder from a foreign corporation in a taxable year
beginning after December 31, 1986, the term first-tier corporation
means a foreign corporation, at least 10 percent of the voting stock of
which is owned by a domestic shareholder at the time the domestic
shareholder receives a dividend from that foreign corporation. The term
first-tier corporation also includes a DISC or former DISC, but only
with respect to dividends from the DISC or former DISC that are treated
under sections 861(a)(2)(D) and 862(a)(2) as income from sources
without the United States.
(3) Second-tier corporation. In the case of dividends paid to a
first-tier corporation by a foreign corporation in a taxable year
beginning after December 31, 1986, the foreign corporation is a second-
tier corporation if, at the time a first-tier corporation receives a
dividend from that foreign corporation, the first-tier corporation owns
at least 10 percent of the foreign corporation's voting stock and the
product of the following equals at least 5 percent--
(i) The percentage of voting stock owned by the domestic
shareholder in the first-tier corporation; multiplied by
(ii) The percentage of voting stock owned by the first-tier
corporation in the second-tier corporation.
(4) Third-tier corporation. In the case of dividends paid to a
second-tier corporation by a foreign corporation in a taxable year
beginning after December 31, 1986, a foreign corporation is a third-
tier corporation if, at the time a second-tier corporation receives a
dividend from that foreign corporation, the second-tier corporation
owns at least 10 percent of the foreign corporation's voting stock and
the product of the following equals at least 5 percent--
(i) The percentage of voting stock owned by the domestic
shareholder in the first-tier corporation; multiplied by
(ii) The percentage of voting stock owned by the first-tier
corporation in the second-tier corporation; multiplied by
(iii) The percentage of voting stock owned by the second-tier
corporation in the third-tier corporation.
(5) Example. The following example illustrates the ownership
requirements of paragraphs (a) (1) through (4) of this section:
Example. (i) Domestic corporation M owns 30 percent of the
voting stock of foreign corporation A on January 1, 1991, and for
all periods thereafter. Corporation A owns 40 percent of the voting
stock of foreign corporation B on January 1, 1991, and continues to
own that stock until June 1, 1991, when Corporation A sells its
stock in Corporation B. Both Corporation A and Corporation B use the
calendar year as the taxable year. Corporation B pays a dividend out
of its post-1986 undistributed earnings to Corporation A, which
Corporation A receives on February 16, 1991. Corporation A pays a
dividend out of its post-1986 undistributed earnings to Corporation
M, which Corporation M receives on January 20, 1992. Corporation M
uses a fiscal year ending on June 30 as the taxable year.
(ii) On February 16, 1991, when Corporation B pays a dividend to
Corporation A, Corporation M satisfies the 10 percent stock
ownership requirement of paragraphs (a) (1) and (2) of this section
with respect to Corporation A. Therefore, Corporation A is a first-
tier corporation within the meaning of paragraph (a)(2) of this
section and Corporation M is a domestic shareholder of Corporation A
within the meaning of paragraph (a)(1) of this section. Also on
February 16, 1991, Corporation B is a second-tier corporation within
the meaning of paragraph (a)(3) of this section because Corporation
A owns at least 10 percent of its voting stock, and the percentage
of voting stock owned by Corporation M in Corporation A on February
16, 1991 (30 percent) multiplied by the percentage of voting stock
owned by Corporation A in Corporation B on February 16, 1991 (40
percent) equals 12 percent. Corporation A shall be deemed to have
paid foreign income taxes of Corporation B with respect to the
dividend received from Corporation B on February 16, 1991.
(iii) On January 20, 1992, Corporation M satisfies the 10-
percent stock ownership requirement of paragraphs (a)(1) and (2) of
this section with respect to Corporation A. Therefore, Corporation A
is a first-tier corporation within the meaning of paragraph (a)(2)
of this section and Corporation M is a domestic shareholder within
the meaning of paragraph (a)(1) of this section. Accordingly, for
its taxable year ending on June 30, 1992, Corporation M is deemed to
have paid a portion of the post-1986 foreign income taxes paid,
accrued, or deemed to be paid, by Corporation A. Those taxes will
include taxes paid by Corporation B that were deemed paid by
Corporation A with respect to the dividend paid by Corporation B to
Corporation A on February 16, 1991, even though Corporation B is no
longer a second-tier corporation with respect to Corporations A and
M on January 20, 1992, and has not been a second-tier corporation
with respect to Corporations A and M at any time during the taxable
years of Corporations A and M that include January 20, 1992.
(6) Upper- and lower-tier corporations. In the case of a third-tier
corporation, the term upper-tier corporation means a first- or second-
tier corporation. In the case of a second-tier corporation, the term
upper-tier corporation means a first-tier corporation. In the case of a
first-tier corporation, the term lower-tier corporation means a second-
or third-tier corporation. In the case of a second-tier corporation,
the term lower-tier corporation means a third-tier corporation.
(7) Foreign income taxes. The term foreign income taxes means
income, war profits, and excess profits taxes as defined in Sec. 1.901-
2(a), and taxes included in the term income, war profits, and excess
profits taxes by reason of section 903, that are imposed by a foreign
country or a possession of the United States, including any such taxes
deemed paid by a foreign corporation under this section. Foreign
income, war profits, and excess profits taxes shall not include amounts
excluded from the definition of those taxes pursuant to section 901 and
the regulations under that section. See also paragraphs (c)(4) and (5)
of this section (concerning foreign taxes paid with respect to foreign
mineral income and in connection with the purchase or sale of oil and
gas).
(8) Post-1986 foreign income taxes--(i) In general. Except as
provided in paragraphs (a)(10) and (13) of this section, the term post-
1986 foreign income taxes of a foreign corporation means the sum of the
foreign income taxes paid, accrued, or deemed paid in the taxable year
of the foreign corporation in which it distributes a dividend plus the
foreign income taxes paid, accrued, or deemed paid in the foreign
corporation's prior taxable years beginning after December 31, 1986, to
[[Page 929]]
the extent the foreign taxes were not paid or deemed paid by the
foreign corporation on or with respect to earnings that in prior
taxable years were distributed to, or otherwise included (e.g., under
sections 304, 367(b), 551, 951(a), 1248 or 1293) in the income of, a
foreign or domestic shareholder. Except as provided in paragraph (b)(4)
of this section, foreign taxes paid or deemed paid by the foreign
corporation on or with respect to earnings that were distributed or
otherwise removed from post-1986 undistributed earnings in prior post-
1986 taxable years shall be removed from post-1986 foreign income taxes
regardless of whether the shareholder is eligible to compute an amount
of foreign taxes deemed paid under section 902, and regardless of
whether the shareholder in fact chose to credit foreign income taxes
under section 901 for the year of the distribution or inclusion. Thus,
if an amount is distributed or deemed distributed by a foreign
corporation to a United States person that is not a domestic
shareholder within the meaning of paragraph (a)(1) of this section
(e.g., an individual or a corporation that owns less than 10% of the
foreign corporation's voting stock), or to a foreign person that does
not meet the definition of a first- or second-tier corporation under
paragraph (a)(2) or (3) of this section, then although no foreign
income taxes shall be deemed paid under section 902, foreign income
taxes attributable to the distribution or deemed distribution that
would have been deemed paid had the shareholder met the ownership
requirements of paragraphs (a)(1) through (4) of this section shall be
removed from post-1986 foreign income taxes. Further, if a domestic
shareholder chooses to deduct foreign taxes paid or accrued for the
taxable year of the distribution or inclusion, it shall nonetheless be
deemed to have paid a proportionate share of the foreign corporation's
post-1986 foreign income taxes under section 902(a), and the foreign
taxes deemed paid must be removed from post-1986 foreign income taxes.
In the case of a foreign corporation the foreign income taxes of which
are determined based on an accounting period of less than one year, the
term year means that accounting period. See sections 441(b)(3) and 443.
(ii) Distributions out of earnings and profits accumulated by a
lower-tier corporation in its taxable years beginning before January 1,
1987, and included in the gross income of an upper-tier corporation in
its taxable year beginning after December 31, 1986. Post-1986 foreign
income taxes shall include foreign income taxes that are deemed paid by
an upper-tier corporation with respect to distributions from a lower-
tier corporation out of nonpreviously taxed pre-1987 accumulated
profits, as defined in paragraph (a)(10) of this section, that are
received by an upper-tier corporation in any taxable year of the upper-
tier corporation beginning after December 31, 1986, provided the upper-
tier corporation's earnings and profits in that year are included in
its post-1986 undistributed earnings under paragraph (a)(9) of this
section. Foreign income taxes deemed paid with respect to a
distribution of pre-1987 accumulated profits shall be translated from
the functional currency of the lower-tier corporation into dollars at
the spot exchange rate in effect on the date of the distribution. To
determine the character of the earnings and profits and associated
taxes for foreign tax credit limitation purposes, see section 904 and
Sec. 1.904-7(a).
(iii) Foreign income taxes paid or accrued with respect to high
withholding tax interest. Post-1986 foreign income taxes shall not
include foreign income taxes paid or accrued by a noncontrolled section
902 corporation (as defined in section 904(d)(2)(E)(i)) with respect to
high withholding tax interest (as defined in section 904(d)(2)(B)) to
the extent the foreign tax rate imposed on such interest exceeds 5
percent. See section 904(d)(2)(E)(ii) and Sec. 1.904-4(g)(2)(iii). The
reduction in foreign income taxes paid or accrued by the amount of tax
in excess of 5 percent imposed on high withholding tax interest income
must be computed in functional currency before foreign income taxes are
translated into U.S. dollars and included in post-1986 foreign income
taxes.
(9) Post-1986 undistributed earnings--(i) In general. Except as
provided in paragraphs (a) (10) and (13) of this section, the term
post-1986 undistributed earnings means the amount of the earnings and
profits of a foreign corporation (computed in accordance with sections
964(a) and 986) accumulated in taxable years of the foreign corporation
beginning after December 31, 1986, determined as of the close of the
taxable year of the foreign corporation in which it distributes a
dividend. Post-1986 undistributed earnings shall not be reduced by
reason of any earnings distributed or otherwise included in income, for
example under section 304, 367(b), 551, 951(a), 1248 or 1293, during
the taxable year. Post-1986 undistributed earnings shall be reduced to
account for distributions or deemed distributions that reduced earnings
and profits and inclusions that resulted in previously-taxed amounts
described in section 959(c) (1) and (2) or section 1293(c) in prior
taxable years beginning after December 31, 1986. Thus, post-1986
undistributed earnings shall not be reduced to the extent of the
ratable share of a controlled foreign corporation's subpart F income,
as defined in section 952, attributable to a shareholder that is not a
United States shareholder within the meaning of section 951(b) or
section 953(c)(1)(A), because that amount has not been included in a
shareholder's gross income. Post-1986 undistributed earnings shall be
reduced as provided herein regardless of whether any shareholder is
deemed to have paid any foreign taxes, and regardless of whether any
domestic shareholder chose to claim a foreign tax credit under section
901(a) for the year of the distribution. For rules on carrybacks and
carryforwards of deficits and their effect on post-1986 undistributed
earnings, see Sec. 1.902-2. In the case of a foreign corporation the
foreign income taxes of which are computed based on an accounting
period of less than one year, the term year means that accounting
period. See sections 441(b)(3) and 443.
