Guidance Related to the Foreign Tax Credit, Including Guidance Implementing Changes Made by the Tax Cuts and Jobs Act

(a) Taxes deemed paid by certain domestic corporations treated as a dividend. If a domestic corporation chooses to have the benefits of the foreign tax credit under section 901 for any taxable year, an amount that is equal to the foreign income taxes deemed to be paid by the corporation for the year under section 960 (in the case of section 960(d), determined without regard to the phrase “80 percent of” in section 960(d)(1)) is, to the extent provided by this section, treated as a dividend (a section 78 dividend) received by the domestic corporation from the foreign corporation. A section 78 dividend is treated as a dividend for all purposes of the Code, except that it is not treated as a dividend for purposes of section 245 or 245A, and does not increase the earnings and profits of the domestic corporation or decrease the earnings and profits of the foreign corporation. Any reduction under section 907(a) of the foreign income taxes deemed paid with respect to combined foreign oil and gas income does not affect the amount treated as a section 78 dividend. See § 1.907(a)-1(e)(3). Similarly, any reduction under section 901(e) of the foreign income taxes deemed paid with respect to foreign mineral income does not affect the amount treated as a section 78 dividend. See § 1.901-3(a)(2)(i), (b)(2)(i)(b), and (d), Example 8. Any reduction under section 6038(c)(1)(B) in the foreign taxes paid or accrued by a foreign corporation is taken into account in determining foreign taxes deemed paid and the amount treated as a section 78 dividend. See, for example, § 1.6038-2(k)(5), Example 1. To the extent provided in the Code, section 78 does not apply to any tax not allowed as a credit. See, for example, sections 901(j)(3), 901(k)(7), 901(l)(4), 901(m)(6), and 908(b). For rules on determining the source of a section 78 dividend in computing the limitation on the foreign tax credit under section 904, see §§ 1.861-3(a)(3), 1.862-1(a)(1)(ii), and 1.904-5(m)(6). For rules on assigning a section 78 dividend to a separate category, see § 1.904-4(o).

(b) Date on which section 78 dividend is received. A section 78 dividend is considered received by a domestic corporation on the date on which—

(1) The corporation includes in gross income under section 951(a)(1)(A) the amounts by reason of which there are deemed paid under section 960(a) the foreign income taxes that give rise to that section 78 dividend, notwithstanding that the foreign income taxes may be carried back or carried over to another taxable year and deemed to be paid or accrued in such other taxable year under section 904(c); or

(2) The corporation includes in gross income under section 951A(a) the amounts by reason of which there are deemed paid under section 960(d) the foreign income taxes that give rise to that section 78 dividend.

(c) Applicability date. This section applies to taxable years of foreign corporations that begin after December 31, 2017, and to taxable years of United States shareholders in which or with which such taxable years of foreign corporations end. The second sentence of paragraph (a) of this section also applies to section 78 dividends that are received after December 31, 2017, by reason of taxes deemed paid under section 960(a) with respect to a taxable year of a foreign corporation beginning before January 1, 2018.

(c) * * *

(2) Apportionment based on assets. Certain taxpayers are required by paragraph (e)(2) of this section and § 1.861-9T to apportion interest expense on the basis of assets. A taxpayer may apportion other deductions based on the comparative value of assets that generate income within each grouping, provided that this method reflects the factual relationship between the deduction and the groupings of income and is applied in accordance with the rules of § 1.861-9T(g). In general, such apportionments must be made either on the basis of the tax book value of those assets or, except in the case of interest expense, on the basis of their fair market value. See § 1.861-9(h). Taxpayers using the fair market value method for their last taxable year beginning before January 1, 2018, must change to the tax book value method (or the alternative tax book value method) for purposes of apportioning interest expense for their first taxable year beginning after December 31, 2017. The Commissioner's approval is not required for this change. In the case of any corporate taxpayer that—

(i) Uses tax book value or alternative tax book value, and

(ii) Owns directly or indirectly (within the meaning of § 1.861-12T(c)(2)(ii)(B)) 10 percent or more of the total combined voting power of all classes of stock entitled to vote in any other corporation (domestic or foreign) that is not a member of the affiliated group (as defined in section 864(e)(5)), the taxpayer must adjust its basis in that stock in the manner described in § 1.861-12(c)(2).

(d) * * *

(2) Allocation and apportionment to exempt, excluded, or eliminated income—(i) In general. [Reserved]. For further guidance, see § 1.861-8T(d)(2)(i).

(ii) Exempt income and exempt asset defined—(A) In general. For purposes of this section, the term exempt income means any gross income to the extent that it is exempt, excluded, or eliminated for Federal income tax purposes. The term exempt asset means any asset to the extent income from the asset is (or is treated as under paragraph (d)(2)(ii)(B) or (C) of this section) exempt, excluded, or eliminated for Federal income tax purposes.

(B) [Reserved]. For further guidance, see § 1.861-8T(d)(2)(ii)(B).

(C) Foreign-derived intangible income and inclusions under section 951A(a) —(1) Exempt income. The term “exempt income” includes an amount of a domestic corporation's gross income included in foreign-derived intangible income (as defined in section 250(b)(1)), and also includes an amount of a domestic corporation's gross income from an inclusion under section 951A(a) and the gross up under section 78 attributable to such an inclusion, in each case equal to the amount of the deduction allowed under section 250(a) for such gross income (taking into account the reduction under section 250(a)(2)(B), if any). Therefore, for purposes of apportioning deductions using a gross income method, gross income does not include gross income included in foreign-derived intangible income, an inclusion under section 951A(a), or the gross up under section 78 attributable to an inclusion under section 951A(a), in an amount equal to the amount of the deduction allowed under section 250(a)(1)(A), (B)(i), or (B)(ii), respectively (taking into account the reduction under section 250(a)(2)(B), if any).

(2) Exempt assets—(i) Assets that produce foreign-derived intangible income. The term “exempt asset” includes the portion of a domestic corporation's assets that produce gross income included in foreign-derived intangible income equal to the amount of such assets multiplied by the fraction that equals the amount of the domestic corporation's deduction allowed under section 250(a)(1)(A) (taking into account the reduction under section 250(a)(2)(B)(i), if any) divided by its foreign-derived intangible income. No portion of the value of stock in a foreign corporation is treated as an exempt asset by reason of this paragraph (d)(2)(ii)(C)(2)(i), including by reason of a transfer of intangible property to a foreign corporation subject to section 367(d) that gives rise to income eligible for a deduction under section 250(a)(1)(A).

(ii) Controlled foreign corporation stock that gives rise to inclusions under section 951A(a). The term “exempt asset” includes a portion of the value of a United States shareholder's stock in a controlled foreign corporation if the United States shareholder is a domestic corporation that is eligible for a deduction under section 250(a) with respect to income described in section 250(a)(1)(B)(i) and all or a portion of the domestic corporation's stock in the controlled foreign corporation is characterized as GILTI inclusion stock. The portion of foreign corporation stock that is treated as an exempt asset for a taxable year equals the portion of the value of such foreign corporation stock (determined in accordance with §§ 1.861-9(g), 1.861-12, and 1.861-13) that is characterized as GILTI inclusion stock multiplied by a fraction that equals the amount of the domestic corporation's deduction allowed under section 250(a)(1)(B)(i) (taking into account the reduction under section 250(a)(2)(B)(ii), if any) divided by its GILTI inclusion amount (as defined in § 1.951A-1(c)(1) or, in the case of a member of a consolidated group, § 1.1502-51(b)) for such taxable year. The portion of controlled foreign corporation stock treated as an exempt asset under this paragraph (d)(2)(ii)(C)(2)(ii) is treated as attributable to the relevant categories of GILTI inclusion stock described in each of paragraphs (d)(2)(ii)(C)(3)(i) through (v) of this section based on the relative value of the portion of the stock in each such category.

(3) GILTI inclusion stock. For purposes of paragraph (d)(2)(ii)(C)(2)(ii) of this section, the term GILTI inclusion stock means the aggregate of the portions of the value of controlled foreign corporation stock that are—

(i) Assigned to the section 951A category under § 1.861-13(a)(2);

(ii) Assigned to a particular treaty category under § 1.861-13(a)(3)(i) (relating to resourced gross tested income stock);

(iii) Assigned under § 1.861-13(a)(1) to the gross tested income statutory grouping within the foreign source passive category less the amount described in § 1.861-13(a)(5)(iii)(A);

(iv) Assigned under § 1.861-13(a)(1) to the gross tested income statutory grouping within the U.S. source general category less the amount described in § 1.861-13(a)(5)(iv)(A); and

(v) Assigned under § 1.861-13(a)(1) to the gross tested income statutory grouping within the U.S. source passive category less the amount described in § 1.861-13(a)(5)(iv)(B).

(4) Non-applicability to section 250(b)(3). This paragraph (d)(2)(ii)(C) does not apply when apportioning deductions for purposes of determining deduction eligible income under the operative section of section 250(b)(3).

(5) Example. The following example illustrates the application of this paragraph (d)(2)(ii)(C).

(i) Facts. USP, a domestic corporation, directly owns all of the stock of CFC1 and CFC2, both of which are controlled foreign corporations. The tax book value of CFC1 and CFC2's stock is $10,000 and $9,000, respectively. Pursuant to § 1.861-13(a), $6,100 of the stock of CFC1 is assigned to the section 951A category under § 1.861-13(a)(2) (“section 951A category stock”) and the remaining $3,900 of the stock of CFC1 is assigned to the general category (“general category stock”). Additionally, $4,880 of the stock of CFC2 is section 951A category stock and the remaining $4,120 of the stock of CFC2 is general category stock. Under section 951A and the section 951A regulations (as defined in § 1.951A-1(a)(1)), USP's GILTI inclusion amount is $610. The portion of USP's deduction under section 250 described in section 250(a)(1)(B)(i) is $305. No portion of USP's deduction is reduced by reason of section 250(a)(2)(B)(ii).

(ii) Analysis. Under paragraph (d)(2)(ii)(C)(1) of this section, $305 of USP's gross income attributable to its GILTI inclusion amount is exempt income for purposes of apportioning deductions for purposes of section 904. Under paragraph (d)(2)(ii)(C)(3) of this section, the GILTI inclusion stock of CFC1 is the $6,100 of stock that is section 951A category stock and the GILTI inclusion stock of CFC2 is the $4,880 of stock that is section 951A category stock. Under paragraph (d)(2)(ii)(C)(2) of this section, the portion of the value of the stock of CFC1 and CFC2 that is treated as an exempt asset equals the portion of the value of the stock of CFC1 and CFC2 that is GILTI inclusion stock multiplied by 50% ($305/$610). Accordingly, the exempt portion of the stock of CFC1 is $3,050 (50% × $6,100) and the exempt portion of CFC2's stock is $2,440 (50% × $4,880). Therefore, the stock of CFC1 taken into account for purposes of apportioning deductions is $3,050 of non-exempt section 951A category stock and $3,900 of general category stock. The stock of CFC2 taken into account for purposes of apportioning deductions is $2,440 of non-exempt section 951A category stock and $4,120 of general category stock.

(d)(2)(iii) through (d)(2)(iii)(B) [Reserved]. For further guidance, see § 1.861-8T(d)(2)(iii) through § 1.861-8T(d)(2)(iii)(B).

(C) Dividends for which a deduction is allowed under section 245A;

(D) Foreign earned income as defined in section 911 and the regulations thereunder (however, the rules of § 1.911-6 do not require the allocation and apportionment of certain deductions, including home mortgage interest, to foreign earned income for purposes of determining the deductions disallowed under section 911(d)(6)); and

(E) Inclusions for which a deduction is allowed under section 965(c). See § 1.965-6(d).

(iv) Value of stock attributable to previously taxed earnings and profits. No portion of the value of stock in a controlled foreign corporation is treated as an exempt asset by reason of the adjustment under § 1.861-12(c)(2) in respect of previously taxed earnings and profits described in section 959(c)(1) or (c)(2) (including earnings and profits described in section 959(c)(2) by reason of section 951A(f)(1) and § 1.951A-6(b)(1)). See also § 1.965-6(d).

(e) * * * (1) * * * Paragraphs (e)(13) and (14) of this section contain rules with respect to the allocation and apportionment of the deduction allowed under section 250(a). Paragraph (e)(15) of this section contains rules with respect to the allocation and apportionment of a taxpayer's distributive share of a partnership's deductions. * * *

(6) * * * (i) In general. The deduction for foreign income, war profits and excess profits taxes (foreign income taxes) allowed by section 164 is allocated and apportioned among the applicable statutory and residual groupings under the principles of § 1.904-6(a)(1)(i), (ii), and (iv). The deduction for state and local taxes (state income taxes) allowed by section 164 is considered definitely related and allocable to the gross income with respect to which such state income taxes are imposed. * * *

(13) Foreign-derived intangible income. The portion of the deduction that is allowed for foreign-derived intangible income under section 250(a)(1)(A) (taking into account the reduction under section 250(a)(2)(B)(i), if any) is considered definitely related and allocable to the class of gross income included in the taxpayer's foreign-derived deduction eligible income (as defined in section 250(b)(4)). If necessary, the portion of the deduction is apportioned within the class ratably between the statutory grouping (or among the statutory groupings) of gross income and the residual grouping of gross income based on the relative amounts of foreign-derived deduction eligible income in each grouping.

(14) Global intangible low-taxed income and related section 78 gross up. The portion of the deduction that is allowed for the global intangible low-taxed income amount described in section 250(a)(1)(B)(i) (taking into account the reduction under section 250(a)(2)(B)(ii), if any) is considered definitely related and allocable to the class of gross income included under section 951A(a). If necessary (for example, because a portion of the inclusion under section 951A(a) is passive category income or U.S. source income), the portion of the deduction is apportioned within the class ratably between the statutory grouping (or among the statutory groupings) of gross income and the residual grouping of gross income based on the relative amounts of gross income in each grouping. Similar rules apply to allocate and apportion the portion of the deduction that is allowed for the section 78 gross up under section 250(a)(1)(B)(ii).

(15) Distributive share of partnership deductions. In general, if deductions are incurred by a partnership in which the taxpayer is a partner, the taxpayer's deductions that are allocated and apportioned include the taxpayer's distributive share of the partnership's deductions. See §§ 1.861-9(e), 1.861-17(f), and 1.904-4(n)(1)(ii) for special rules for apportioning a partner's distributive share of deductions of a partnership.

(f) * * *

(1) * * *

(i) Separate foreign tax credit limitations. Section 904(d)(1) and other sections described in § 1.904-4(m) require that a separate foreign tax credit limitation be determined with respect to each separate category of income specified in those sections. Accordingly, the foreign source income within each separate category described in § 1.904-5(a)(4)(v) constitutes a separate statutory grouping of income. U.S. source income is treated as income in the residual category for purposes of determining the limitation on the foreign tax credit.

(h) Applicability date. This section applies to taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

(a) through (c)(4) [Reserved]. For further guidance, see § 1.861-9T(a) through (c)(4).

(5) Section 163(j). If a taxpayer is subject to section 163(j), the taxpayer's deduction for business interest expense is limited to the sum of the taxpayer's business interest income, 30 percent of the taxpayer's adjusted taxable income for the taxable year, and the taxpayer's floor plan financing interest expense. In the taxable year that any deduction is permitted for business interest expense with respect to a disallowed business interest carryforward, that business interest expense is apportioned for purposes of this section under rules set forth in paragraphs (d), (e), or (f) of this section (as applicable) as though it were incurred in the taxable year in which the expense is deducted.

(d) through (e)(1) [Reserved]. For further guidance, see § 1.861-9T(d) through (e)(1).

(4) Entity rule for less than 10 percent limited partners and less than 10 percent corporate general partners—(i) Partnership interest expense. A limited partner (whether individual or corporate) or corporate general partner whose ownership, together with ownership by persons that bear a relationship to the partner described in section 267(b) or section 707, of the capital and profits interests of the partnership is less than 10 percent directly allocates its distributive share of partnership interest expense to its distributive share of partnership gross income. Under § 1.904-4(n)(1)(ii), such a partner's distributive share of foreign source income of the partnership is treated as passive income (subject to the high-taxed income exception of section 904(d)(2)(B)(iii)(II)), except in the case of income from a partnership interest held in the ordinary course of the partner's active trade or business, as defined in § 1.904-4(n)(1)(ii)(B). A partner's distributive share of partnership interest expense (other than partnership interest expense that is directly allocated to identified property under § 1.861-10T) is apportioned in accordance with the partner's relative distributive share of gross foreign source income in each separate category and of gross domestic source income from the partnership. To the extent that partnership interest expense is directly allocated under § 1.861-10T, a comparable portion of the income to which such interest expense is allocated is disregarded in determining the partner's relative distributive share of gross foreign source income in each separate category and domestic source income. The partner's distributive share of the interest expense of the partnership that is directly allocable under § 1.861-10T is allocated according to the treatment, after application of § 1.904-4(n)(1), of the partner's distributive share of the income to which the expense is allocated.

(e)(4)(ii) through (e)(7) [Reserved]. For further guidance, see § 1.861-9T(e)(4)(ii) through (e)(7).

(8) Special rule for specified partnership loans—(i) In general. For purposes of apportioning interest expense that is not directly allocable under paragraph (e)(4) of this section or § 1.861-10T, the disregarded portion of a specified partnership loan is not considered an asset of a SPL lender. The disregarded portion of a specified partnership loan is the portion of the value of the loan (as determined under paragraph (h)(4)(i) of this section) that bears the same proportion to the total value of the loan as the matching income amount that is included by the SPL lender for a taxable year with respect to the loan bears to the total amount of SPL interest income that is included directly or indirectly in gross income by the SPL lender with respect to the loan during that taxable year.

(ii) Treatment of interest expense and interest income attributable to a specified partnership loan. If a SPL lender (or any other person in the same affiliated group as the SPL lender) takes into account a distributive share of SPL interest expense, the SPL lender includes the matching income amount for the taxable year that is attributable to the same loan in gross income in the same statutory and residual groupings as the statutory and residual groupings of gross income from which the SPL interest expense is deducted by the SPL lender (or any other person in the same affiliated group as the SPL lender).

(iii) Anti-avoidance rule for third party back-to-back loans. If, with a principal purpose of avoiding the rules in this paragraph (e)(8), a person makes a loan to a person that is not related (within the meaning of section 267(b) or 707) to the lender, the unrelated person makes a loan to a partnership, and the first loan would constitute a specified partnership loan if made directly to the partnership, then the rules of this paragraph (e)(8) apply as if the first loan was made directly to the partnership. Such a series of loans will be subject to this recharacterization rule without regard to whether there was a principal purpose of avoiding the rules in this paragraph (e)(8) if the loan to the unrelated person would not have been made or maintained on substantially the same terms irrespective of the loan of funds by the unrelated person to the partnership. The principles of this paragraph (e)(8)(iii) also apply to similar transactions that involve more than two loans and regardless of the order in which the loans are made.

(iv) Anti-avoidance rule for loans held by CFCs. A loan receivable held by a controlled foreign corporation with respect to a loan to a partnership in which a United States shareholder (as defined in § 1.904-5(a)(4)(vi)) of the controlled foreign corporation owns an interest, directly or indirectly through one or more other partnerships or other pass-through entities (as defined in § 1.904-5(a)(4)(iv)), is recharacterized as a loan receivable held directly by the United States shareholder with respect to the loan to such partnership for purposes of this paragraph (e)(8) if the loan was made or transferred with a principal purpose of avoiding the rules in this paragraph (e)(8).

(v) Interest equivalents. The principles of this paragraph (e)(8) apply in the case of a partner, or any person in the same affiliated group as the partner, that takes into account a distributive share of an expense or loss (to the extent deductible) that is allocated and apportioned in the same manner as interest expense under § 1.861-9T(b) and has a matching income amount with respect to the transaction that gives rise to that expense or loss.

(vi) Definitions. For purposes of this paragraph (e)(8), the following definitions apply.

(A) Affiliated group. The term affiliated group has the meaning provided in § 1.861-11(d)(1).

(B) Matching income amount. The term matching income amount means the lesser of the total amount of the SPL interest income included directly or indirectly in gross income by the SPL lender for the taxable year with respect to a specified partnership loan or the total amount of the distributive shares of the SPL interest expense of the SPL lender (or any other person in the same affiliated group as the SPL lender) with respect to the loan.

(C) Specified partnership loan. The term specified partnership loan means a loan to a partnership for which the loan receivable is held, directly or indirectly through one or more other partnerships, either by a person that owns an interest, directly or indirectly through one or more other partnerships, in the partnership, or by any person in the same affiliated group as that person.

(D) SPL interest expense. The term SPL interest expense means an item of interest expense paid or accrued with respect to a specified partnership loan, without regard to whether the expense was currently deductible (for example, by reason of section 163(j)).

(E) SPL interest income. The term SPL interest income means an item of gross interest income received or accrued with respect to a specified partnership loan.

(F) SPL lender. The term SPL lender means the person that holds the receivable with respect to a specified partnership loan. If a partnership holds the receivable, then any partner in the partnership (other than a partner described in paragraph (e)(4)(i) of this section) is also considered a SPL lender.

(9) Characterizing certain partnership assets as foreign branch category assets. For purposes of applying this paragraph (e) to section 904 as the operative section, a partner that is a United States person that has a distributive share of partnership income that is treated as foreign branch category income under § 1.904-4(f)(1)(i)(B) characterizes its pro rata share of the partnership assets that give rise to such income as assets in the foreign branch category.

(f) through (f)(1) [Reserved]. For further guidance, see § 1.861-9T(f) through (f)(1).

(2) Section 987 QBUs of domestic corporations—(i) In general. In the application of the asset method described in paragraph (g) of this section, a domestic corporation—

(A) Takes into account the assets of any section 987 QBU (as defined in § 1.987-1(b)(2)), translated according to the rules set forth in paragraph (g) of this section, and

(B) Combines with its own interest expense any deductible interest expense incurred by a section 987 QBU, translated according to the rules of section 987 and the regulations under that section.

(ii) Coordination with section 987(3). For purposes of computing foreign currency gain or loss under section 987(3) (including section 987 gain or loss recognized under § 1.987-5), the rules of this paragraph (f)(2) do not apply. See § 1.987-4.

(iii) Example. The following example illustrates the application of this paragraph (f)(2).

(A) Facts. X is a domestic corporation that operates B, a branch doing business in a foreign country. B is a section 987 QBU (as defined in § 1.987-1(b)(2)) as well as a foreign branch (as defined in § 1.904-4(f)(3)(iii)). In 2020, without regard to B, X has gross domestic source income of $1,000 and gross foreign source general category income of $500 and incurs $200 of interest expense. Using the tax book value method of apportionment, X, without regard to B, determines the value of its assets that generate domestic source income to be $6,000 and the value of its assets that generate foreign source general category income to be $1,000. Applying the translation rules of section 987, X (through B) earned $500 of gross foreign source foreign branch category income and incurred $100 of interest expense. B incurred no other expenses. For 2020, the average functional currency book value of B's assets that generate foreign source foreign branch category income translated at the year-end rate for 2020 is $3,000.

(B) Analysis. The combined assets of X and B for 2020 (averaged under § 1.861-9T(g)(3)) consist 60% ($6,000/$10,000) of assets generating domestic source income, 30% ($3,000/$10,000) of assets generating foreign source foreign branch category income, and 10% ($1,000/$10,000) of assets generating foreign source general category income. The combined interest expense of X and B is $300. Thus, $180 ($300 × 60%) of the combined interest expense is apportioned to domestic source income, $90 ($300 × 30%) is apportioned to foreign source foreign branch category income, and $30 ($300 × 10%) is apportioned to foreign source general category income, yielding net U.S. source income of $820 ($1,000 − $180), net foreign source foreign branch category income of $410 ($500 − $90), and net foreign source general category income of $470 ($500 − $30).

(3) Controlled foreign corporations—(i) In general. For purposes of computing subpart F income and tested income and computing earnings and profits for all Federal income tax purposes, the interest expense of a controlled foreign corporation may be apportioned using either the asset method described in paragraph (g) of this section or the modified gross income method described in paragraph (j) of this section, subject to the rules of paragraph (f)(3)(ii) and (iii) of this section.

(4) Noncontrolled 10-percent owned foreign corporations. * * *

(iii) Stock characterization. The stock of a noncontrolled 10-percent owned foreign corporation is characterized under the rules in § 1.861-12(c)(4).

(f)(5) [Reserved]. For further guidance, see § 1.861-9T(f)(5).

(g) through (g)(1)(i) [Reserved]. For further guidance, see § 1.861-9T(g) through (g)(1)(i).

(ii) A taxpayer may elect to determine the value of its assets on the basis of either the tax book value or the fair market value of its assets. However, for taxable years beginning after December 31, 2017, the fair market value method is not allowed with respect to allocations and apportionments of interest expense. See section 864(e)(2). For rules concerning the application of an alternative method of valuing assets for purposes of the tax book value method, see paragraph (i) of this section. For rules concerning the application of the fair market value method, see paragraph (h) of this section.

(iii) [Reserved]

(iv) For rules relating to earnings and profits adjustments by taxpayers using the tax book value method for the stock in certain 10 percent owned corporations, see § 1.861-12(c)(2).

(v) [Reserved]

(2) Asset values—(i) General rule—(A) Average of values. For purposes of determining the value of assets under this section, an average of values (book or market) within each statutory grouping and the residual grouping is computed for the year on the basis of values of assets at the beginning and end of the year. For the first taxable year beginning after December 31, 2017 (post-2017 year), a taxpayer that determined the value of its assets on the basis of the fair market value method for purposes of apportioning interest expense in its prior taxable year may choose to determine asset values under the tax book value method (or the alternative tax book value method) by treating the value of its assets as of the beginning of the post-2017 year as equal to the value of its assets at the end of the first quarter of the post-2017 year, provided that each member of the affiliated group (as defined in § 1.861-11T(d)) determines its asset values on the same basis. Where a substantial distortion of asset values would result from averaging beginning-of-year and end-of-year values, as might be the case in the event of a major corporate acquisition or disposition, the taxpayer must use a different method of asset valuation that more clearly reflects the average value of assets weighted to reflect the time such assets are held by the taxpayer during the taxable year.

(B) Tax book value method. Under the tax book value method, the value of an asset is determined based on the adjusted basis of the asset. For purposes of determining the value of stock in a 10 percent owned corporation at the beginning and end of the year under the tax book value method, the tax book value is determined without regard to any adjustments under section 961(a) or 1293(d), see § 1.861-12(c)(2)(i)(B)(1), and before the adjustment required by § 1.861-12(c)(2)(i)(A) to the basis of stock in the 10 percent owned corporation. The average of the tax book value of the stock at the beginning and end of the year is then adjusted with respect to earnings and profits as described in § 1.861-12(c)(2)(i).

(g)(2)(ii) through (g)(2)(ii)(A)(1) [Reserved]. For further guidance, see § 1.861-9T(g)(2)(ii) through (g)(2)(ii)(A)(1).

(2) United States dollar approximate separate transactions method. In the case of a branch to which the United States dollar approximate separate transactions method of accounting described in § 1.985-3 applies, the beginning-of-year dollar amount of the assets is determined by reference to the end-of-year balance sheet of the branch for the immediately preceding taxable year, adjusted for United States generally accepted accounting principles and United States tax accounting principles, and translated into U.S. dollars as provided in § 1.985-3(c). The end-of-year dollar amount of the assets of the branch is determined in the same manner by reference to the end-of-year balance sheet for the current taxable year. The beginning-of-year and end-of-year dollar tax book value of assets, as so determined, within each grouping is then averaged as provided in paragraph (g)(2)(i) of this section.

(g)(2)(ii)(B) through (g)(3) [Reserved]. For further guidance, see § 1.861-9T(g)(2)(ii)(B) through (g)(3).

(h) Fair market value method. An affiliated group (as defined in section 1.861-11T(d)) or other taxpayer (the taxpayer) that elects to use the fair market value method of apportionment values its assets according to the methodology described in this paragraph (h). Effective for taxable years beginning after December 31, 2017, the fair market value method is not allowed for purposes of apportioning interest expense. See section 864(e)(2). However, a taxpayer may continue to apportion deductions other than interest expense that are properly apportioned based on fair market value according to the methodology described in this paragraph (h). See § 1.861-8(c)(2).

(h)(1) through (h)(3) [Reserved]. For further guidance, see § 1.861-9T(h)(1) through (h)(3).

