You are on page 1of 84

Bulletin No.

2005-25
June 20, 2005

HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.

INCOME TAX T.D. 9206, page 1283.


REG–158138–04, page 1341.
Temporary and proposed regulations under section 6050L pro-
T.D. 9204, page 1279. vide guidance for the filing of information returns by donees re-
Final regulations under section 143 of the Code provide rules
lating to qualified intellectual property contributions. The regu-
for calculating the effective rate of mortgage interest. Specifi-
lations affect donees receiving net income from qualified intel-
cally, the regulations provide that amounts paid for pool mort-
lectual property contributions after June 3, 2004.
gage insurance are to be excluded from the calculation of the
effective rate of mortgage interest (which results in a lower ef- REG–168892–03, page 1293.
fective rate of mortgage interest). Generally, interest on bonds Proposed regulations under section 7702 of the Code define
issued by state and local governments is excluded from gross the attained age of the insured under contracts intending to
income. However, this exclusion does not apply to non-qual- qualify as life insurance contracts and explain how to use that
ified private activity bonds. A qualified mortgage bond or a age to test whether a contract qualifies as a life insurance
qualified veterans’ mortgage bond (together, “qualified mort- contract for federal income tax purposes. A public hearing is
gage revenue bonds”) may be a qualified bond. A bond may scheduled for September 14, 2005.
only be a qualified mortgage revenue bond if the effective rate
of mortgage interest on the mortgages provided with the bond REG–102144–04, page 1297.
proceeds does not exceed the yield on the bonds by more than Proposed regulations under section 1503(d) of the Code ad-
1.125 percentage points. dress various dual consolidated loss issues, including excep-
tions to the general prohibition against using a dual consoli-
T.D. 9205, page 1267. dated loss to reduce the taxable income of any other member
REG–134030–04, page 1339. of the affiliated group. Section 1503(d) generally provides that
Temporary and proposed regulations under section 41 of the a dual consolidated loss of a dual resident corporation cannot
Code provide rules for the computation and allocation of the reduce the taxable income of any other member of the affiliated
credit for increasing research activities in the case of a con- group unless, to the extent provided in regulations, such loss
trolled group of corporations or a group of trades or busi- does not offset the income of any foreign corporation. Similar
nesses under common control. The regulations also provide rules apply to losses of separate units of domestic corpora-
rules for making and revoking an election to compute the re- tions. A public hearing is scheduled for September 7, 2005.
search credit using the alternative incremental research credit
rules. A public hearing on the proposed regulations is sched-
uled for October 19, 2005. REG–133791–02 withdrawn.

(Continued on the next page)

Finding Lists begin on page ii.


Notice 2005–44, page 1287.
Charitable contributions of qualified vehicles. This no-
tice provides interim guidance under section 170(f)(12) of the
Code regarding the deductibility of vehicle contributions. The
notice explains the new requirements applicable to the acknowl-
edgments that donee organizations provide to vehicle donors.
In addition, the notice provides guidance on the new penal-
ties section 6720 imposes on donee organizations that pro-
vide a false or fraudulent acknowledgment of a vehicle contri-
bution, or fail to properly furnish the acknowledgment. Sec-
tions 170(f)(12) and 6720 are effective for vehicle contribu-
tions made after December 31, 2004.

ADMINISTRATIVE

T.D. 9203, page 1285.


Final regulations under section 7701 of the Code provide that
an eligible entity that makes a timely and valid election to be
classified as an S corporation will be deemed to have elected
to be classified as an association taxable as a corporation.

T.D. 9206, page 1283.


REG–158138–04, page 1341.
Temporary and proposed regulations under section 6050L pro-
vide guidance for the filing of information returns by donees re-
lating to qualified intellectual property contributions. The regu-
lations affect donees receiving net income from qualified intel-
lectual property contributions after June 3, 2004.

June 20, 2005 2005–25 I.R.B.


The IRS Mission
Provide America’s taxpayers top quality service by helping applying the tax law with integrity and fairness to all.
them understand and meet their tax responsibilities and by