(ii) Distributions out of earnings and profits accumulated by a
lower-tier corporation in its taxable years beginning before January 1,
1987, and included in the gross income of an upper-tier corporation in
its taxable year beginning after December 31, 1986. Distributions by a
lower-tier corporation out of non-previously taxed pre-1987 accumulated
profits, as defined in paragraph (a)(10) of this section, that are
received by an upper-tier corporation in any taxable year of the upper-
tier corporation beginning after December 31, 1986, shall be treated as
post-1986 undistributed earnings of the upper-tier corporation,
provided the upper-tier corporation's earnings and profits for that
year are included in its post-1986 undistributed earnings under
paragraph (a)(9)(i) of this section. To determine the character of the
earnings and profits and associated taxes for foreign tax credit
limitation purposes, see section 904 and Sec. 1.904-7(a).
(iii) Reduction for foreign income taxes paid or accrued. In
computing post-1986 undistributed earnings, earnings and profits shall
be reduced by foreign income taxes paid or accrued regardless of
whether the taxes are creditable. Thus, earnings and profits shall be
reduced by foreign income taxes paid with respect to high withholding
tax interest even though a portion of the taxes is not creditable
[[Page 930]]
pursuant to section 904(d)(2)(E)(ii) and is not included in post-1986
foreign income taxes under paragraph (a)(8)(iii) of this section.
Earnings and profits of an upper-tier corporation, however, shall not
be reduced by foreign income taxes paid by a lower-tier corporation and
deemed to have been paid by the upper-tier corporation.
(iv) Special allocations. The term post-1986 undistributed earnings
means the total amount of the earnings of the corporation determined at
the corporate level. Special allocations of earnings and taxes to
particular shareholders, whether required or permitted by foreign law
or a shareholder agreement, shall be disregarded. If, however, the
Commissioner establishes that there is an agreement to pay dividends
only out of earnings in the separate categories for passive or high
withholding tax interest income, then only taxes imposed on passive or
high withholding tax interest earnings shall be treated as related to
the dividend. See Sec. 1.904-6(a)(2).
(10) Pre-1987 accumulated profits--(i) Definition. The term pre-
1987 accumulated profits means the amount of the earnings and profits
of a foreign corporation computed in accordance with section 902 and
attributable to its taxable years beginning before January 1, 1987. If
the special effective date of paragraph (a)(13) of this section
applies, pre-1987 accumulated profits also includes any earnings and
profits (computed in accordance with sections 964(a) and 986)
attributable to the foreign corporation's taxable years beginning after
December 31, 1986, but before the first day of the first taxable year
of the foreign corporation in which the ownership requirements of
section 902(c)(3)(B) and paragraphs (a) (1) through (4) of this section
are met with respect to that corporation.
(ii) Computation of pre-1987 accumulated profits. Pre-1987
accumulated profits must be computed under United States principles
governing the computation of earnings and profits. Pre-1987 accumulated
profits are determined at the corporate level. Special allocations of
accumulated profits and taxes to particular shareholders with respect
to distributions of pre-1987 accumulated profits in taxable years
beginning after December 31, 1986, whether required or permitted by
foreign law or a shareholder agreement, shall be disregarded. Pre-1987
accumulated profits of a particular year shall be reduced by amounts
distributed from those accumulated profits or otherwise included in
income from those accumulated profits, for example under sections 304,
367(b), 551, 951(a), 1248 or 1293. If a deficit in post-1986
undistributed earnings is carried back to offset pre-1987 accumulated
profits, pre-1987 accumulated profits of a particular taxable year
shall be reduced by the amount of the deficit carried back to that
year. See Sec. 1.902-2. The amount of a distribution out of pre-1987
accumulated profits, and the amount of foreign income taxes deemed paid
under section 902, shall be determined and translated into United
States dollars by applying the law as in effect prior to the effective
date of the Tax Reform Act of 1986. See Secs. 1.902-3, 1.902-4 and
1.964-1.
(iii) Foreign income taxes attributable to pre-1987 accumulated
profits. The term pre-1987 foreign income taxes means any foreign
income taxes paid, accrued, or deemed paid by a foreign corporation on
or with respect to its pre-1987 accumulated profits. Pre-1987 foreign
income taxes of a particular year shall be reduced by the amount of
taxes paid or deemed paid by the foreign corporation on or with respect
to amounts distributed or otherwise included in income from pre-1987
accumulated profits of that year. Thus, pre-1987 foreign income taxes
shall be reduced by the amount of taxes deemed paid by a domestic
shareholder (regardless of whether the shareholder chose to credit
foreign income taxes under section 901 for the year of the distribution
or inclusion) or a first-tier or second-tier corporation, and by the
amount of taxes that would have been deemed paid had any other
shareholder been eligible to compute an amount of foreign taxes deemed
paid under section 902. Foreign income taxes deemed paid with respect
to a distribution of pre-1987 accumulated profits shall be translated
from the functional currency of the distributing corporation into
United States dollars at the spot exchange rate in effect on the date
of the distribution.
(11) Dividend. For purposes of section 902, the definition of the
term dividend in section 316 and the regulations under that section
applies. Thus, for example, distributions and deemed distributions
under sections 302, 304, 305(b) and 367(b) that are treated as
dividends within the meaning of section 301(c)(1) also are dividends
for purposes of section 902. In addition, the term dividend includes
deemed dividends under sections 551 and 1248, but not deemed inclusions
under sections 951(a) and 1293. For rules concerning excess
distributions from section 1291 funds that are treated as dividends
solely for foreign tax credit purposes, (see Regulation Project INTL-
656-87 published in 1992-1 C.B. 1124; see Sec. 601.601(d)(2)(ii)(b) of
this chapter).
(12) Dividend received. A dividend shall be considered received for
purposes of section 902 when the cash or other property is
unqualifiedly made subject to the demands of the distributee. See
Sec. 1.301-1(b). A dividend also is considered received for purposes of
section 902 when it is deemed received under section 304, 367(b), 551,
or 1248.
(13) Special effective date--(i) Rule. If the first day on which
the ownership requirements of section 902(c)(3)(B) and paragraphs
(a)(1) through (4) of this section are met with respect to a foreign
corporation, without regard to whether a dividend is distributed, is in
a taxable year of the foreign corporation beginning after December 31,
1986, then--
(A) The post-1986 undistributed earnings and post-1986 foreign
income taxes of the foreign corporation shall be determined by taking
into account only taxable years beginning on and after the first day of
the first taxable year of the foreign corporation in which the
ownership requirements are met, including subsequent taxable years in
which the ownership requirements of section 902(c)(3)(B) and paragraphs
(a)(1) through (4) of this section are not met; and
(B) Earnings and profits accumulated prior to the first day of the
first taxable year of the foreign corporation in which the ownership
requirements of section 902(c)(3)(B) and paragraphs (a)(1) through (4)
of this section are met shall be considered pre-1987 accumulated
profits.
(ii) Example. The following example illustrates the special
effective date rules of this paragraph (a)(13):
Example. As of December 31, 1991, and since its incorporation,
foreign corporation A has owned 100 percent of the stock of foreign
corporation B. Corporation B is not a controlled foreign
corporation. Corporation B uses the calendar year as its taxable
year, and its functional currency is the u. Assume 1u equals $1 at
all relevant times. On April 1, 1992, Corporation B pays a 200u
dividend to Corporation A and the ownership requirements of section
902(c)(3)(B) and paragraphs (a)(1) through (4) of this section are
not met at that time. On July 1, 1992, domestic corporation M
purchases 10 percent of the Corporation B stock from Corporation A
and, for the first time, Corporation B meets the ownership
requirements of section 902(c)(3)(B) and paragraph (a)(2) of this
section. Corporation M uses the calendar year as its taxable year.
Corporation B does not distribute any dividends to Corporation M
during 1992. For its taxable year ending December 31, 1992,
Corporation B has 500u of earnings and profits (after foreign taxes
but before taking into account the 200u
[[Page 931]]
distribution to Corporation A) and pays 100u of foreign income taxes
that is equal to $100. Pursuant to paragraph (a)(13)(i) of this
section, Corporation B's post-1986 undistributed earnings and post-
1986 foreign income taxes will include earnings and profits and
foreign income taxes attributable to Corporation B's entire 1992
taxable year and all taxable years thereafter. Thus, the April 1,
1992, dividend to Corporation A will reduce post-1986 undistributed
earnings to 300u (500u-200u) under paragraph (a)(9)(i) of this
section. The foreign income taxes attributable to the amount
distributed as a dividend to Corporation A will not be creditable
because Corporation A is not a domestic shareholder. Post-1986
foreign income taxes, however, will be reduced by the amount of
foreign taxes attributable to the dividend. Thus, as of the
beginning of 1993, Corporation B has $60 ($100-[$100 x 40% (200u/
500u)]) of post-1986 foreign income taxes. See paragraphs (a)(8)(i)
and (b)(1) of this section.
(b) Computation of foreign income taxes deemed paid by a domestic
shareholder, first-tier corporation, and second-tier corporation--(1)
General rule. If a foreign corporation pays a dividend in any taxable
year out of post-1986 undistributed earnings to a shareholder that is a
domestic shareholder or an upper-tier corporation at the time it
receives the dividend, the recipient shall be deemed to have paid the
same proportion of any post-1986 foreign income taxes paid, accrued or
deemed paid by the distributing corporation on or with respect to post-
1986 undistributed earnings which the amount of the dividend out of
post-1986 undistributed earnings (determined without regard to the
gross-up under section 78) bears to the amount of the distributing
corporation's post-1986 undistributed earnings. An upper-tier
corporation shall not be entitled to compute an amount of foreign taxes
deemed paid on a dividend from a lower-tier corporation, however,
unless the ownership requirements of paragraphs (a) (1) through (4) of
this section are met at each tier at the time the upper-tier
corporation receives the dividend. Foreign income taxes deemed paid by
a domestic shareholder or an upper-tier corporation must be computed
under the following formula:
Dividend paid to domestic
shareholder (or upper-tier
corporation) by first-tier
corporation (or lower-tier
Foreign income taxes deemed paid by Post-1986 foreign income taxes corporation)
domestic shareholder (or upper-tier = of first-tier corporation (or x -------------------------------
corporation) lower-tier corporation) Post-1986 undistributed
earnings of first-tier
corporation (or lower-tier
corporation)
(2) Allocation rule for dividends attributable to post-1986
undistributed earnings and pre-1987 accumulated profits--(i) Portion of
dividend out of post-1986 undistributed earnings. Dividends will be
deemed to be paid first out of post-1986 undistributed earnings to the
extent thereof. If dividends exceed post-1986 undistributed earnings
and dividends are paid to more than one shareholder, then the dividend
to each shareholder shall be deemed to be paid pro rata out of post-
1986 undistributed earnings, computed as follows:
Dividends to
Portion of Dividend to a Shareholder
Shareholder Attributable to = Post-1986 Undistributed Earnings x -----------------------
Post-1986 Undistributed Total Dividends Paid
Earnings To all Shareholders
(ii) Portion of dividend out of pre-1987 accumulated profits. After
the portion of the dividend attributable to post-1986 undistributed
earnings is determined under paragraph (b)(2)(i) of this section, the
remainder of the dividend received by a shareholder is attributable to
pre-1987 accumulated profits to the extent thereof. That part of the
dividend attributable to pre-1987 accumulated profits will be treated
as paid first from the most recently accumulated earnings and profits.