(5) Characterizing stock in related persons. Stock in a related person held by the taxpayer or by another related person shall be characterized on the basis of the fair market value of the taxpayer's pro rata share of assets held by the related person attributed to each statutory grouping and the residual grouping under the stock characterization rules of § 1.861-12T(c)(3)(ii), except that the portion of the value of intangible assets of the taxpayer and related persons that is apportioned to the related person under § 1.861-9T(h)(2) shall be characterized on the basis of the net income before interest expense of the related person within each statutory grouping or residual grouping (excluding income that is passive under § 1.904-4(b)).

(i) * * *

(2) * * * (i) Except as provided in this paragraph (i)(2)(i), a taxpayer may elect to use the alternative tax book value method. For the taxpayer's first taxable year beginning after December 31, 2017, the Commissioner's approval is not required to switch from the fair market value method to the alternative tax book value method for purposes of apportioning interest expense. * * *

(j) through (j)(2)(i) [Reserved]. For further guidance, see § 1.861-9T(j) through (j)(2)(i).

(ii) Step 2. Moving to the next higher-tier controlled foreign corporation, combine the gross income of such corporation within each grouping with its pro rata share (as determined under principles similar to section 951(a)(2)) of the gross income net of interest expense of all lower-tier controlled foreign corporations held by such higher-tier corporation within the same grouping adjusted as follows:

(A) Exclude from the gross income of the higher-tier corporation any dividends or other payments received from the lower-tier corporation other than interest income received from the lower-tier corporation;

(B) Exclude from the gross income net of interest expense of any lower-tier corporation any gross subpart F income, net of interest expense apportioned to such income;

(C) Exclude from the gross income net of interest expense of any lower-tier corporation any gross tested income as defined in § 1.951A-2(c)(1), net of interest expense apportioned to such income;

(D) Then apportion the interest expense of the higher-tier controlled foreign corporation based on the adjusted combined gross income amounts; and

(E) Repeat paragraphs (j)(2)(ii)(A) through (D) of this section for each next higher-tier controlled foreign corporation in the chain.

(k) Applicability date. This section applies to taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

(e) * * *

(8) * * *

(vi) Classification of hybrid stock. In determining the amount of its related group indebtedness for any taxable year, a U.S. shareholder must not treat stock in a related controlled foreign corporation as related group indebtedness, regardless of whether the related controlled foreign corporation claims a deduction for interest under foreign law for distributions on such stock. For purposes of determining the foreign base period ratio under paragraph (e)(2)(iv) of this section for a taxable year that ends on or after December 4, 2018, the rules of this paragraph (e)(8)(vi) apply to determine the related group debt-to-asset ratio in each taxable year included in the foreign base period, including in taxable years that end before December 4, 2018.

(10) [Reserved]

(f) Applicability date. This section applies to taxable years that end on or after December 4, 2018.

(a) [Reserved]. For further guidance, see § 1.861-11T(a).

(b) Scope of application—(1) Application of section 864(e)(1) and (5) (concerning the definition and treatment of affiliated groups). Section 864(e)(1) and (5) and the portions of this section implementing section 864(e)(1) and (5) apply to the computation of foreign source taxable income for purposes of section 904 (relating to various limitations on the foreign tax credit). Section 864(e)(1) and (5) and the portions of this section implementing section 864(e)(1) and (5) also apply in connection with section 907 to determine reductions in the amount allowed as a foreign tax credit under section 901. Section 864(e)(1) and (5) and the portions of this section implementing section 864(e)(1) and (5) also apply to the computation of the combined taxable income of the related supplier and a foreign sales corporation (FSC) (under sections 921 through 927) as well as the combined taxable income of the related supplier and a domestic international sales corporation (DISC) (under sections 991 through 997).

(b)(2) through (c) [Reserved]. For further guidance, see § 1.861-11T(b)(2) through (c).

(d) * * *

(2) [Reserved]

(h) Applicability dates. This section applies to taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

(a) In general. The rules in this section are applicable to taxpayers in apportioning expenses under an asset method to income in the various separate categories described in § 1.904-5(a)(4)(v), and supplement other rules provided in §§ 1.861-9 through 1.861-11T. The principles of the rules in this section are also applicable in apportioning expenses among statutory and residual groupings for any other operative section. See also § 1.861-8(f)(2)(i) for a rule requiring conformity of allocation methods and apportionment principles for all operative sections. Paragraph (b) of this section describes the treatment of inventories. Paragraph (c)(1) of this section concerns the treatment of various stock assets. Paragraph (c)(2) of this section describes a basis adjustment for stock in 10 percent owned corporations. Paragraph (c)(3) of this section sets forth rules for characterizing the stock in controlled foreign corporations. Paragraph (c)(4) of this section describes the treatment of stock of noncontrolled 10-percent owned foreign corporations. Paragraph (d)(1) of this section concerns the treatment of notes. Paragraph (d)(2) of this section concerns the treatment of notes of controlled foreign corporations. Paragraph (e) of this section describes the treatment of certain portfolio securities that constitute inventory or generate income primarily in the form of gains. Paragraph (f) of this section describes the treatment of assets that are subject to the capitalization rules of section 263A. Paragraph (g) of this section concerns the treatment of FSC stock and of assets of the related supplier generating foreign trade income. Paragraph (h) of this section concerns the treatment of DISC stock and of assets of the related supplier generating qualified export receipts. Paragraph (i) of this section is reserved. Paragraph (j) of this section sets forth an example illustrating the rules of this section, as well as the rules of § 1.861-9(g).

(b) through (c)(1) [Reserved]. For further guidance, see § 1.861-12T(b) through (c)(1).

(2) Basis adjustment for stock in 10 percent owned corporations—(i) * * *

(B) Computational rules—(1) Adjustments to basis—(i) Application of section 961 or 1293(d). For purposes of this section, a taxpayer's adjusted basis in the stock of a foreign corporation does not include any amount included in basis under section 961 or 1293(d) of the Code.

(ii) Application of section 965(b). If a taxpayer owned the stock of a specified foreign corporation (as defined in § 1.965-1(f)(45)) as of the close of the last taxable year of the specified foreign corporation that began before January 1, 2018, the taxpayer's adjusted basis in the stock of the specified foreign corporation for that taxable year and any subsequent taxable year is determined as if the taxpayer made the election described in § 1.965-2(f)(2)(i) (regardless of whether the election was actually made) but does not include the amount included (or that would be included if the election were made) in basis under § 1.965-2(f)(2)(ii)(A) (without regard to whether any portion of the amount is netted against the amounts of any other basis adjustments under § 1.965-2(h)(2)).

(2) Amount of earnings and profits. For purposes of this paragraph (c)(2), earnings and profits (or deficits) are computed under the rules of section 312 and, in the case of a foreign corporation, sections 964(a) and 986 for taxable years of the 10 percent owned corporation ending on or before the close of the taxable year of the taxpayer. Accordingly, the earnings and profits of a controlled foreign corporation includes all earnings and profits described in section 959(c). The amount of the earnings and profits with respect to stock of a foreign corporation held by the taxpayer is determined according to the attribution principles of section 1248 and the regulations under section 1248. The attribution principles of section 1248 apply without regard to the requirements of section 1248 that are not relevant to the determination of a shareholder's pro rata portion of earnings and profits, such as whether earnings and profits (or deficits) were derived (or incurred) during taxable years beginning before or after December 31, 1962.

(3) Annual noncumulative adjustment. The adjustment required by paragraph (c)(2)(i)(A) of this section is made annually and is noncumulative. Thus, the adjusted basis of the stock (determined without regard to prior years' adjustments under paragraph (c)(2)(i)(A) of this section) is adjusted annually by the amount of accumulated earnings and profits (or deficits) attributable to the stock as of the end of each year.

(4) Translation of non-dollar functional currency earnings and profits. Earnings and profits (or deficits) of a qualified business unit that has a functional currency other than the dollar must be computed under this paragraph (c)(2) in functional currency and translated into dollars using the exchange rate at the end of the taxpayer's current taxable year (and not the exchange rates for the years in which the earnings and profits or deficits were derived or incurred).

(C) Examples. The following examples illustrate the application of paragraph (c)(2)(i)(B) of this section.

(1 ) Example 1: No election described in § 1.965-2(f)(2)(i)—(i) Facts. USP, a domestic corporation, owns all of the stock of CFC1 and CFC2, both controlled foreign corporations. USP, CFC1, and CFC2 all use the calendar year as their U.S. taxable year. USP owned CFC1 and CFC2 as of December 31, 2017, and CFC1 and CFC2 were specified foreign corporations with respect to USP. USP did not make the election described in § 1.965-2(f)(2)(i), but if USP had made the election, USP's basis in the stock of CFC1 would have been increased by $75 under § 1.965-2(f)(2)(ii)(A) and USP's basis in the stock of CFC2 would have been decreased by $75 under § 1.965-2(f)(2)(ii)(B). For purposes of determining the value of the stock of CFC1 and CFC2 at the beginning of the 2019 taxable year, without regard to amounts included in basis under section 961 or 1293(d), USP's adjusted basis in the stock of CFC1 is $100 and its adjusted basis in the stock of CFC2 is $350 (before the application of this paragraph (c)(2)(i)(B)).

(ii) Analysis. Under paragraph (c)(2)(i)(B)(1) of this section, USP's adjusted basis in CFC1 and CFC2 is determined as if USP had made the election described in § 1.965-2(f)(2)(i), and therefore USP's adjusted basis in CFC2 includes the $75 reduction USP would have made to its basis in that stock under § 1.965-2(f)(2)(ii)(B). However, USP's adjusted basis in the stock of CFC1 does not include the $75 that USP would have included in its basis in that stock under § 1.965-2(f)(2)(ii)(A). Accordingly, for purposes of determining the value of stock of CFC1 and CFC2 at the beginning of the 2019 taxable year, USP's adjusted basis in the stock of CFC1 is $100 and USP's adjusted basis in the stock of CFC2 is $275 ($350−$75).

(2 ) Example 2: Election described in § 1.965-2(f)(2)(i)—(i) Facts. USP, a domestic corporation, owns all of the stock of CFC1, which owns all of the stock of CFC2, both foreign corporations. USP, CFC1, and CFC2 all use the calendar year as their U.S. taxable year. USP owned CFC1, and CFC1 owned CFC2 as of December 31, 2017, and CFC1 and CFC2 were specified foreign corporations with respect to USP. USP made the election described in § 1.965-2(f)(2)(i). As a result of the election, USP was required to increase its basis in CFC1 by $90 under § 1.965-2(f)(2)(ii)(A), and to decrease its basis in CFC1 by $90 under § 1.965-2(f)(2)(ii)(B). Pursuant to § 1.965-2(h)(2), USP netted the increase of $90 against the decrease of $90 and made no net adjustment to the basis of the stock of CFC1. For purposes of determining the value of the stock of CFC1 at the beginning of the 2019 taxable year, without regard to amounts included in basis under section 961 or 1293(d), USP's adjusted basis in the stock of CFC1 is $600 (before the application of this paragraph (c)(2)(i)(B)).

(ii) Analysis. Under paragraph (c)(2)(i)(B)(1) of this section, USP's adjusted basis in CFC1 is determined as if USP had made the election described in § 1.965-2(f)(2)(i), and therefore USP's adjusted basis in CFC1 includes the $90 reduction USP would have made to its basis in that stock, without regard to the netting rule described in § 1.965-2(h)(2). However, USP's adjusted basis in the stock of CFC1 does not include the amount that would have been included in basis under § 1.965-2(f)(2)(ii)(A) without regard to the netting rule described in § 1.965-2(h)(2). Accordingly, for purposes of determining the value of stock of CFC1 at the beginning of the 2019 taxable year, USP's adjusted basis in the stock of CFC1 is $510 ($600−$90).

(c)(2)(ii) through (c)(2)(vi) [Reserved]. For further guidance, see § 1.861-12T(c)(2)(ii) through (c)(2)(vi).

(3) Characterization of stock of controlled foreign corporations—(i) Operative sections. (A) Operative sections other than section 904. For purposes of applying this section to an operative section other than section 904, stock in a controlled foreign corporation (as defined in section 957) is characterized as an asset in the relevant groupings on the basis of the asset method described in paragraph (c)(3)(ii) of this section, or the modified gross income method described in paragraph (c)(3)(iii) of this section. Stock in a controlled foreign corporation whose interest expense is apportioned on the basis of assets is characterized in the hands of its United States shareholders under the asset method described in paragraph (c)(3)(ii) of this section. Stock in a controlled foreign corporation whose interest expense is apportioned on the basis of modified gross income is characterized in the hands of its United States shareholders under the modified gross income method described in paragraph (c)(3)(iii) of this section.

(B) Section 904 as operative section. For purposes of applying this section to section 904 as the operative section, § 1.861-13 applies to characterize the stock of a controlled foreign corporation as an asset producing foreign source income in the separate categories described in § 1.904-5(a)(4)(v), or as an asset producing U.S. source income in the residual grouping, in the hands of the United States shareholder, and to determine the portion of the stock that gives rise to an inclusion under section 951A(a) that is treated as an exempt asset under § 1.861-8(d)(2)(ii)(C). Section 1.861-13 also provides rules for subdividing the stock in the various separate categories and the residual grouping into a section 245A subgroup and a non-section 245A subgroup in order to determine the amount of the adjustments required by section 904(b)(4) and § 1.904(b)-3(c) with respect to the section 245A subgroup, and provides rules for determining the portion of the stock that gives rise to a dividend eligible for a deduction under section 245(a)(5) that is treated as an exempt asset under § 1.861-8(d)(2)(ii)(B).

(ii) [Reserved]. For further guidance, see § 1.861-12T(c)(3)(ii).

(iii) Modified gross income method. Under the modified gross income method, the taxpayer characterizes the tax book value of the stock of the first-tier controlled foreign corporation based on the gross income, net of interest expense, of the controlled foreign corporation (as computed under § 1.861-9T(j) to include certain gross income, net of interest expense, of lower-tier controlled foreign corporations) within each relevant category for the taxable year of the controlled foreign corporation ending with or within the taxable year of the taxpayer. For this purpose, however, the gross income, net of interest expense, of the first-tier controlled foreign corporation includes the total amount of gross subpart F income, net of interest expense, of any lower-tier controlled foreign corporation that was excluded under the rules of § 1.861-9(j)(2)(ii)(B). The gross income, net of interest expense, of the first-tier controlled foreign corporation also includes the total amount of gross tested income, net of interest expense, of any lower-tier controlled foreign corporation that was excluded under the rules of § 1.861-9(j)(2)(ii)(C).

(4) Characterization of stock of noncontrolled 10-percent owned foreign corporations—(i) In general. Except in the case of a nonqualifying shareholder described in paragraph (c)(4)(ii) of this section, the principles of § 1.861-12(c)(3), including the relevant rules of § 1.861-13 when section 904 is the operative section, apply to characterize stock in a noncontrolled 10-percent owned foreign corporation (as defined in section 904(d)(2)(E)). Accordingly, stock in a noncontrolled 10-percent owned foreign corporation is characterized as an asset in the various separate categories on the basis of either the asset method described in § 1.861-12T(c)(3)(ii) or the modified gross income method described in § 1.861-12(c)(3)(iii). Stock in a noncontrolled 10-percent owned foreign corporation the interest expense of which is apportioned on the basis of assets is characterized in the hands of its shareholders under the asset method described in § 1.861-12T(c)(3)(ii). Stock in a noncontrolled 10-percent owned foreign corporation the interest expense of which is apportioned on the basis of gross income is characterized in the hands of its shareholders under the modified gross income method described in § 1.861-12(c)(3)(iii).

(ii) Nonqualifying shareholders. Stock in a noncontrolled 10-percent owned foreign corporation is characterized as a passive category asset in the hands of a shareholder that either is not a domestic corporation or is not a United States shareholder with respect to the noncontrolled 10-percent owned foreign corporation for the taxable year. Stock in a noncontrolled 10-percent owned foreign corporation is characterized as in the separate category described in section 904(d)(4)(C)(ii) in the hands of any shareholder with respect to whom look-through treatment is not substantiated. See also § 1.904-5(c)(4)(iii)(B). In the case of a noncontrolled 10-percent owned foreign corporation that is a passive foreign investment company with respect to a shareholder, stock in the noncontrolled 10-percent owned foreign corporation is characterized as a passive category asset in the hands of the shareholder if such shareholder does not meet the ownership requirements described in section 904(d)(2)(E)(i)(II).

(d) Treatment of notes—(1) General rule. [Reserved]. For further guidance, see § 1.861-12T(d)(1).

(2) Characterization of related controlled foreign corporation notes. The debt of a controlled foreign corporation is characterized in the same manner as the interest income derived from that debt obligation. See §§ 1.904-4 and 1.904-5(c)(2) for rules treating interest income as income in a separate category.

(e) through (j) [Reserved]. For further guidance, see § 1.861-12T(e) through (j).

(k) Applicability date. This section applies to taxable years that both begin after December 31, 2017, and end on or after December 4, 2018. Section 1.861-12(c)(2)(i)(B)(1)(ii) also applies to the last taxable year of a foreign corporation that begins before January 1, 2018, and with respect to a United States person, the taxable year in which or with which such taxable year of the foreign corporation ends.

(a) Methodology. For purposes of allocating and apportioning deductions for purposes of section 904 as the operative section, stock in a controlled foreign corporation owned directly or indirectly through a partnership or other pass-through entity by a United States shareholder is characterized by the United States shareholder under the rules described in this section. In general, paragraphs (a)(1) through (5) of this section characterize the stock of the controlled foreign corporation as an asset in the various statutory groupings and residual grouping based on the type of income that the stock of the controlled foreign corporation generates, has generated, or may reasonably be expected to generate when the income is included by the United States shareholder.

(1) Step 1: Characterize stock as generating income in statutory groupings under the asset or modified gross income method—(i) Asset method. United States shareholders using the asset method to characterize stock of a controlled foreign corporation must apply the asset method described in § 1.861-12T(c)(3)(ii) to assign the assets of the controlled foreign corporation to the statutory groupings described in paragraphs (a)(1)(i)(A)(1) through (10) and (a)(1)(i)(B) of this section. If the controlled foreign corporation owns stock in a lower-tier noncontrolled 10-percent owned foreign corporation, the assets of the lower-tier noncontrolled 10-percent owned foreign corporation are assigned to a gross subpart F income grouping to the extent such assets generate income that, if distributed to the controlled foreign corporation, would be gross subpart F income of the controlled foreign corporation. See also § 1.861-12(c)(4).

(A) General and passive categories. Within each of the controlled foreign corporation's general category and passive category, each of the following subgroups within each category is a separate statutory grouping—

(1) Foreign source gross tested income;

(2) For each applicable treaty, U.S. source gross tested income that, when taken into account by a United States shareholder under section 951A, is resourced in the hands of the United States shareholder (resourced gross tested income);

(3) U.S. source gross tested income not described in paragraph (a)(1)(i)(A)(2) of this section;

(4) Foreign source gross subpart F income;

(5) For each applicable treaty, U.S. source gross subpart F income that, when included by a United States shareholder under section 951(a)(1), is resourced in the hands of the United States shareholder (resourced gross subpart F income);

(6) U.S. source gross subpart F income not described in paragraph (a)(1)(i)(A)(5) of this section;

(7) Foreign source gross section 245(a)(5) income;

(8) U.S. source gross section 245(a)(5) income;

(9) Any other foreign source gross income (specified foreign source general category income or specified foreign source passive category income, as the case may be); and

(10) Any other U.S. source gross income (specified U.S. source general category gross income or specified U.S. source passive category gross income, as the case may be).

(B) Section 901(j) income. For each country described in section 901(j), all gross income from sources in that country.

(ii) Modified gross income method. United States shareholders using the modified gross income method to characterize stock in a controlled foreign corporation must apply the modified gross income method under § 1.861-12(c)(3)(iii) to assign the modified gross income of the controlled foreign corporation to the statutory groupings described in paragraphs (a)(1)(i)(A)(1) through (10) and (a)(1)(i)(B) of this section. For this purpose, the rules described in §§ 1.861-12(c)(3)(iii) and 1.861-9T(j)(2) apply to combine gross income in a statutory grouping that is earned by the controlled foreign corporation with gross income of lower-tier controlled foreign corporations that is in the same statutory grouping. For example, foreign source general category gross tested income (net of interest expense) earned by the controlled foreign corporation is combined with its pro rata share of the foreign source general category gross tested income (net of interest expense) of lower-tier controlled foreign corporations. If the controlled foreign corporation owns stock in a lower-tier noncontrolled 10-percent owned foreign corporation, gross income of the lower-tier noncontrolled 10-percent owned foreign corporation is assigned to a gross subpart F income grouping to the extent that the income, if distributed to the upper-tier controlled foreign corporation, would be gross subpart F income of the upper-tier controlled foreign corporation. See also § 1.861-12(c)(4).

(2) Step 2: Assign stock to the section 951A category. A controlled foreign corporation is not treated as earning section 951A category income. The portion of the value of the stock of the controlled foreign corporation that is assigned to the section 951A category equals the value of the portion of the stock of the controlled foreign corporation that is assigned to the foreign source gross tested income statutory groupings within the general category (general category gross tested income stock) multiplied by the United States shareholder's inclusion percentage. Under § 1.861-8(d)(2)(ii)(C)(2)(ii), a portion of the value of stock assigned to the section 951A category may be treated as an exempt asset. The portion of the general category gross tested income stock that is not characterized as a section 951A category asset remains a general category asset and may result in expenses being disregarded under section 904(b)(4). See paragraph (a)(5)(ii) of this section and § 1.904(b)-3. No portion of the passive category gross tested income stock or U.S. source gross tested income stock is assigned to the section 951A category.

(3) Step 3: Assign stock to a treaty category. (i) Inclusions under section 951A(a). The portion of the value of the stock of the controlled foreign corporation that is assigned to a particular treaty category due to an inclusion of U.S. source income under section 951A(a) that was resourced under a particular treaty equals the value of the portion of the stock of the controlled foreign corporation that is assigned to the resourced gross tested income statutory grouping within each of the controlled foreign corporation's general or passive categories (resourced gross tested income stock) multiplied by the United States shareholder's inclusion percentage. Under § 1.861-8(d)(2)(ii)(C)(2)(ii), a portion of the value of stock assigned to a particular treaty category by reason of this paragraph (a)(3)(i) may be treated as an exempt asset. The portion of the resourced gross tested income stock that is not characterized as a treaty category asset remains a U.S. source general or passive category asset, as the case may be, that is in the residual grouping and may result in expenses being disregarded under section 904(b)(4) for purposes of determining entire taxable income under section 904(a). See paragraph (a)(5)(iv) of this section and § 1.904(b)-3.

(ii) Inclusions under section 951(a)(1). The portion of the value of the stock of the controlled foreign corporation that is assigned to a particular treaty category due to an inclusion of U.S. source income under section 951(a)(1) that was resourced under a treaty equals the value of the portion of the stock of the controlled foreign corporation that is assigned to the resourced gross subpart F income statutory grouping within each of the controlled foreign corporation's general category or passive category.

(4) Step 4: Aggregate stock within each separate category and assign stock to the residual grouping. The portions of the value of stock of the controlled foreign corporation assigned to foreign source statutory groupings that were not specifically assigned to the section 951A category under paragraph (a)(2) of this section (Step 2) are aggregated within the general category and the passive category to characterize the stock as general category stock and passive category stock, respectively. The portions of the value of stock of the controlled foreign corporation assigned to U.S. source statutory groupings that were not specifically assigned to a particular treaty category under paragraph (a)(3) of this section (Step 3) are aggregated to characterize the stock as U.S. source category stock, which is in the residual grouping. Stock assigned to the separate category for income described in section 901(j)(1) remains in that category.

(5) Step 5: Determine section 245A and non-section 245A subgroups for each separate category and U.S. source category—(i) In general. In the case of stock of a controlled foreign corporation that is held directly or indirectly through a partnership or other pass-through entity by a United States shareholder that is a domestic corporation, stock of the controlled foreign corporation that is general category stock, passive category stock, and U.S. source category stock is subdivided between a section 245A subgroup and a non-section 245A subgroup under paragraphs (a)(5)(ii) through (v) of this section for purposes of applying section 904(b)(4) and § 1.904(b)-3(c). Each subgroup is treated as a statutory grouping under § 1.861-8(a)(4) for purposes of allocating and apportioning deductions under §§ 1.861-8 through 1.861-14T and 1.861-17 in applying section 904 as the operative section. Deductions apportioned to each section 245A subgroup are disregarded under section 904(b)(4). See § 1.904(b)-3. Deductions apportioned to the statutory groupings for gross section 245(a)(5) income are not disregarded under section 904(b)(4); however, a portion of the stock assigned to those groupings is treated as exempt under § 1.861-8T(d)(2)(ii)(B).

(ii) Section 245A subgroup of general category stock. The portion of the general category stock of the controlled foreign corporation that is assigned to the section 245A subgroup of the general category equals the value of the general category gross tested income stock of the controlled foreign corporation that is not assigned to the section 951A category under paragraph (a)(2) of this section (Step 2), plus the value of the portion of the stock of the controlled foreign corporation that is assigned to the specified foreign source general category income statutory grouping.

(iii) Section 245A subgroup of passive category stock. The portion of passive category stock of the controlled foreign corporation that is assigned to the section 245A subcategory of the passive category equals the sum of—

(A) The value of the portion of the stock of the controlled foreign corporation that is assigned to the gross tested income statutory grouping within foreign source passive category income multiplied by a percentage equal to 100 percent minus the United States shareholder's inclusion percentage for passive category gross tested income; and

(B) The value of the portion of the stock of the controlled foreign corporation that was assigned to the specified foreign source passive category income statutory grouping.

(iv) Section 245A subgroup of U.S. source category stock. The portion of U.S. source category stock of the controlled foreign corporation that is assigned to the section 245A subgroup of the U.S. source category equals the sum of—

(A) The value of the portion of the stock of the controlled foreign corporation that is assigned to the U.S. source general category gross tested income statutory grouping multiplied by a percentage equal to 100 percent minus the United States shareholder's inclusion percentage for the general category;

(B) The value of the portion of the stock of the controlled foreign corporation that is assigned to the U.S. source passive category gross tested income statutory grouping multiplied by a percentage equal to 100 percent minus the United States shareholder's inclusion percentage for the passive category;

(C) The value of the resourced gross tested income stock of the controlled foreign corporation that is not assigned to a particular treaty category under paragraph (a)(3)(i) of this section (Step 3);

(D) The value of the portion of the stock of the controlled foreign corporation that is assigned to the specified U.S. source general category gross income statutory grouping; and

(E) The value of the portion of the stock of the controlled foreign corporation that is assigned to the specified U.S. source passive category gross income statutory grouping.

(v) Non-section 245A subgroup. The value of stock of a controlled foreign corporation that is not assigned to the section 245A subgroup within the general or passive category or the residual grouping is assigned to the non-section 245A subgroup within such category or grouping. The value of stock of a controlled foreign corporation that is assigned to the section 951A category, the separate category for income described in section 901(j)(1), or a particular treaty category is always assigned to a non-section 245A subgroup.

(b) Definitions. This paragraph (b) provides definitions that apply for purposes of this section.

(1) Gross section 245(a)(5) income. The term gross section 245(a)(5) income means all items of gross income described in section 245(a)(5)(A) and (B).

(2) Gross subpart F income. The term gross subpart F income means all items of gross income that are taken into account by a controlled foreign corporation in determining its subpart F income under section 952, except for items of gross income described in section 952(a)(5).

(3) Gross tested income. The term gross tested income has the meaning provided in § 1.951A-1(c)(1).

(4) Inclusion percentage. The term inclusion percentage has the meaning provided in § 1.960-2(c)(2).

(5) Separate category. The term separate category has the meaning provided in § 1.904-5(a)(4)(v).

(6) Treaty category. The term treaty category means a category of income earned by a controlled foreign corporation for which section 904(a), (b), and (c) are applied separately as a result of income being resourced under a treaty. See, for example, section 245(a)(10), 865(h), or 904(h)(10). A United States shareholder may have multiple treaty categories for amounts of income resourced by the United States shareholder under a treaty. See § 1.904-5(m)(7).

(7) U.S. source category. The term U.S. source category means the aggregate of U.S. source income in each separate category listed in section 904(d)(1).

(c) Examples. The following examples illustrate the application of the rules in this section.

(1) Example 1: Asset method—(i) Facts—(A) USP, a domestic corporation, directly owns all of the stock of a controlled foreign corporation, CFC1. The tax book value of CFC1's stock is $20,000. USP uses the asset method described in § 1.861-12T(c)(3)(ii) to characterize the stock of CFC1. USP's inclusion percentage is 70%.