Introduction
The Internal Revenue Bulletin is the authoritative instrument of court decisions, rulings, and procedures must be considered,
the Commissioner of Internal Revenue for announcing official and Service personnel and others concerned are cautioned
rulings and procedures of the Internal Revenue Service and for against reaching the same conclusions in other cases unless
publishing Treasury Decisions, Executive Orders, Tax Conven- the facts and circumstances are substantially the same.
tions, legislation, court decisions, and other items of general
interest. It is published weekly and may be obtained from the
The Bulletin is divided into four parts as follows:
Superintendent of Documents on a subscription basis. Bulletin
contents are compiled semiannually into Cumulative Bulletins,
which are sold on a single-copy basis. Part I.—1986 Code.
This part includes rulings and decisions based on provisions of
It is the policy of the Service to publish in the Bulletin all sub- the Internal Revenue Code of 1986.
stantive rulings necessary to promote a uniform application of
the tax laws, including all rulings that supersede, revoke, mod- Part II.—Treaties and Tax Legislation.
ify, or amend any of those previously published in the Bulletin. This part is divided into two subparts as follows: Subpart A,
All published rulings apply retroactively unless otherwise indi- Tax Conventions and Other Related Items, and Subpart B, Leg-
cated. Procedures relating solely to matters of internal man- islation and Related Committee Reports.
agement are not published; however, statements of internal
practices and procedures that affect the rights and duties of
taxpayers are published. Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
Revenue rulings represent the conclusions of the Service on the included in this part are Bank Secrecy Act Administrative Rul-
application of the law to the pivotal facts stated in the revenue ings. Bank Secrecy Act Administrative Rulings are issued by
ruling. In those based on positions taken in rulings to taxpayers the Department of the Treasury’s Office of the Assistant Sec-
or technical advice to Service field offices, identifying details retary (Enforcement).
and information of a confidential nature are deleted to prevent
unwarranted invasions of privacy and to comply with statutory
requirements. Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be The last Bulletin for each month includes a cumulative index
relied on, used, or cited as precedents by Service personnel in for the matters published during the preceding months. These
the disposition of other cases. In applying published rulings and monthly indexes are cumulated on a semiannual basis, and are
procedures, the effect of subsequent legislation, regulations, published in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

2005–25 I.R.B. June 20, 2005


Part I. Rulings and Decisions Under the Internal Revenue Code
of 1986
Section 41.—Credit for SUPPLEMENTARY INFORMATION: the written comments and the statements
Increasing Research at the public hearing, the Treasury De-
Activities Background partment and the IRS are withdrawing the
2003 proposed regulations and are issuing
26 CFR 1.41–6T: Aggregation of expenditures (tem- On July 29, 2003, the Treasury Depart-
temporary regulations and proposed reg-
porary). ment and the IRS published in the Federal
ulations cross-referencing the temporary
Register (68 FR 44499) proposed amend-
T.D. 9205 regulations. In substantial part, the tempo-
ments to the regulations under section
rary regulations retain the rules contained
41(f) (REG–133791–02, 2003–2 C.B.
DEPARTMENT OF in the 2003 proposed regulations with cer-
493) (the 2003 proposed regulations) re-
tain modifications discussed below.
THE TREASURY lating to the computation and allocation
Internal Revenue Service of the credit for increasing research ac- Summary of Comments and
26 CFR Part 1 tivities (research credit) under section Explanation of Provisions
41 for members of a controlled group of
Credit for Increasing Research corporations or a group of trades or busi- Computation of the Group Credit
nesses under common control (controlled
Activities groups). The 2003 proposed regulations Section 41(f)(1)(A)(i) provides that “all
withdrew the proposed regulations pub- members of the same controlled group of
AGENCY: Internal Revenue Service
lished in the Federal Register on January corporations shall be treated as a single
(IRS), Treasury.
4, 2000 (65 FR 258) (REG–105606–99, taxpayer” in determining the amount of
ACTION: Temporary regulations. 2000–1 C.B. 421) (the 2000 proposed reg- the research credit under section 41. Sec-
ulations). In general, the 2000 proposed tion 41(f)(1)(B)(i) provides a similar rule
SUMMARY: This document contains regulations required controlled groups to for a group of trades or businesses under
temporary regulations relating to the com- compute a group credit and then to allo- common control. The 2003 proposed reg-
putation and allocation of the credit for cate that group credit among the members ulations applied the section 41 computa-
increasing research activities for members of the controlled group. The allocation tional rules on an aggregate basis for pur-
of a controlled group of corporations or a of the group credit under the 2000 pro- poses of determining the amount of the
group of trades or businesses under com- posed regulations was based on the rela- group credit. Additionally, a controlled
mon control. These temporary regulations tive increases of each member’s qualified group would have been treated as a start-up
reflect changes made to section 41 by research expenses (QREs) over a base company for purposes of determining the
the Revenue Reconciliation Act of 1989 amount that was computed by multiplying group’s fixed-base percentage only if each
(1989 Act), which introduced the current that member’s most recent average annual member of the group qualified as a start-up
computational regime for the credit, and gross receipts by the controlled group’s company. Therefore, a controlled group
the Small Business Job Protection Act fixed-base percentage. with only two members would have been
of 1996, which introduced the alterna- Although the 2003 proposed regula- subject to the start-up rules if one mem-
tive incremental research credit. The text tions did not modify the rules relating to ber of the group had QREs but no gross
of the temporary regulations also serves the computation of the group credit, the receipts in 1983 and the other member had
as the text of the proposed regulations 2003 proposed regulations did modify gross receipts but no QREs in 1983.
(REG–134030–04) set forth in the notice the rules relating to the allocation of the Commentators generally agreed with
of proposed rulemaking on this subject in group credit among the members of the the proposed rules for computing the group
this issue of the Bulletin. controlled group. In particular, the 2003 credit. Commentators were concerned,
proposed regulations allocated the group however, with perceived ambiguities re-
DATES: Effective Date: These regulations lated to the application of the start-up
credit in proportion to the credit, if any,
are effective May 24, 2005. company rules to a controlled group. For
that a member of a controlled group would
Applicability Dates: For dates of example, commentators asked that the reg-
be entitled to claim if it were not a mem-
applicability, see §§1.41–6T(j) and ulations clarify what a controlled group’s
ber of a controlled group (the stand-alone
1.41–8T(b)(5). start-up date is if all the members of the
entity credit). In addition, based on the
comments to the 2000 proposed regula- group are start-up companies with differ-
FOR FURTHER INFORMATION
tions, the 2003 proposed regulations did ent start-up dates.
CONTACT: Nicole R. Cimino (202)
not propose special rules that would apply These temporary regulations retain the
622–3120 (not a toll-free number).
to consolidated groups that were members rules in the 2003 proposed regulations for
of a controlled group. A public hearing on the computation of the group credit, except
the 2003 proposed regulations was held for the start-up company rules. The tem-
on November 13, 2003. After considering porary regulations state that a controlled
group is treated as a start-up company for