See Sec. 1.902-3. If dividends paid out of pre-1987 accumulated profits
are attributable to more than one pre-1987 taxable year and are paid to
more than one shareholder, then the dividend to each shareholder
attributable to earnings and profits accumulated in a particular pre-
1987 taxable year shall be deemed to be paid pro rata out of
accumulated profits of that taxable year, computed as follows:
(Dividend Paid Out of Pre-1987 Dividend to Shareholder
Portion of Dividend to a Shareholder Accumulated Profits with -------------------------------
Attributable to Accumulated Profits of = Respect to the Particular Pre- x Total Dividends Paid to all
a Particular Pre-1987 Taxable Year 1987 Taxable Year Shareholders
(3) Dividends paid out of pre-1987 accumulated profits. If
dividends are paid by a first-tier corporation or a lower-tier
corporation out of pre-1987 accumulated profits, the domestic
shareholder or upper-tier corporation that receives the dividends shall
be deemed to have paid foreign income taxes to the extent provided
under section 902 and the regulations thereunder as in effect prior to
the effective date of the Tax Reform Act of 1986. See paragraphs (a)
(10) and (13) of this section and Secs. 1.902-3 and 1.902-4.
(4) Deficits in accumulated earnings and profits. No foreign income
taxes shall be deemed paid with respect to a distribution from a
foreign corporation out of current earnings and profits that is treated
as a dividend under section 316(a)(2), and post-1986 foreign income
taxes shall not be reduced, if as of the end of the taxable year in
which the dividend is paid or accrued, the corporation has zero or a
deficit in post-1986 undistributed earnings and the sum of current plus
accumulated earnings and profits is zero or less than zero. The
dividend shall reduce post-
[[Page 932]]
1986 undistributed earnings and accumulated earnings and profits.
(5) Examples. The following examples illustrate the rules of this
paragraph (b):
Example 1. Domestic corporation M owns 100 percent of foreign
corporation A. Both Corporation M and Corporation A use the calendar
year as the taxable year, and Corporation A uses the u as its
functional currency. Assume that 1u equals $1 at all relevant times.
All of Corporation A's pre-1987 accumulated profits and post-1986
undistributed earnings are non-subpart F general limitation earnings
and profits under section 904(d)(1)(I). As of December 31, 1992,
Corporation A has 100u of post-1986 undistributed earnings and $40
of post-1986 foreign income taxes. For its 1986 taxable year,
Corporation A has accumulated profits of 200u (net of foreign taxes)
and paid 60u of foreign income taxes on those earnings. In 1992,
Corporation A distributes 150u to Corporation M. Corporation A has
100u of post-1986 undistributed earnings and the dividend,
therefore, is treated as paid out of post-1986 undistributed
earnings to the extent of 100u. The first 100u distribution is from
post-1986 undistributed earnings, and, because the distribution
exhausts those earnings, Corporation M is deemed to have paid the
entire amount of post-1986 foreign income taxes of Corporation A
($40). The remaining 50u dividend is treated as a dividend out of
1986 accumulated profits under paragraph (b)(2) of this section.
Corporation M is deemed to have paid $15 (60u x 50u/200u, translated
at the appropriate exchange rates) of Corporation A's foreign income
taxes for 1986. As of January 1, 1993, Corporation A's post-1986
undistributed earnings and post-1986 foreign income taxes are 0.
Corporation A has 150u of accumulated profits and 45u of foreign
income taxes remaining in 1986.
Example 2. Domestic corporation M (incorporated on January 1,
1987) owns 100 percent of foreign corporation A (incorporated on
January 1, 1987). Both Corporation M and Corporation A use the
calendar year as the taxable year, and Corporation A uses the u as
its functional currency. Assume that 1u equals $1 at all relevant
times. Corporation A has no pre-1987 accumulated profits. All of
Corporation A's post-1986 undistributed earnings are non-subpart F
general limitation earnings and profits under section 904(d)(1)(I).
On January 1, 1992, Corporation A has a deficit in accumulated
earnings and profits and a deficit in post-1986 undistributed
earnings of (200u). No foreign taxes have been paid with respect to
post-1986 undistributed earnings. During 1992, Corporation A earns
100u (net of foreign taxes), pays $40 of foreign taxes on those
earnings and distributes 50u to Corporation M. As of the end of
1992, Corporation A has a deficit of (100u) ((200u) post1986
undistributed earnings + 100u current earnings and profits) in post-
1986 undistributed earnings. Corporation A, however, has current
earnings and profits of 100u. Therefore, the 50u distribution is
treated as a dividend in its entirety under section 316(a)(2). Under
paragraph (b)(4) of this section, Corporation M is not deemed to
have paid any of the foreign taxes paid by Corporation A because
post-1986 undistributed earnings and the sum of current plus
accumulated earnings and profits are (100u). The dividend reduces
both post-1986 undistributed earnings and accumulated earnings and
profits. Therefore, as of January 1, 1993, Corporation A's post-1986
undistributed earnings are (150u) and its accumulated earnings and
profits are (150u). Corporation A's post-1986 foreign income taxes
at the start of 1993 are $40.
(c) Special rules--(1) Separate computations required for dividends
from each first-tier and lower-tier corporation--(i) Rule. If in a
taxable year dividends are received by a domestic shareholder or an
upper-tier corporation from two or more first-tier corporations or two
or more lower-tier corporations, the foreign income taxes deemed paid
by the domestic shareholder or the upper-tier corporation under
sections 902 (a) and (b) and paragraph (b) of this section shall be
computed separately with respect to the dividends received from each
first-tier corporation or lower-tier corporation. If a domestic
shareholder receives dividend distributions from one or more first-tier
corporations and in the same taxable year the first-tier corporation
receives dividends from one or more lower-tier corporations, then the
amount of foreign income taxes deemed paid shall be computed by
starting with the lowest-tier corporation and working upward.
(ii) Example. The following example illustrates the application of
this paragraph (c)(1):
Example. P, a domestic corporation, owns 40 percent of the
voting stock of foreign corporation S. S owns 30 percent of the
voting stock of foreign corporation T, and 30 percent of the voting
stock of foreign corporation U. Neither S, T, nor U is a controlled
foreign corporation. P, S, T and U all use the calendar year as
their taxable year. In 1993, T and U both pay dividends to S and S
pays a dividend to P. To compute foreign taxes deemed paid,
paragraph (c)(1) of this section requires P to start with the lowest
tier corporations and to compute foreign taxes deemed paid
separately for dividends from each first-tier and lower-tier
corporation. Thus, S first will compute foreign taxes deemed paid
separately on its dividends from T and U. The deemed paid taxes will
be added to S's post-1986 foreign income taxes, and the dividends
will be added to S's post-1986 undistributed earnings. Next, P will
compute foreign taxes deemed paid with respect to the dividend from
S. This computation will take into account the taxes paid by T and U
and deemed paid by S.
(2) Section 78 gross-up--(i) Foreign income taxes deemed paid by a
domestic shareholder. Except as provided in section 960(b) and the
regulations under that section (relating to amounts excluded from gross
income under section 959(b)), any foreign income taxes deemed paid by a
domestic shareholder in any taxable year under section 902(a) and
paragraph (b) of this section shall be included in the gross income of
the domestic shareholder for the year as a dividend under section 78.
Amounts included in gross income under section 78 shall, for purposes
of section 904, be deemed to be derived from sources within the United
States to the extent the earnings and profits on which the taxes were
paid are treated under section 904(g) as United States source earnings
and profits. Section 1.904-5(m)(6). Amounts included in gross income
under section 78 shall be treated for purposes of section 904 as income
in a separate category to the extent that the foreign income taxes were
allocated and apportioned to income in that separate category. See
section 904(d)(3)(G) and Sec. 1.904-6(b)(3).
(ii) Foreign income taxes deemed paid by an upper-tier corporation.
Foreign income taxes deemed paid by an uppertier corporation on a
distribution from a lower-tier corporation are not included in the
earnings and profits of the upper-tier corporation. For purposes of
section 904, foreign income taxes shall be allocated and apportioned to
income in a separate category to the extent those taxes were allocated
to the earnings and profits of the lower-tier corporation in that
separate category. See section 904(d)(3)(G) and Sec. 1.904-6(b)(3). To
the extent that section 904(g) treats the earnings of the lower-tier
corporation on which those foreign income taxes were paid as United
States source earnings and profits, the foreign income taxes deemed
paid by the upper-tier corporation on the distribution from the lower-
tier corporation shall be treated as attributable to United States
source earnings and profits. See section 904(g) and Sec. 1.904-5(m)(6).
(iii) Example. The following example illustrates the rules of this
paragraph (c)(2):
Example. P, a domestic corporation, owns 100 percent of the
voting stock of controlled foreign corporation S. Corporations P and
S use the calendar year as their taxable year, and S uses the u as
its functional currency. Assume that 1u equals $1 at all relevant
times. As of January 1, 1992, S has -0- post-1986 undistributed
earnings and -0- post-1986 foreign income taxes. In 1992, S earns
150u of non-subpart F general limitation income net of foreign taxes
and pays 60u of foreign income taxes. As of the end of 1992, but
before dividend payments, S has 150u of post-1986 undistributed
earnings and $60 of post-1986 foreign income taxes. Assume that 50u
of S's earnings for 1992 are from United States sources. S pays P a
dividend of 75u
[[Page 933]]
which P receives in 1992. Under Sec. 1.904-5(m)(4), one-third of the
dividend, or 25u (75u x 50u/150u), is United States source income to
P. P computes foreign taxes deemed paid on the dividend under
paragraph (b)(1) of this section of $30 ($60 x 50%[75u/150u]) and
includes that amount in gross income under section 78 as a dividend.
Because 25u of the 75u dividend is United States source income to P,
$10 ($30 x 33.33%[25u/75u]) of the section 78 dividend will be
treated as United States source income to P under this paragraph
(c)(2).
(3) Creditable foreign income taxes. The amount of creditable
foreign income taxes under section 901 shall include, subject to the
limitations and conditions of sections 902 and 904, foreign income
taxes actually paid and deemed paid by a domestic shareholder that
receives a dividend from a first-tier corporation. Foreign income taxes
deemed paid by a domestic shareholder under paragraph (b) of this
section shall be deemed paid by the domestic shareholder only for
purposes of computing the foreign tax credit allowed under section 901.
(4) Foreign mineral income. Certain foreign income, war profits and
excess profits taxes paid or accrued with respect to foreign mineral
income will not be considered foreign income taxes for purposes of
section 902. See section 901(e) and Sec. 1.901-3.
(5) Foreign taxes paid or accrued in connection with the purchase
or sale of certain oil and gas. Certain income, war profits, or excess
profits taxes paid or accrued to a foreign country in connection with
the purchase and sale of oil or gas extracted in that country will not
be considered foreign income taxes for purposes of section 902. See
section 901(f).
(6) Foreign oil and gas extraction income. For rules relating to
reduction of the amount of foreign income taxes deemed paid with
respect to foreign oil and gas extraction income, see section 907(a)
and the regulations under that section.
(7) United States shareholders of controlled foreign corporations.
See paragraph (d) of this section and sections 960 and 962 and the
regulations under those sections for special rules relating to the
application of section 902 in computing foreign income taxes deemed
paid by United States shareholders of controlled foreign corporations.