(B) CFC1 owns the following assets with the following values as determined under §§ 1.861-9(g)(2) and 1.861-9T(g)(3): Assets that generate income described in the foreign source gross tested income statutory grouping within the general category ($4,000), assets that generate income described in the foreign source gross subpart F income statutory grouping within the general category ($1,000), assets that generate specified foreign source general category income ($3,000), and assets that generate income described in the foreign source gross subpart F income statutory grouping within the passive category ($2,000).

(C) CFC1 also owns all of the stock of CFC2, a controlled foreign corporation. The tax book value of CFC1's stock in CFC2 is $5,000. CFC2 owns the following assets with the following values as determined under §§ 1.861-9(g)(2) and 1.861-9T(g)(3): Assets that generate income described in the foreign source gross subpart F income statutory grouping within the general category ($2,250) and assets that generate specified foreign source general category income ($750).

(ii) Analysis—(A) Step 1—(1) Characterization of CFC2 stock. CFC2 has total assets of $3,000, $2,250 of which are in the foreign source gross subpart F income statutory grouping within the general category and $750 of which are in the specified foreign source general category income statutory grouping. Accordingly, CFC2's stock is characterized as $3,750 ($2,250/$3,000 × $5,000) in the foreign source gross subpart F income statutory grouping within the general category and $1,250 ($750/$3,000 × $5,000) in the specified foreign source general category income statutory grouping.

(2) Characterization of CFC1 stock. CFC1 has total assets of $15,000, $4,000 of which are in the foreign source gross tested income statutory grouping within the general category, $4,750 of which are in the foreign source gross subpart F income statutory grouping within the general category (including the portion of CFC2 stock assigned to that statutory grouping), $4,250 of which are in the specified foreign source general category income statutory grouping (including the portion of CFC2 stock assigned to that statutory grouping), and $2,000 of which are in the foreign source gross subpart F income statutory grouping within the passive category. Accordingly, CFC1's stock is characterized as $5,333 ($4,000/$15,000 × $20,000) in the foreign source gross tested income statutory grouping within the general category, $6,333 ($4,750/$15,000 × $20,000) in the foreign source gross subpart F income statutory grouping within the general category, $5,667 ($4,250/$15,000 × $20,000) in the specified foreign source general category income statutory grouping, and $2,667 ($2,000/$15,000 × $20,000) in the foreign source gross subpart F income statutory grouping within the passive category.

(B) Step 2. The portion of the value of the stock of CFC1 that is general category gross tested income stock is $5,333. USP's inclusion percentage is 70%. Accordingly, under paragraph (a)(2) of this section, $3,733 of the stock of CFC1 is assigned to the section 951A category and a portion thereof may be treated as an exempt asset under § 1.861-8(d)(2)(ii)(C)(2)(ii). The remainder, $1,600, remains a general category asset.

(C) Step 3. No portion of the stock of CFC1 is resourced gross tested income stock or assigned to the resourced gross subpart F income statutory grouping in any treaty category. Accordingly, no portion of the stock of CFC1 is assigned to a treaty category under paragraph (a)(3) of this section.

(D) Step 4—(1) General category stock. The total portion of the value of the stock of CFC1 that is general category stock is $13,600, which is equal to $1,600 (the portion of the value of the general category stock of CFC1 that was not assigned to the section 951A category in Step 2) plus $5,667 (the value of the portion of the stock of CFC1 assigned to the specified foreign source income statutory grouping within the general category) plus $6,333 (the value of the portion of the stock of CFC1 assigned to the foreign source gross subpart F income statutory grouping within the general category).

(2) Passive category stock. The total portion of the value of the stock of CFC1 that is passive category stock is $2,667.

(3) U.S source category stock. No portion of the value of the stock of CFC1 is U.S. source category stock.

(E) Step 5—(1) General category stock. Under paragraph (a)(5)(ii) of this section, the value of the stock of CFC1 assigned to the section 245A subgroup of general category stock is $7,267, which is equal to $1,600 (the portion of the value of the general category stock of CFC1 that was not assigned to the section 951A category in Step 2) plus $5,667 (the value of the portion of the stock of CFC1 assigned to the specified foreign source general category income statutory grouping). Under paragraph (a)(5)(v) of this section, the remainder of the general category stock of CFC1, $6,333, is assigned to the non-section 245A subgroup of general category stock.

(2) Passive category stock. No portion of the passive category stock of CFC1 is in the foreign source gross tested income statutory grouping or the specified foreign source passive category income statutory grouping. Accordingly, under paragraph (a)(5)(iii) of this section, no portion of the value of the stock of CFC1 is assigned to the section 245A subgroup of passive category stock. Under paragraph (a)(5)(v) of this section, the passive category stock of CFC1, $2,667 is assigned to the non-section 245A subgroup of passive category stock.

(3) Section 951A category stock. Under paragraph (a)(5)(v) of this section, all of the section 951A category stock, $3,733, is assigned to the non-section 245A subgroup of section 951A category stock.

(F) Summary. For purpose of the allocation and apportionment of expenses, $13,600 of the stock of CFC1 is characterized as general category stock, $7,267 of which is in the section 245A subgroup and $6,333 of which is in the non-section 245A subgroup; $2,667 of the stock of CFC1 is characterized as passive category stock, all of which is in the non-section 245A subgroup; and $3,733 of the stock of CFC1 is characterized as section 951A category stock, all of which is in the non-section 245A subgroup.

(2) Example 2: Asset method with noncontrolled 10-percent owned foreign corporation—(i) Facts. The facts are the same as in paragraph (c)(1)(i) of this section, except that CFC1 does not own CFC2 and instead owns 20% of the stock of FC2, a foreign corporation that is a noncontrolled 10-percent owned foreign corporation. The tax book value of CFC1's stock in FC2 is $5,000. FC2 owns assets with the following values as determined under §§ 1.861-9(g)(2) and 1.861-9T(g)(3): Assets that generate specified foreign source general category income ($3,000). All of the assets of FC2 generate income that, if distributed to CFC1 as a dividend, would be foreign source gross subpart F income in the general category to CFC1.

(ii) Analysis—(A) Step 1—(1) Characterization of FC2 stock. All of the assets of FC2 generate income that, if distributed to CFC1, would be foreign source gross subpart F income in the general category to CFC1. Accordingly, under paragraph (a)(1)(i) of this section, all of CFC1's stock in FC2 ($5,000) is characterized as in the foreign source gross subpart F income statutory grouping within the general category.

(2) Characterization of CFC1 stock. CFC1 has total assets of $15,000, $4,000 of which are in the foreign source gross tested income statutory grouping within the general category, $6,000 of which are in the foreign source gross subpart F income statutory grouping within the general category (including the FC2 stock assigned to that statutory grouping), $3,000 of which are in the specified foreign source general category income statutory grouping, and $2,000 of which are in the foreign source gross subpart F income statutory grouping within the passive category. Accordingly, CFC1's stock is characterized as $5,333 ($4,000/$15,000 × $20,000) in the foreign source gross tested income statutory grouping within the general category, $8,000 ($6,000/$15,000 × $20,000) in the foreign source gross subpart F income statutory grouping within the general category, $4,000 ($3,000/$15,000 × $20,000) in the specified foreign source general category income statutory grouping, and $2,667 ($2,000/$15,000 × $20,000) in the foreign source gross subpart F income statutory grouping within the passive category.

(B) Step 2. The analysis is the same as in paragraph (c)(1)(ii)(B) of this section.

(C) Step 3. The analysis is the same as in paragraph (c)(1)(ii)(C) of this section.

(D) Step 4—(1) General category stock. The total portion of the value of the stock of CFC1 that is general category stock is $13,600, which is equal to $1,600 (the portion of the value of the general category stock of CFC1 that was not assigned to the section 951A category in Step 2) plus $4,000 (the value of the portion of the stock of CFC1 assigned to the specified foreign source income statutory grouping within the general category general category) plus $8,000 (the value of the portion of the stock of CFC1 assigned to the foreign source gross subpart F income statutory grouping within the general category).

(2) Passive category stock. The analysis is the same as in paragraph (c)(1)(ii)(D)(2) of this section.

(E) Step 5—(1) General category stock. Under paragraph (a)(5)(ii) of this section, the value of the stock of CFC1 assigned to the section 245A subgroup of general category stock is $5,600, which is equal to $1,600 (the portion of the value of the general category stock of CFC1 that was not assigned to the section 951A category in Step 2) plus $4,000 (the value of the portion of the stock of CFC1 assigned to the specified foreign source general category income statutory grouping). Under paragraph (a)(5)(v) of this section, the remainder of the general category stock of CFC1, $8,000, is assigned to the non-section 245A subgroup of general category stock.

(2) Passive category stock. The analysis is the same as in paragraph (c)(1)(ii)(E)(2) of this section.

(3) Section 951A category stock. The analysis is the same as in paragraph (c)(1)(ii)(E)(3) of this section.

(F) Summary. For purpose of the allocation and apportionment of expenses, $13,600 of the stock of CFC1 is characterized as general category stock, $5,600 of which is in the section 245A subgroup and $8,000 of which is in the non-section 245A subgroup; $2,667 of the stock of CFC1 is characterized as passive category stock, all of which is in the non-section 245A subgroup; and $3,733 of the stock of CFC1 is characterized as section 951A category stock, all of which is in the non-section 245A subgroup.

(3) Example 3: Modified gross income method—(i) Facts—(A) USP, a domestic corporation, directly owns all of the stock of a controlled foreign corporation, CFC1. The tax book value of CFC1's stock is $100,000. CFC1 owns all of the stock of CFC2, a controlled foreign corporation. USP uses the modified gross income method described in § 1.861-12(c)(3)(iii) to characterize the stock in CFC1. USP's inclusion percentage is 100%.

(B) CFC1 earns $1,500 of foreign source gross tested income within the general category and $500 of foreign source gross subpart F income within the passive category. CFC1 incurs $200 of interest expense.

(C) CFC2 earns $3,000 of foreign source gross tested income within the general category, $2,000 of foreign source gross subpart F income within the general category, and $1,000 of specified foreign source general category income. CFC2 incurs $3,000 of interest expense.

(ii) Analysis—(A) Step 1—(1) Determination of CFC2 gross income (net of interest expense). CFC2 has total gross income of $6,000. CFC2's $3,000 of interest expense is apportioned among the statutory groupings of gross income based on the gross income of CFC2 to determine the gross income (net of interest expense) of CFC2 in each statutory grouping. As a result, $1,500 ($3,000/$6,000 × $3,000) of interest expense is apportioned to foreign source gross tested income within the general category, $1,000 ($2,000/$6,000 × $3,000) of interest expense is apportioned to foreign source gross subpart F income within the general category, and $500 ($1,000/$6,000 × $3,000) of interest expense is apportioned to specified foreign source general category income. Accordingly, CFC2 has the following amounts of gross income (net of interest expense): $1,500 ($3,000−$1,500) of foreign source gross tested income within the general category, $1,000 ($2,000−$1,000) of foreign source gross subpart F income within the general category, and $500 ($1,000−$500) of specified foreign source general category income.

(2) Determination of CFC1 gross income (net of interest expense). Before including the gross income consisting of subpart F income and tested income (net of interest expense) of CFC2, CFC1 has total gross income of $2,500, including $500 of CFC2's specified foreign source general category income which is combined with CFC1's items of gross income under § 1.861-9(j)(2)(ii). CFC1's $200 of interest expense is apportioned among the statutory groupings of gross income of CFC1 to determine the gross income (net of interest expense) of CFC1 in each statutory grouping. As a result, $120 ($1,500/$2,500 × $200) of interest expense is apportioned to foreign source gross tested income within the general category, $40 ($500/$2,500 × $200) to foreign source gross subpart F income within the passive category, and $40 ($500/$2,500 × $200) to specified foreign source general category income. Accordingly, CFC1 has the following amounts of gross income (net of interest expense) before including the gross income (net of interest expense) of CFC2: $1,380 ($1,500−$120) of foreign source gross tested income within the general category, $460 ($500−$40) of foreign source gross subpart F income within the passive category, and $460 ($500−$40) of specified foreign source general category income. After including the gross income consisting of subpart F income and tested income (net of interest expense) of CFC2, CFC1 has the following amounts of gross income (net of interest expense): $2,880 ($1,380 + $1,500) of foreign source gross tested income within the general category, $1,000 of foreign source gross subpart F income within the general category, $460 of specified foreign source general category income, and $460 of foreign source gross subpart F income within the passive category.

(3) Characterization of CFC1 stock. CFC1 is considered to have a total of $4,800 of gross income (net of interest expense) for purposes of characterizing the stock of CFC1. Accordingly, CFC1's stock is characterized as $60,000 ($2,880/$4,800 × $100,000) in the foreign source gross tested income statutory grouping within the general category, $20,834 ($1,000/$4,800 × $100,000) in the foreign source gross subpart F income statutory grouping within the general category, $9,583 ($460/$4,800 × $100,000) in the specified foreign source general category income statutory grouping, and $9,583 ($460/$4,800 × $100,000) in the foreign source gross subpart F income statutory grouping within the passive category.

(B) Step 2. The portion of the value of the stock of CFC1 that is general category gross tested income stock is $60,000. USP's inclusion percentage is 100%. Accordingly, under paragraph (a)(2) of this section, all of the $60,000 of the stock of CFC1 is assigned to the section 951A category.

(C) Step 3. No portion of the stock of CFC1 is resourced gross tested income or assigned to the resourced gross subpart F income statutory group in any treaty category. Accordingly, no portion of the stock of CFC1 is assigned to a treaty category under paragraph (a)(3) of this section.

(D) Step 4—(1) General category stock. The total portion of the value of the stock of CFC1 that is general category stock is $30,417, which is equal to $20,834 (the value of the portion of the stock of CFC1 assigned to the subpart F income statutory grouping within the general category income statutory grouping) plus $9,583 (the value of the portion of the stock of CFC1 assigned to the specified foreign source general category income statutory grouping).

(2) Passive category stock. The total portion of the value of the stock of CFC1 that is passive category stock is $9,583.

(3) U.S. source category stock. No portion of the value of the stock of CFC1 is U.S. source category stock.

(E) Step 5—(1) General category stock. All of the value of the general category gross tested income stock of CFC1 was assigned to the section 951A category in Step 2. Accordingly, under paragraph (a)(5)(ii) of this section, the value of the stock of CFC1 assigned to the section 245A subgroup of general category stock is $9,583, which is equal to the value of the portion assigned to the specified foreign source general category income statutory grouping. Under paragraph (a)(5)(v) of this section, the remainder of the general category stock of CFC1, $20,834, is assigned to the non-section 245A subgroup of general category stock.

(2) Passive category stock. No portion of the passive category stock of CFC1 is in the foreign source gross tested income statutory grouping or the specified foreign source passive category income statutory grouping. Accordingly, under paragraph (a)(5)(iii) of this section, no portion of the value of the stock of CFC1 is assigned to the section 245A subgroup. Under paragraph (a)(5)(v) of this section, the passive category stock of CFC1, $9,534, is assigned to the non-section 245A subgroup of passive category stock.

(3) Section 951A category stock. Under paragraph (a)(5)(v) of this section, all of the section 951A category stock, $60,000, is assigned to the non-section 245A subgroup of section 951A category stock.

(F) Summary. For purposes of the allocation and apportionment of expenses, $60,000 of the stock of CFC1 is characterized as section 951A category stock, all of which is in the non-section 245A subgroup; $30,417 of the stock of CFC1 is characterized as general category stock, $9,583 of which is in the section 245A subgroup and $20,834 of which is in the non-section 245A subgroup; and $9,583 of the stock of CFC1 is characterized as passive category stock, all of which is in the non-section 245A subgroup.

(d) Applicability dates. This section applies for taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

(e) * * *

(3) Change of method for first taxable year beginning after December 31, 2017. A taxpayer otherwise subject to the binding election described in paragraph (e)(1) of this section may change its method once for its first taxable year beginning after December 31, 2017, without the prior consent of the Commissioner. The taxpayer's use of a new method constitutes a binding election to use the new method for its return filed for the first year for which the taxpayer uses the new method and for four taxable years thereafter.

(g) [Reserved]

(i) Applicability date. This section applies to taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

(a) Sourcing rule for related party payments and inclusions. Any income paid or accrued through one or more entities is treated as income from sources within a country described in section 901(j)(2) if the income was, without regard to such entities, from sources within that country.

(b) Applicability date. This section applies to taxable years that end on or after December 4, 2018.

(a) In general. For each separate category described in § 1.904-5(a)(4)(v), the total credit for taxes paid or accrued (including those deemed to have been paid or accrued other than by reason of section 904(c)) shall not exceed that proportion of the tax against which such credit is taken which the taxpayer's taxable income from foreign sources (but not in excess of the taxpayer's entire taxable income) in such separate category bears to his entire taxable income for the same taxable year.

(b) Special computation of taxable income. For purposes of computing the limitation under paragraph (a) of this section, the taxable income in the case of an individual, estate, or trust is computed without any deduction for personal exemptions under section 151 or 642(b).

(c) Joint return. In the case of spouses making a joint return, the applicable limitation prescribed by section 904(a) on the credit for taxes paid or accrued to foreign countries and possessions of the United States is applied with respect to the aggregate taxable income in each separate category from sources without the United States, and the aggregate taxable income from all sources, of the spouses.

(d) Consolidated group. For rules relating to the computation of the foreign tax credit limitation for a consolidated group, see § 1.1502-4.

(e) Applicability dates. This section applies to taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

(a) Credit for foreign tax carryback or carryover. A taxpayer who chooses to claim a credit under section 901 for a taxable year is allowed a credit under that section not only for taxes otherwise allowable as a credit but also for taxes deemed paid or accrued in that year as a result of a carryback or carryover of an unused foreign tax under section 904(c). However, the taxes so deemed paid or accrued are not allowed as a deduction under section 164(a). Foreign tax paid or accrued with respect to section 951A category income, including section 951A category income that is reassigned to a separate category for income resourced under a treaty, may not be carried back or carried forward or deemed paid or accrued under section 904(c). For special rules regarding these computations in case of taxes paid, accrued, or deemed paid with respect to foreign oil and gas extraction income or foreign oil related income, see section 907(f) and the regulations under that section.

(b) Years to which foreign taxes are carried. If the taxpayer chooses the benefits of section 901 for a taxable year, any unused foreign tax paid or accrued in that year is carried first to the immediately preceding taxable year and then, as applicable, to each of the ten succeeding taxable years, in chronological order, but only to the extent not absorbed as taxes deemed paid or accrued under paragraph (d) of this section in a prior taxable year.

(c) Definitions. This paragraph (c) provides definitions that apply for purposes of this section.

(1) Unused foreign tax. The term unused foreign tax means, with respect to each separate category for any taxable year, the excess of the amount of creditable foreign tax paid or accrued, or deemed paid under section 902 (as in effect on December 21, 2017) or section 960, in such year, over the applicable foreign tax credit limitation under section 904 for the separate category in such year. Unused foreign tax does not include any amount for which a credit is disallowed, including foreign income taxes for which a credit is disallowed or reduced when the tax is paid, accrued, or deemed paid.

(2) Separate category. The term separate category has the same meaning as provided in § 1.904-5(a)(4)(v).

(3) Excess limitation—(i) In general. The term excess limitation means, with respect to a separate category for any taxable year (the excess limitation year) and an unused foreign tax carried from another taxable year (the excess credit year), the amount (if any) by which the limitation for that separate category with respect to that excess limitation year exceeds the sum of—

(A) The creditable foreign tax actually paid or accrued or deemed paid under section 902 (as in effect on December 21, 2017) or section 960 with respect to the separate category in the excess limitation year, and

(B) The portion of any unused foreign tax for a taxable year preceding the excess credit year that is absorbed as taxes deemed paid or accrued in the excess limitation year under paragraph (a) of this section.

(ii) Deduction years. Excess limitation for a taxable year absorbs unused foreign tax, regardless of whether the taxpayer chooses to claim a credit under section 901 for the year. In such case, the amount of the excess limitation, if any, for the year is determined in the same manner as though the taxpayer had chosen to claim a credit under section 901 for that year. For purposes of this determination, if the taxpayer has an overall foreign loss account, the excess limitation in a deduction year is determined based on the amount of the overall foreign loss the taxpayer would have recaptured if the taxpayer had chosen to claim a credit under section 901 for that year and had not made an election under § 1.904(f)-2(c)(2) to recapture more of the overall foreign loss account than is required under § 1.904(f)-2(c)(1).

(d) Taxes deemed paid or accrued—(1) Amount deemed paid or accrued. The amount of unused foreign tax with respect to a separate category that is deemed paid or accrued in any taxable year to which such unused foreign tax may be carried under paragraph (b) of this section is equal to the smaller of—

(i) The portion of the unused foreign tax that may be carried to the taxable year under paragraph (b) of this section, or

(ii) The amount, if any, of the excess limitation for such taxable year with respect to such unused foreign tax.

(2) Carryback or carryover tax deemed paid or accrued in the same separate category. Any unused foreign tax, which is deemed to be paid or accrued under section 904(c) in the year to which it is carried, is deemed to be paid or accrued with respect to the same separate category as the category to which it was assigned in the year in which it was actually paid or accrued. However, see paragraphs (h) through (j) of this section for transition rules in the case of certain carrybacks and carryovers.

(3) No duplicate disallowance of creditable foreign tax. Foreign income taxes for which a credit is partially disallowed, including when the tax is paid, accrued, or deemed paid, are not reduced again by reason of the unused foreign tax being deemed to be paid or accrued in the year to which it is carried under section 904(c).

(g) [Reserved]

(h) Transition rules for carryovers of pre-2003 unused foreign tax and carrybacks of post-2002 unused foreign tax paid or accrued with respect to dividends from noncontrolled section 902 corporations. For transition rules for carryovers of pre-2003 unused foreign tax, and carrybacks of post-2002 unused foreign tax, paid or accrued with respect to dividends from noncontrolled section 902 corporations, see 26 CFR 1.904-2(h) (revised as of April 1, 2018).

(i) Transition rules for carryovers of pre-2007 unused foreign tax and carrybacks of post-2006 unused foreign tax. For transition rules for carryovers of pre-2007 unused foreign tax, and carrybacks of post-2006 unused foreign tax, see 26 CFR 1.904-2(i) (revised as of April 1, 2018).

(j) Transition rules for carryovers and carrybacks of pre-2018 and post-2017 unused foreign tax—(1) Carryover of unused foreign tax—(i) In general. For purposes of this paragraph (j), the terms post-2017 separate category, pre-2018 separate category, and specified separate category have the meanings set forth in § 1.904(f)-12(j)(1). The rules of this paragraph (j)(1) apply to reallocate to the taxpayer's post-2017 separate categories for foreign branch category income, general category income, passive category income, and specified separate categories of income, any unused foreign taxes (as defined in paragraph (c)(1) of this section) that were paid or accrued or deemed paid under sections 902 and 960 with respect to income in a pre-2018 separate category.

(ii) Allocation to the same separate category. Except as provided in paragraph (j)(1)(iii) of this section, to the extent any unused foreign taxes paid or accrued or deemed paid with respect to a separate category of income are carried forward to a taxable year beginning after December 31, 2017, such taxes are allocated to the same post-2017 separate category as the pre-2018 separate category from which the unused foreign taxes are carried.

(iii) Exception for certain general category unused foreign taxes—(A) In general. To the extent any unused foreign taxes paid or accrued (but not taxes deemed paid) with respect to general category income are carried forward to a taxable year beginning after December 31, 2017, a taxpayer may choose to allocate those taxes to the taxpayer's post-2017 separate category for foreign branch category income to the extent those taxes would have been allocated to the taxpayer's post-2017 separate category for foreign branch category income if the taxes were paid or accrued in a taxable year beginning after December 31, 2017. Any remaining unused foreign taxes paid or accrued or deemed paid with respect to general category income carried forward to a taxable year beginning after December 31, 2017, are allocated to the taxpayer's post-2017 separate category for general category income.

(B) Rules regarding the exception. A taxpayer applying the exception described in paragraph (j)(1)(iii)(A) of this section (the branch carryover exception) must apply the exception to all of its unused foreign taxes paid or accrued with respect to general category income that are carried forward to all taxable years beginning after December 31, 2017. A taxpayer may choose to apply the branch carryover exception on a timely filed original return (including extensions) or an amended return. A taxpayer that applies the exception on an amended return must make appropriate adjustments to eliminate any double benefit arising from application of the exception to years that are not open for assessment.

(2) Carryback of unused foreign tax—(i) In general. The rules of this paragraph (j)(2) apply to any unused foreign taxes that were paid or accrued, or deemed paid under section 960, with respect to income in a post-2017 separate category.

(ii) Passive category income and specified separate categories of income described in § 1.904-4(m). Any unused foreign taxes paid or accrued or deemed paid with respect to passive category income or a specified separate category of income in a taxable year beginning after December 31, 2017, that are carried back to a taxable year beginning before January 1, 2018, are allocated to the same pre-2018 separate category as the post-2017 separate category from which the unused foreign taxes are carried.

(iii) General category income and foreign branch category income. Any unused foreign taxes paid or accrued or deemed paid with respect to general category income or foreign branch category income in a taxable year beginning after December 31, 2017, that are carried back to a taxable year beginning before January 1, 2018, are allocated to the taxpayer's pre-2018 separate category for general category income.

(k) Applicability date. Paragraphs (a) through (i) of this section apply to taxable years that both begin after December 31, 2017, and end on or after December 4, 2018. Paragraph (j) of this section applies to taxable years beginning after December 31, 2017. Paragraph (j)(2) of this section also applies to the last taxable year beginning before January 1, 2018.

(a) * * * The rules in this section apply separately with respect to each separate category as defined in § 1.904-5(a)(4)(v).

(e) Amounts carried from or through a joint return year to or through a separate return year—(1) In general. It is necessary to allocate to each spouse the spouse's share of an unused foreign tax or excess limitation for any taxable year for which the spouses filed a joint return if—

(i) The spouses file separate returns for the current taxable year and an unused foreign tax is carried thereto from a taxable year for which they filed a joint return;

(ii) The spouses file separate returns for the current taxable year and an unused foreign tax is carried to such taxable year from a year for which they filed separate returns but is first carried through a year for which they filed a joint return; or

(iii) The spouses file a joint return for the current taxable year and an unused foreign tax is carried from a taxable year for which they filed joint returns but is first carried through a year for which they filed separate returns.

(2) Computation and adjustments. In the cases described in paragraph (e)(1) of this section, the separate carryback or carryover of each spouse to the current taxable year shall be computed in the manner described in § 1.904-2 but with the modifications set forth in paragraph (f) of this section. Where applicable, appropriate adjustments are made to take into account the fact that, for any taxable year involved in the computation of the carryback or the carryover, either spouse has combined foreign oil and gas income described in section 907(b) with respect to which the limitation in section 907(a) applies.

(f) * * * (1) Separate category limitation. The limitation in a separate category of a particular spouse for a taxable year for which a joint return is made shall be the portion of the limitation on the joint return which bears the same ratio to such limitation as such spouse's foreign source taxable income (with gross income and deductions taken into account to the same extent as taken into account on the joint return) in such separate category (but not in excess of the joint foreign source taxable income) bears to the joint foreign source taxable income in such separate category.

(2) Unused foreign tax. For purposes of this section, the term unused foreign tax means, with respect to a particular spouse and separate category for a taxable year for which a joint return is made, the excess of the foreign tax paid or accrued by that spouse with respect to that separate category over that spouse's separate category limitation.

(3) Excess limitation. For purposes of this section, the term excess limitation means, with respect to a particular spouse and separate category for a taxable year for which a joint return is made, the excess of that spouse's separate category limitation over the foreign taxes paid or accrued by such spouse with respect to such separate category for such taxable year.

(g) [Reserved]

(h) Applicability date. This section is applicable for taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

(a) In general. A taxpayer is required to compute a separate foreign tax credit limitation for income received or accrued in a taxable year that is described in section 904(d)(1)(A) (section 951A category income), 904(d)(1)(B) (foreign branch category income), 904(d)(1)(C) (passive category income), 904(d)(1)(D) (general category income), or paragraph (m) of this section (specified separate categories). For purposes of this section, the definitions in § 1.904-5(a)(4) apply.

(b) * * *

(2) * * *

(i) * * *

(C) Distributive shares of partnership income treated as passive category income under paragraph (n)(1) of this section, and income from the sale of a partnership interest treated as passive category income under paragraph (n)(2) of this section; or

(D) Income treated as passive category income under the look-through rules in § 1.904-5.