2005–25 I.R.B. 1267 June 20, 2005


purposes of computing the group credit the 2003 proposed regulations or with controlled or otherwise related persons.
if (A) the first taxable year in which at any single, prescribed method. Conse- H. Rep. No. 97–201, 1981–3 C.B. (Vol.
least one member of the group had gross quently, commentators either proposed 2) 364, and Sen. Rep. 97–144, 1981–3
receipts and at least one member of the specific alternatives or stated that final C.B. (Vol. 2) 442. In effect, the group
group had QREs begins after December regulations should allow members to allo- credit computation rule serves as a cap
31, 1983, or (B) there were fewer than cate the group credit using any reasonable on the maximum amount of credit that
three taxable years beginning after Decem- method. One commentator advocated the members of the group, in the aggre-
ber 31, 1983, and before January 1, 1989, that a method that allocates the group gate, may claim.
in which at least one member of the group credit based on the relative amounts of
had gross receipts and at least one mem- each member’s total QREs (gross QREs Prior to the 1989 Act, the research
ber of the group had QREs. Consistent method) is the only allocation method credit was computed by multiplying the
with this approach, the first taxable year permitted under the statute. Another com- credit rate by the excess of the taxpayer’s
in which a controlled group has gross re- mentator urged the Treasury Department current year QREs over the taxpayer’s av-
ceipts for purposes of the start-up com- and the IRS to adopt an allocation method erage QREs for the preceding three years.
pany rules is the first year in which at that, based on techniques of differential Final regulations issued in 1989, prescrib-
least one member of the group has gross calculus, allocates the group credit based ing rules for the allocation of the group
receipts. Likewise, the first taxable year on the marginal contribution to the group credit prior to the 1989 Act, allocated
in which a controlled group has QREs for credit of each member’s QREs for the the group credit based on what effec-
purposes of the start-up company rules is current year, QREs for the base years, and tively would have been each member’s
the first year in which at least one mem- gross-receipts for the base years, as well stand-alone entity credit (without giving
ber of the group has QREs. The Treasury as the controlled group’s fixed-base per- effect to the minimum base period amount
Department and the IRS believe that this centage and the growth in gross receipts in computing each member’s stand-alone
approach is more consistent with treating for the controlled group (marginal con- entity credit). The 1989 Act significantly
a controlled group as a single taxpayer be- tribution method). Other commentators modified the computation of the credit
cause a controlled group with two mem- suggested that no single allocation method while retaining the incremental approach
bers is not subject to the start-up rules if can appropriately allocate the group credit of the pre–1989 Act credit. Congress did
one member of the group had QREs but in all cases; therefore, members of a con- not indicate in either the statute or the
no gross receipts in 1983 and the other trolled group should be permitted to use legislative history that either the purpose
member had gross receipts but no QREs in any reasonable method to allocate the or the application of section 41(f) was
1983. Additionally, the temporary regula- group credit. For the reasons discussed being changed. Although the phrase “in-
tions specifically state that for purposes of below, these temporary regulations gen- crease in” in sections 41(f)(1)(A)(ii) and
determining the fixed-base percentage, the erally retain the stand-alone entity credit 41(f)(1)(B)(ii) was deleted by the 1989
first taxable year after December 31, 1993, method of the 2003 proposed regulations Act, for the reasons set out in the preamble
for which a controlled group has QREs is with some modifications. to the 2003 proposed regulations, the Trea-
the first taxable year in which at least one The preamble to the 2003 proposed sury Department and the IRS concluded
member of the group has QREs. regulations sets out at length the reasons that this change to the statute was intended
why the Treasury Department and the to reflect only the fact that a taxpayer’s
Allocation of the Group Credit IRS believe that the allocation method entitlement to the research credit after the
under section 41(f) should be based on 1989 Act no longer depended on whether
Section 41(f)(1)(A)(ii) provides that a group member’s QREs in excess of a the taxpayer had increased its current year
“the [portion of the group] credit (if any) base amount. The stand-alone entity credit QREs over its average QREs for the pre-
allowable by this section to each such method reflects the incremental nature of ceding three years.
member shall be its proportionate shares the credit and also is consistent with the With respect to the alternative alloca-
of the qualified research expenses and Treasury Department and the IRS’ view tion methods suggested by the commen-
basic research payments giving rise to the of the purpose of section 41(f). As stated tators, the Treasury Department and the
credit.” Section 41(f)(1)(B)(ii) provides a in the preamble to the 2003 proposed reg- IRS conclude that these methods are in-
similar rule for a group of trades or busi- ulations: consistent with the purpose of section 41
nesses under common control. The 2003 The legislative history to the research generally and section 41(f) specifically. A
proposed regulations apply these provi- credit, as originally enacted in 1981, gross QREs method is at odds fundamen-
sions by allocating the group credit based indicates that the group credit compu- tally with the incremental nature of the re-
on the relative amounts of each individual tation and aggregation rules were en- search credit, and the Treasury Department
member’s stand-alone entity credit. acted to ensure that the research credit and the IRS continue to believe that neither
A number of commentators requested would be allowed only for actual in- the statute nor the legislative history sug-
changes to the method of allocating the creases in research expenditures. These gests that Congress intended that the allo-
group credit contained in the 2003 pro- aggregation rules were intended to pre- cation of the group credit be based solely
posed regulations. In general, these com- vent taxpayers from creating artificial on a member’s total QREs without refer-
ments reflected dissatisfaction either with increases in research expenditures by ence to whether those QREs exceed a base
the stand-alone entity credit method in shifting expenditures among commonly amount.