(8) Credit for foreign taxes deemed paid in a section 304
transaction. [Reserved].
(9) Effect of section 482 adjustments on post-1986 foreign income
taxes and post-1986 undistributed earnings. [Reserved].
(d) Dividends from controlled foreign corporations--(1) General
rule. Except as provided in paragraph (d)(3) of this section, if a
dividend is received by a domestic shareholder that is a United States
shareholder (as defined in section 951(b) or section 953(c)(1)(A)) from
a first-tier corporation that is a controlled foreign corporation (as
defined in section 957(a) or section 953(c)(1)(B)), or by an upper-tier
corporation from a lower-tier corporation if the corporations are
related look-through entities within the meaning of Sec. 1.904-5(i),
the following rule applies. If a dividend is paid out of post-1986
undistributed earnings or pre-1987 accumulated profits of the upper- or
lower-tier controlled foreign corporation attributable to more than one
separate category under section 904(d), the amount of foreign income
taxes deemed paid by the domestic shareholder or the upper-tier
corporation under section 902 and paragraph (b) of this section shall
be computed separately with respect to the post-1986 undistributed
earnings or pre-1987 accumulated profits in each separate category out
of which the dividend is paid. See Sec. 1.904-5(c)(4) and paragraph
(d)(2) of this section. The separately computed deemed paid taxes shall
be added to other taxes paid by the U.S. shareholder or upper-tier
corporation with respect to income in the appropriate separate
category.
(2) Look-through--(i) Dividends. Except as otherwise provided in
paragraph (d)(3) of this section, any dividend distribution out of
post-1986 undistributed earnings of a look-through entity to a related
look-through entity shall be deemed to be paid pro rata out of each
separate category of income. See Secs. 1.904-5(c)(4) and 1.904-7. The
portion of the foreign income taxes attributable to a particular
separate category that shall be deemed paid by the domestic shareholder
or upper-tier corporation must be computed under the following formula:
Dividend amount
attributable to
a separate
category
Foreign taxes deemed paid by ----------------
domestic shareholder or Post-1986
upper-tier corporation with Post-1986 foreign income taxes of first-tier or lower- undistributed
respect to a separate = tier corporation allocated and apportioned to a separate x earnings of
category under section category under Sec. 1.904-6 first-tier or
904(d) lower-tier
corporation
attributable to
the separate
category
(ii) Coordination with section 960. For rules coordinating the
computation of foreign taxes deemed paid with respect to amounts
included in gross income under section 951(a) and dividends distributed
by a controlled foreign corporation, see section 960 and the
regulations under that section.
(3) Dividends distributed out of earnings accumulated before a
controlled foreign corporation became a controlled foreign
corporation--(i) General rule. Any dividend distributed by a controlled
foreign corporation out of earnings accumulated before the controlled
foreign corporation became a controlled foreign corporation shall be
treated as a dividend from a noncontrolled section 902 corporation
regardless of whether the earnings were accumulated in a taxable year
beginning before January 1, 1987, or after December 31, 1986.
(ii) Dividend distributions out of earnings and profits for a year
during which a shareholder that is currently a more-than-90-percent
United States shareholder of a controlled foreign corporation was not a
United States shareholder of the controlled foreign corporation.
[Reserved].
(e) Information to be furnished. If the credit for foreign income
taxes claimed under section 901 includes foreign income taxes deemed
paid under section 902 and paragraph (b) of this section, the domestic
shareholder must furnish the same information with respect to the
foreign income taxes deemed paid as it is required to furnish with
respect to the foreign income taxes it directly paid or accrued and for
which the credit is claimed. See Sec. 1.905-2. For other information
required to be furnished by the domestic shareholder for the annual
accounting period of certain foreign corporations ending with
[[Page 934]]
or within the shareholder's taxable year, and for reduction in the
amount of foreign income taxes paid, accrued, or deemed paid for
failure to furnish the required information, see section 6038 and the
regulations under that section.
(f) Examples. The following examples illustrate the application of
this section:
Example 1. Since 1987, domestic corporation M has owned 10
percent of the one class of stock of foreign corporation A. The
remaining 90 percent of Corporation A's stock is owned by Z, a
foreign corporation. Corporation A is not a controlled foreign
corporation. Corporation A uses the u as its functional currency,
and 1u equals $1 at all relevant times. Both Corporation A and
Corporation M use the calendar year as the taxable year. In 1992,
Corporation A pays a 30u dividend out of post-1986 undistributed
earnings, 3u to Corporation M and 27u to Corporation Z. Corporation
M is deemed, under paragraph (b) of this section, to have paid a
portion of the post-1986 foreign income taxes paid by Corporation A
and includes the amount of foreign taxes deemed paid in gross income
under section 78 as a dividend. Both the foreign taxes deemed paid
and the dividend would be subject to a separate limitation for
dividends from Corporation A, a noncontrolled section 902
corporation. Under paragraph (a)(9)(i) of this section, Corporation
A must reduce its post-1986 undistributed earnings as of January 1,
1993, by the total amount of dividends paid to Corporation M and
Corporation Z in 1992. Under paragraph (a)(8)(i) of this section,
Corporation A must reduce its post-1986 foreign income taxes as of
January 1, 1993, by the amount of foreign income taxes that were
deemed paid by Corporation M and by the amount of foreign income
taxes that would have been deemed paid by Corporation Z had
Corporation Z been eligible to compute an amount of foreign income
taxes deemed paid with respect to the dividend received from
Corporation A. Foreign income taxes deemed paid by Corporation M and
Corporation A's opening balances in post-1986 undistributed earnings
and post-1986 foreign income taxes for 1993 are computed as follows:
1. Assumed post-1986 undistributed earnings of 25u
Corporation A at start of 1992.
2. Assumed post-1986 foreign income taxes of $25
Corporation A at start of 1992.
3. Assumed pre-tax earnings and profits of 50u
Corporation A for 1992.
4. Assumed foreign income taxes paid or accrued 15u
by Corporation A in 1992.
5. Post-1986 undistributed earnings in 60u
Corporation A for 1992 (pre-dividend) (Line 1
plus Line 3 minus Line 4).
6. Post-1986 foreign income taxes in Corporation $40
A for 1992 (pre-dividend) (Line 2 plus Line 4
translated at the appropriate exchange rates).
7. Dividends paid out of post-1986 undistributed 3u
earnings of Corporation A to Corporation M in
1992.
8. Percentage of Corporation A's post-1986 5%
undistributed earnings paid to Corporation M
(Line 7 divided by Line 5).
9. Foreign income taxes of Corporation A deemed $2
paid by Corporation M under section 902(a) (Line
6 multiplied by Line 8).
10. Total dividends paid out of post-1986 30u
undistributed earnings of Corporation A to all
shareholders in 1992.
11. Percentage of Corporation A's post-1986 50%
undistributed earnings paid to all shareholders
in 1992 (Line 10 divided by Line 5).
12. Post-1986 foreign income taxes paid with $20
respect to post-1986 undistributed earnings
distributed to all shareholders in 1992 (Line 6
multiplied by Line 11).
13. Corporation A's post-1986 undistributed 30u
earnings at the start of 1993 (Line 5 minus Line
10).
14. Corporation A's post-1986 foreign income $20
taxes at the start of 1993 (Line 6 minus Line
12).
Example 2. (i) The facts are the same as in Example 1, except
that Corporation M has also owned 10 percent of the one class of
stock of foreign corporation B since 1987. Corporation B uses the
calendar year as the taxable year. The remaining 90 percent of
Corporation B's stock is owned by Corporation Z. Corporation B is
not a controlled foreign corporation. Corporation B uses the u as
its functional currency, and 1u equals $1 at all relevant times. In
1992, Corporation B has earnings and profits and pays foreign income
taxes, a portion of which are attributable to high withholding tax
interest, as defined in section 904(d)(2)(B)(i). Corporation B must
reduce its pool of post-1986 foreign income taxes by the amount of
tax imposed on high withholding tax interest in excess of 5 percent
because that amount is not treated as a tax for purposes of section
902. See section 904(d)(2)(E)(ii) and paragraph (a)(8)(iii) of this
section. Corporation B pays 50u in dividends in 1992, 5u to
Corporation M and 45u to Corporation Z. Corporation M must compute
its section 902(a) deemed paid taxes separately for the dividends it
receives in 1992 from Corporation A (as computed in Example 1) and
from Corporation B. Foreign income taxes of Corporation B deemed
paid by Corporation M, and Corporation B's opening balances in post-
1986 undistributed earnings and post-1986 foreign income taxes for
1993 are computed as follows:
1. Assumed post-1986 undistributed earnings of (100u)
Corporation B at start of 1992.
2. Assumed post-1986 foreign income taxes of $0
Corporation B at start of 1992.
3. Assumed pre-tax earnings and profits of 302.50u
Corporation B for 1992 (including 50u of high
withholding tax interest on which 5u of tax is
withheld).
4. Assumed foreign income taxes paid or accrued 102.50u
by Corporation B in 1992.
5. Post-1986 undistributed earnings in 100u
Corporation B for 1992 (pre-dividend) (Line 1
plus Line 3 minus Line 4).
6. Amount of foreign income tax of Corporation B 2.50u
imposed on high withholding tax interest in
excess of 5% (5u withholding tax--[5% x 50u high
withholding tax interest]).
7. Post-1986 foreign income taxes in Corporation $100
B for 1992 (pre-dividend) (Line 2 plus [Line 4
minus Line 6 translated at the appropriate
exchange rate]).
8. Dividends paid out of post-1986 undistributed 5u
earnings to Corporation M in 1992.
9. Percentage of Corporation B's post-1986 5%
undistributed earnings paid to Corporation M
(Line 8 divided by Line 5).
10. Foreign income taxes of Corporation B deemed $5
paid by Corporation M under section 902(a) (Line
7 multiplied by Line 9).
11. Total dividends paid out of post-1986 50u
undistributed earnings of Corporation B to all
shareholders in 1992.
12. Percentage of Corporation B's post-1986 50%
undistributed earnings paid to all shareholders
in 1992 (Line 11 divided by Line 5).
13. Post-1986 foreign income taxes of Corporation $50
B paid on or with respect to post-1986
undistributed earnings distributed to all
shareholders in 1992 (Line 7 multiplied by Line
12).
14. Corporation B's post-1986 undistributed 50u
earnings at start of 1993 (Line 5 minus Line 11).
15. Corporation B's post-1986 foreign income $50
taxes at start of 1993 (Line 7 minus Line 13).
(ii) For 1992, as computed in Example 1, Corporation M is deemed
to have paid $2 of the post-1986 foreign income taxes paid by
Corporation A and includes $2 in gross income as a dividend under
section 78. Both the income inclusion and the credit are subject to
a separate limitation for dividends from Corporation A, a
noncontrolled section 902 corporation. Corporation M also is deemed
to have paid $5 of the post-1986 foreign income taxes paid by
Corporation B and includes $5 in gross income as a deemed dividend
under section 78. Both the income inclusion and the foreign taxes
deemed paid are subject to a separate limitation for dividends from
Corporation B, a noncontrolled section 902 corporation.