(ii) Exceptions. Passive income does not include any export financing interest (as defined in paragraph (h) of this section), any high-taxed income (as defined in paragraph (c) of this section), financial services income (as defined in paragraph (e)(1)(ii) of this section), or any active rents and royalties (as defined in paragraph (b)(2)(iii) of this section). In addition, passive income does not include any income that would otherwise be passive but is excluded from passive category income under § 1.904-5(b)(1). * * *

(c) * * * (1) * * * Income is considered to be high-taxed income if, after allocating expenses, losses, and other deductions of the United States person to that income under paragraph (c)(2) of this section, the sum of the foreign income taxes paid or accrued, and deemed paid under section 960, by the United States person with respect to such income (reduced by any portion of such taxes for which a credit is not allowed) exceeds the highest rate of tax specified in section 1 or 11, whichever applies (and with reference to section 15 if applicable), multiplied by the amount of such income (including the amount treated as a dividend under section 78). If, after application of this paragraph (c), income that would otherwise be passive income is determined to be high-taxed income, the income is treated as general category income, foreign branch category income, section 951A category income, or income in a specified separate category, as determined under the rules of this section, and any taxes imposed on that income are considered related to the same separate category of income under § 1.904-6. If, after application of this paragraph (c), passive income is zero or less than zero, any taxes imposed on the passive income are considered related to the same separate category of income to which the passive income (if not reduced to zero or less than zero) would have been assigned had the income been treated as high-taxed income (general category, foreign branch category, section 951A category, or a specified separate category). * * *

(3) * * * Paragraph (c)(4) of this section provides additional rules for inclusions under section 951(a)(1) or 951A(a) that are passive income, dividends from a controlled foreign corporation or noncontrolled 10-percent owned foreign corporation that are passive income, and income that is received or accrued by a United States person through a foreign QBU that is passive income. For purposes of this paragraph (c), a foreign QBU is a qualified business unit (as defined in section 989(a)), other than a controlled foreign corporation or noncontrolled 10-percent owned foreign corporation, that has its principal place of business outside the United States. These rules apply whether the income is received from a controlled foreign corporation of which the United States person is a United States shareholder, from a noncontrolled 10-percent owned foreign corporation of which the United States person is a United States shareholder that is a domestic corporation, or from any other person. In applying these rules, passive income is not treated as subject to a withholding tax or other foreign tax for which a credit is disallowed in full, for example, under section 901(k). * * *

(4) Dividends and inclusions from controlled foreign corporations, dividends from noncontrolled 10-percent owned foreign corporations, and income attributable to foreign QBUs. Except as provided in paragraph (c)(5) of this section, the rules of this paragraph (c)(4) apply to all dividends and all amounts included in gross income of a United States shareholder under section 951(a)(1) or 951A(a) with respect to the foreign corporation that (after application of the look-through rules of section 904(d)(3) and § 1.904-5) are attributable to passive income received or accrued by a controlled foreign corporation, all dividends from a noncontrolled 10-percent owned foreign corporation that are received or accrued by a United States shareholder that (after application of the look-through rules of section 904(d)(4) and § 1.904-5) are treated as passive income, and all amounts of passive income received or accrued by a United States person through a foreign QBU. The grouping rules of paragraph (c)(3)(i) through (iv) of this section apply separately to dividends, to inclusions under section 951(a)(1) and to inclusions under section 951A(a) with respect to each controlled foreign corporation of which the taxpayer is a United States shareholder, and to dividends with respect to each noncontrolled 10-percent owned foreign corporation of which the taxpayer is a United States shareholder that is a domestic corporation. The grouping rules of paragraph (c)(3)(i) through (iv) of this section also apply separately to income attributable to each foreign QBU of a controlled foreign corporation, noncontrolled 10-percent owned foreign corporation, any other look-through entity as defined in § 1.904-5(i), or any United States person.

(5) * * *

(ii) Treatment of partnership income. A partner's distributive share of income from a foreign or United States partnership that is treated as passive income under paragraph (n)(1)(ii) of this section (generally providing that a less than 10 percent partner's distributive share of partnership income is passive income) is treated as a single item of income and is not grouped with other amounts. A distributive share of income from a partnership that is treated as passive income under paragraph (n)(1)(i) of this section is grouped according to the rules in paragraph (c)(3) of this section, except that the portion, if any, of the distributive share of income attributable to income earned by a United States partnership through a foreign QBU is separately grouped under the rules of paragraph (c)(4) of this section.

(6) * * * (i) * * * The determination of whether an amount included in gross income under section 951(a)(1) or 951A(a) is high-taxed income is made in the taxable year the income is included in the gross income of the United States shareholder under section 951(a) or 951A(a) (for purposes of this paragraph (c), the year of inclusion). * * *

(iii) * * * If an item of income is considered high-taxed income in the year of inclusion and paragraph (c)(6)(i) of this section applies, then any increase in foreign income taxes imposed with respect to that item are considered to be related to the same separate category to which the income was assigned in the taxable year of inclusion. * * * The taxpayer shall treat any taxes paid or accrued, or deemed paid, on the distribution in excess of this amount as taxes related to the same category of income to which such inclusion would have been assigned had the income been treated as high-taxed income in the year of inclusion (general category income, section 951A category income, or income in a specified separate category). If these additional taxes are not creditable in the year of distribution, the carryover rules of section 904(c) apply (see section 904(c) and § 1.904-2(a) for rules disallowing carryovers in the section 951A category). For purposes of this paragraph (c)(6), the foreign tax on an inclusion under section 951(a)(1) or 951A(a) is considered increased on distribution of the earnings and profits associated with that inclusion if the total of taxes paid and deemed paid on the inclusion and the distribution (taking into account any reductions in tax and any withholding taxes) exceeds the total taxes deemed paid in the year of inclusion. * * *

(iv) Increase in taxes paid by successors. If passive earnings and profits previously included in income of a United States shareholder are distributed to a person that was not a United States shareholder of the distributing corporation in the year the earnings were included, any increase in foreign taxes paid or accrued, or deemed paid, on that distribution is treated as tax related to general category income (or income in a specified separate category, if applicable) in the case of earnings and profits previously included under section 951(a)(1), and is treated as tax related to section 951A category income (or income in a specified separate category, if applicable) in the case of earnings and profits previously included under section 951A(a), regardless of whether the previously-taxed income was considered high-taxed income under section 904(d)(2)(F) in the year of inclusion.

(7) * * * (i) * * * If the inclusion is considered to be high-taxed income, then the taxpayer shall treat the inclusion as general category income, section 951A category income or income in a specified separate category as provided in paragraph (c)(1) of this section. * * * For this purpose, the foreign tax on an inclusion under section 951(a)(1) or 951A(a) shall be considered reduced on distribution of the earnings and profits associated with the inclusion if the total taxes paid and deemed paid on the inclusion and the distribution (taking into account any reductions in tax and any withholding taxes) is less than the total taxes deemed paid in the year of inclusion. * * *

(d) General category income. The term general category income means all income other than passive category income, foreign branch category income, section 951A category income, and income in a specified separate category. Any item that is excluded from the passive category under section 904(d)(2)(B)(iii) or § 1.904-5(b)(1) is included in general category income only to the extent that such item does not meet the definition of another separate category. General category income also includes income treated as general category income under the look-through rules referenced in § 1.904-5(a)(2).

(e) * * * (1) In general—(i) Treatment of financial services income. Financial services income that meets the definition of foreign branch category income is treated as income in that category. Financial services income of a controlled foreign corporation that is included in gross income of a United States shareholder under section 951A(a) is treated as section 951A category income in the hands of the United States shareholder. Financial services income that is neither treated as foreign branch category income nor treated as section 951A category income is treated as general category income.

(ii) Definition of financial services income. The term financial services income means income derived by a financial services entity, as defined in paragraph (e)(3) of this section, that is:

(A) Income derived in the active conduct of a banking, insurance, financing, or similar business (active financing income as defined in paragraph (e)(2) of this section);

(B) Passive income as defined in section 904(d)(2)(B) and paragraph (b) of this section as determined before the application of the exception for high-taxed income but after the application of the exception for export financing interest; or

(C) Incidental income as defined in paragraph (e)(4) of this section.

(2) * * *

(i) * * *

(W) [Reserved]

(f) Foreign branch category income—(1) Foreign branch category income—(i) In general. Except as provided in paragraph (f)(1)(ii) of this section, the term foreign branch category income means income of a United States person, other than a pass-through entity, that is—

(A) Income attributable to foreign branches of the United States person held directly or indirectly through disregarded entities;

(B) A distributive share of partnership income that is attributable to foreign branches held by the partnership directly or indirectly through disregarded entities, or held indirectly by the partnership through another partnership or other pass-through entity that holds the foreign branch directly or indirectly through disregarded entities; and

(C) Income from other pass-through entities determined under principles similar to those described in paragraph (f)(1)(i)(B) of this section.

(ii) Passive category income excluded from foreign branch category income. Income assigned to the passive category under paragraph (b) of this section is not foreign branch category income, regardless of whether the income is described in paragraph (f)(1)(i) of this section. Income that is treated as passive category income under the look-through rules in § 1.904-5 is also excluded from foreign branch category income, regardless of whether the income is attributable to a foreign branch. However, income that would be passive category income but for the application of section 904(d)(2)(B)(iii) (export financing interest and high-taxed income) or 904(d)(2)(C) (financial services income) and the regulations under those sections and also meets the definition of foreign branch category income is foreign branch category income.

(2) Gross income attributable to a foreign branch—(i) In general. Except as provided in this paragraph (f)(2), gross income is attributable to a foreign branch to the extent the gross income (as adjusted to conform to Federal income tax principles) is reflected on the separate set of books and records (as defined in § 1.989(a)-1(d)(1) and (2)) of the foreign branch. Gross income that is not attributable to the foreign branch and is therefore attributable to the foreign branch owner is treated as income in a separate category (other than the foreign branch category) under the other rules of this section.

(ii) Income attributable to U.S. activities. Gross income attributable to a foreign branch does not include items arising from activities carried out in the United States, regardless of whether the items are reflected on the foreign branch's separate books and records.

(iii) Income arising from stock—(A) In general. Except as provided in paragraph (f)(2)(iii)(B) of this section, gross income attributable to a foreign branch does not include items of income arising from stock of a corporation (whether foreign or domestic), including gain from the disposition of such stock or any inclusion under sections 951(a), 951A(a), or 1293(a).

(B) Exception for dealer property. Paragraph (f)(2)(iii)(A) of this section does not apply to gain recognized from dispositions of stock in a corporation, if the stock would be dealer property (as defined in § 1.954-2(a)(4)(v)) if the foreign branch were a controlled foreign corporation.

(iv) Disposition of interests in certain entities—(A) In general. Except as provided in paragraph (f)(2)(iv)(B) of this section, gross income attributable to a foreign branch does not include gain from the disposition of an interest in a partnership or other pass-through entity or an interest in a disregarded entity. See also paragraph (n)(2) of this section for general rules relating to the sale of a partnership interest.

(B) Exception for sales by a foreign branch in the ordinary course of business. The rule in paragraph (f)(2)(iv)(A) of this section does not apply to gain from the sale or exchange of an interest in a partnership or other pass-through entity or an interest in a disregarded entity if the gain is reflected on the books and records of a foreign branch and the interest is held by the foreign branch in the ordinary course of its active trade or business. An interest is considered to be held in the ordinary course of the foreign branch's active trade or business if the foreign branch engages in the same or a related trade or business as the partnership or other pass-through entity (other than through a less than 10 percent interest) or disregarded entity.

(v) Adjustments to items of gross income reflected on the books and records. If a principal purpose of recording or failing to record an item of gross income on the books and records of a foreign branch, or of making a disregarded payment described in paragraph (f)(2)(vi) of this section, is the avoidance of Federal income tax, the purposes of section 904, or the purposes of section 250 (in connection with section 250(b)(3)(A)(i)(VI)), the item must be attributed to one or more foreign branches or the foreign branch owner in a manner that reflects the substance of the transaction. For purposes of this paragraph (f)(2)(v), interest received by a foreign branch from a related person is presumed to be attributable to the foreign branch owner (and not to the foreign branch) unless the interest income meets the definition of financial services income under paragraph (e)(1)(ii) of this section. For purposes of this paragraph (f)(2)(v), a related person is any person that bears a relationship to the foreign branch owner described in section 267(b) or 707.

(vi) Attribution of gross income to which disregarded payments are allocable—(A) In general. If a foreign branch makes a disregarded payment to its foreign branch owner and the disregarded payment is allocable to non-passive category gross income of the foreign branch reflected on the foreign branch's separate set of books and records under paragraph (f)(2)(i) of this section, the gross income attributable to the foreign branch is adjusted downward to reflect the allocable amount of the disregarded payment, and the general category gross income attributable to the foreign branch owner is adjusted upward by the same amount, translated (if necessary) from the foreign branch's functional currency to U.S. dollars at the spot rate, as defined in § 1.988-1(d), on the date of the disregarded payment. Similarly, if a foreign branch owner makes a disregarded payment to its foreign branch and the disregarded payment is allocable to general category gross income of the foreign branch owner that was not reflected on the separate set of books and records of any foreign branch of the foreign branch owner, the gross income attributable to the foreign branch owner is adjusted downward to reflect the allocable amount of the disregarded payment, and the gross income attributable to the foreign branch is adjusted upward by the same amount, translated (if necessary) from U.S. dollars to the foreign branch's functional currency at the spot rate, as defined in § 1.988-1(d), on the date of the disregarded payment. An adjustment to the attribution of gross income under this paragraph (f)(2)(vi) does not change the total amount, character, or source of the United States person's gross income. Similar rules apply in the case of disregarded payments between a foreign branch and another foreign branch with the same foreign branch owner.

(B) Allocation of disregarded payments—(1) In general. Whether a disregarded payment is allocable to gross income of a foreign branch or its foreign branch owner, and the source and separate category of the gross income to which the disregarded payment is allocable, is determined under the following rules:

(i) Disregarded payments from a foreign branch owner to its foreign branch are allocable to gross income attributable to the foreign branch owner to the extent a deduction for that payment, if regarded, would be allocated and apportioned to general category gross income of the foreign branch owner under the principles of §§ 1.861-8 through 1.861-14T and 1.861-17 by treating foreign source general category gross income and U.S. source general category gross income each as a statutory grouping; and

(ii) Disregarded payments from a foreign branch to its foreign branch owner are allocable to gross income attributable to the foreign branch to the extent a deduction for that payment, if regarded, would be allocated and apportioned to gross income of the foreign branch under the principles of §§ 1.861-8 through 1.861-14T and 1.861-17 by treating foreign source gross income in the foreign branch category and U.S. source gross income in the foreign branch category each as a statutory grouping.

(2) Disregarded sales of property. The principles of paragraph (f)(2)(vi)(B)(1)(i) and (ii) of this section apply in the case of disregarded payments in consideration for the transfer of property between a foreign branch and its foreign branch owner to the extent the disregarded payment, if regarded, would, for purposes of determining gross income, be subtracted from gross receipts that are regarded for Federal income tax purposes.

(3) Conditions and timing of reallocation. The gross income attributable to the foreign branch is adjusted only in the taxable year, and only to the extent, that a disregarded payment, if regarded, would be allowed as a deduction or otherwise would be taken into account (for example, as an increase to cost of goods sold).

(C) Exclusion of certain disregarded payments. Paragraph (f)(2)(vi)(A) of this section does not apply to the following payments, accruals, or other transfers between a foreign branch and its foreign branch owner that are disregarded for Federal income tax purposes:

(1) Interest and interest equivalents that, if regarded, would be described in § 1.861-9T(b);

(2) Remittances from the foreign branch to its foreign branch owner, except as provided in paragraph (f)(2)(vi)(D) of this section; or

(3) Contributions of money, securities, and other property from the foreign branch owner to its foreign branch, except as set forth in paragraph (f)(2)(vi)(D) of this section.

(D) Certain transfers of intangible property. For purposes of applying this paragraph (f)(2)(vi), the amount of gross income attributable to a foreign branch (and the amount of gross income attributable to its foreign branch owner) that is not passive category income must be adjusted under the principles of paragraph (f)(2)(vi)(B) of this section to reflect all transactions that are disregarded for Federal income tax purposes in which property described in section 367(d)(4) is transferred to or from a foreign branch, whether or not a disregarded payment is made in connection with the transfer. In determining the amount of gross income that is attributable to a foreign branch that must be adjusted by reason of this paragraph (f)(2)(vi)(D), the principles of sections 367(d) and 482 apply. For example, if a foreign branch owner transfers property described in section 367(d)(4), the principles of section 367(d) are applied by treating the foreign branch as a separate corporation to which the property is transferred in exchange for stock of the corporation in a transaction described in section 351.

(E) Amount of disregarded payments. The amount of each disregarded payment used to make an adjustment under this paragraph (f)(2)(vi) (or the absence of any adjustment) must be determined in a manner that results in the attribution of the proper amount of gross income to each of a foreign branch and its foreign branch owner under the principles of section 482, applied as if the foreign branch were a corporation.

(F) Ordering rules. For purposes of applying this paragraph (f)(2)(vi), adjustments related to disregarded payments from a foreign branch to its foreign branch owner are computed first, followed by adjustments related to disregarded payments from a foreign branch owner to its foreign branch.

(3) Definitions. The following definitions apply for purposes of this paragraph (f).

(i) Disregarded entity. The term disregarded entity means an entity described in § 301.7701-2(c)(2) of this chapter that is disregarded as an entity separate from its owner for Federal income tax purposes.

(ii) Disregarded payment. The term disregarded payment means any amount described in paragraph (f)(3)(ii)(A) or (B) of this section.

(A) Payments to or from a disregarded entity. An amount described in this paragraph (f)(3)(ii)(A) is an amount that is paid to or by a disregarded entity in connection with a transaction that is disregarded for Federal income tax purposes and that is reflected on the separate set of books and records of a foreign branch.

(B) Other disregarded amounts. An amount described in this paragraph (f)(3)(ii)(B) is any amount reflected on the separate set of books and records of a foreign branch that would constitute an item of income, gain, deduction, or loss (other than an amount described in paragraph (f)(3)(ii)(A) of this section) if the transaction to which the amount is attributable were regarded for Federal income tax purposes.

(iii) Foreign branch—(A) In general. The term foreign branch means a qualified business unit (QBU), as defined in § 1.989(a)-1(b)(2)(ii) and (b)(3), that conducts a trade or business outside the United States. For an illustration of the principles of this paragraph (f)(3)(iii), see paragraph (f)(4)(i) Example 1 of this section.

(B) Trade or business outside the United States. Activities carried out in the United States, whether or not such activities are described in § 1.989(a)-1(b)(3), do not constitute the conduct of a trade or business outside the United States. Activities carried out outside the United States that constitute a permanent establishment under the terms of an income tax treaty between the United States and the country in which the activities are carried out are presumed to constitute a trade or business conducted outside the United States for purposes of this paragraph (f)(3)(iii)(B). In determining whether activities constitute a trade or business under § 1.989(a)-1(c), disregarded payments are taken into account and may give rise to a trade or business, provided that the activities (together with any other activities of the QBU) would otherwise satisfy the rule in § 1.989(a)-1(c).

(C) Activities of a partnership, estate, or trust—(1) Treatment as a foreign branch. For purposes of this paragraph (f)(3)(iii), the activities of a partnership, estate, or trust that conducts a trade or business that satisfies the requirements of § 1.989(a)-1(b)(2)(ii)(A) (as modified by paragraph (f)(3)(iii)(B) of this section) are—

(i) Deemed to satisfy the requirements of § 1.989(a)-1(b)(2)(ii)(B); and

(ii) Comprise a foreign branch.

(2) Separate set of books and records. A foreign branch described in this paragraph (f)(3)(iii)(C) is treated as maintaining a separate set of books and records with respect to the activities described in paragraph (f)(3)(iii)(C)(1) of this section, and must determine, as the context requires, the items of gross income, disregarded payments, and any other items that would be reflected on those books and records in applying this paragraph (f) with respect to the foreign branch.

(iv) Foreign branch owner. The term foreign branch owner means, with respect to a foreign branch, the person (including a foreign or domestic partnership or other pass-through entity) that owns the foreign branch, either directly or indirectly through one or more disregarded entities. For this purpose, the foreign branch owner does not include the foreign branch or another foreign branch of the person that owns the foreign branch.

(v) Remittance. The term remittance means a transfer of property (within the meaning of section 317(a)) by a foreign branch that would be treated as a distribution if the foreign branch were treated as a separate corporation.

(4) Examples. The following examples illustrate the application of this paragraph (f).

(i) Example 1: Determination of foreign branches and foreign branch owner—(A) Facts—(1) P, a domestic corporation, is a partner in PRS, a domestic partnership. All other partners in PRS are unrelated to P. PRS conducts activities solely in Country A (the Country A Business), and those activities constitute a trade or business outside the United States within the meaning of paragraph (f)(3)(iii)(B) of this section. PRS reflects items of income, gain, loss, and expense of the Country A Business on the books and records of PRS's home office. PRS's functional currency is the U.S. dollar. PRS is in the business of manufacturing bicycles.

(2) PRS owns FDE1, a disregarded entity organized in Country B. FDE1 conducts activities in Country B (the Country B Business), and those activities constitute a trade or business outside the United States within the meaning of paragraph (f)(3)(iii)(B) of this section. FDE1 maintains a set of books and records that are separate from those of PRS, and the separate set of books and records reflects items of income, gain, loss, and expense with respect to the Country B Business. Country B Business's functional currency is the U.S. dollar. FDE1 is in the business of selling bicycles manufactured by PRS.

(3) FDE1 owns FDE2, a disregarded entity organized in Country C. FDE2 conducts activities in Country C (the Country C Business), and those activities constitute a trade or business outside the United States within the meaning of paragraph (f)(3)(iii)(B) of this section. FDE2 maintains a set of books and records that are separate from those of PRS and FDE1, and the separate set of books and records reflects items of income, gain, loss, and expense with respect to the Country C Business. Country C Business's functional currency is the U.S. dollar. FDE2 sells paper. FDE2's paper business is not related to FDE1's bicycle sales business, and FDE1 does not hold its interest in FDE2 in the ordinary course of its trade or business.

(B) Analysis—(1) Country A Business's activities comprise a trade or business conducted outside the United States within the meaning of § 1.989(a)-1(b)(2)(ii)(A) and (b)(3) (in each case, as modified by paragraph (f)(3)(iii) of this section). PRS does not maintain a separate set of books and records with respect to the Country A Business. However, under paragraph (f)(3)(iii)(C) of this section, the Country A Business's activities are deemed to satisfy the requirement of § 1.989(a)-1(b)(2)(ii)(B) that a QBU maintain a separate set of books and records with respect to the relevant activities. Thus, for purposes of this paragraph (f), the activities of the Country A Business constitute a QBU as defined in § 1.989-1(b)(2)(ii) and (b)(3), as modified by paragraph (f)(3)(iii) of this section, that conducts a trade or business outside the United States. Accordingly, the activities of the Country A Business constitute a foreign branch within the meaning of paragraph (f)(3)(iii) of this section. PRS, the person that owns the Country A Business, is the foreign branch owner, within the meaning of paragraph (f)(3)(iv) of this section, with respect to the Country A Business.

(2) Country B Business's activities comprise a trade or business outside the United States within the meaning of § 1.989(a)-1(b)(2)(ii)(A) and (b)(3) (in each case, as modified by paragraph (f)(3)(iii) of this section). PRS maintains a separate set of books and records with respect to the Country B Business, as described in § 1.989(a)-1(b)(2)(ii)(B). Thus, for purposes of this section, the activities of the Country B Business constitute a QBU as defined in § 1.989-1(b)(2)(ii) and (b)(3), as modified by paragraph (f)(3)(iii) of this section, that conducts a trade or business outside the United States. Accordingly, the activities of the Country B Business constitute a foreign branch within the meaning of paragraph (f)(3)(iii) of this section. Under paragraph (f)(3)(iv) of this section, PRS, the person that owns the Country B Business indirectly through FDE1 (a disregarded entity), but not including the activities of PRS that constitute the Country A business, is the foreign branch owner with respect to the Country B Business.

(3) The same analysis that applies to the Country B Business applies to the Country C Business. Accordingly, the activities of the Country C Business constitute a foreign branch within the meaning of paragraph (f)(3)(iii) of this section. PRS, the person that owns the Country C Business indirectly through FDE1 and FDE2 (disregarded entities), but not including the activities of PRS that constitute the Country A Business, is the foreign branch owner with respect to the Country C Business.

(ii) Example 2: Sale of foreign branch—(A) Facts. The facts are the same as in paragraph (f)(4)(i)(A) of this section, except that in 2019, FDE1 sold FDE2 to an unrelated person, recording gain from the sale on its books and records. In 2020, PRS sells FDE1 to another unrelated person, recording gain from the sale on its books and records. In each year, PRS allocates a portion of the gain to P.

(B) Analysis—(1) Sale of FDE2. Under paragraph (f)(1)(i)(B) of this section, P's distributive share of gain recognized by PRS in connection with the sales of FDE1 and FDE2 constitutes foreign branch category income if it is attributable to a foreign branch held by PRS directly or indirectly through one or more disregarded entities. PRS's gross income from the 2019 sale of FDE2 is reflected on the separate set of books and records maintained with respect to the Country B Business (a foreign branch) operated by FDE1. Therefore, absent an exception, under paragraph (f)(2)(i) of this section PRS's gross income from the sale of FDE2 would be attributable to the Country B Business, and would constitute foreign branch category income. However, under paragraph (f)(2)(iv) of this section, gross income attributable to the Country B Business does not include gain from the sale or exchange of an interest in FDE2, a disregarded entity, unless the interest in FDE2 is held by the Country B Business in the ordinary course of its active trade or business (within the meaning of paragraph (f)(2)(iv)(B) of this section). In this case, the Country B Business does not hold FDE2 in the ordinary course of its active trade or business within the meaning of paragraph (f)(2)(iv)(B) of this section. As a result, P's distributive share of gain from the sale of FDE2 is not attributable to a foreign branch, and is not foreign branch category income.

(2) Sale of FDE1. The analysis of PRS's sale of FDE1 in 2020 is the same as the analysis for the sale of FDE2, except that PRS, through its Country A Business, holds FDE1 in the ordinary course of its active trade or business within the meaning of paragraph (f)(2)(iv)(B) of this section because the Country A Business engages in a trade or business that is related to the trade or business of FDE1. Therefore, P's distributive share of gain from the sale of FDE1 is attributable to a foreign branch, and is foreign branch category income.

(iii) Example 3: Disregarded payment for services—(A) Facts. P, a domestic corporation, owns FDE, a disregarded entity that is a foreign branch within the meaning of paragraph (f)(3)(iii) of this section. FDE's functional currency is the U.S. dollar. In 2019, P accrued and recorded on its books and records (and not FDE's books and records) $1,000 of gross income from the performance of services to unrelated parties that was not passive category income, $400 of which was foreign source income in respect of services performed outside the United States by employees of FDE and $600 of which was United States source income in respect of services performed in the United States. Absent the application of paragraph (f)(2)(vi) of this section, the $1,000 of gross income earned by P would be general category income that would not be attributable to FDE. FDE provided services in support of P's gross income from services. P compensated FDE for its services with an arm's length payment of $400, which was disregarded for Federal income tax purposes. The deduction for the payment of $400 from P to FDE would be allocated and apportioned to the $400 of P's foreign source services income if the payment were regarded for Federal income tax purposes.

(B) Analysis. The disregarded payment from P, a United States person, to FDE, its foreign branch, is not recorded on FDE's separate books and records (as adjusted to conform to Federal income tax principles) within the meaning of paragraph (f)(2)(i) of this section because it is disregarded for United States tax purposes. However, the disregarded payment is allocable to gross income attributable to P because a deduction for the payment, if it were regarded, would be allocated to P's $1,000 of gross services income and apportioned between U.S. and foreign source income under § 1.861-8. Under paragraph (f)(2)(vi)(A) of this section, the amount of gross income attributable to the FDE foreign branch (and the gross income attributable to P) is adjusted to take the disregarded payment into account. As such, all of P's $400 of foreign source gross income from the performance of services is attributable to the FDE foreign branch for purposes of this section. Therefore, $400 of the foreign source gross income that P earned with respect to its services in 2019 constitutes gross income that is assigned to the foreign branch category.

(g) Section 951A category income—(1) In general. Except as provided in paragraph (g)(2) of this section, the term section 951A category income means amounts included (directly or indirectly through a pass-through entity) in gross income of a United States person under section 951A(a).

(2) Exceptions for passive category income. Section 951A category income does not include any amounts included under section 951A(a) that are allocable to passive category income under § 1.904-5(c)(6). Section 951A category income also does not include any amounts treated as passive category income under paragraph (n)(2) of this section.

(h) * * *

(2) Treatment of export financing interest. Except as provided in paragraph (h)(3) of this section, if a taxpayer (including a financial services entity) receives or accrues export financing interest from an unrelated person, then that interest is not treated as passive category income. Instead, the interest income is treated as foreign branch category income, section 951A category income, general category income, or income in a specified separate category under the rules of this section.

(5) * * * (i) Income other than interest. If any foreign person receives or accrues income that is described in section 864(d)(7) (income on a trade or service receivable acquired from a related person in the same foreign country as the recipient) and such income would also meet the definition of export financing interest if section 864(d)(1) applied to such income (income on a trade or service receivable acquired from a related person treated as interest), then the income is considered to be export financing interest and is not treated as passive category income. The income is treated as foreign branch category income, section 951A category income, general category income, or income in a specified separate category under the rules of this section.

(ii) Interest income. If export financing interest is received or accrued by any foreign person and that income would otherwise be treated as related person factoring income of a controlled foreign corporation under section 864(d)(6) if section 864(d)(7) did not apply, section 904(d)(2)(B)(iii)(I) applies and the interest is not treated as passive category income. The income is treated as general category income in the hands of the controlled foreign corporation.

(k) Separate category under section 904(d)(6) for items resourced under treaties—(1) In general. Except as provided in paragraph (k)(4)(i) of this section, sections 904(a), (b), (c), (d), (f), and (g), and sections 907 and 960 are applied separately to any item of income that, without regard to a treaty obligation of the United States, would be treated as derived from sources within the United States, but under a treaty obligation of the United States such item of income would be treated as arising from sources outside the United States, and the taxpayer chooses the benefits of such treaty obligation.

(2) Aggregation of items of income in each other separate category. For purposes of applying the general rule of paragraph (k)(1) of this section, items of income in each other separate category of income that are resourced under each applicable treaty are aggregated in a single separate category for income in that separate category that is resourced under that treaty. For example, all items of general category income that would otherwise be treated as derived from sources within the United States but which the taxpayer chooses to treat as arising from sources outside the United States pursuant to a provision of a bilateral U.S. income tax treaty are treated as income in a separate category for general category income resourced under the particular treaty. Resourced items are not combined with other income that is foreign source income under the Code, even if the other income arises from sources within the treaty country and is included in the same separate category to which the resourced income would be assigned without regard to section 904(d)(6).

(3) Related taxes. Foreign taxes are allocated to each separate category described in paragraph (k)(2) of this section in accordance with § 1.904-6.

(4) Coordination with certain income tax treaty provisions—(i) Exception for special relief from double taxation for individual residents of treaty countries. Section 904(d)(6)(A) and paragraph (k)(1) of this section do not apply to any item of income deemed to be from foreign sources by reason of the relief from double taxation rules in any U.S. income tax treaty that is solely applicable to United States citizens who are residents of the other Contracting State.

(ii) U.S. competent authority assistance. For purposes of applying paragraph (k)(1) of this section, if, under the mutual agreement procedure provisions of an applicable income tax treaty, the U.S. competent authority agrees to allow a taxpayer to treat an item of income as foreign source income, where such item of income would otherwise be treated as derived from sources within the United States, then the taxpayer is considered to have chosen the benefits of such treaty obligation to treat the item as foreign source income.

(5) Coordination with other Code provisions. Section 904(d)(6)(A) and paragraph (k)(1) of this section do not apply to any item of income to which any of sections 245(a)(10), 865(h), or 904(h)(10) applies. See paragraph (l) of this section.

(l) Priority rule. Income that meets the definitions of a specified separate category and another category of income described in section 904(d)(1) is subject to the separate limitation described in paragraph (m) of this section and is not treated as general category income, foreign branch category income, passive category income, or section 951A category income.

(m) Income treated as allocable to a specified separate category. If section 904(a), (b), and (c) are applied separately to any category of income under the Internal Revenue Code and regulations (for example, under section 245(a)(10), 865(h), 901(j), 904(d)(6), or 904(h)(10), and the regulations under those sections), that category of income is treated for all purposes of the Internal Revenue Code and regulations as if it were a separate category listed in section 904(d)(1). For purposes of this section, a separate category that is treated as if it were listed in section 904(d)(1) by reason of the first sentence in this paragraph (m) is referred to as a specified separate category.

(n) Income from partnerships and other pass-through entities—(1) Distributive shares of partnership income—(i) In general. Except as provided in paragraph (n)(1)(ii) of this section, a partner's distributive share of partnership income is characterized as passive category income to the extent that the distributive share is a share of income earned or accrued by the partnership in the passive category. A partner's distributive share of partnership income that is not described in the first sentence of this paragraph is treated as foreign branch category income, section 951A category income, general category income, or income in a specified separate category under the rules of this section. Similar principles apply for a person's share of income from any other pass-through entity.

(ii) Less than 10 percent partners partnership interests—(A) In general. Except as provided in paragraph (n)(1)(ii)(B) of this section, if any limited partner or corporate general partner owns less than 10 percent of the value in a partnership, the partner's distributive share of partnership income from the partnership is passive income to the partner (subject to the high-taxed income exception of section 904(d)(2)(B)(iii)(II)), and the partner's distributive share of partnership deductions from the partnership is allocated and apportioned under the principles of section 1.861-8 only to the partner's passive income from that partnership. See also § 1.861-9(e)(4) for rules for apportioning partnership interest expense.

(B) Exception for partnership interest held in the ordinary course of business. If a partnership interest described in paragraph (n)(1)(ii)(A) of this section is held in the ordinary course of a partner's active trade or business, the rules of paragraph (n)(1)(i) of this section apply for purposes of characterizing the partner's distributive share of the partnership income. A partnership interest is considered to be held in the ordinary course of a partner's active trade or business if the partner (or a member of the partner's affiliated group of corporations (within the meaning of section 1504(a) and without regard to section 1504(b)(3))) engages (other than through a less than 10 percent interest in a partnership) in the same or a related trade or business as the partnership.

(2) Income from the sale of a partnership interest—(i) In general. To the extent a partner recognizes gain on the sale of a partnership interest, that income shall be treated as passive category income to the partner, unless the income is considered to be high-taxed under section 904(d)(2)(B)(iii)(II) and paragraph (c) of this section.

(ii) Exception for sale by 25-percent owner. Except as provided in paragraph (f)(2)(iv) of this section, in the case of a sale of an interest in a partnership by a partner that is a 25-percent owner of the partnership, determined by applying section 954(c)(4)(B) and substituting “partner” for “controlled foreign corporation” every place it appears, for purposes of determining the separate category to which the income recognized on the sale of the partnership interest is assigned such partner is treated as selling the proportionate share of the assets of the partnership attributable to such interest.

(3) Value of a partnership interest. For purposes of paragraphs (n)(1) and (2) of this section, a partner will be considered as owning 10 percent of the value of a partnership for a particular year if the partner, together with any person that bears a relationship to the partner described in section 267(b) or 707, owns 10 percent of the capital and profits interest of the partnership. For this purpose, value will be determined at the end of the partnership's taxable year.

(o) Separate category of section 78 gross up. The amount included in income under section 78 by reason of taxes deemed paid under section 960 is assigned to the separate category to which the taxes are allocated under § 1.904-6(b).

(p) Separate category of foreign currency gain or loss. Foreign currency gain or loss recognized under section 986(c) with respect to a distribution of previously taxed earnings and profits (as described in section 959 or 1293(c)) is assigned to the separate category or categories of the previously taxed earnings and profits from which the distribution is made. See § 1.987-6(b) for rules on assigning section 987 gain or loss on a remittance from a section 987 QBU to a separate category or categories.

(q) Applicability dates. This section applies for taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

(a) Scope and definitions. (1) Look-through rules under section 904(d)(3) to passive category income. Paragraph (c) of this section provides rules for determining the extent to which dividends, interest, rents, and royalties received or accrued by certain eligible persons, and inclusions under sections 951(a)(1) and 951A(a), are treated as passive category income. Paragraph (g) of this section provides rules applying the principles of paragraph (c) of this section to foreign source interest, rents, and royalties paid by a United States corporation to a related corporation. Paragraph (h) of this section provides rules for assigning a partnership payment to a partner described in section 707 to the passive category. Paragraph (i) of this section provides rules applying the principles of this section to assign distributions and payments from certain related entities to the passive category or to treat the distributions and payments as not in the passive category.

(2) Other look-through rules under section 904(d). Under section 904(d)(4) and paragraph (c)(4)(iii) of this section, certain dividends from noncontrolled 10-percent owned foreign corporations are treated as income in a separate category. Under section 904(d)(3)(H) and paragraph (j) of this section, certain inclusions under section 1293 are treated as income in a separate category. Paragraph (i) of this section provides rules applying the principles of this section to assign distributions from certain related entities to separate categories.

(3) Other rules provided in this section. Paragraph (b) of this section provides operative rules for this section. Paragraph (d) of this section provides rules addressing exceptions to passive category income for certain purposes in the case of controlled foreign corporations that meet the requirements of section 954(b)(3)(A) (de minimis rule) or section 954(b)(4) (high-tax exception). Paragraph (e) of this section provides rules for characterizing a controlled foreign corporation's foreign base company income and gross insurance income when section 954(b)(3)(B) (full inclusion rule) applies. Paragraph (f) of this section modifies the look-through rules for certain types of income. Paragraph (k) of this section provides ordering rules for applying the look-through rules. Paragraph (l) of this section provides examples illustrating the application of certain rules in this section. Paragraphs (m) and (n) of this section provide rules related to the resourcing rules described in section 904(h).

(4) Definitions. For purposes of this section, the following definitions apply:

(i) The term controlled foreign corporation has the meaning given such term by section 957 (taking into account the special rule for certain captive insurance companies contained in section 953(c)).

(ii) The term look-through rules means the rules described in this section that assign income to a separate category based on the separate category of the income to which it is allocable.

(iii) The term noncontrolled 10-percent owned foreign corporation has the meaning provided in section 904(d)(2)(E)(i).

(iv) The term pass-through entity means a partnership, S corporation, or any other person (whether domestic or foreign) other than a corporation to the extent that the income or deductions of the person are included in the income of one or more direct or indirect owners or beneficiaries of the person. For example, if a domestic trust is subject to Federal income tax on a portion of its income and its owners are subject to tax on the remaining portion, the domestic trust is treated as a domestic pass-through entity with respect to such remaining portion.

(v) The term separate category means, as the context requires, any category of income described in 904(d)(1)(A), (B), (C), or (D), any specified separate category of income as defined in § 1.904-4(m), or any category of earnings and profits to which income described in such provisions is attributable.

(vi) The term United States shareholder has the meaning given such term by section 951(b) (taking into account the special rule for certain captive insurance companies contained in section 953(c)), except that for purposes of this section, a United States shareholder includes any member of the controlled group of the United States shareholder. For this purpose the controlled group is any member of the affiliated group within the meaning of section 1504(a)(1) except that “more than 50 percent” is substituted for “at least 80 percent” wherever it appears in section 1504(a)(2). When used in reference to a noncontrolled 10-percent owned foreign corporation described in section 904(d)(2)(E)(i)(II), the term United States shareholder also means a taxpayer that meets the stock ownership requirements described in section 904(d)(2)(E)(i)(II).

(b) Operative rules—(1) Assignment of income not assigned under the look-through rules. Except as provided by the look-through rules, dividends, interest, rents, and royalties received or accrued by a taxpayer from a controlled foreign corporation in which the taxpayer is a United States shareholder are excluded from passive category income. Income excluded from the passive category under this paragraph (b)(1) is assigned to another separate category (other than the passive category) under the rules in § 1.904-4.

(2) Priority and ordering of look-through rules. Except as provided in § 1.904-4(l), to the extent the look-through rules assign income to a separate category, the income is assigned to that separate category rather than the separate category to which the income would have been assigned under § 1.904-4 (not taking into account § 1.904-4(l)). See paragraph (k) of this section for ordering rules for applying the look-through rules.

(c) * * * (1) Scope. Subject to the exceptions in paragraph (f) of this section, paragraphs (c)(2) through (c)(6) (other than paragraph (c)(4)(iii)) of this section provide look-through rules with respect to interest, rents, royalties, dividends, and inclusions under section 951(a)(1) and 951A(a) that are received or accrued from a controlled foreign corporation in which the taxpayer is a United States shareholder. Paragraph (c)(4)(iii) of this section provides a look-through rule for dividends received from a noncontrolled 10-percent owned foreign corporation by a domestic corporation that is a United States shareholder in the foreign corporation.

(2) * * * (i) * * * Related person interest is treated as passive category income to the extent it is allocable to passive category income of the controlled foreign corporation. If related person interest is received or accrued from a controlled foreign corporation by two or more persons, the amount of interest received or accrued by each person that is allocable to passive category income is determined by multiplying the amount of related person interest allocable to passive category income by a fraction. * * *

(3) Rents and royalties. Any rents or royalties received or accrued from a controlled foreign corporation in which the taxpayer is a United States shareholder are treated as passive category income to the extent they are allocable to passive category income of the controlled foreign corporation under the principles of §§ 1.861-8 through 1.861-14T.

(4) * * * (i) * * * Except as provided in paragraph (d)(2) of this section, any dividend paid or accrued out of the earnings and profits of any controlled foreign corporation is treated as passive category income in proportion to the ratio of the portion of earnings and profits attributable to passive category income to the total amount of earnings and profits of the controlled foreign corporation. * * *

(iii) Look-through rule for dividends from noncontrolled 10-percent owned foreign corporations—(A) In general. Except as provided in paragraph (c)(4)(iii)(B) of this section, any dividend that is distributed by a noncontrolled 10-percent owned foreign corporation and received or accrued by a domestic corporation that is a United States shareholder of such foreign corporation is treated as income in a separate category in proportion to the ratio of the portion of earnings and profits attributable to income in such category to the total amount of earnings and profits of the noncontrolled 10-percent owned foreign corporation.

(B) Inadequate substantiation. A dividend distributed by a noncontrolled 10-percent owned foreign corporation is treated as income in the separate category described in section 904(d)(4)(C)(ii) if the Commissioner determines that the look-through characterization of the dividend cannot reasonably be determined based on the available information.

(5) Inclusions under section 951(a)(1)(A)—(i) Any amount included in gross income under section 951(a)(1)(A) is treated as passive category income to the extent the amount included is attributable to income received or accrued by the controlled foreign corporation that is passive category income. All other amounts included in gross income under section 951(a)(1)(A) are treated as general category income or income in a specified separate category under the rules in § 1.904-4. For rules concerning a distributive share of partnership income, see § 1.904-4(n). For rules concerning the gross up under section 78, see § 1.904-4(o). For rules concerning inclusions under section 951(a)(1)(B), see paragraph (c)(4)(i) of this section.

(ii) [Reserved]

(6) Inclusions under section 951A(a). Any amount included in gross income under section 951A(a) is treated as passive category income to the extent the amount included is attributable to income received or accrued by the controlled foreign corporation that is passive category income. All other amounts included in gross income under section 951A(a) are treated as section 951A category income or income in a specified separate category under the rules in § 1.904-4. For rules concerning a distributive share of partnership income, see § 1.904-4(n). For rules concerning the gross up under section 78, see § 1.904-4(o).

(d) * * * (1) De minimis amount of subpart F income. If the sum of a controlled foreign corporation's gross foreign base company income (determined under section 954(a) without regard to section 954(b)(5)) and gross insurance income (determined under section 953(a)) for the taxable year is less than the lesser of 5 percent of gross income or $1,000,000, then none of that income is treated as passive category income. In addition, if the test in the first sentence of this paragraph is satisfied, for purposes of paragraphs (c)(2)(ii)(D) and (E) of this section (apportionment of interest expense to passive income using the asset method), any passive category assets are not treated as passive category assets but are treated as assets in the general category or a specified separate category. The determination in the first sentence is made before the application of the exception for certain income subject to a high rate of foreign tax described in paragraph (d)(2) of this section.

(2) Exception for certain income subject to high foreign tax. Except as provided in § 1.904-4(c)(7)(iii) (relating to reductions in tax upon distribution), for purposes of the dividend look-through rule of paragraph (c)(4)(i) of this section, an item of net income that would otherwise be passive income (after application of the priority rules of § 1.904-4(l)) and that is received or accrued by a controlled foreign corporation is not treated as passive category income, and the earnings and profits attributable to such income is not treated as passive category earnings and profits, if the taxpayer establishes to the satisfaction of the Secretary under section 954(b)(4) that the income was subject to an effective rate of income tax imposed by a foreign country greater than 90 percent of the maximum rate of tax specified in section 11 (with reference to section 15, if applicable). Such income is treated as general category income or income in a specified separate category under the rules in § 1.904-4. The first sentence of this paragraph has no effect on amounts (other than dividends) paid or accrued by a controlled foreign corporation to a United States shareholder of such controlled foreign corporation to the extent those amounts are allocable to passive category income of the controlled foreign corporation.

(f) * * * (1) [Reserved]

(h) Application of look-through rules to payments from a partnership or other pass-through entity. Payments to a partner described in section 707 (e.g., payments to a partner not acting in capacity as a partner) are characterized as passive category income to the extent that the payment is attributable under the principles of § 1.861-8 and this section to passive category income of the partnership, if the payments are interest, rents, or royalties that would be characterized under the controlled foreign corporation look-through rules of paragraph (c) of this section if the partnership were a foreign corporation, and the partner who receives the payment owns 10 percent or more of the value of the partnership (as determined under § 1.904-4(n)(3)). A payment by a partnership to a member of the controlled group (as defined in paragraph (a)(4)(vi) of this section) of the partner is characterized under the look-through rules of this paragraph (h) if the payment would be a section 707 payment entitled to look-through treatment if it were made to the partner. Similar principles apply for a payment from any other pass-through entity. The rules in this paragraph (h) do not apply with respect to interest to the extent the interest income is assigned to a separate category under the specified partnership loan rules described in § 1.861-9(e)(8).

(i) * * * (1) * * * For purposes of this paragraph (i)(1), indirect ownership of stock is determined under section 318 and the regulations under that section. In the case of a partnership or other pass-through entity, indirect ownership and value is determined under the rules in paragraph (i)(2) of this section.

(2) Indirect ownership and value of a partnership interest. A person is considered as owning, directly or indirectly, more than 50 percent of the value of a partnership if the person, together with other any person that bears a relationship to the first person that is described in section 267(b) or 707, owns more than 50 percent of the capital and profits interests of the partnership. For this purpose, value will be determined at the end of the partnership's taxable year. Similar principles apply for a person that owns a pass-through entity other than a partnership.

(3) Special rule for dividends between certain foreign corporations. Solely for purposes of dividend payments between controlled foreign corporations, noncontrolled 10-percent owned foreign corporations, or a controlled foreign corporation and a noncontrolled 10-percent owned foreign corporation, the two foreign corporations are considered related look-through entities if the same person is a United States shareholder of both foreign corporations.

(4) [Reserved]

(k) * * *

(2) * * *

(iii) Inclusions under sections 951(a)(1)(A) and 951A(a) and distributive shares of partnership income;

(m) * * *

(2) * * *

(ii) Interest payments from noncontrolled 10-percent owned foreign corporations. If interest is received or accrued by a shareholder from a noncontrolled 10-percent owned foreign corporation (where the shareholder is a domestic corporation that is a United States shareholder of such noncontrolled 10-percent owned foreign corporation), the rules of paragraph (m)(2)(i) of this section apply in determining the portion of the interest payment that is from sources within the United States, except that the related party interest rules of paragraph (c)(2)(ii)(C) of this section do not apply.

(4) * * * (i) Rule. Any dividend or distribution treated as a dividend under this paragraph (m) (including an amount included in gross income under section 951(a)(1)(B)) that is received or accrued by a United States shareholder from a controlled foreign corporation, or any dividend that is received or accrued by a domestic corporation from a noncontrolled 10-percent owned foreign corporation with respect to which the shareholder is a United States shareholder, are treated as income in a separate category derived from sources within the United States in proportion to the ratio of the portion of the earnings and profits of the controlled foreign corporation or noncontrolled 10-percent owned foreign corporation in the corresponding separate category from United States sources to the total amount of earnings and profits of the controlled foreign corporation or noncontrolled 10-percent owned foreign corporation in that separate category.

(5) * * * (i) * * * Any amount included in the gross income of a United States shareholder of a controlled foreign corporation under section 951(a)(1)(A), 951A, or in the gross income of a domestic corporation that is a United States shareholder of a noncontrolled 10-percent owned foreign corporation described in section 904(d)(2)(E)(i)(II) that is a qualified electing fund under section 1293 is treated as income subject to a separate category that is derived from sources within the United States to the extent the amount is attributable to income of the controlled foreign corporation or qualified electing fund, respectively, in the corresponding category of income from sources within the United States. * * *

(n) * * * Section 904(d)(3), (d)(4), and (h), and this section are then applied for purposes of characterizing and sourcing income received, accrued, or included by a United States shareholder of the foreign corporation that is attributable or allocable to income or earnings and profits of the foreign corporation.

(o) Applicability dates. This section is applicable for taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

(a) * * * (1) * * * (i) * * * The amount of foreign taxes paid or accrued with respect to a separate category (as defined in § 1.904-5(a)(4)(v)) of income (including United States source income within the separate category) includes only those taxes that are related to income in that separate category. * * * Income included in the foreign tax base is calculated under foreign law, but characterized as income in a separate category under United States tax principles. For example, a foreign tax imposed on an amount realized on the disposition of controlled foreign corporation stock that is characterized as a capital gain under foreign law but as a dividend under section 1248 is generally assigned to the general category, not the passive category. * * *

(iv) Base and timing differences. If, under the law of a foreign country or possession of the United States, a tax is imposed on a type of item that does not constitute income under Federal income tax principles (a base difference), such as gifts or life insurance proceeds, that tax is treated as imposed with respect to income in the separate category described in section 904(d)(2)(H)(i). If, under the law of a foreign country or possession of the United States, a tax is imposed on an item of income that constitutes income under Federal income tax principles but is not recognized for Federal income tax purposes in the current year (a timing difference), that tax is allocated and apportioned to the appropriate separate category or categories to which the tax would be allocated and apportioned if the income were recognized under Federal income tax principles in the year in which the tax was imposed. If the amount of an item of income as computed for foreign tax purposes is positive but is greater than the amount of income that is currently recognized for Federal income tax purposes, for example, due to a difference in depreciation conventions or the timing of recognition of gross income, or because of a permanent difference between U.S. and foreign tax law in the amount of deductions that are allowed to reduce gross income, the tax is allocated or apportioned to the separate category to which the income is assigned, and no portion of the tax is attributable to a base difference. In addition, a tax imposed on a distribution that is excluded from gross income under section 959(a) or section 959(b) is treated as attributable to a timing difference (and not a base difference) and is treated as tax imposed on the earnings and profits from which the distribution was paid.

(2) Special rules for foreign branches—(i) In general. Except as provided in this paragraph (a)(2), any foreign tax reflected on the books and records of a foreign branch under the principles of § 1.987-2(b) is allocated and apportioned under the rules of paragraph (a)(1) of this section.

(ii) Disregarded reallocation transactions—(A) Foreign branch to foreign branch owner. In the case of a disregarded payment from a foreign branch to a foreign branch owner that is treated as a disregarded reallocation transaction that results in foreign branch category income being reallocated to the general category, any foreign tax imposed solely by reason of that payment, such as a withholding tax imposed on the disregarded payment, is allocated and apportioned to the general category.

(B) Foreign branch owner to foreign branch. In the case of a disregarded payment from a foreign branch owner to a foreign branch that is treated as a disregarded reallocation transaction that results in general category income being reallocated to the foreign branch category, any foreign tax imposed solely by reason of that transaction is allocated and apportioned to the foreign branch category.

(iii) Other disregarded payments—(A) Foreign branch to foreign branch owner. In the case of a disregarded payment from a foreign branch to a foreign branch owner that is not a disregarded reallocation transaction, foreign tax imposed solely by reason of that disregarded payment is allocated and apportioned to a separate category under the principles of paragraph (a)(1) of this section based on the nature of the item (determined under Federal income tax principles) that is included in the foreign tax base. For example, if a remittance of an appreciated asset results in gain recognition under foreign law, the tax imposed on that gain is treated as attributable to a timing difference with respect to recognition of the gain, and is allocated and apportioned to the separate category to which gain on a sale of that asset would have been assigned if it were recognized for Federal income tax purposes. However, a gross basis withholding tax on a remittance is attributable to a timing difference in taxation of the income out of which the remittance is made, and is allocated and apportioned to the separate category or categories to which a section 987 gain or loss would be assigned under § 1.987-6(b).

(B) Foreign branch owner to foreign branch. In the case of a disregarded payment from a foreign branch owner to a foreign branch that is not a disregarded reallocation transaction, any foreign tax imposed solely by reason of that disregarded payment is allocated and apportioned to the foreign branch category.

(iv) Definitions. The following definitions apply for purposes of this paragraph (a)(2):

(A) Disregarded reallocation transaction. The term disregarded reallocation transaction means a disregarded payment or a transfer described in § 1.904-4(f)(2)(vi)(D) that results in an adjustment to the gross income attributable to the foreign branch under § 1.904-4(f)(2)(vi)(A).

(B) The terms disregarded payment, foreign branch, foreign branch owner, and remittance have the same meaning given to those terms in § 1.904-4(f)(3).

(3) Taxes imposed on high-taxed income. For rules on the treatment of taxes imposed on high-taxed income, see § 1.904-4(c).

(b) Allocation and apportionment of deemed paid taxes and certain creditable foreign tax expenditures—(1) Taxes deemed paid under section 960(a) or (d). If a domestic corporation that is a United States shareholder includes any amount in gross income under sections 951(a)(1)(A) or 951A(a), any foreign tax deemed paid with respect to such amount under section 960(a) or (d) is allocated to the separate category to which the inclusion is assigned.

(2) Taxes deemed paid under section 960(b)(1). If a domestic corporation that is a United States shareholder receives a distribution of previously taxed earnings and profits from a first-tier corporation that is excluded from the domestic corporation's income under section 959(a) and § 1.959-1, any foreign tax deemed paid under section 960(b)(1) with respect to such distribution is allocated to the same separate category as the annual PTEP account and PTEP group (as defined in § 1.960-3(c)) from which the distribution is made.

(3) Taxes deemed paid under section 960(b)(2). If a controlled foreign corporation receives a distribution of previously taxed earnings and profits from an immediately lower-tier corporation that is excluded from such controlled foreign corporation's gross income under section 959(b) and § 1.959-2, any foreign tax deemed paid under section 960(b)(2) with respect to such distribution is allocated to the same separate category as the annual PTEP account and PTEP group (as defined in § 1.960-3(c)) from which the distribution is made. See also § 1.960-3(c)(2).

(4) Creditable foreign tax expenditures—(i) In general. Except as provided in paragraph (b)(4)(ii) of this section, creditable foreign tax expenditures (CFTEs) allocated to a partner under § 1.704-1(b)(4)(viii)(a) are allocated for purposes of this section to the same separate category as the separate category to which the taxes were allocated in the hands of the partnership under the rules of paragraph (a) of this section.

(ii) Foreign branch category. CFTEs allocated to a partner in a partnership under § 1.704-1(b)(4)(viii)(a) are allocated and apportioned to the foreign branch category of the partner to the extent that:

(A) The CFTEs are allocated and apportioned by the partnership under the rules of paragraph (a) of this section to the general category;

(B) In the hands of the partnership, the CFTEs are related to general category income attributable to a foreign branch (as described in § 1.904-4(f)(2)) under the principles of paragraph (a) of this section; and

(C) The partner's distributive share of the income described in paragraph (b)(4)(ii)(B) of this section is foreign branch category income of the partner under § 1.904-4(f)(1)(i)(B).

(d) Applicability dates. This section is applicable for taxable years that both begin after December 31, 2017, and end on or after December 4, 2018.