[[Page 935]]
Example 3. (i) Since 1987, domestic corporation M has owned 50
percent of the one class of stock of foreign corporation A. The
remaining 50 percent of Corporation A is owned by foreign
corporation Z. For the same time period, Corporation A has owned 40
percent of the one class of stock of foreign corporation B, and
Corporation B has owned 30 percent of the one class of stock of
foreign corporation C. The remaining 60 percent of Corporation B is
owned by foreign corporation Y, and the remaining 70 percent of
Corporation C is owned by foreign corporation X. Corporations A, B,
and C are not controlled foreign corporations. Corporations A, B,
and C use the u as their functional currency, and 1u equals $1 at
all relevant times. Corporation B uses a fiscal year ending June 30
as its taxable year; all other corporations use the calendar year as
the taxable year. On February 1, 1992, Corporation C pays a 500u
dividend out of post-1986 undistributed earnings, 150u to
Corporation B and 350u to Corporation X. On February 15, 1992,
Corporation B pays a 300u dividend out of post-1986 undistributed
earnings computed as of the close of Corporation B's fiscal year
ended June 30, 1992, 120u to Corporation A and 180u to Corporation
Y. On August 15, 1992, Corporation A pays a 200u dividend out of
post-1986 undistributed earnings, 100u to Corporation M and 100u to
Corporation Z. In computing foreign taxes deemed paid by
Corporations B and A, section 78 does not apply and Corporations B
and A thus do not have to include the foreign taxes deemed paid in
earnings and profits. See paragraph (c)(2)(ii) of this section.
Foreign income taxes deemed paid by Corporations B, A and M, and the
foreign corporations' opening balances in post-1986 undistributed
earnings and post-1986 foreign income taxes for Corporation B's
fiscal year beginning July 1, 1992, and Corporation C's and
Corporation A's 1993 calendar years are computed as follows:
A. Corporation C (third-tier corporation):
1. Assumed post-1986 undistributed earnings 1300u
in Corporation C at start of 1992.
2. Assumed post-1986 foreign income taxes in $500
Corporation C at start of 1992.
3. Assumed pre-tax earnings and profits of 500u
Corporation C for 1992.
4. Assumed foreign income taxes paid or 300u
accrued in 1992.
5. Post-1986 undistributed earnings in 1500u
Corporation C for 1992 (pre-dividend) (Line
1 plus Line 3 minus Line 4).
6. Post-1986 foreign income taxes in $800
Corporation C for 1992 (pre-dividend) (Line
2 plus Line 4 translated at the appropriate
exchange rates).
7. Dividends paid out of post-1986 150u
undistributed earnings of Corporation C to
Corporation B in 1992.
8. Percentage of Corporation C's post-1986 10%
undistributed earnings paid to Corporation B
(Line 7 divided by Line 5).
9. Foreign income taxes of Corporation C $80
deemed paid by Corporation B under section
902(b)(2) (Line 6 multiplied by Line 8).
10. Total dividends paid out of post-1986 500u
undistributed earnings of Corporation C to
all shareholders in 1992.
11. Percentage of Corporation C's post-1986 33.33%
undistributed earnings paid to all
shareholders in 1992 (Line 10 divided by
Line 5).
12. Post-1986 foreign income taxes paid with $266.66
respect to post-1986 undistributed earnings
distributed to all shareholders in 1992
(Line 6 multiplied by Line 11).
13. Post-1986 undistributed earnings in 1000u
Corporation C at start of 1993 (Line 5 minus
Line 10).
14. Post-1986 foreign income taxes in $533.34
Corporation C at start of 1993 (Line 6 minus
Line 12).
B. Corporation B (second-tier corporation):
1. Assumed post-1986 undistributed earnings 0
in Corporation B as of July 1, 1991.
2. Assumed post-1986 foreign income taxes in 0
Corporation B as of July 1, 1991.
3. Assumed pre-tax earnings and profits of 1000u
Corporation B for fiscal year ended June 30,
1992, (including 150u dividend from
Corporation B).
4. Assumed foreign income taxes paid or 200u
accrued by Corporation B in fiscal year
ended June 30, 1992.
5. Foreign income taxes of Corporation C $80
deemed paid by Corporation B in its fiscal
year ended June 30, 1992 (Part A, Line 9 of
paragraph (i) of this Example 3).
6. Post-1986 undistributed earnings in 800u
Corporation B for fiscal year ended June 30,
1992 (pre-dividend) (Line 1 plus Line 3
minus Line 4).
7. Post-1986 foreign income taxes in $280
Corporation B for fiscal year ended June 30,
1992 (pre-dividend) (Line 2 plus Line 4
translated at the appropriate exchange rates
plus Line 5).
8. Dividends paid out of post-1986 120u
undistributed earnings of Corporation B to
Corporation A on February 15, 1992.
9. Percentage of Corporation B's post-1986 15%
undistributed earnings for fiscal year ended
June 30, 1992, paid to Corporation A (Line 8
divided by Line 6).
10. Foreign income taxes paid and deemed paid $42
by Corporation B as of June 30, 1992, deemed
paid by Corporation A under section
902(b)(1) (Line 7 multiplied by Line 9).
11. Total dividends paid out of post-1986 300u
undistributed earnings of Corporation B for
fiscal year ended June 30, 1992.
12. Percentage of Corporation B's post-1986 37.5%
undistributed earnings for fiscal year ended
June 30, 1992, paid to all shareholders
(Line 11 divided by Line 6).
13. Post-1986 foreign income taxes paid and $105
deemed paid with respect to post-1986
undistributed earnings distributed to all
shareholders during Corporation B's fiscal
year ended June 30, 1992 (Line 7 multiplied
by Line 12).
14. Post-1986 undistributed earnings in 500u
Corporation B as of July 1, 1992 (Line 6
minus Line 11).
15. Post-1986 foreign income taxes in $175
Corporation B as of July 1, 1992 (Line 7
minus Line 13).
C. Corporation A (first-tier corporation):
1. Assumed post-1986 undistributed earnings 250u
in Corporation A at start of 1992.
2. Assumed post-1986 foreign income taxes in $100
Corporation A at start of 1992.
3. Assumed pre-tax earnings and profits of 250u
Corporation A for 1992 (including 120u
dividend from Corporation B).
4. Assumed foreign income taxes paid or 100u
accrued by Corporation A in 1992.
5. Foreign income taxes paid or deemed paid $42
by Corporation B as of June 30, 1992, that
are deemed paid by Corporation A in 1992
(Part B, Line 10 of paragraph (i) of this
Example 3).
6. Post-1986 undistributed earnings in 400u
Corporation A for 1992 (pre-dividend) (Line
1 plus Line 3 minus Line 4).
7. Post-1986 foreign income taxes in $242
Corporation A for 1992 (pre-dividend) (Line
2 plus Line 4 translated at the appropriate
exchange rates plus Line 5).
8. Dividends paid out of post-1986 100u
undistributed earnings of Corporation A to
Corporation M on August 15, 1992.
9. Percentage of Corporation A's post-1986 25%
undistributed earnings paid to Corporation M
in 1992 (Line 8 divided by Line 6).
10. Foreign income taxes paid and deemed paid $60.50
by Corporation A in 1992 that are deemed
paid by Corporation M under section 902(a)
(Line 7 multiplied by Line 9).
11. Total dividends paid out of post-1986 200u
undistributed earnings of Corporation A to
all shareholders in 1992.
[[Page 936]]
12. Percentage of Corporation A's post-1986 50%
undistributed earnings paid to all
shareholders in 1992 (Line 11 divided by
Line 6).
13. Post-1986 foreign income taxes paid and $121
deemed paid by Corporation A with respect to
post-1986 undistributed earnings distributed
to all shareholders in 1992 (Line 7
multiplied by Line 12).
14. Post-1986 undistributed earnings in 200u
Corporation A at start of 1993 (Line 6 minus
Line 11).
15. Post-1986 foreign income taxes in $121
Corporation A at start of 1993 (Line 7 minus
Line 13).
(ii) Corporation M is deemed, under section 902(a) and paragraph
(b) of this section, to have paid $60.50 of post-1986 foreign income
taxes paid, or deemed paid, by Corporation A on or with respect to
its post-1986 undistributed earnings (Part C, Line 10) and
Corporation M includes that amount in gross income as a dividend
under section 78. Both the income inclusion and the credit are
subject to a separate limitation for dividends from Corporation A, a
noncontrolled section 902 corporation.
Example 4. (i) Since 1987, domestic corporation M has owned 100
percent of the voting stock of controlled foreign corporation A, and
Corporation A has owned 100 percent of the voting stock of
controlled foreign corporation B. Corporations M, A and B use the
calendar year as the taxable year. Corporations A and B are
organized in the same foreign country and use the u as their
functional currency. 1u equals $1 at all relevant times. Assume that
all of the earnings of Corporations A and B are general limitation
earnings and profits within the meaning of section 904(d)(2)(I), and
that neither Corporation A nor Corporation B has any previously
taxed income accounts. In 1992, Corporation B pays a dividend of
150u to Corporation A out of post-1986 undistributed earnings, and
Corporation A computes an amount of foreign taxes deemed paid under
section 902(b)(1). The dividend is not subpart F income to
Corporation A because section 954(c)(3)(B)(i) (the same country
dividend exception) applies. Pursuant to paragraph (c)(2)(ii) of
this section, Corporation A is not required to include the deemed
paid taxes in earnings and profits. Corporation A has no pre-1987
accumulated profits and a deficit in post-1986 undistributed
earnings for 1992. In 1992, Corporation A pays a dividend of 100u to
Corporation M out of its earnings and profits for 1992 (current
earnings and profits). Under paragraph (b)(4) of this section,
Corporation M is not deemed to have paid any of the foreign income
taxes paid or deemed paid by Corporation A because Corporation A has
a deficit in post-1986 undistributed earnings as of December 31,
1992, and the sum of its current plus accumulated profits is less
than zero. Note that if instead of paying a dividend to Corporation
A in 1992, Corporation B had made an additional investment of $150
in United States property under section 956, that amount would have
been included in gross income by Corporation M under section
951(a)(1)(B) and Corporation M would have been deemed to have paid
$50 of foreign income taxes paid by Corporation B. See sections
951(a)(1)(B) and 960. Foreign income taxes of Corporation B deemed
paid by Corporation A and the opening balances in post-1986
undistributed earnings and post-1986 foreign income taxes for
Corporation A and Corporation B for 1993 are computed as follows:
A. Corporation B (second-tier corporation):
1. Assumed post-1986 undistributed earnings 200u
in Corporation B at start of 1992.
2. Assumed post-1986 foreign income taxes in $50
Corporation B at start of 1992.
3. Assumed pre-tax earnings and profits of 150u
Corporation B for 1992.
4. Assumed foreign income taxes paid or 50u
accrued in 1992.
5. Post-1986 undistributed earnings in 300u
Corporation B for 1992 (pre-dividend) (Line
1 plus Line 3 minus Line 4).
6. Post-1986 foreign income taxes in $100
Corporation B for 1992 (pre-dividend) (Line
2 plus Line 4 translated at the appropriate
exchange rates).
7. Dividends paid out of post-1986 150u
undistributed earnings of Corporation B to
Corporation A in 1992.
8. Percentage of Corporation B's post-1986 50%
undistributed earnings paid to Corporation A
(Line 7 divided by Line 5).
9. Foreign income taxes of Corporation B $50
deemed paid by Corporation A under section
902(b)(1) (Line 6 multiplied by Line 8).