(a) Disregard of certain dividends and deductions—(1) In general. For purposes of section 904(a), in the case of a domestic corporation which is a United States shareholder with respect to a specified 10-percent owned foreign corporation (as defined in section 245A(b)), the domestic corporation's foreign source taxable income in a separate category and entire taxable income is determined without regard to the following items:

(i) Any dividend for which a deduction is allowed under section 245A;

(ii) Deductions properly allocable or apportioned to gross income in the section 245A subgroup as determined under paragraphs (b) and (c)(1) of this section; and

(iii) Deductions properly allocable or apportioned to stock of specified 10-percent owned foreign corporations in the section 245A subgroup as determined under paragraphs (b) and (c) of this section.

(2) Deductions properly allocable or apportioned to the residual grouping. Deductions that are properly allocable or apportioned to gross income or stock in the section 245A subgroup of the residual grouping (consisting of U.S. source income) are disregarded solely for purposes of determining entire taxable income under section 904(a).

(b) Determining properly allocable or apportioned deductions. The amount of deductions properly allocable or apportioned to gross income or stock described in paragraphs (a)(1)(ii) and (iii) of this section is determined by subdividing the United States shareholder's gross income and assets in each separate category described in § 1.904-5(a)(4)(v) into a section 245A subgroup and a non-section 245A subgroup. Gross income and assets in the residual grouping for U.S. source income are also subdivided into a section 245A subgroup and a non-section 245A subgroup. Each section 245A subgroup is treated as a statutory grouping under § 1.861-8(a)(4). Deductions properly allocable or apportioned to dividends or stock described in paragraphs (a)(1)(ii) and (iii) of this section only include those deductions that are allocated and apportioned under §§ 1.861-8 through 1.861-14T and 1.861-17 to the section 245A subgroups. The deduction allowed under section 245A(a) for dividends is allocated and apportioned solely among the section 245A subgroups on the basis of the relative amounts of gross income from such dividends in each section 245A subgroup.

(c) Income and assets in the 245A subgroups—(1) In general. For purposes of applying the allocation and apportionment rules under §§ 1.861-8 through 1.861-14T and 1.861-17 to the deductions of a United States shareholder, the only gross income included in a section 245A subgroup is dividend income for which a deduction is allowed under section 245A. The only asset included in a section 245A subgroup is the portion of the value of stock of each specified 10-percent owned foreign corporation that is assigned to the section 245A subgroup determined under paragraph (c)(2) of this section.

(2) Assigning stock to a subgroup. The value of stock of a specified 10-percent owned foreign corporation is characterized as an asset in a separate category described in § 1.904-5(a)(4)(v) or the residual grouping for U.S. source income under the rules of § 1.861-12(c). If the specified 10-percent owned foreign corporation is not a controlled foreign corporation, all of the value of its stock (other than the portion of stock assigned to the statutory groupings for gross section 245(a)(5) income under §§ 1.861-12(c)(4) and 1.861-13) in each separate category and in the residual grouping for U.S. source income is assigned to the section 245A subgroup in such separate category or residual grouping. If the specified 10-percent owned foreign corporation is a controlled foreign corporation, a portion of the value of stock in each separate category and in the residual grouping for U.S. source income is subdivided between a section 245A and non-section 245A subgroup under § 1.861-13(a)(5).

(d) Coordination with OFL and ODL rules. Section 904(b)(4) and this section apply before the operation of the overall foreign loss rules in section 904(f) and the overall domestic loss rules in section 904(g).

(e) Example. The following example illustrates the application of this section.

(1) Facts—(i) Income and assets of USP. USP is a domestic corporation. USP owns a factory in the United States with a tax book value of $21,000. USP also directly owns all of the stock of each of the following three controlled foreign corporations: CFC1, CFC2, and CFC3. USP's tax book value in each of CFC1, CFC2, and CFC3 is $10,000. USP incurs $1,500 of interest expense and earns $1,600 of U.S. source gross income. Under section 951A and the section 951A regulations (as defined in § 1.951A-1(a)(1)), USP's GILTI inclusion amount is $2,200. USP's deduction under section 250 is $1,100 (“section 250 deduction”), all of which is by reason of section 250(a)(1)(B)(i). No portion of USP's section 250 deduction is reduced by reason of section 250(a)(2)(B). None of the CFCs makes any distributions.

(ii) Characterization of CFC stock. After application of § 1.861-13(a), USP determined that $7,300 of the stock of each of CFC1, CFC2, and CFC3 is assigned to the section 951A category (“section 951A category stock”) in the non-section 245A subgroup and the remaining $2,700 of the stock of each of CFC1, CFC2, and CFC3 is assigned to the general category (“general category stock”) in the section 245A subgroup. Additionally, under § 1.861-8(d)(2)(ii)(C)(2), $3,650 of the stock of each of CFC1, CFC2, and CFC3 that is section 951A category stock is an exempt asset. Accordingly, with respect to the stock of its controlled foreign corporations in the aggregate, USP has $10,950 of section 951A category stock in a non-section 245A subgroup; $8,100 of general category stock in a section 245A subgroup; and $10,950 of stock that is an exempt asset.

(iii) Apportioning of expenses. Taking into account USP's factory and its stock in CFC1, CFC2, and CFC3, the tax book value of USP's assets for purposes of apportioning expenses is $40,050 (excluding the $10,950 of exempt assets). Under § 1.861-9T(g), USP's $1,500 of interest expense is apportioned as follows: $410 ($1,500 × $10,950/$40,050) to section 951A category income, $303 ($1,500 × $8,100/$40,050) to general category income, and the remaining $787 ($1,500 × $21,000/$40,050) to the residual U.S. source grouping. Under § 1.861-8(e)(14), all of USP's section 250 deduction is allocated and apportioned to section 951A category income.

(2) Analysis—(i) USP's pre-credit U.S. tax. USP's worldwide taxable income is $1,200, which equals its GILTI inclusion amount of $2,200 plus its U.S. source gross income of $1,600, less its deduction under section 250 of $1,100 and its interest expense of $1,500. For purposes of applying section 904(a), before taking into account any foreign tax credit under section 901, USP's federal income tax liability is 21% of $1,200, or $252.

(ii) Application of section 904(b)(4). Under section 904(d)(1), USP applies section 904(a) separately to each separate category of income.

(A) General category income. Before application of section 904(b)(4) and the rules in this section, USP's foreign source taxable income in the general category is a loss of $303, which equals $0 (USP's foreign source general category income) less $303 (interest expense apportioned to general category income), and USP's worldwide taxable income is $1,200. Under paragraph (d) of this section, the rules in section 904(f) and (g) apply after section 904(b)(4) and the rules in this section. Under paragraphs (b) and (c)(1) of this section, USP has no deductions properly allocable or apportioned to gross income in the section 245A subgroup because USP has no dividend income in the general category for which a deduction is allowed under section 245A. Under paragraphs (b) and (c) of this section, USP has $303 of deductions for interest expense that are properly allocable or apportioned to stock of specified 10-percent owned foreign corporations in the section 245A subgroup because USP's only general category assets are the general category stock of CFC1, CFC2, and CFC3, all of which are in the section 245A subgroup. Therefore, under paragraph (a) of this section, USP's foreign source taxable income in the general category and its worldwide taxable income are determined without regard to the $303 of deductions for interest expense. Accordingly, USP's foreign source taxable income in the general category is $0 and its worldwide taxable income is $1,503, and therefore, there is no separate limitation loss for purposes of section 904(f). Under section 904(a) and (d)(1) USP's foreign tax credit limitation for the general category is $0.

(B) Section 951A category income. Before application of section 904(b)(4) and the rules in this section, USP's foreign source taxable income in the section 951A category is $690, which equals $2,200 (USP's GILTI inclusion amount) less $1,100 (USP's section 250 deduction) less $410 (interest apportioned to section 951A category income). Under paragraphs (b) and (c)(1) of this section, USP has no deductions properly allocable and apportioned to gross income in a section 245A subgroup of the section 951A category. Under paragraphs (b) and (c) of this section, USP has no deductions properly allocable and apportioned to stock of specified 10-percent owned foreign corporations in a section 245A subgroup of section 951A category stock because no portion of section 951A category stock is assigned to a section 245A subgroup. See § 1.861-13(a)(5)(v). Therefore, under paragraph (a) of this section no adjustment is made to USP's foreign source taxable income in the section 951A category. However, the adjustments to USP's worldwide taxable income described in paragraph (e)(2)(ii)(A) of this section apply for purposes of calculating USP's foreign tax credit limitation for the section 951A category. Accordingly, USP's foreign source taxable income in the section 951A category is $690 and its worldwide taxable income is $1,503. Under section 904(a) and (d)(1), USP's foreign tax credit limitation for the section 951A category is $116 ($252 × $690/$1,503).

(f) Applicability date. Except as provided in this paragraph (f), this section applies to taxable years beginning after December 31, 2017. For a taxable year that both begins before January 1, 2018, and ends after December 31, 2017, this section applies without regard to the rules relating to inclusions arising under section 951A.

(i) [Reserved]

(j) Recapture in years beginning after December 31, 2017, of separate limitation losses, overall foreign losses, and overall domestic losses incurred in years beginning before January 1, 2018—(1) Definitions—(i) The term pre-2018 separate categories means the separate categories of income described in section 904(d) and any specified separate categories of income, as applicable to taxable years beginning before January 1, 2018.

(ii) The term post-2017 separate categories means the separate categories of income described in section 904(d) and any specified separate categories of income, as applicable to taxable years beginning after December 31, 2018.

(iii) The term specified separate category has the meaning set forth in § 1.904-4(m)).

(2) Losses related to pre-2018 passive category income or a specified separate category of income—(i) Allocation of separate limitation loss or overall foreign loss account incurred in a pre-2018 separate category for passive category income or a specified separate category of income. To the extent that a taxpayer has a balance in any separate limitation loss or overall foreign loss account in a pre-2018 separate category for passive category income or a specified separate category of income at the end of the taxpayer's last taxable year beginning before January 1, 2018, the amount of such balance is allocated on the first day of the taxpayer's next taxable year to the same post-2017 separate category as the pre-2018 separate category of the separate limitation loss or overall foreign loss account.

(ii) Recapture of separate limitation loss or overall domestic loss that reduced pre-2018 passive category income or a specified separate category of income. To the extent that at the end of the taxpayer's last taxable year beginning before January 1, 2018, a taxpayer has a balance in any separate limitation loss or overall domestic loss account which offset pre-2018 separate category income that was passive category income or income in a specified separate category, such loss is recaptured in subsequent taxable years as income in the same post-2017 separate category as the pre-2018 separate category of income that was offset by the loss.

(3) Losses related to pre-2018 general category income—(i) Allocation of separate limitation loss or overall foreign loss account incurred in a pre-2018 separate category for general category income. To the extent that a taxpayer has a balance in any separate limitation loss or overall foreign loss account in a pre-2018 separate category for general category income at the end of the taxpayer's last taxable year beginning before January 1, 2018, the amount of such balance is allocated on the first day of the taxpayer's next taxable year to the taxpayer's post-2017 separate category for general category income, or, if the taxpayer applies the exception described in § 1.904-2(j)(1)(iii), on a pro rata basis to the taxpayer's post-2017 separate categories for general category and foreign branch category income, based on the proportion in which any unused foreign taxes in the same pre-2018 separate category for general category income are allocated under § 1.904-2(j)(1)(iii)(A). If the taxpayer has no unused foreign taxes in the pre-2018 separate category for general category income, then any loss account balance in that category is allocated to the post-2017 separate category for general category income.

(ii) Recapture of separate limitation loss or overall domestic loss that reduced pre-2018 general category income. To the extent that a taxpayer's separate limitation loss or overall domestic loss offset pre-2018 separate category income that was general category income, the balance in the loss account at the end of the taxpayer's last taxable year beginning before January 1, 2018, is recaptured in subsequent taxable years as income in the post-2017 separate category for general category income, or, if the taxpayer applies the exception described in § 1.904-2(j)(1)(iii), on a pro rata basis as income in the post-2017 separate categories for general category and foreign branch category income, based on the proportion in which any unused foreign taxes in the pre-2018 separate category for general category income are allocated under § 1.904-2(j)(1)(iii)(A). If the taxpayer has no unused foreign taxes in the pre-2018 separate category for general category income, then the loss account balance shall be recaptured in subsequent taxable years solely as income in the post-2017 separate category for general category income.

(4) Treatment of foreign losses that are part of net operating losses incurred in pre-2018 taxable years which are carried forward to post-2017 taxable years. A foreign loss that is part of a net operating loss incurred in a taxable year beginning before January 1, 2018, which is carried forward, pursuant to section 172, to a taxable year beginning after December 31, 2017, will be carried forward under the rules of § 1.904(g)-3(b)(2). For purposes of applying those rules, the portion of a net operating loss carryforward that is attributable to a foreign loss from the pre-2018 separate category for passive category income or a specified separate category of income will be treated as a loss in the same post-2017 separate category as the pre-2018 separate category. The portion of a net operating loss carryforward that is attributable to a foreign loss from the pre-2018 separate category for general category income must be treated as a loss in the post-2017 separate category for general or branch category income under the allocation principles of paragraph (j)(3)(i) of this section.

(5) Applicability date. This paragraph (j) applies to taxable years beginning after December 31, 2017.

(d) * * *

(3) * * *

(i) * * * Except as provided in the next sentence, the amount of foreign income taxes paid or accrued with respect to a net item of income, determined in the manner provided in this paragraph (d), is not affected by a subsequent reduction in foreign income taxes attributable to a distribution to shareholders of all or part of such income. To the extent the foreign income taxes paid or accrued by the controlled foreign corporation are reasonably certain to be returned by the foreign jurisdiction imposing such taxes to a shareholder, directly or indirectly, through any means (including, but not limited to, a refund, credit, payment, discharge of an obligation, or any other method) on a subsequent distribution to such shareholder, the foreign income taxes are not treated as paid or accrued for purposes of this paragraph (d)(3)(i).

(ii) * * * However, notwithstanding the rules in § 1.904-4(c)(7), to the extent the foreign income taxes paid or accrued by the controlled foreign corporation are reasonably certain to be returned by the foreign jurisdiction imposing such taxes to a shareholder, directly or indirectly, through any means (including, but not limited to, a refund, credit, payment, discharge of an obligation, or any other method) on a subsequent distribution to such shareholder, the foreign income taxes are not treated as paid or accrued for purposes of this paragraph (d)(3)(ii).

(h) Applicability dates—(1) Paragraphs (d)(3)(i) and (ii). Paragraphs (d)(3)(i) and (ii) of this section apply to taxable years of a controlled foreign corporation ending on or after December 4, 2018.

(2) Paragraph (g). Paragraph (g) of this section applies to taxable years of a controlled foreign corporation beginning on or after July 23, 2002.

(a) Overview—(1) Scope of §§ 1.960-1 through 1.960-3. This section and §§ 1.960-2 and 1.960-3 provide rules to associate foreign income taxes of a controlled foreign corporation with the income that a domestic corporation that is a United States shareholder of the controlled foreign corporation takes into account in determining a subpart F inclusion or GILTI inclusion amount of the domestic corporation, as well as to associate foreign income taxes of a controlled foreign corporation with distributions of previously taxed earnings and profits. These regulations provide the exclusive rules for determining the foreign income taxes deemed paid by a domestic corporation. Therefore, only foreign income taxes of a controlled foreign corporation that are associated under these rules with a subpart F inclusion or GILTI inclusion amount of a domestic corporation that is a United States shareholder of the controlled foreign corporation, or with previously taxed earnings and profits, are eligible to be deemed paid. This section provides definitions and computational rules for determining foreign income taxes deemed paid under section 960(a), (b), and (d). Section 1.960-2 provides rules for computing the amount of foreign income taxes deemed paid by a domestic corporation that is a United States shareholder of a controlled foreign corporation under section 960(a) and (d). Section 1.960-3 provides rules for computing the amount of foreign income taxes deemed paid by a domestic corporation that is a United States shareholder of a controlled foreign corporation, or by a controlled foreign corporation, under section 960(b).

(2) Scope of this section. Paragraph (b) of this section provides definitions for purposes of this section and §§ 1.960-2 and 1.960-3. Paragraph (c) of this section provides computational rules to coordinate the various calculations under this section and §§ 1.960-2 and 1.960-3. Paragraph (d) of this section provides rules for computing the income in an income group within a section 904 category, and for associating foreign income taxes with an income group. Paragraph (e) of this section provides a rule for the creditability of taxes associated with the residual income group. Paragraph (f) of this section provides an example illustrating the application of this section.

(b) Definitions. The following definitions apply for purposes of this section and §§ 1.960-2 and 1.960-3.

(1) Annual PTEP account. The term annual PTEP account has the meaning set forth in § 1.960-3(c)(1).

(2) Controlled foreign corporation. The term controlled foreign corporation means a foreign corporation described in section 957(a).

(3) Current taxable year. The term current taxable year means the U.S. taxable year of a controlled foreign corporation that is an inclusion year, or during which the controlled foreign corporation receives a section 959(b) distribution or makes a section 959(a) distribution or a section 959(b) distribution.

(4) Current year taxes. The term current year taxes means foreign income taxes paid or accrued by a controlled foreign corporation in a current taxable year. Foreign income taxes accrue when all the events have occurred that establish the fact of the liability and the amount of the liability can be determined with reasonable accuracy. See §§ 1.446-1(c)(1)(ii)(A) and 1.461-4(g)(6)(iii)(B) (economic performance exception for certain foreign taxes). Withholding taxes described in section 901(k)(1)(B) that are withheld from a payment accrue when the payment is made. Foreign income taxes calculated on the basis of net income recognized in a foreign taxable year accrue on the last day of the foreign taxable year. Accordingly, current year taxes include foreign withholding taxes that are withheld from payments made to the controlled foreign corporation during the current taxable year, and foreign income taxes that accrue in the controlled foreign corporation's current taxable year in which or with which its foreign taxable year ends. Additional payments of foreign income taxes resulting from a redetermination of foreign tax liability, including contested taxes that accrue when the contest is resolved, “relate back” and are considered to accrue as of the end of the foreign taxable year to which the taxes relate.

(5) Foreign income taxes. The term foreign income taxes means income, war profits, and excess profits taxes as defined in § 1.901-2(a), and taxes included in the term income, war profits, and excess profits taxes by reason of section 903 and § 1.903-1(a), that are imposed by a foreign country or a possession of the United States, including any such taxes that are deemed paid by a controlled foreign corporation under section 960(b). Income, war profits, and excess profits taxes do not include amounts excluded from the definition of those taxes pursuant to section 901 and the regulations under that section. See, for example, section 901(f), (g), and (i). Foreign income taxes also do not include taxes paid by a controlled foreign corporation for which a credit is disallowed at the level of the controlled foreign corporation. See, for example, sections 245A(e)(3), 901(k)(1), (l), and (m), 909, and 6038(c)(1)(B). Foreign income taxes, however, include taxes that may be deemed paid but for which a credit is reduced or disallowed at the level of the United States shareholder. See, for example, sections 901(e), 901(j), 901(k)(2), 908, 965(g), and 6038(c)(1)(A).

(6) Foreign taxable year. The term foreign taxable year has the meaning set forth in section 7701(a)(23), applied by substituting “under foreign law” for the phrase “under subtitle A.”

(7) GILTI inclusion amount. The term GILTI inclusion amount has the meaning set forth in § 1.951A-1(c)(1) (or, in the case of a member of a consolidated group, § 1.1502-51(b)).

(8) Gross tested income. The term gross tested income has the meaning set forth in § 1.951A-2(c)(1).

(9) Inclusion percentage. The term inclusion percentage has the meaning set forth in § 1.960-2(c)(2).

(10) Inclusion year. The term inclusion year means the U.S. taxable year of a controlled foreign corporation which ends during or with the taxable year of a United States shareholder of the controlled foreign corporation in which the United States shareholder includes an amount in income under section 951(a)(1) or 951A(a) with respect to the controlled foreign corporation.

(11) Income group. The term income group means a group of income described in paragraph (d)(2)(ii) of this section.

(12) Partnership CFC. The term partnership CFC has the meaning set forth in § 1.951A-5(e)(2).

(13) Passive category. The term passive category means the separate category of income described in section 904(d)(1)(C) and § 1.904-4(b).

(14) Previously taxed earnings and profits. The term previously taxed earnings and profits means earnings and profits described in section 959(c)(1) or (2), including earnings and profits described in section 959(c)(2) by reason of section 951A(f)(1) and § 1.951A-6(b)(1).

(15) PTEP group. The term PTEP group has the meaning set forth in § 1.960-3(c)(2).

(16) PTEP group taxes. The term PTEP group taxes has the meaning set forth in § 1.960-3(d)(1).

(17) Recipient controlled foreign corporation. The term recipient controlled foreign corporation has the meaning set forth in § 1.960-3(b)(2).

(18) Reclassified previously taxed earnings and profits. The term reclassified previously taxed earnings and profits has the meaning set forth in § 1.960-3(c)(4).

(19) Reclassified PTEP group. The term reclassified PTEP group has the meaning set forth in § 1.960-3(c)(4).

(20) Residual income group. The term residual income group has the meaning set forth in paragraph (d)(2)(ii)(D) of this section.

(21) Section 904 category. The term section 904 category means a separate category of income described in § 1.904-5(a)(4)(v).

(22) Section 951A category. The term section 951A category means the separate category of income described in section 904(d)(1)(A) and § 1.904-4(g).

(23) Section 959 distribution. The term section 959 distribution means a section 959(a) distribution or a section 959(b) distribution.

(24) Section 959(a) distribution. The term section 959(a) distribution means a distribution excluded from the gross income of a United States shareholder under section 959(a).

(25) Section 959(b) distribution. The term section 959(b) distribution means a distribution excluded from the gross income of a controlled foreign corporation for purposes of section 951(a) under section 959(b).

(26) Section 959(c)(2) PTEP group. The term section 959(c)(2) PTEP group has the meaning set forth in § 1.960-3(c)(4).

(27) Subpart F inclusion. The term subpart F inclusion has the meaning set forth in § 1.960-2(b)(1).

(28) Subpart F income. The term subpart F income has the meaning set forth in section 952 and § 1.952-1(a).

(29) Subpart F income group. The term subpart F income group has the meaning set forth in paragraph (d)(2)(ii)(B)(1) of this section.

(30) Tested foreign income taxes. The term tested foreign income taxes has the meaning set forth in § 1.960-2(c)(3).

(31) Tested income. The term tested income means the amount with respect to a controlled foreign corporation that is described in section 951A(c)(2)(A) and § 1.951A-2(b)(1).

(32) Tested income group. The term tested income group has the meaning set forth in paragraph (d)(2)(ii)(C) of this section.

(33) United States shareholder. The term United States shareholder has the meaning set forth in section 951(b).

(34) U.S. shareholder partner. The term U.S. shareholder partner has the meaning set forth in § 1.951A-5(e)(3).

(35) U.S. shareholder partnership. The term U.S. shareholder partnership has the meaning set forth in § 1.951A-5(e)(4).

(36) U.S. taxable year. The term U.S. taxable year has the same meaning as that of the term taxable year set forth in section 7701(a)(23).

(c) Computational rules—(1) In general. For purposes of computing foreign income taxes deemed paid by either a domestic corporation that is a United States shareholder with respect to a controlled foreign corporation under § 1.960-2 or 1.960-3 or by a controlled foreign corporation under § 1.960-3 for the current taxable year, the following rules apply in the following order, beginning with the lowest-tier controlled foreign corporation in a chain with respect to which the domestic corporation is a United States shareholder:

(i) First, items of gross income of the controlled foreign corporation for the current taxable year other than a section 959(b) distribution are assigned to section 904 categories and included in income groups within those section 904 categories under the rules in paragraph (d)(2) of this section. The receipt of a section 959(b) distribution by the controlled foreign corporation is accounted for under § 1.960-3(c)(3).

(ii) Second, deductions (other than for current year taxes) of the controlled foreign corporation for the current taxable year are allocated and apportioned to reduce gross income in the section 904 categories and the income groups within a section 904 category. See paragraph (d)(3)(i) of this section. Additionally, the functional currency amounts of current year taxes of the controlled foreign corporation for the current taxable year are allocated and apportioned to reduce gross income in the section 904 categories and the income groups within a section 904 category, and to reduce earnings and profits in any PTEP groups that were increased as provided in paragraph (c)(1)(i) of this section. See paragraph (d)(3)(ii) of this section. For purposes of computing foreign taxes deemed paid, current year taxes allocated and apportioned to income groups and PTEP groups in the section 904 categories are translated into U.S. dollars in accordance with section 986(a). See paragraph (c)(3) of this section.

(iii) Third, current year taxes deemed paid under section 960(a) and (d) by the domestic corporation with respect to income of the controlled foreign corporation are computed under the rules of § 1.960-2. In addition, foreign income taxes deemed paid under section 960(b)(2) with respect to the receipt of a section 959(b) distribution by the controlled foreign corporation are computed under the rules of § 1.960-3(b).

(iv) Fourth, any previously taxed earnings and profits of the controlled foreign corporation resulting from subpart F inclusions and GILTI inclusion amounts with respect to the controlled foreign corporation's current taxable year are separated from other earnings and profits of the controlled foreign corporation and added to an annual PTEP account, and a PTEP group within the PTEP account, under the rules of § 1.960-3(c).

(v) Fifth, paragraphs (c)(1)(i) through (iv) of this section are repeated for each next higher-tier controlled foreign corporation in the chain.

(vi) Sixth, with respect to the highest-tier controlled foreign corporation in a chain that is owned directly (or indirectly through a partnership) by the domestic corporation, foreign income taxes that are deemed paid under section 960(b)(1) in connection with the receipt of a section 959(a) distribution by the domestic corporation are computed under the rules of § 1.960-3(b).

(2) Inclusion of current year items. For a current taxable year, the items of income and deductions (including for taxes), and the U.S. dollar amounts of current year taxes, that are included in the computations described in this section and assigned to income groups and PTEP groups for the taxable year are the items that the controlled foreign corporation accrues and takes into account during the current taxable year.

(3) Functional currency and translation. The computations described in this paragraph (c) that relate to income and earnings and profits are made in the functional currency of the controlled foreign corporation (as determined under section 985), and references to taxes deemed paid are to U.S. dollar amounts (translated in accordance with section 986(a)).

(d) Computing income in a section 904 category and an income group within a section 904 category—(1) Scope. This paragraph (d) provides rules for assigning gross income (including gains) of a controlled foreign corporation for the current taxable year to a section 904 category and income group within a section 904 category, and for allocating and apportioning deductions (including losses and current year taxes) and the U.S. dollar amount of current year taxes of the controlled foreign corporation for the current taxable year among the section 904 categories, income groups within a section 904 category, and PTEP groups. For rules regarding maintenance of previously taxed earnings and profits in an annual PTEP account, and assignment of those previously taxed earnings and profits to PTEP groups, see § 1.960-3.

(2) Assignment of gross income to section 904 categories and income groups within a category—(i) Assigning items of gross income to section 904 categories. Items of gross income of the controlled foreign corporation for the current taxable year are first assigned to a section 904 category of the controlled foreign corporation under §§ 1.904-4 and 1.904-5, and under § 1.960-3(c)(1) in the case of gross income relating to a section 959(b) distribution received by the controlled foreign corporation. Income of a controlled foreign corporation, other than gross income relating to a section 959(b) distribution, cannot be assigned to the section 951A category or the foreign branch category. See § 1.904-4(f) and (g).

(ii) Grouping gross income within a section 904 category—(A) In general. Gross income within a section 904 category is assigned to an income group under the rules of this paragraph (d)(2)(ii), or to a PTEP group under the rules of § 1.960-3(c)(3). Gross income other than a section 959(b) distribution is assigned to a subpart F income group, tested income group, or residual income group.

(B) Subpart F income groups—(1) In general. The term subpart F income group means an income group within a section 904 category that consists of income that is described in paragraph (d)(2)(ii)(B)(2) of this section. Gross income that is treated as a single item of income under § 1.954-1(c)(1)(iii) is in a separate subpart F income group under paragraph (d)(2)(ii)(B)(2)(i) of this section. Items of gross income that give rise to income described in paragraph (d)(2)(ii)(B)(2)(ii) of this section are aggregated and treated as gross income in a separate subpart F income group. Similarly, items of gross income that give rise to income described in each one of paragraphs (d)(2)(ii)(B)(2)(iii) through (v) of this section are aggregated and treated as gross income in a separate subpart F income group.