10. Post-1986 undistributed earnings in 150u
Corporation B at start of 1993 (Line 5 minus
Line 7).
11. Post-1986 foreign income taxes in $50
Corporation B at start of 1993 (Line 6 minus
Line 9).
B. Corporation A (first-tier corporation):
1. Assumed post-1986 undistributed earnings (200u)
in Corporation A at start of 1992.
2. Assumed post-1986 foreign income taxes in 0
Corporation A at start of 1992.
3. Assumed pre-tax earnings and profits of 200u
Corporation A for 1992 (including 150u
dividend from Corporation B).
4. Assumed foreign income taxes paid or 40u
accrued by Corporation A in 1992.
5. Foreign income taxes paid by Corporation B $50
in 1992 that are deemed paid by Corporation
A (Part A, Line 9 of paragraph (i) of this
Example 4).
6. Post-1986 undistributed earnings in (40u)
Corporation A for 1992 (pre-dividend) (Line
1 plus Line 3 minus Line 4).
7. Post-1986 foreign income taxes in $90
Corporation A for 1992 (pre-dividend) (Line
2 plus Line 4 translated at the appropriate
exchange rates plus Line 5).
8. Dividends paid out of current earnings and 100u
profits of Corporation A for 1992.
9. Percentage of post-1986 undistributed 0
earnings of Corporation A paid to
Corporation M in 1992 (Line 8 divided by the
greater of Line 6 or zero).
10. Foreign income taxes paid and deemed paid 0
by Corporation A in 1992 that are deemed
paid by Corporation M under section 902(a)
(Line 7 multiplied by Line 9).
11. Post-1986 undistributed earnings in (140u)
Corporation A at start of 1993 (line 6 minus
line 8).
12. Post-1986 foreign income taxes in $90
Corporation A at start of 1993 (Line 7 minus
Line 10).
(ii) For 1993, Corporation A has 500u of earnings and profits on
which it pays 160u of foreign income taxes. Corporation A receives
no dividends from Corporation B, and pays a 100u dividend to
Corporation M. The 100u dividend to Corporation M carries with it
some of the foreign income taxes paid and deemed paid by Corporation
A in 1992, which were not deemed paid by Corporation M in 1992
because Corporation A had no post-1986 undistributed earnings. Thus,
for 1993, Corporation M is deemed to have paid $125 of post-1986
foreign income taxes paid and deemed paid by Corporation A and
includes that amount in gross income as a dividend under section 78,
determined as follows:
1. Post-1986 undistributed earnings in (140u)
Corporation A at start of 1993.
2. Post-1986 foreign income taxes in Corporation $90
A at start of 1993.
3. Pre-tax earnings and profits of Corporation A 500u
for 1993.
4. Foreign income taxes paid or accrued by 160u
Corporation A in 1993.
5. Post-1986 undistributed earnings in 200u
Corporation A for 1993 (pre-dividend) (Line 1
plus Line 3 minus Line 4).
6. Post-1986 foreign income taxes in Corporation $250
A for 1993 (pre-dividend) (Line 2 plus Line 4
translated at the appropriate exchange rates).
[[Page 937]]
7. Dividends paid out of post-1986 undistributed 100u
earnings of Corporation A to Corporation M in
1993.
8. Percentage of post-1986 undistributed earnings 50%
of Corporation A paid to Corporation M in 1993
(Line 7 divided by Line 5).
9. Foreign income taxes paid and deemed paid by $125
Corporation A that are deemed paid by
Corporation M in 1993 (Line 6 multiplied by Line
8).
10. Post-1986 undistributed earnings in 100u
Corporation A at start of 1994 (Line 5 minus
Line 7).
11. Post-1986 foreign income taxes in Corporation $125
A at start of 1994 (Line 6 minus Line 9).
Example 5. (i) Since 1987, domestic corporation M has owned 100
percent of the voting stock of controlled foreign corporation A.
Corporation M also conducts operations through a foreign branch.
Both Corporation A and Corporation M use the calendar year as the
taxable year. Corporation A uses the u as its functional currency
and 1u equals $1 at all relevant times. Corporation A has no subpart
F income, as defined in section 952, and no increase in earnings
invested in United States property under section 956 for 1992.
Corporation A also has no previously taxed income accounts.
Corporation A has general limitation income and high withholding tax
interest income that, by operation of section 954(b)(4), does not
constitute foreign base company income under section 954(a). Because
Corporation A is a controlled foreign corporation, it is not
required to reduce post-1986 foreign income taxes by foreign taxes
paid or accrued with respect to high withholding tax interest in
excess of 5 percent. See Sec. 1.902-1(a)(8)(iii). Corporation A pays
a 60u dividend to Corporation M in 1992. For 1992, Corporation M is
deemed, under paragraph (b) of this section, to have paid $24 of the
post-1986 foreign income taxes paid by Corporation A and includes
that amount in gross income under section 78 as a dividend,
determined as follows:
1. Assumed post-1986 undistributed earnings in
Corporation A at start of 1992 attributable to:
(a) Section 904(d)(1)(B) high withholding tax 20u
interest.
(b) Section 904(d)(1)(I) general limitation 55u
income.
2. Assumed post-1986 foreign income taxes in
Corporation A at start of 1992 attributable to:
(a) Section 904(d)(1)(B) high withholding tax $5
interest.
(b) Section 904(d)(1)(I) general limitation $20
income.
3. Assumed pre-tax earnings and profits of
Corporation A for 1992 attributable to:
(a) Section 904(d)(1)(B) high withholding tax 20u
interest.
(b) Section 904(d)(1)(I) general limitation 20u
income.
4. Assumed foreign income taxes paid or accrued
in 1992 on or with respect to:
(a) Section 904(d)(1)(B) high withholding tax 10u
interest.
(b) Section 904(d)(1)(I) general limitation 5u
income.
5. Post-1986 undistributed earnings in
Corporation A for 1992 (pre-dividend)
attributable to:
(a) Section 904(d)(1)(B) high withholding tax 30u
interest (Line 1(a) + Line 3(a) minus Line
4(a)).
(b) Section 904(d)(1)(I) general limitation 70u
income (Line 1(b) + Line 3(b) minus Line
4(b)).
----------------------
(c) Total.................................... 100u
6. Post-1986 foreign income taxes in Corporation
A for 1992 (pre-dividend) attributable to:
(a) Section 904(d)(1)(B) high withholding tax $15
interest (Line 2(a) + Line 4(a) translated
at the appropriate exchange rates).
(b) Section 904(d)(1)(I) general limitation $25
income (Line 2(b) + Line 4(b) translated at
the appropriate exchange rates).
7. Dividends paid to Corporation M in 1992....... 60u
8. Dividends paid to Corporation M in 1992
attributable to section 904(d) separate
categories pursuant to Sec. 1.904-5(d):
(a) Dividends paid to Corporation M in 1992 18u
attributable to section 904(d)(1)(B) high
withholding tax interest (Line 7 multiplied
by Line 5(a) divided by Line 5(c)).
(b) Dividends paid to Corporation M in 1992 42u
attributable to section 904(d)(1)(I) general
limitation income (Line 7 multiplied by Line
5(b) divided by Line 5(c)).
9. Percentage of Corporation A's post-1986
undistributed earnings for 1992 paid to
Corporation M attributable to:
(a) Section 904(d)(1)(B) high withholding tax 60%
interest (Line 8(a) divided by Line 5(a)).
(b) Section 904(d)(1)(I) general limitation 60%
income (Line 8(b) divided by Line 5(b)).
10. Foreign income taxes of Corporation A deemed
paid by Corporation M under section 902(a)
attributable to:
(a) Foreign income taxes of Corporation A $9
deemed paid by Corporation M under section
902(a) with respect to section 904(d)(1)(B)
high withholding tax interest (Line 6(a)
multiplied by Line 9(a)).
(b) Foreign income taxes of Corporation A $15
deemed paid by Corporation M under section
902(a) with respect to section 904(d)(1)(I)
general limitation income (Line 6(b)
multiplied by Line 9(b)).
11. Post-1986 undistributed earnings in
Corporation A at start of 1993 attributable to:
(a) Section 904(d)(1)(B) high withholding tax 12u
interest (Line 5(a) minus Line 8(a)).
(b) Section 904(d)(1)(I) general limitation 28u
income (Line 5(b) minus Line 8(b)).
12. Post-1986 foreign income taxes in Corporation
A at start of 1989 allocable to:
(a) Section 904(d)(1)(B) high withholding tax $6
interest (Line 6(a) minus Line 10(a)).
(b) Section 904(d)(1)(I) general limitation $10
income (Line 6(b) minus Line 10(b)).
(ii) For purposes of computing Corporation M's foreign tax
credit limitation, the post-1986 foreign income taxes of Corporation
A deemed paid by Corporation M with respect to income in separate
categories will be added to the foreign income taxes paid or accrued
by Corporation M associated with income derived from Corporation M's
branch operation in the same separate categories. The dividend (and
the section 78 inclusion with respect to the dividend) will be
treated as income in separate categories and added to Corporation
M's other income, if any, attributable to the same separate
categories. See section 904(d) and Sec. 1.904-6.
(g) Effective date. This section applies to any distribution made
in and after a foreign corporation's first taxable year beginning on or
after January 1, 1987.
Sec. 1.902-2 Treatment of deficits in post-1986 undistributed earnings
and pre-1987 accumulated profits of a first-, second-, or third-tier
corporation for purposes of computing an amount of foreign taxes deemed
paid under Sec. 1.902-1.
(a) Carryback of deficits in post-1986 undistributed earnings of a
first-, second-, or third-tier corporation to pre-effective date
taxable years--(1) Rule. For purposes of computing foreign income taxes
deemed paid under Sec. 1.902-1(b) with respect to dividends paid by a
first-, second-, or third-tier corporation, when there is a deficit in
the post-1986 undistributed earnings of that corporation and the
corporation makes a distribution to shareholders that is a dividend or
would be a dividend if there were current or accumulated earnings and
profits, then the post-1986 deficit shall be carried
[[Page 938]]
back to the most recent pre-effective date taxable year of the first-,
second-, or third-tier corporation with positive accumulated profits
computed under section 902. See Sec. 1.902-3(e). For purposes of this
Sec. 1.902-2, a pre-effective date taxable year is a taxable year
beginning before January 1, 1987, or a taxable year beginning after
December 31, 1986, if the special effective date of Sec. 1.902-1(a)(13)
applies. The deficit shall reduce the section 902 accumulated profits
in the most recent preeffective date year to the extent thereof, and
any remaining deficit shall be carried back to the next preceding year
or years until the deficit is completely allocated. The amount carried
back shall reduce the deficit in post-1986 undistributed earnings. Any
foreign income taxes paid in a post-effective date year will not be
carried back to preeffective date taxable years or removed from post-
1986 foreign income taxes. See section 960 and the regulations under
that section for rules governing the carryback of deficits and the
computation of foreign income taxes deemed paid with respect to deemed
income inclusions from controlled foreign corporations.
(2) Examples. The following examples illustrate the rules of this
paragraph (a):
Example 1. (i) From 1985 through 1990, domestic corporation M
owns 10 percent of the one class of stock of foreign corporation A.
The remaining 90 percent of Corporation A's stock is owned by Z, a
foreign corporation. Corporation A is not a controlled foreign
corporation and uses the u as its functional currency. 1u equals $1
at all relevant times. Both Corporation A and Corporation M use the
calendar year as the taxable year. Corporation A has pre-1987
accumulated profits and post-1986 undistributed earnings or deficits
in post-1986 undistributed earnings, pays pre-1987 and post-1986
foreign income taxes, and pays dividends as summarized below:
Taxable year..................... 1985.............. 1986.............. 1987.............. 1988.............. 1989.............. 1990
Current E & P (Deficits) of Corp. 150u.............. 150u.............. (100u)............ 100u.............. 0................. 0
A.
Current Plus Accumulated E & P of 150u.............. 300u.............. 200u.............. 250u.............. 250u.............. 200u
Corp. A.
Post-'86 Undistributed Earnings .................. .................. (100u)............ 100u.............. 100u.............. 50u
of Corp. A.
Post-'86 Undistributed Earnings .................. .................. 0................. 100u.............. 50u............... 50u
of Corp. A Reduced By Current
Year Dividend Distributions
(increased by deficit carryback).
Foreign Income Taxes of Corp. A 120u.............. 120u.............. $10............... $50............... 0................. 0
(Annual).
Post-'86 Foreign Income Taxes of .................. .................. $10............... $60............... $60............... $30
Corp. A.
12/31 Distributions to Corp. M... 0................. 0................. 5u................ 0................. 5u................ 0
12/31 Distributions to Corp. Z... 0................. 0................. 45u............... 0................. 45u............... 0
(ii) On December 31, 1987, Corporation A distributes a 5u
dividend to Corporation M and a 45u dividend to Corporation Z. At
that time Corporation A has a deficit of (100u) in post-1986
undistributed earnings and $10 of post-1986 foreign income taxes.
The (100u) deficit (but not the post-1986 foreign income taxes) is
carried back to offset the accumulated profits of 1986 and removed
from post-1986 undistributed earnings. The accumulated profits for
1986 are reduced to 50u (150u-100u). The dividend is paid out of the
reduced 1986 accumulated profits. Foreign taxes deemed paid by
Corporation M with respect to the 5u dividend are 12u (120u x (5u/
50u)). See Sec. 1.902-1(b)(3). Corporation M must include 12u in
gross income (translated under the rule applicable to foreign income
taxes paid on earnings accumulated in pre-effective date years)
under section 78 as a dividend. Both the income inclusion and the
foreign taxes deemed paid are subject to a separate limitation for
dividends from Corporation A, a noncontrolled section 902
corporation. No accumulated profits remain in Corporation A with
respect to 1986 after the carryback of the 1987 deficit and the
December 31, 1987, dividend distributions to Corporations M and Z.
(iii) On December 31, 1989, Corporation A distributes a 5u
dividend to Corporation M and a 45u dividend to Corporation Z. At
that time Corporation A has 100u of post-1986 undistributed earnings
and $60 of post-1986 foreign income taxes. Therefore, the dividend
is considered paid out of Corporation A's post-1986 undistributed
earnings. Foreign taxes deemed paid by Corporation M with respect to
the 5u dividend are $3 ($60 x 5%[5u/100u]). Corporation M must
include $3 in gross income under section 78 as a dividend. Both the
income inclusion and the foreign taxes deemed paid are subject to a
separate limitation for dividends from noncontrolled section 902
corporation A. Corporation A's post-1986 undistributed earnings as
of January 1, 1990, are 50u (100u-50u). Corporation A's post-1986
foreign income taxes must be reduced by the amount of foreign taxes
that would have been deemed paid if both Corporations M and Z were
eligible to compute an amount of deemed paid taxes. Section 1.902-
1(a)(8)(i). The amount of foreign income taxes that would have been
deemed paid if both Corporations M and Z were eligible to compute an
amount of deemed paid taxes on the 50u dividend distributed by
Corporation A is $30 ($60 x 50%[50u/100u]). Thus, post-1986 foreign
income taxes as of January 1, 1990, are $30 ($60-$30).
Example 2. The facts are the same as in Example 1, except that
Corporation A has a deficit in its post-1986 undistributed earnings
of (150u) on December 31, 1987. The deficit is carried back to 1986
and reduces accumulated profits for that year to -0-. Thus, the
foreign income taxes paid with respect to the 1986 accumulated
profits will never be deemed paid. The 1987 dividend is deemed to be
out of Corporation A's 1985 accumulated profits. Foreign taxes
deemed paid by Corporation M under section 902 with respect to the
5u dividend paid on December 31, 1987, are 4u (120u x 5u/150u). See
Sec. 1.902-1(b)(3). As a result of the December 31, 1987, dividend
distributions, 100u (150u-50u) of accumulated profits and 80u (120u
reduced by 40u[120u x 50u/150u] of foreign taxes that would have
been deemed paid had all of Corporation A's shareholders been
eligible to compute an amount of foreign taxes deemed paid with
respect to the dividend paid out of 1985 accumulated profits) remain
in Corporation A with respect to 1985.
Example 3. (i) From 1986 through 1991, domestic corporation M
owns 10 percent of the one class of stock of foreign corporation A.
The remaining 90 percent of Corporation A's stock is owned by
Corporation Z, a foreign corporation. Corporation A is not a
controlled foreign corporation and uses the u as its functional
currency. 1u equals $1 at all relevant times. Both Corporation A and
Corporation M use the calendar year as the taxable year. Corporation
A has pre-1987 accumulated profits and post-1986 undistributed
earnings or deficits in post-1986 undistributed earnings, pays pre-
1987 and post-1986 foreign income taxes, and pays dividends as
summarized below:
Taxable year..................... 1986.............. 1987.............. 1988.............. 1989.............. 1990.............. 1991
Current E & P (Deficits) of Corp. 100u.............. (50u)............. 150u.............. 75u............... 25u............... 0
A.
Current Plus Accumulated E & P of 100u.............. 50u............... 200u.............. 175u.............. 200u.............. 80u
Corp. A.
Post-'86 Undistributed Earnings .................. (50u)............. 100u.............. 75u............... 100u.............. 0
of Corp. A.
Post-'86 Undistributed Earnings .................. (50u)............. 0................. 75u............... 0................. 0
of Corp. A Reduced By Current
Year Dividend Distributions
(increased by deficit carryback).
Foreign Income Taxes (Annual) of 80u............... 0................. $120.............. $20............... $20............... 0
Corp. A.
[[Page 939]]
Post-'86 Foreign Income Taxes of .................. 0................. $120.............. $20............... $40............... 0
Corp. A.
12/31 Distributions to Corp. M... 0................. 0................. 10u............... 0................. 12u............... 0
12/31 Distributions to Corp. Z... 0................. 0................. 90u............... 0................. 108u.............. 0
(ii) On December 31, 1988, Corporation A distributes a 10u
dividend to Corporation M and a 90u dividend to Corporation Z. At
that time Corporation A has 100u in its post-1986 undistributed
earnings and $120 in its post-1986 foreign income taxes. Corporation
M is deemed, under Sec. 1.902-1(b)(1), to have paid $12 ($120
x 10%[10u/100u]) of the post-1986 foreign income taxes paid by
Corporation A and includes that amount in gross income under section
78 as a dividend. Both the income inclusion and the foreign taxes
deemed paid are subject to a separate limitation for dividends from
noncontrolled section 902 corporation A. Corporation A's post-1986
undistributed earnings as of January 1, 1989, are 0 (100u-100u). Its
post-1986 foreign taxes as of January 1, 1989, also are 0, $120
reduced by $120 of foreign income taxes paid that would have been
deemed paid if both Corporations M and Z were eligible to compute an
amount of foreign taxes deemed paid on the dividend from Corporation
A ($120 x 100%[100u/100u]).
(iii) On December 31, 1990, Corporation A distributes a 12u
dividend to Corporation M and a 108u dividend to Corporation Z. At
that time Corporation A has 100u in its post-1986 undistributed
earnings and $40 in its post-1986 foreign income taxes. The dividend
is paid out of post-1986 undistributed earnings to the extent
thereof (100u), and the remainder of 20u is paid out of 1986
accumulated profits. Under Sec. 1.902-1(b)(2), the 12u dividend to
Corporation M is deemed to be paid out of post-1986 undistributed
earnings to the extent of 10u (100u x 12u/120u) and the remaining
2u is deemed to be paid out of Corporation A's 1986 accumulated
profits. Similarly, the 108u dividend to Corporation Z is deemed to
be paid out of post-1986 undistributed earnings to the extent of 90u
(100u x 108u/120u) and the remaining 18u is deemed to be paid out
of Corporation A's 1986 accumulated profits. Foreign income taxes
deemed paid by Corporation M under section 902 with respect to the
portion of the dividend paid out of post-1986 undistributed earnings
are $4 ($40 x 10%[10u/100u]), and foreign taxes deemed paid by
Corporation M with respect to the portion of the dividend deemed
paid out of 1986 accumulated profits are 1.6u (80u x 2u/100u).
Corporation M must include $4 plus 1.6u translated under the rule
applicable to foreign income taxes paid on earnings accumulated in
taxable years prior to the effective date of the Tax Reform Act of
1986 in gross income as a dividend under section 78. The income
inclusion and the foreign income taxes deemed paid are subject to a
separate limitation for dividends from noncontrolled section 902
Corporation A. As of January 1, 1991, Corporation A's post-1986
undistributed earnings are 0 (100u-100u). 80u (100u-20u) of
accumulated profits remain with respect to 1986. Post-1986 foreign
income taxes as of January 1, 1991, are 0, $40 reduced by $40 of
foreign income taxes paid that would have been deemed paid if both
Corporations M and Z were eligible to compute an amount of deemed
paid taxes on the 100u dividend distributed by Corporation A out of
post-1986 undistributed earnings ($40 x 100%[100u/100u]).
Corporation A has 64u of foreign income taxes remaining with respect
to 1986, 80u reduced by 16u [80u x 20u/100u] of foreign income
taxes that would have been deemed paid if Corporations M and Z both
were eligible to compute an amount of deemed paid taxes on the 20u
dividend distributed by Corporation A out of 1986 accumulated
profits.
(b) Carryforward of deficits in pre-1987 accumulated profits of a
first-, second-, or third-tier corporation to post-1986 undistributed
earnings for purposes of section 902--(1) General rule. For purposes of
computing foreign income taxes deemed paid under Sec. 1.902-1(b) with
respect to dividends paid by a first-, second-, or third-tier
corporation out of post-1986 undistributed earnings, the amount of a
deficit in accumulated profits of the foreign corporation determined
under section 902 as of the end of its last pre-effective date taxable
year is carried forward and reduces post-1986 undistributed earnings on
the first day of the foreign corporation's first taxable year beginning
after December 31, 1986, or on the first day of the first taxable year
in which the ownership requirements of section 902(c)(3)(B) and
Sec. 1.902-1(a)(1) through (4) are met if the special effective date of
Sec. 1.902-1(a)(13) applies. Any foreign income taxes paid with respect
to a pre-effective date year shall not be carried forward and included
in post-1986 foreign income taxes. Post-1986 undistributed earnings may
not be reduced by the amount of a pre-1987 deficit in earnings and
profits computed under section 964(a). See section 960 and the
regulations under that section for rules governing the carryforward of
deficits and the computation of foreign income taxes deemed paid with
respect to deemed income inclusions from controlled foreign
corporations. For translation rules governing carryforwards of deficits
in pre-1987 accumulated profits to post-1986 taxable years of a foreign
corporation with a dollar functional currency, see Sec. 1.985-6(d)(2).