(2) Income in subpart F income groups. The income included in subpart F income groups is:

(i) Items of foreign base company income treated as a single item of income under § 1.954-1(c)(1)(iii);

(ii) Insurance income described in section 952(a)(1);

(iii) Income subject to the international boycott factor described in section 952(a)(3);

(iv) Income from certain bribes, kickbacks and other payments described in section 952(a)(4); and

(v) Income subject to section 901(j) described in section 952(a)(5).

(C) Tested income groups. The term tested income group means an income group that consists of tested income within a section 904 category. Items of gross tested income in each section 904 category are aggregated and treated as gross income in a separate tested income group.

(D) Residual income group. The term residual income group means the income group within a section 904 category that consists of income not described in paragraph (d)(2)(ii)(B) or (C) of this section.

(E) Examples. The following examples illustrate the application of this paragraph (d)(2)(ii).

(1 ) Example 1: Subpart F income groups—(i) Facts. CFC, a controlled foreign corporation, is incorporated in Country X. CFC uses the “u” as its functional currency. At all relevant times, 1u=$1. CFC earns from sources outside of Country X portfolio dividend income of 100,000u, portfolio interest income of 1,500,000u, and 70,000u of royalty income that is not derived from the active conduct of a trade or business. CFC also earns 50,000u from the sale of personal property to a related person for use outside of Country X that gives rise to foreign base company sales income under section 954(d). Finally, CFC earns 45,000u for performing consulting services outside of Country X for related persons that gives rise to foreign base company services income under section 954(e). None of the income is taxed by Country X. The dividend income is subject to a 15 percent third-country withholding tax after application of the applicable income tax treaty. The interest income and the royalty income are subject to no third-country withholding tax. CFC incurs no expenses.

(ii) Analysis. Under paragraph (d)(2)(i) of this section and § 1.904-4, the interest income, dividend income, and royalty income are passive category income and the sales and consulting income are general category income. Under paragraph (d)(2)(ii)(B) of this section, CFC has a separate subpart F income group within the passive category with respect to the 100,000u of dividend income, which is foreign personal holding company income described in § 1.954-1(c)(1)(iii)(A)(1)(i) (dividends, interest, rents, royalties and annuities) that falls within a single group of income under § 1.904-4(c)(3)(i) for passive income that is subject to withholding tax of fifteen percent or greater. CFC also has a separate subpart F income group within the passive category with respect to the 1,500,000u of interest income and the 70,000u of royalty income (in total 1,570,000u) which together are foreign personal holding company income described in § 1.954-1(c)(1)(iii)(A)(1)(i) (dividends, interest, rents, royalties and annuities) that falls within a single group of income under § 1.904-4(c)(3)(iii) for passive income that is subject to no withholding tax or other foreign tax. With respect to its 50,000u of sales income, CFC has a separate subpart F income group with respect to foreign base company sales income described in § 1.954-1(c)(1)(iii)(A)(2)(i) within the general category. With respect to its 45,000u of services income, CFC has a separate subpart F income group with respect to foreign base company services income described in § 1.954-1(c)(1)(iii)(A)(2)(ii) within the general category.

(2 ) Example 2: Tested income groups—(i) Facts. CFC, a controlled foreign corporation, is incorporated in Country X. CFC uses the “u” as its functional currency. At all relevant times, 1u=$1. CFC earns 500u from the sale of goods to unrelated parties. CFC also earns 75u for performing consulting services for unrelated parties. All of its income is gross tested income. CFC incurs no deductions.

(ii) Analysis. Under paragraph (d)(2)(i) of this section and section 904 and § 1.904-4, the sales income and services income are both general category income. Under paragraph (d)(2)(ii)(C) of this section, with respect to the 500u of sales income and 75u services income (in total 575u), CFC has one tested income group within the general category.

(3) Allocation and apportionment of deductions among section 904 categories, income groups within a section 904 category, and certain PTEP groups—(i) In general. Gross income of the controlled foreign corporation in each income group within each section 904 category is reduced by deductions (including losses) of the controlled foreign corporation for the current taxable year under the following rules.

(A) First, the rules of sections 861 through 865 and 904(d) and the regulations under those sections (taking into account the rules of section 954(b)(5) and § 1.954-1(c), and section 951A(c)(2)(A)(ii) and § 1.951A-2(c)(3), as appropriate) apply to allocate and apportion to reduce gross income (or create a loss) in each section 904 category and income group within a section 904 category any deductions of the controlled foreign corporation that are definitely related to less than all of the controlled foreign corporation's gross income as a class. See paragraph (d)(3)(ii) of this section for special rules for allocating and apportioning current year taxes to section 904 categories, income groups, and PTEP groups.

(B) Second, related person interest expense is allocated to and apportioned among the subpart F income groups within the passive category under the principles of § 1.904-5(c)(2) and § 1.954-1(c)(1)(i).

(C) Third, any remaining deductions are allocated and apportioned to reduce gross income (or create a loss) in the section 904 categories and income groups within each section 904 category under the rules referenced in paragraph (d)(3)(i)(A) of this section. No deductions of the controlled foreign corporation for the current taxable year other than a deduction for current year taxes imposed solely by reason of the receipt of a section 959(b) distribution are allocated or apportioned to reduce earnings and profits in a PTEP group.

(ii) Allocation and apportionment of current year taxes—(A) In general. Current year taxes are allocated and apportioned among the section 904 categories under the rules of § 1.904-6(a)(1)(i) and (ii) on the basis of the amount of taxable income computed under foreign law in each section 904 category that is included in the foreign tax base. Current year taxes in a section 904 category are then allocated and apportioned among the income groups within a section 904 category under the principles of § 1.904-6(a)(1)(i) and (ii). If the amount of previously taxed earnings and profits in a PTEP group is increased in the current taxable year of the controlled foreign corporation under § 1.960-3(c)(3) by reason of the receipt of a section 959(b) distribution, then for purposes of allocating and apportioning current year taxes that are imposed solely by reason of the receipt of the section 959(b) distribution under this paragraph (d)(3)(ii)(A), the PTEP group is treated as an income group within the section 904 category. In applying § 1.904-6(a)(1)(i) and (ii) for purposes of this paragraph (d)(3)(ii)(A), the gross items of income and deduction calculated under foreign law that are included in a section 904 category, income group, or PTEP group that is treated as an income group are the items that are included in taxable income under foreign law for the foreign taxable year of the controlled foreign corporation that ends with or within the controlled foreign corporation's current taxable year. For purposes of determining foreign income taxes deemed paid under the rules in §§ 1.960-2 and 1.960-3, the U.S. dollar amounts of current year taxes are assigned to the section 904 categories, income groups, and PTEP groups, if any, to which the current year taxes are allocated and apportioned.

(B) Base and timing differences—(1) In general. Current year taxes that are attributable to a base difference described in § 1.904-6(a)(1)(iv) are not allocated and apportioned to any subpart F income group, tested income group or PTEP group, but are treated as related to income in the residual income group. Except as provided in paragraph (d)(3)(ii)(B)(2) of this section, current year taxes that are attributable to a timing difference described in § 1.904-6(a)(1)(iv) are treated as related to the appropriate section 904 category and income group within a section 904 category to which the particular tax would be assigned if the income on which the tax is imposed were recognized under Federal income tax principles in the year in which the tax was imposed.

(2) Tax on previously taxed earnings and profits. Current year taxes imposed solely by reason of the controlled foreign corporation's receipt of a section 959(b) distribution are not allocated and apportioned under the general rule for timing differences but are allocated or apportioned to a PTEP group. Current year taxes imposed with respect to previously taxed earnings and profits by reason of any other timing difference are allocated or apportioned, under the general rule described in paragraph (d)(3)(ii)(B)(1) of this section, to the income group to which the income that gave rise to the previously taxed earnings and profits was assigned in the inclusion year. For example, a net basis tax imposed on a controlled foreign corporation's receipt of a section 959(b) distribution by the corporation's country of residence is allocated or apportioned to a PTEP group. Similarly, a withholding tax imposed with respect to a controlled foreign corporation's receipt of a section 959(b) distribution is allocated and apportioned to a PTEP group. In contrast, a withholding tax imposed on a disregarded payment from a disregarded entity to its controlled foreign corporation owner is treated as a timing difference and is never treated as related to a PTEP group, even if all of the controlled foreign corporation's earnings are previously taxed earnings and profits, because the tax is not imposed solely by reason of a section 959(b) distribution. Such a withholding tax, however, may be treated as related to a subpart F income group or tested income group under the general rule for timing differences.

(e) No deemed paid credit for current year taxes related to residual income group. Current year taxes paid or accrued by a controlled foreign corporation that are allocated and apportioned under paragraph (d)(3)(ii) of this section to a residual income group cannot be deemed paid under section 960 for any taxable year.

(f) Example. The following example illustrates the application of this section and § 1.960-3.

(1) Facts—(i) Income of CFC1 and CFC2. CFC1, a controlled foreign corporation, conducts business in Country X. CFC1 uses the “u” as its functional currency. At all relevant times, 1u=$1. CFC1 owns all of the stock of CFC2, a controlled foreign corporation. CFC1 and CFC2 both use the calendar year as their U.S. and foreign taxable years. In 2019, CFC1 earns 2,000,000u of gross income that is foreign oil and gas extraction income, within the meaning of section 907(c)(1), and 2,000,000u of interest income from unrelated persons, for both U.S. and Country X tax law purposes. Country X exempts interest income from tax. In 2019, CFC1 also receives a section 959(b) distribution from CFC2 of 4,000,000u of previously taxed earnings and profits attributable to an inclusion under section 965(a) for CFC2's 2017 U.S. taxable year. The inclusion under section 965(a) was income in the general category. There are no PTEP group taxes associated with the previously taxed earnings and profits distributed by CFC2 at the level of CFC2. The section 959(b) distribution is treated as a dividend taxable to CFC1 under Country X law. In 2019, CFC2 earns no gross income and receives no distributions.

(ii) Pre-tax deductions of CFC1 and CFC2. For both U.S. and Country X tax purposes, in 2019, CFC1 incurs 1,500,000u of deductible expenses other than current year taxes that are allocable to all gross income. For U.S. tax purposes, under §§ 1.861-8 through 1.861-14T, 750,000u of such deductions are apportioned to each of CFC1's foreign oil and gas extraction income and interest income. Under Country X law, 1,000,000u of deductions are allocated and apportioned to the 4,000,000u treated as a dividend, and 500,000u of deductions are allocated and apportioned to the 2,000,000u of foreign oil and gas extraction income. Under Country X law, no deductions are allocable to the interest income. Country X imposes tax of 900,000u on a base of 4,500,000u (6,000,000u gross income−1,500,000u deductions) consisting of 3,000,000u (4,000,000u−1,000,000u) attributable to CFC1's section 959(b) distribution and 1,500,000u (2,000,000u−500,000u) attributable to CFC1's foreign oil and gas extraction income. In 2019, CFC2 has no expenses (including current year taxes).

(iii) United States shareholders of CFC1. All of the stock of CFC1 is owned (within the meaning of section 958(a)) by corporate United States shareholders that use the calendar year as their U.S. taxable year. In 2019, the United States shareholders of CFC1 include in gross income subpart F inclusions in the passive category totaling $1,250,000 with respect to 1,250,000u of subpart F income of CFC1.

(2) Analysis—(i) CFC2. Under paragraph (c)(1) of this section, the computational rules of paragraph (c)(1) of this section are applied beginning with CFC2. However, CFC2 has no gross income or expenses in 2019 (the “current taxable year”). Accordingly, the computational rules described in paragraph (c)(1)(i) through (iv) of this section are not relevant with respect to CFC2. Under paragraph (c)(1)(v) of this section, the rules in paragraph (c)(1)(i) through (iv) of this section are then applied to CFC1.

(ii) CFC1. (A) Step 1. Under paragraph (c)(1)(i) of this section, CFC1's items of gross income for the current taxable year are assigned to section 904 categories and included in income groups within those section 904 categories. In addition, CFC1's receipt of a section 959(b) distribution is assigned to a PTEP group. Under paragraph (d)(2)(i) of this section and § 1.904-4, the interest income is passive category income and the foreign oil and gas extraction income is general category income. Under paragraph (d)(2)(ii) of this section, the 2,000,000u of interest income is assigned to a subpart F income group (the “subpart F income group”) within the passive category because it is foreign personal holding company income described in § 1.954-1(c)(1)(iii)(A)(1)(i) that falls within a single group of income under § 1.904-4(c)(3)(iii) for passive income that is subject to no withholding tax or other foreign tax. The 2,000,000u of foreign oil and gas extraction income is assigned to the residual income group within the general category. Under § 1.960-3(c), the 4,000,000u section 959(b) distribution is assigned to the PTEP group described in § 1.960-3(c)(2)(vii) within the 2017 annual PTEP account (the “PTEP group”) within the general category.

(B) Step 2—(1) Allocation and apportionment of deductions for expenses other than taxes. Under paragraph (c)(1)(ii) of this section, CFC1's deductions for the current taxable year are allocated and apportioned among the section 904 categories, income groups within a section 904 category, and any PTEP groups that were increased as provided in paragraph (c)(1)(i) of this section. Under paragraph (d)(3)(i) of this section and § 1.861-8 through 1.861-14T, 750,000u of deductions are allocated and apportioned to the residual income group within the general category, and 750,000u of deductions are allocated and apportioned to the subpart F income group within the passive category. Therefore, CFC1 has 1,250,000u (2,000,000u−750,000u) of pre-tax income attributable to the residual income group within the general category and 1,250,000u (2,000,000u−750,000u) of pre-tax income attributable to the subpart F income group within the passive category. For U.S. tax purposes, no deductions other than current year taxes are allocated and apportioned to the 4,000,000u in CFC1's PTEP group.

(2) Allocation and apportionment of current year taxes. Under paragraph (c)(1)(ii) of this section, CFC1's current year taxes are allocated and apportioned among the section 904 categories, income groups within a section 904 category, and any PTEP groups that were increased as provided in paragraph (c)(1)(i) of this section. Under paragraphs (d)(3)(i) and (ii) of this section, for purposes of allocating and apportioning taxes to reduce the income in a section 904 category, an income group, or PTEP group, § 1.904-6(a)(1) and (ii) are applied to determine the amount of taxable income computed under Country X law in each section 904 category, income group, and PTEP group that is included in the Country X tax base. For Country X purposes, 1,000,000u of deductions are apportioned to CFC1's PTEP group within the general category, 500,000u of deductions are apportioned to the residual income group within the general category, and no deductions are apportioned to the subpart F income group in the passive category. Therefore, for Country X purposes, CFC1 has 3,000,000u of income attributable to the PTEP group within the general category, 1,500,000u of income attributable to the residual income group within the general category, and no income attributable to the subpart F income group within the passive category. Under paragraph (d)(3)(ii) of this section, 600,000u (3,000,000u/4,500,000u × 900,000u) of the 900,000u current year taxes paid by CFC1 are related to the PTEP group within the general category, and 300,000u (1,500,000u/4,500,000u × 900,000u) are related to the residual income group within the general category. No current year taxes are allocated or apportioned to the subpart F income group within the passive category because the interest expense is exempt from Country X tax. Thus, for U.S. tax purposes, CFC1 has 3,400,000u of previously taxed earnings and profits (4,000,000u−600,000u) in the PTEP group within the general category, 1,250,000u of income in the subpart F income group within the passive category, and 950,000u of income (1,250,000u−300,000u) in the residual income group within the general category. For purposes of determining foreign taxes deemed paid under section 960, CFC1 has $600,000 of foreign income taxes in the PTEP group within the general category and $300,000 of current year taxes in the residual income group within the general category. Under paragraph (e) of this section, the United States shareholders of CFC1 cannot claim a credit with respect to the $300,000 of taxes on CFC1's income in the residual income group.

(C) Step 3. Under paragraph (c)(1)(iii) of this section, the United States shareholders of CFC1 compute current year taxes deemed paid under section 960(a) and (d) and the rules of § 1.960-2. None of the Country X tax is allocated to CFC1's subpart F income group. Therefore, there are no current year taxes deemed paid by CFC1's United States shareholders with respect to their passive category subpart F inclusions. See § 1.960-2(b)(5) and (c)(7) for examples of the application of section 960(a) and (d) and the rules in § 1.960-2. Additionally, under paragraph (c)(1)(iii) of this section, foreign income taxes deemed paid under section 960(b)(2) by CFC1 are determined with respect to the section 959(b) distribution from CFC2 under the rules of § 1.960-3. There are no PTEP group taxes associated with the previously taxed earnings and profits distributed by CFC2 in the hands of CFC2. Therefore, there are no foreign income taxes deemed paid by CFC1 under section 960(b)(2) with respect to the section 959(b) distribution from CFC2. See § 1.960-3(e) for examples of the application of section 960(b) and the rules in § 1.960-3.

(D) Step 4. Under paragraph (c)(1)(iv) of this section, previously taxed earnings and profits resulting from subpart F inclusions and GILTI inclusion amounts with respect to CFC1's current taxable year are separated from CFC1's other earnings and profits and added to an annual PTEP account and PTEP group within the PTEP account, under the rules of § 1.960-3(c). The United States shareholders of CFC1 include in gross income subpart F inclusions totaling $1,250,000 with respect to 1,250,000u of subpart F income of CFC1, and the subpart F inclusions are passive category income. Therefore, under § 1.960-3(c)(2), 1,250,000u of previously taxed earnings and profits resulting from the subpart F inclusions is added to CFC1's PTEP group described in § 1.960-3(c)(2)(x) within the 2019 annual PTEP account within the passive category.

(E) Step 5. Paragraph (c)(1)(v) of this section does not apply because CFC1 is the highest-tier controlled foreign corporation in the chain.

(F) Step 6. Paragraph (c)(1)(vi) of this section does not apply because CFC1 did not make a section 959(a) distribution.

(a) Scope. Paragraph (b) of this section provides rules for computing the amount of foreign income taxes deemed paid by a domestic corporation that is a United States shareholder of a controlled foreign corporation under section 960(a). Paragraph (c) of this section provides rules for computing the amount of foreign income taxes deemed paid by a domestic corporation that is a United States shareholder of a controlled foreign corporation under section 960(d).

(b) Foreign income taxes deemed paid under section 960(a) —(1) In general. If a domestic corporation that is a United States shareholder of a controlled foreign corporation includes in gross income under section 951(a)(1)(A) its pro rata share of the subpart F income of the controlled foreign corporation (a subpart F inclusion), the domestic corporation is deemed to have paid the amount of the controlled foreign corporation's foreign income taxes that are properly attributable to the items of income in a subpart F income group of the controlled foreign corporation that give rise to the subpart F inclusion of the domestic corporation that is attributable to the subpart F income group. For each section 904 category, the domestic corporation is deemed to have paid foreign income taxes equal to the sum of the controlled foreign corporation's foreign income taxes that are properly attributable to the items of income in the subpart F income groups to which the subpart F inclusion is attributable. See § 1.904-6(b)(1) for rules on assigning the foreign income tax to a section 904 category. No foreign income taxes are deemed paid under section 960(a) with respect to an inclusion under section 951(a)(1)(B).

(2) Properly attributable. The amount of the controlled foreign corporation's foreign income taxes that are properly attributable to the items of income in the subpart F income group of the controlled foreign corporation to which a subpart F inclusion is attributable equals the domestic corporation's proportionate share of the current year taxes of the controlled foreign corporation that are allocated and apportioned under § 1.960-1(d)(3)(ii) to the subpart F income group. No other foreign income taxes are considered properly attributable to an item of income of the controlled foreign corporation.

(3) Proportionate share—(i) In general. A domestic corporation's proportionate share of the current year taxes of a controlled foreign corporation that are allocated and apportioned under § 1.960-1(d)(3)(ii) to a subpart F income group within a section 904 category of the controlled foreign corporation is equal to the total U.S. dollar amount of current year taxes that are allocated and apportioned under § 1.960-1(d)(3)(ii) to the subpart F income group multiplied by a fraction (not to exceed one), the numerator of which is the portion of the domestic corporation's subpart F inclusion that is attributable to the subpart F income group and the denominator of which is the total net income in the subpart F income group, both determined in the functional currency of the controlled foreign corporation. If the numerator or denominator of the fraction is zero or less than zero, then the proportionate share of the current year taxes that are allocated and apportioned under § 1.960-1(d)(3)(ii) to the subpart F income group is zero.

(ii) Effect of qualified deficits. Neither an accumulated deficit nor any prior year deficit in the earnings and profits of a controlled foreign corporation reduces its net income in a subpart F income group. Accordingly, any such deficit does not affect the denominator of the fraction described in paragraph (b)(3)(i) of this section. However, the first sentence of this paragraph (b)(3)(ii) does not affect the application of section 952(c)(1)(B) for purposes of determining the domestic corporation's subpart F inclusion. Any reduction to the domestic corporation's subpart F inclusion under section 952(c)(1)(B) is reflected in the numerator of the fraction described in paragraph (b)(3)(i) of this section.

(iii) Effect of current year E&P limitation or chain deficit. To the extent that an amount of income in a subpart F income group is excluded from the subpart F income of the controlled foreign corporation under section 952(c)(1)(A) or (C), the net income in the subpart F income group that is the denominator of the fraction described in paragraph (b)(3)(i) of this section is reduced (but not below zero) by the amount excluded. The domestic corporation's subpart F inclusion that is the numerator of the fraction described in paragraph (b)(3)(i) of this section is based on the controlled foreign corporation's subpart F income computed with the application of section 952(c)(1)(A) and (C).

(4) Domestic partnerships. For purposes of applying this paragraph (b), in the case of a domestic partnership that is a U.S. shareholder partnership with respect to a partnership CFC, the distributive share of a U.S. shareholder partner of the U.S. shareholder partnership's subpart F inclusion with respect to the partnership CFC is treated as a subpart F inclusion of the U.S. shareholder partner with respect to the partnership CFC.

(5) Example. The following example illustrates the application of this paragraph (b).

(i) Facts. USP, a domestic corporation, owns 80% of the stock of CFC, a controlled foreign corporation. The remaining portion of the stock of CFC is owned by an unrelated person. USP and CFC both use the calendar year as their U.S. taxable year, and CFC also uses the calendar year as its foreign taxable year. CFC uses the “u” as its functional currency. At all relevant times, 1u=$1. For its U.S. taxable year ending December 31, 2018, after the application of the rules in § 1.960-1(d) the income of CFC after foreign taxes is assigned to the following income groups: 1,000,000u of dividend income in a subpart F income group within the passive category (“subpart F income group 1”); 2,400,000u of gain from commodities transactions in a subpart F income group within the passive category (“subpart F income group 2”); and 1,800,000u of foreign base company services income in a subpart F income group within the general category (“subpart F income group 3”). CFC has current year taxes, translated into U.S. dollars, of $740,000 that are allocated and apportioned as follows: $50,000 to subpart F income group 1; $240,000 to subpart F income group 2; and $450,000 to subpart F income group 3. USP has a subpart F inclusion with respect to CFC of 4,160,000u = $4,160,000, of which 800,000u is attributable to subpart F income group 1, 1,920,000u to subpart F income group 2, and 1,440,000u to subpart F income group 3.

(ii) Analysis—(A) Passive category. Under paragraphs (b)(2) and (3) of this section, the amount of CFC's current year taxes that are properly attributable to items of income in subpart F income group 1 to which a subpart F inclusion is attributable equals USP's proportionate share of the current year taxes that are allocated and apportioned under § 1.960-1(d)(3)(ii) to subpart F income group 1, which is $40,000 ($50,000 × 800,000u/1,000,000u). Under paragraphs (b)(2) and (3) of this section, the amount of CFC's current year taxes that are properly attributable to items of income in subpart F income group 2 to which a subpart F inclusion is attributable equals USP's proportionate share of the current year taxes that are allocated and apportioned under § 1.960-1(d)(3)(ii) to subpart F income group 2, which is $192,000 ($240,000 × 1,920,000u/2,400,000u). Accordingly, under paragraph (b)(1), USP is deemed to have paid $232,000 ($40,000 + $192,000) of passive category foreign income taxes of CFC with respect to its $2,720,000 subpart F inclusion in the passive category.

(B) General category. Under paragraphs (b)(2) and (3) of this section, the amount of CFC's current year taxes that are properly attributable items of income in subpart F income group 3 to which a subpart F inclusion is attributable equals USP's proportionate share of the foreign income taxes that are allocated and apportioned under § 1.960-1(d)(3)(ii) to subpart F income group 3, which is $360,000 ($450,000 × 1,440,000u/1,800,000u). CFC has no other subpart F income groups within the general category. Accordingly, under paragraph (b)(1) of this section, USP is deemed to have paid $360,000 of general category foreign income taxes of CFC with respect to its $1,440,000 subpart F inclusion in the general category.

(c) Foreign income taxes deemed paid under section 960(d) —(1) In general. If a domestic corporation that is a United States shareholder of one or more controlled foreign corporations includes an amount in gross income under section 951A(a) and § 1.951A-1(b), the domestic corporation is deemed to have paid an amount of foreign income taxes equal to 80 percent of the product of its inclusion percentage multiplied by the sum of all tested foreign income taxes in the tested income group within each section 904 category of the controlled foreign corporation or corporations.

(2) Inclusion percentage. The term inclusion percentage means, with respect to a domestic corporation that is a United States shareholder of one or more controlled foreign corporations, the domestic corporation's GILTI inclusion amount divided by the aggregate amount described in section 951A(c)(1)(A) and § 1.951A-1(c)(2)(i) with respect to the United States shareholder.

(3) Tested foreign income taxes. The term tested foreign income taxes means, with respect to a domestic corporation that is a United States shareholder of a controlled foreign corporation, the amount of the controlled foreign corporation's foreign income taxes that are properly attributable to tested income taken into account by the domestic corporation under section 951A and § 1.951A-1.

(4) Properly attributable. The amount of the controlled foreign corporation's foreign income taxes that are properly attributable to tested income taken into account by the domestic corporation under section 951A(a) and § 1.951A-1(b) equals the domestic corporation's proportionate share of the current year taxes of the controlled foreign corporation that are allocated and apportioned under § 1.960-1(d)(3)(ii) to the tested income group within each section 904 category of the controlled foreign corporation. No other foreign income taxes are considered properly attributable to tested income.

(5) Proportionate share. A domestic corporation's proportionate share of current year taxes of a controlled foreign corporation that are allocated and apportioned under § 1.960-1(d)(3)(ii) to a tested income group within a section 904 category of the controlled foreign corporation is the U.S. dollar amount of current year taxes that are allocated and apportioned under § 1.960-1(d)(3)(ii) to a tested income group within a section 904 category of the controlled foreign corporation multiplied by a fraction (not to exceed one), the numerator of which is the portion of the tested income of the controlled foreign corporation in the tested income group within the section 904 category that is included in computing the domestic corporation's aggregate amount described in section 951A(c)(1)(A) and § 1.951A-1(c)(2)(i), and the denominator of which is the income in the tested income group within the section 904 category, both determined in the functional currency of the controlled foreign corporation. If the numerator or denominator of the fraction is zero or less than zero, the domestic corporation's proportionate share of the current year taxes allocated and apportioned under § 1.960-1(d)(3)(ii) to the tested income group is zero.

(6) Domestic partnerships. See § 1.951A-5 for rules regarding the determination of the GILTI inclusion amount of a U.S. shareholder partner.

(7) Examples. The following examples illustrate the application of this paragraph (c).

(i) Example 1: Directly owned controlled foreign corporation—(A) Facts. USP, a domestic corporation, owns 100% of the stock of a number of controlled foreign corporations, including CFC1. USP and CFC1 each use the calendar year as their U.S. taxable year. CFC1 uses the “u” as its functional currency. At all relevant times, 1u=$1. For its U.S. taxable year ending December 31, 2018, after application of the rules in § 1.960-1(d), the income of CFC1 is assigned to a single income group: 2,000u of income from the sale of goods in a tested income group within the general category (“tested income group”). CFC1 has current year taxes, translated into U.S. dollars, of $400 that are all allocated and apportioned to the tested income group. For its U.S. taxable year ending December 31, 2018, USP has a GILTI inclusion amount determined by reference to all of its controlled foreign corporations, including CFC1, of $6,000, and an aggregate amount described in section 951A(c)(1)(A) and § 1.951A-1(c)(2)(i) of $10,000. All of the income in CFC1's tested income group is included in computing USP's aggregate amount described in section 951A(c)(1)(A) and § 1.951A-1(c)(2)(i).

(B) Analysis. Under paragraph (c)(5) of this section, USP's proportionate share of the current year taxes that are allocated and apportioned under § 1.960-1(d)(3)(ii) to CFC1's tested income group is $400 ($400 × 2,000u/2,000u). Therefore, under paragraph (c)(4) of this section, the amount of current year taxes properly attributable to tested income taken into account by USP under section 951A(a) and § 1.951A-1(b) is $400. Under paragraph (c)(3) of this section, USP's tested foreign income taxes with respect to CFC1 are $400. Under paragraph (c)(2) of this section, USP's inclusion percentage is 60% ($6,000/$10,000). Accordingly, under paragraph (c)(1) of this section, USP is deemed to have paid $192 of the foreign income taxes of CFC1 (80% × 60% × $400).

(ii) Example 2: Controlled foreign corporation owned through domestic partnership—(A) Facts—(1) US1, a domestic corporation, owns 95% of PRS, a domestic partnership. The remaining 5% of PRS is owned by US2, a domestic corporation that is unrelated to US1. PRS owns all of the stock of CFC1, a controlled foreign corporation. In addition, US1 owns all of the stock of CFC2, a controlled foreign corporation. US1, US2, PRS, CFC1, and CFC2 all use the calendar year as their taxable year. CFC1 and CFC2 both use the “u” as their functional currency. At all relevant times, 1u=$1. For its U.S. taxable year ending December 31, 2018, after application of the rules in § 1.960-1(d), the income of CFC1 is assigned to a single income group: 300u of income from the sale of goods in a tested income group within the general category (“CFC1's tested income group”). CFC1 has current year taxes, translated into U.S. dollars, of $100 that are all allocated and apportioned to CFC1's tested income group. The income of CFC2 is also assigned to a single income group: 200u of income from the sale of goods in a tested income group within the general category (“CFC2's tested income group”). CFC2 has current year taxes, translated into U.S. dollars, of $20 that are allocated and apportioned to CFC2's tested income group.

(2) In the same year, US1 is a U.S. shareholder partner with respect to CFC1, a partnership CFC, and accordingly, determines its GILTI inclusion amount under § 1.951A-5(c), as if US1 owned (within the meaning of section 958(a)) 95% of the stock of CFC1. Taking into account both CFC1 and CFC2, US1 has a GILTI inclusion amount in the general category of $485, and an aggregate amount described in section 951A(c)(1)(A) and § 1.951A-1(c)(2)(i) within the general category of $485. 285u (95% × 300u) of the income in CFC1's tested income group and 200u of the income in CFC2's tested income group is included in computing US1's aggregate amount described in section 951A(c)(1)(A) and § 1.951A-1(c)(2)(i) within the general category. Because US2 is not a U.S. shareholder partner with respect to CFC1, US2 does not take into account CFC1's tested income in determining its GILTI inclusion amount. However, under § 1.951A-5(b)(2), US2 includes in income $15, its distributive share of PRS's GILTI inclusion amount.

(B) Analysis—(1) US1—(i) CFC1. Under paragraph (c)(5) and (6) of this section, US1's proportionate share of the current year taxes that are allocated and apportioned under § 1.960-1(d)(3)(ii) to CFC1's tested income group is $95 ($100 × 285u/300u). Therefore, under paragraph (c)(4) of this section, the amount of the current year taxes properly attributable to tested income taken into account by US1 under section 951A(a) and § 1.951A-1(b) is $95. Under paragraph (c)(3) of this section, US1's tested foreign income taxes with respect to CFC1 are $95. Under paragraph (c)(2) of this section, US1's inclusion percentage is 100% ($485/$485). Accordingly, under paragraph (c)(1) of this section, US1 is deemed to have paid $76 of the foreign income taxes of CFC1 (80% × 100% × $95).

(ii) CFC2. Under paragraph (c)(5) of this section, US1's proportionate share of the foreign income taxes that are allocated and apportioned under § 1.960-1(d)(3)(ii) to CFC2's tested income group is $20 ($20 × 200u/200u). Therefore, under paragraph (c)(4) of this section, the amount of foreign income taxes properly attributable to tested income taken into account by US1 under section 951A(a) and § 1.951A-1(b) is $20. Under paragraph (c)(3) of this section, US1's tested foreign income taxes with respect to CFC2 are $20. Under paragraph (c)(2) of this section, US1's inclusion percentage is 100% ($485/$485). Accordingly, under paragraph (c)(1) of this section, US1 is deemed to have paid $16 of the foreign income taxes of CFC2 (80% × 100% × $20).

(2) US2. US2 is not a United States shareholder of CFC1 or CFC2. Accordingly, under paragraph (c)(1) of this section, US2 is not deemed to have paid any of the foreign income taxes of CFC1 or CFC2.

(a) Scope. Paragraph (b) of this section provides rules for computing the amount of foreign income taxes deemed paid by a domestic corporation that is a United States shareholder of a controlled foreign corporation, or by a controlled foreign corporation, under section 960(b). Paragraph (c) of this section provides rules for the establishment and maintenance of PTEP groups within an annual PTEP account. Paragraph (d) of this section defines the term PTEP group taxes. Paragraph (e) of this section provides examples illustrating the application of this section.

(b) Foreign income taxes deemed paid under section 960(b) —(1) Foreign income taxes deemed paid by a domestic corporation with respect to a section 959(a) distribution. If a controlled foreign corporation makes a distribution to a domestic corporation that is a United States shareholder with respect to the controlled foreign corporation and that distribution is, in whole or in part, a section 959(a) distribution with respect to a PTEP group within a section 904 category, the domestic corporation is deemed to have paid the amount of the foreign corporation's foreign income taxes that are properly attributable to the section 959(a) distribution with respect to the PTEP group and that have not been deemed to have been paid by a domestic corporation under section 960 for the current taxable year or any prior taxable year. See § 1.965-5(c)(1)(iii) for rules disallowing credits in relation to a distribution of certain previously taxed earnings and profits resulting from the application of section 965. For each section 904 category, the domestic corporation is deemed to have paid foreign income taxes equal to the sum of the controlled foreign corporation's foreign income taxes that are properly attributable to section 959(a) distributions with respect to all PTEP groups within the section 904 category. See § 1.904-6(b)(2) for rules on assigning the foreign income tax to a section 904 category.

(2) Foreign income taxes deemed paid by a controlled foreign corporation with respect to a section 959(b) distribution. If a controlled foreign corporation (distributing controlled foreign corporation) makes a distribution to another controlled foreign corporation (recipient controlled foreign corporation) and the distribution is, in whole or in part, a section 959(b) distribution from a PTEP group within a section 904 category, the recipient controlled foreign corporation is deemed to have paid the amount of the distributing controlled foreign corporation's foreign income taxes that are properly attributable to the section 959(b) distribution from the PTEP group and that have not been deemed to have been paid by a domestic corporation under section 960 for the current taxable year or any prior taxable year. See § 1.904-6(b)(3) for rules on assigning the foreign income tax to a section 904 category.

(3) Properly attributable. The amount of foreign income taxes that are properly attributable to a section 959 distribution from a PTEP group within a section 904 category equals the domestic corporation's or recipient controlled foreign corporation's proportionate share of the PTEP group taxes with respect to the PTEP group within the section 904 category. No other foreign income taxes are considered properly attributable to a section 959 distribution.

(4) Proportionate share. A domestic corporation's or recipient controlled foreign corporation's proportionate share of the PTEP group taxes with respect to a PTEP group within a section 904 category is equal to the total amount of the PTEP group taxes with respect to the PTEP group multiplied by a fraction (not to exceed one), the numerator of which is the amount of the section 959 distribution from the PTEP group, and the denominator of which is the total amount of previously taxed earnings and profits in the PTEP group, both determined in the functional currency of the controlled foreign corporation. If the numerator or denominator of the fraction is zero or less than zero, then the proportionate share of the PTEP group taxes with respect to the PTEP group is zero.

(5) Domestic partnerships. For purposes of applying this paragraph (b), in the case of a domestic partnership that is a U.S. shareholder partnership with respect to a partnership CFC, the distributive share of a U.S. shareholder partner of a U.S. shareholder partnership's section 959(a) distribution from the partnership CFC is treated as a section 959(a) distribution received by the U.S. shareholder partner from the partnership CFC.

(c) Accounting for previously taxed earnings and profits—(1) Establishment of annual PTEP account. A separate, annual account (annual PTEP account) must be established for the previously taxed earnings and profits of the controlled foreign corporation to which inclusions under section 951(a) and GILTI inclusion amounts of United States shareholders of the CFC are attributable. Each account must correspond to the inclusion year of the previously taxed earnings and profits and to the section 904 category to which the inclusions under section 951(a) or GILTI inclusion amounts were assigned at the level of the United States shareholders. Accordingly, a controlled foreign corporation may have an annual PTEP account in the section 951A category or a treaty category (as defined in § 1.861-13(b)(6)), even though income of the controlled foreign corporation that gave rise to the previously taxed earnings and profits cannot initially be assigned to the section 951A category or a treaty category.

(2) PTEP groups within an annual PTEP account. The amount in an annual PTEP account is further assigned to one or more of the following groups of previously taxed earnings and profits (each, a PTEP group) within the account:

(i) Earnings and profits described in section 959(c)(1)(A) by reason of section 951(a)(1)(B) and not by reason of the application of section 959(a)(2);

(ii) Earnings and profits described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 965(a);

(iii) Earnings and profits described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 965(b)(4)(A);

(iv) Earnings and profits described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 951A;

(v) Earnings and profits described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 951(a)(1)(A) (other than as a result of the application of section 965);

(vi) Earnings and profits described in section 959(c)(1)(B);

(vii) Earnings and profits described in section 959(c)(2) by reason of section 965(a);

(viii) Earnings and profits described in section 959(c)(2) by reason of section 965(b)(4)(A);

(ix) Earnings and profits described in section 959(c)(2) by reason of section 951A;

(x) Earnings and profits described in section 959(c)(2) by reason of section 951(a)(1)(A) (other than as a result of the application of section 965).

(3) Accounting for distributions of previously taxed earnings and profits. With respect to a recipient controlled foreign corporation that receives a section 959(b) distribution, such distribution amount is added to the annual PTEP account, and PTEP group within the annual PTEP account, that corresponds to the inclusion year and section 904 category of the annual PTEP account, and PTEP group within the annual PTEP account, from which the distributing controlled foreign corporation is treated as making the distribution under section 959 and the regulations under that section. Similarly, with respect to a controlled foreign corporation that makes a section 959 distribution, such distribution amount reduces the annual PTEP account, and PTEP group within the annual PTEP account, that corresponds to the inclusion year and section 904 category of the annual PTEP account, and PTEP group within the annual PTEP account, from which the controlled foreign corporation is treated as making the distribution under section 959 and the regulations under that section. Earnings and profits in a PTEP group are reduced by the amount of current year taxes that are allocated and apportioned to the PTEP group under § 1.960-1(d)(3)(ii), and the U.S. dollar amount of the taxes are added to an account of PTEP group taxes under the rules in paragraph (d)(1) of this section.

(4) Accounting for reclassifications of earnings and profits described in section 959(c)(2) to earnings and profits described in section 959(c)(1). If an amount of previously taxed earnings and profits that is in a PTEP group described in paragraphs (c)(2)(vii) through (x) of this section (each, a section 959(c)(2) PTEP group) is reclassified as previously taxed earnings and profits described in section 959(c)(1) (reclassified previously taxed earnings and profits), the section 959(c)(2) PTEP group is reduced by the functional currency amount of the reclassified previously taxed earnings and profits. This amount is added to the corresponding PTEP group described in paragraphs (c)(2)(ii) through (v) of this section (each, a reclassified PTEP group) in the same section 904 category and same annual PTEP account as the reduced section 959(c)(2) PTEP group.

(d) PTEP group taxes—(1) In general. The term PTEP group taxes means the U.S. dollar amount of foreign income taxes (translated in accordance with section 986(a)) that are paid, accrued, or deemed paid with respect to an amount in each PTEP group within an annual PTEP account. The foreign income taxes that are paid, accrued, or deemed paid with respect to a PTEP group within an annual PTEP account of a controlled foreign corporation are—

(i) The sum of—

(A) The current year taxes paid or accrued by the controlled foreign corporation that are allocated and apportioned to the PTEP group under § 1.960-1(d)(3)(ii);

(B) Foreign income taxes that are deemed paid under section 960(b)(2) and paragraph (b)(2) of this section by the controlled foreign corporation with respect to a section 959(b) distribution received by the controlled foreign corporation, the amount of which is added to the PTEP group under paragraph (c)(3) of this section; and

(C) In the case of a reclassified PTEP group of the controlled foreign corporation, reclassified PTEP group taxes that are attributable to the section 959(c)(2) PTEP group that corresponds to the reclassified PTEP group;

(ii) Reduced by—

(A) Foreign income taxes that were deemed paid under section 960(b)(2) and paragraph (b)(2) of this section by another controlled foreign corporation that received a section 959(b) distribution from the controlled foreign corporation, the amount of which is subtracted from the controlled foreign corporation's PTEP group under paragraph (c)(3) of this section;

(B) Foreign income taxes that were deemed paid under section 960(b)(1) and paragraph (b)(1) of this section by a domestic corporation that is a United States shareholder of the controlled foreign corporation that received a section 959(a) distribution from the controlled foreign corporation, the amount of which is subtracted from the controlled foreign corporation's PTEP group under paragraph (c)(3) of this section; and

(C) In the case of a section 959(c)(2) PTEP group of the controlled foreign corporation, reclassified PTEP group taxes.

(2) Reclassified PTEP group taxes. Reclassified PTEP group taxes are foreign income taxes that are initially included in PTEP group taxes with respect to a section 959(c)(2) PTEP group under paragraph (d)(1)(i)(A) or (B) of this section multiplied by a fraction, the numerator of which is the portion of the previously taxed earnings and profits in the section 959(c)(2) PTEP group that become reclassified previously taxed earnings and profits, and the denominator of which is the total previously taxed earnings and profits in the section 959(c)(2) PTEP group.

(3) Foreign income taxes deemed paid with respect to PTEP groups established for pre-2018 inclusion years. Foreign income taxes paid or accrued with respect to an annual PTEP account, and a PTEP group within such account, that was established for an inclusion year that begins before January 1, 2018, are treated as PTEP group taxes of a controlled foreign corporation for purposes of this section only if those foreign income taxes were—

(i) Paid or accrued in a taxable year of the controlled foreign corporation that began before January 1, 2018;

(ii) Not included in a controlled foreign corporation's post-1986 foreign income taxes (as defined in section 902(c)(2) as in effect on December 21, 2017) used to compute foreign taxes deemed paid under section 902 (as in effect on December 21, 2017) in any taxable year that began before January 1, 2018; and

(iii) Not treated as deemed paid under section 960(a)(3) (as in effect on December 21, 2017) by a domestic corporation that was a United States shareholder of the controlled foreign corporation.

(e) Examples. The following examples illustrate the application of this section.

(1) Example 1: Establishment of PTEP groups and PTEP accounts—(i) Facts. USP, a domestic corporation, owns all of the stock of CFC1, a controlled foreign corporation. CFC1 owns all of the stock of CFC2, a controlled foreign corporation. USP, CFC1, and CFC2 each use the calendar year as their U.S. taxable year. CFC1 and CFC2 use the “u” as their functional currency. At all relevant times, 1u=$1. With respect to CFC2, USP includes in gross income a subpart F inclusion of 1,000,000u=$1,000,000 for the taxable year ending December 31, 2018. The inclusion is with respect to passive category income. In its U.S. taxable year ending December 31, 2019, CFC2 distributes 1,000,000u to CFC1. CFC2 has no earnings and profits except for the 1,000,000u of previously taxed earnings and profits resulting from USP's 2018 taxable year subpart F inclusion. CFC2's country of organization, Country X, imposes a withholding tax on CFC1 of 300,000u on CFC2's distribution to CFC1. Under § 1.960-1(d)(3)(ii), CFC1's 300,000u of current year taxes are allocated and apportioned to the PTEP group within the annual PTEP account within the section 904 category to which the 1,000,000u of previously taxed earnings and profits are assigned.

(ii) Analysis—(A) Under paragraph (c)(1) of this section, a separate annual PTEP account in the passive category for the 2018 taxable year is established for CFC2 as a result of USP's subpart F inclusion. Under paragraph (c)(2) of this section, this account contains one PTEP group, which is described in paragraph (c)(2)(x) of this section.

(B) Under paragraph (c)(3) of this section, in the 2019 taxable year, the 1,000,000u related to the section 959(b) distribution from CFC2 is added to CFC1's annual PTEP account for the 2018 taxable year in the passive category and to the PTEP group within such account described in paragraph (c)(2)(x) of this section. Similarly, CFC2's 2018 taxable year annual PTEP account within the passive category, and the PTEP group within such account described in paragraph (c)(2)(x) of this section, is reduced by the amount of the 1,000,000u section 959(b) distribution to CFC1. Additionally, CFC1's annual PTEP account for the 2018 taxable year in the passive category, and the PTEP group within such account described in paragraph (c)(2)(x) of this section, is reduced by the 300,000u of withholding taxes imposed on CFC1 by Country X. Therefore, CFC1's annual PTEP account for the 2018 taxable year within the passive category and the PTEP group within such account described in paragraph (c)(2)(x) of this section is 700,000u.

(C) Under paragraph (d)(1) of this section, the 300,000u of withholding tax is translated into U.S. dollars and $300,000 is added to the PTEP group taxes with respect to CFC1's PTEP group described in paragraph (c)(2)(x) of this section within the annual PTEP account for the 2018 taxable year within the passive category.

(2) Example 2: Foreign income taxes deemed paid under section 960(b) —(i) Facts. USP, a domestic corporation, owns 100% of the stock of CFC1, which in turn owns 60% of the stock of CFC2, which in turn owns 100% of the stock of CFC3. USP, CFC1, CFC2, and CFC3 all use the calendar year as their U.S. taxable year. CFC1, CFC2, and CFC3 all use the “u” as their functional currency. At all relevant times, 1u=$1. On July 1, 2020, CFC2 distributes 600u to CFC1 and the entire distribution is a section 959(b) distribution (“distribution 1”). On October 1, 2020, CFC1 distributes 800u to USP and the entire distribution is a section 959(a) distribution (“distribution 2”). CFC1 and CFC2 make no other distributions in the year ending December 31, 2020, earn no other income, and incur no taxes on distribution 1 or distribution 2. Before taking into account distribution 1, CFC2 has 1,000u in a PTEP group described in paragraph (c)(2)(x) of this section within an annual PTEP account for the 2016 taxable year within the general category. The previously taxed earnings and profits in CFC2's PTEP group relate to subpart F income of CFC3 that was included by USP in 2016. CFC3 distributed the earnings and profits to CFC2 before the 2020 taxable year and, solely as a result of the distribution of the previously taxed earnings and profits, CFC2 incurred withholding and net basis tax, resulting in $150 of PTEP group taxes with respect to the PTEP group. Before taking into account distribution 1 and distribution 2, CFC1 has 200u in a PTEP group described in paragraph (c)(2)(ix) of this section within an annual PTEP account for the 2018 taxable year within the section 951A category. The previously taxed earnings and profits in CFC1's PTEP group relate to the portion of a GILTI inclusion amount that was included by USP in 2018 and allocated to CFC2 under section 951A(f)(2) and § 1.951A-6(b)(2). CFC2 distributed the earnings and profits to CFC1 before the 2020 taxable year and, solely as a result of the distribution of the previously taxed earnings and profits, CFC1 incurred withholding and net basis tax, resulting in $25 of PTEP group taxes with respect to the PTEP group.

(ii) Analysis—(A) Foreign income taxes deemed paid by CFC1. With respect to distribution 1 from CFC2 to CFC1, under paragraph (b)(4) of this section CFC1's proportionate share of PTEP group taxes with respect to CFC2's PTEP group described in paragraph (c)(2)(x) of this section within an annual PTEP account for the 2016 taxable year within the general category is $90 ($150 × 600u/1,000u). Under paragraph (b)(3) of this section, the amount of foreign income taxes that are properly attributable to distribution 1 is $90. Accordingly, under paragraph (b)(2) of this section, CFC1 is deemed to have paid $90 of general category foreign income taxes of CFC2 with respect to its 600u section 959(b) distribution in the general category.

(B) Adjustments to PTEP accounts of CFC1 and CFC2. Under paragraph (c)(3) of this section, the 600u related to distribution 1 is added to CFC1's PTEP group described in paragraph (c)(2)(x) of this section within an annual PTEP account for the 2016 taxable year within the general category. Similarly, CFC2's PTEP group described in paragraph (c)(2)(x) of this section within an annual PTEP account for the 2016 taxable year within the general category is reduced by 600u, the amount of the section 959(b) distribution to CFC1. Additionally, under paragraph (d) of this section, CFC1's PTEP group taxes with respect to its PTEP group described in paragraph (c)(2)(x) of this section within an annual PTEP account for the 2016 taxable year within the general category are increased by $90 and CFC2's PTEP group described in paragraph (c)(2)(x) of this section within an annual PTEP account for the 2016 taxable year within the general category are reduced by $90.

(C) Foreign income taxes deemed paid by USP. With respect to distribution 2 from CFC1 to USP, because CFC1 has PTEP groups in more than one section 904 category, this section is applied separately to each section 904 category (that is, distribution 2 of 800u is applied separately to the 200u of CFC1's PTEP group described in paragraph (c)(2)(ix) of this section and 600u of CFC1's PTEP group described in paragraph (c)(2)(x) of this section).

(1) Section 951A category. Under paragraph (b)(4) of this section, USP's proportionate share of PTEP group taxes with respect to CFC1's PTEP group described in paragraph (c)(2)(ix) of this section within an annual PTEP account for the 2018 taxable year within the section 951A category is $25 ($25 × 200u/200u). Under paragraph (b)(3) of this section, the amount of foreign income taxes within the section 951A category that are properly attributable to distribution 2 is $25. Accordingly, under paragraph (b)(1) of this section USP is deemed to have paid $25 of section 951A category foreign income taxes of CFC1 with respect to its 200u section 959(a) distribution in the section 951A category.

(2) General category. Under paragraph (b)(4) of this section, USP's proportionate share of PTEP group taxes with respect to CFC1's PTEP group described in paragraph (c)(2)(x) of this section within an annual PTEP account for the 2016 taxable year within the general category is $90 ($90 × 600u/600u). Under paragraph (b)(3) of this section, the amount of foreign income taxes that are properly attributable to distribution 2 is $90. Accordingly, under paragraph (b)(1), USP is deemed to have paid $90 of general category foreign income taxes of CFC1 with respect to its 600u section 959(a) distribution in the general category.

(a) * * * (1) * * * For purposes of this section, an amount included in gross income under section 951A(a) is treated as an amount included in gross income under section 951(a). The amount of the increase in the foreign tax credit limitation allowed by this section is determined with regard to each separate category of income described in § 1.904-5(a)(4)(v).

(d) * * * For purposes of this paragraph (d), the term “foreign income taxes” includes foreign income taxes paid or accrued, foreign income taxes deemed paid or accrued under section 904(c), and foreign income taxes deemed paid under section 960, for the taxable year of inclusion.

Applicability dates. Sections 1.960-1 through 1.960-6 apply to a taxable year of a foreign corporation beginning after December 31, 2017, and a taxable year of a domestic corporation that is a United States shareholder of the foreign corporation in which or with which such taxable year of such foreign corporation ends.

(c) * * *

(1) * * *

(iii) Foreign income taxes deemed paid under section 960(b) (as applicable to taxable years of controlled foreign corporations beginning after December 31, 2017, and to taxable years of United States persons in which or with which such taxable years of foreign corporations end). No credit is allowed for the applicable percentage of foreign income taxes deemed paid under section 960(b) (as in effect for a taxable year of a controlled foreign corporation beginning after December 31, 2017, and a taxable year of a United States person in which or with which such controlled foreign corporation's taxable year ends) and § 1.960-3(b)(1) with respect to distributions to the domestic corporation of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits. The foreign income taxes deemed paid under § 1.960-3(b)(1) with respect to a distribution to the domestic corporation of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits is equal to the foreign income taxes properly attributable to a distribution from the distributing controlled foreign corporation's individual PTEP groups described in § 1.960-3(c)(2)(ii), (iii), (vii), or (viii). For purposes of this paragraph (c)(1)(iii), the terms “properly attributable” and “PTEP group” have the meanings set forth in § 1.960-3(b)(3) and (c)(2) respectively. In addition, foreign income taxes that would have been deemed paid under section 960(a)(1) (as in effect on December 21, 2017) with respect to the portion of a section 965(a) earnings amount that was reduced under § 1.965-1(b)(2) or § 1.965-8(b) are not eligible to be deemed paid under section 960(b) and § 1.960-3(b)(1) or any other section of the Code.

(e) * * *

(1) * * *

(i) * * * If the section 965(n) election creates or increases a net operating loss under section 172 for the taxable year, then the taxable income of the person for the taxable year cannot be less than the amount described in paragraph (e)(1)(ii) of this section. The amount of deductions equal to the amount by which a net operating loss is created or increased for the taxable year by reason of the section 965(n) election (the “deferred amount”) is not taken into account in computing taxable income or the separate foreign tax credit limitations under section 904 for that year. The source and separate category (as defined in § 1.904-5(a)(4)(v)) components of the deferred amount are determined in accordance with paragraph (e)(1)(iv) of this section.

(iv) Effect of section 965(n) election—(A) In general. The section 965(n) election for a taxable year applies solely for purposes of determining the amount of net operating loss under section 172 for the taxable year and determining the amount of taxable income for the taxable year (computed without regard to the deduction allowable under section 172) that may be reduced by net operating loss carryovers or carrybacks to such taxable year under section 172. Paragraph (e)(1)(iv)(B) of this section provides a rule for coordinating the section 965(n) election's effect on section 172 with the computation of the separate foreign tax credit limitations under section 904.

(B) Ordering rule for allocation and apportionment of deductions for purposes of the section 904 limitation. The effect of a section 965(n) election with respect to a taxable year on the computation of the separate foreign tax credit limitations under section 904 is computed as follows and in the following order.

(1) Deductions that would have been allowed for the taxable year but for the section 965(n) election, other than the amount of any net operating loss carryover or carryback to that year that is not allowed by reason of the section 965(n) election, are allocated and apportioned under §§ 1.861-8 through 1.861-17 to the relevant statutory and residual groupings, taking into account the amount described in paragraph (e)(1)(ii) of this section. The source and separate category of the net operating loss carryover or carryback to the taxable year, if any, is determined under the rules of § 1.904(g)-3(b), taking into account the amount described in paragraph (e)(1)(ii) of this section. If the amount of the net operating loss carryover or carryback to the taxable year is reduced by reason of the section 965(n) election to an amount less than the U.S. source loss component of the net operating loss, the potential carryovers (or carrybacks) of the separate limitation losses that are part of the net operating loss are proportionately reduced as provided in § 1.904(g)-3(b)(3)(ii).

(2) If a net operating loss is created or increased for the taxable year by reason of the section 965(n) election, the deferred amount (as defined in paragraph (e)(1)(i) of this section) is not allowed as a deduction for the taxable year. See paragraph (e)(1)(i) of this section. The deferred amount (which is the corresponding addition to the net operating loss for the taxable year) comprises a ratable portion of the deductions (other than the deduction allowed under section 965(c)) allocated and apportioned to each statutory and residual grouping under paragraph (e)(1)(iv)(B)(1) of this section. Such ratable portion equals the deferred amount multiplied by a fraction, the numerator of which is the deductions allocated and apportioned to the statutory or residual grouping under paragraph (e)(1)(iv)(B)(1) of this section (other than the section 965(c) deduction) and the denominator of which is the total deductions (other than the section 965(c) deduction) described in paragraph (e)(1)(iv)(B)(1) of this section. Accordingly, the fraction described in the previous sentence takes into account the deferred amount.

(3) Taxable income and the separate foreign tax credit limitations under section 904 for the taxable year are computed without taking into account any deferred amount. Deductions allocated and apportioned to the statutory and residual groupings under paragraph (e)(1)(iv)(B)(1)) of this section, to the extent deducted in the taxable year rather than deferred to create or increase a net operating loss, are combined with income in the statutory and residual groupings to which those deductions are assigned in order to compute the amount of separate limitation income or loss in each separate category and U.S. source income or loss for the taxable year. Section 904(b), (f), and (g) are then applied to determine the applicable foreign tax credit limitations for the taxable year.

Kirsten Wielobob,

Deputy Commissioner for Services and Enforcement.

[FR Doc. 2018-26322 Filed 12-4-18; 4:15 pm]

BILLING CODE 4830-01-P