(2) Effect of pre-effective date deficit. If a foreign corporation
has a deficit in accumulated profits as of the end of its last pre-
effective date taxable year, then the foreign corporation cannot pay a
dividend out of preeffective date years unless there is an adjustment
made (for example, a refund of foreign taxes paid) that restores
section 902 accumulated profits to a pre-effective date taxable year or
years. Moreover, if a foreign corporation has a deficit in section 902
accumulated profits as of the end of its last pre-effective date
taxable year, then no deficit in post-1986 undistributed earnings will
be carried back under paragraph (a) of this section. For rules
concerning carrybacks of eligible deficits from post-1986 undistributed
earnings to reduce pre-1987 earnings and profits computed under section
964(a), see section 960 and the regulations under that section.
(3) Examples. The following examples illustrate the rules of this
paragraph (b):
Example 1. (i) From 1984 through 1988, domestic corporation M
owns 10 percent of the one class of stock of foreign corporation A.
The remaining 90 percent of Corporation A's stock is owned by
Corporation Z, a foreign corporation. Corporation A is not a
controlled foreign corporation and uses the u as its functional
currency. 1u equals $1 at all relevant times. Both Corporation A and
Corporation M use the calendar year as the taxable year. Corporation
A has pre-1987 accumulated profits or deficits in accumulated
profits and post-1986 undistributed earnings, pays pre-1987 and
post-1986 foreign income taxes, and pays dividends as summarized
below:
Taxable year.................. 1984........... 1985........... 1986.......... 1987.......... 1988
Current E & P (Deficits) of 25u............ (100u)......... (25u)......... 200u.......... 100u
Corp. A.
Current Plus Accumulated E & P 25u............ (75u).......... (100u)........ 100u.......... 50u
(Deficits) of Corp. A.
Post-'86 Undistributed ............... ............... .............. 100u.......... 50u
Earnings of Corp. A.
Post-'86 Undistributed ............... ............... .............. (50u)......... 50u
Earnings of Corp. A Reduced
By Current Year Dividend
Distributions (reduced by
deficit carryforward).
Foreign Income Taxes (Annual) 20u............ 5u............. 0............. $100.......... $50
of Corp. A.
Post-'86 Foreign Income Taxes ............... ............... .............. $100.......... $50
of Corp. A.
12/31 Distributions to Corp. M 0.............. 0.............. 0............. 15u........... 0
12/31 Distributions to Corp. Z 0.............. 0.............. 0............. 135u.......... 0
[[Page 940]]
(ii) On December 31, 1987, Corporation A distributes a 150u
dividend, 15u to Corporation M and 135u to Corporation Z.
Corporation A has 200u of current earnings and profits for 1987, but
its post-1986 undistributed earnings are only 100u as a result of
the reduction for pre-1987 accumulated deficits required under
paragraph (b)(1) of this section. Corporation A has $100 of post-
1986 foreign income taxes. Only 100u of the 150u distribution is a
dividend out of post-1986 undistributed earnings. Foreign income
taxes deemed paid by Corporation M in 1987 with respect to the 10u
dividend attributable to post-1986 undistributed earnings, computed
under Sec. 1.902-1(b), are $10 ($100 x 10%[10u/100u]). Corporation
M includes this amount in gross income under section 78 as a
dividend. Both the income inclusion and the foreign taxes deemed
paid are subject to a separate limitation for dividends from
noncontrolled section 902 corporation A. After the distribution,
Corporation A has (50u) of post-1986 undistributed earnings (100u-
150u) and -0- post-1986 foreign income taxes, $100 reduced by $100
of foreign income taxes paid that would have been deemed paid if
both Corporations M and Z were eligible to compute an amount of
deemed paid taxes on the 100u dividend distributed by Corporation A
out of post-1986 undistributed earnings ($100 x 100%[100u/100u]).
(iii) The remaining 50u of the 150u distribution cannot be
deemed paid out of accumulated profits of a pre-1987 year because
Corporation A has an accumulated deficit as of the end of 1986 that
eliminated all pre-1987 accumulated profits. See paragraph (b)(2) of
this section. The 50u is a dividend out of current earnings and
profits under section 316(a)(2), but Corporation M is not deemed to
have paid any additional foreign income taxes paid by Corporation A
with respect to that 50u dividend out of current earnings and
profits. See Sec. 1.902-1(b)(4).
Example 2. (i) From 1986 through 1991, domestic corporation M
owns 10 percent of the one class of stock of foreign corporation A.
The remaining 90 percent of Corporation A's stock is owned by
Corporation Z, a foreign corporation. Corporation A is not a
controlled foreign corporation and uses the u as its functional
currency. 1u equals $1 at all relevant times. Both Corporation A and
Corporation M use the calendar year as the taxable year. Corporation
A has pre-1987 accumulated profits or deficits in accumulated
profits and post-1986 undistributed earnings, pays post-1986 foreign
income taxes, and pays dividends as summarized below:
Taxable year.................. 1986........... 1987........... 1988.......... 1989.......... 1990
Current E & P (Deficits) of (100u)......... 150u........... (150u)........ 100u.......... 250u
Corp. A.
Current Plus Accumulated E & P (100u)......... 50u............ (200u)........ (100u)........ 50u
(Deficits) of Corp. A.
Post-'86 Undistributed ............... 50u............ (200u)........ (100u)........ 50u
Earnings of Corp. A.
Post-'86 Undistributed ............... (50u).......... (200u)........ (200u)........ 0
Earnings of Corp. A Reduced
By Current Year Dividend
Distributions (reduced by
deficit carryforward).
Foreign Income Taxes (Annual) 0.............. $120........... 0............. $50........... $100
of Corp. A.
Post-'86 Foreign Income Taxes ............... $120........... 0............. $50........... $150
of Corp. A.
12/31 Distributions to Corp. M 0.............. 10u............ 0............. 10u........... 5u
12/31 Distributions to Corp. Z 0.............. 90u............ 0............. 90u........... 45u
(ii) On December 31, 1987, Corporation A distributes a 10u
dividend to Corporation M and a 90u dividend to Corporation Z. At
the time of the distribution, Corporation A has 50u of post-1986
undistributed earnings and 150u of current earnings and profits.
Thus, 50u of the dividend distribution (5u to Corporation M and 45u
to Corporation Z) is a dividend out of post-1986 undistributed
earnings. The remaining 50u is a dividend out of current earnings
and profits under section 316(a)(2), but Corporation M is not deemed
to have paid any additional foreign income taxes paid by Corporation
A with respect to that 50u dividend out of current earnings and
profits. See Sec. 1.902-1(b)(4). Note that even if there were no
current earnings and profits in Corporation A, the remaining 50u of
the 100u distribution cannot be deemed paid out of accumulated
profits of a pre1987 year because Corporation A has an accumulated
deficit as of the end of 1986 that eliminated all pre-1987
accumulated profits. See paragraph (b)(2) of this section.
Corporation A has $120 of post-1986 foreign income taxes. Foreign
taxes deemed paid by Corporation M under section 902 with respect to
the 5u dividend out of post-1986 undistributed earnings are $12
($120 x 10%[5u/50u]). Corporation M includes this amount in gross
income as a dividend under section 78. Both the foreign taxes deemed
paid and the deemed dividend are subject to a separate limitation
for dividends from noncontrolled section 902 corporation A. As of
January 1, 1988, Corporation A has (50u) in its post-1986
undistributed earnings (50u-100u) and -0- in its post-1986 foreign
income taxes, $120 reduced by $120 of foreign taxes that would have
been deemed paid if both Corporations M and Z were eligible to
compute an amount of deemed paid taxes on the dividend distributed
by Corporation A out of post-1986 undistributed earnings ($120
x 100%[50u/50u]).
(iii) On December 31, 1989, Corporation A distributes a 10u
dividend to Corporation M and a 90u dividend to Corporation Z.
Although the distribution is considered a dividend in its entirety
out of 1989 earnings and profits pursuant to section 316(a)(2),
post-1986 undistributed earnings are (100u). Accordingly, for
purposes of section 902, Corporation M is deemed to have paid no
post-1986 foreign income taxes. See Sec. 1.902-1(b)(4). Corporation
A's post-1986 undistributed earnings as of January 1, 1990, are
(200u) ((100u)-100u). Corporation A's post-1986 foreign income taxes
are not reduced because no taxes were deemed paid.
(iv) On December 31, 1990, Corporation A distributes a 5u
dividend to Corporation M and a 45u dividend to Corporation Z. At
that time Corporation A has 50u of post-1986 undistributed earnings,
and $150 of post-1986 foreign income taxes. Foreign taxes deemed
paid by Corporation M under section 902 with respect to the 5u
dividend are $15 ($150 x 10%[5u/50u]). Post-1986 undistributed
earnings as of January 1, 1991, are -0- (50u-50u). Post-1986 foreign
income taxes as of January 1, 1991, also are -0-, $150 reduced by
$150 ($150 x 100%[50u/50u]) of foreign income taxes that would have
been deemed paid if both Corporations M and Z were eligible to
compute an amount of deemed paid taxes on the 50u dividend.
Par. 4. Newly designated Sec. 1.902-3 is amended by revising the
section heading and paragraph (a) introductory text, and by designating
the last paragraph as paragraph (l) and revising it to read as follows:
Sec. 1.902-3 Credit for domestic corporate shareholder of a foreign
corporation for foreign income taxes paid with respect to accumulated
profits of taxable years of the foreign corporation beginning before
January 1, 1987.
(a) Definitions. For purposes of section 902 and Secs. 1.902-3 and
1.902-4:
* * * * *
(l) Effective date. Except as provided in Sec. 1.902-4, this
section applies to any distribution received from a first-tier
corporation by its domestic shareholder after December 31, 1964, and
before the beginning of the foreign corporation's first taxable year
beginning after December 31, 1986. If, however, the first day on which
the ownership requirements of section 902(c)(3)(B) and Sec. 1.902-
1(a)(1) through (4) are met with respect to the foreign corporation is
in a taxable year of the foreign corporation beginning after December
31, 1986, then this section shall apply to all taxable years beginning
after December 31, 1964, and before the year in which the ownership
requirements are first met. See Sec. 1.902-1(a)(13)(iii). For
corresponding rules applicable to distributions received by the
domestic shareholder prior to January 1, 1965, see Sec. 1.902-5 as
contained in the 26 CFR part 1 edition revised April 1, 1976.
Sec. 1.902-4 [Amended]
Par. 5. Newly designated Sec. 1.902-4, paragraph (b), in the last
sentence, the
[[Page 941]]
language ``Sec. 1.902-1'' is removed and ``Sec. 1.902-3'' is added in
its place.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 6. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 7. In Sec. 602.101, paragraph (c) is amended by adding an
entry in numerical order to the table to read as follows:
Sec. 602.101 OMB Control Numbers.
* * * * *
(c) * * *
------------------------------------------------------------------------
Current OMB
CFR part of section where identified and described control No.
------------------------------------------------------------------------
* * * * *
1.902-1.................................................... 1545-1458
* * * * *
------------------------------------------------------------------------
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: December 12, 1996.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 97-153 Filed 1-6-97; 8:45 am]
BILLING CODE 4830-01-U