June 20, 2005 1268 2005–25 I.R.B.


Similarly, the Treasury Department and troversy. As discussed in the preamble to computing the stand-alone entity credit
the IRS do not believe that the suggested the 2003 proposed regulations, the Trea- as that used to compute the group credit.
marginal contribution method is consistent sury Department and the IRS believe that The Treasury Department and the IRS
with section 41(f). The Treasury Depart- the purpose of section 41(f) is undermined do not believe that requiring taxpayers to
ment and the IRS recognize the potential if the members of a controlled group use be consistent in the method used to com-
for that method to more closely associate different allocation methods to claim more pute the group credit and the stand-alone
the amount of group credit allocated to a than 100 percent of the group credit. The entity credit would serve the purpose of
particular member to the contributions of Treasury Department and the IRS believe section 41. Section 41(f) was intended
that member’s QREs for the current year, that a single, prescribed method is neces- to encourage taxpayers to increase their
gross receipts for the current year, QREs sary to preclude such potential for abuse. individual research efforts to maximize
for the base years, and gross receipts for Accordingly, the Treasury Department the group credit and thus their share of
the base years to the amount of the group and the IRS continue to believe that the the group credit. The Treasury Depart-
credit. The marginal contribution method purposes of the research credit statute gen- ment and the IRS believe that allowing
proposed, however, has significant flaws erally and the provisions of section 41(f) the members to compute their stand-alone
that would change the function of the ag- specifically are best furthered by an alloca- entity credits without regard to the method
gregation rules in section 41(f) in a man- tion method that allocates the group credit used to compute the group credit will en-
ner that the Treasury Department and the based on each member’s stand-alone entity courage increasing research efforts. Thus,
IRS do not believe was intended by Con- credit. the temporary regulations provide that a
gress. First, the method would allow al- member’s stand-alone entity credit must
locations of credit to members that have Special Allocation Rule For Excess Group be computed using whichever method
no QREs, a result the Treasury Depart- Credit Situations results in the greater stand-alone entity
ment and the IRS believe is contrary to credit for that member, without regard to
Under the 2003 proposed regulations, if
the statutory directive to allocate the group the method used to compute the group
the group credit exceeded the sum of the
credit in proportion to a member’s share credit.
stand-alone entity credits of the members
of QREs giving rise to the credit. Sec- Commentators also pointed out that the
of a controlled group, the members with
ond, the method uses different formulas for computation of the stand-alone entity cred-
stand-alone entity credits would be entitled
groups that are affected by special rules, its under the 2003 proposed regulations
to the entire group credit. In addition, if
such as the maximum fixed-base percent- would no longer require the intra-group
no member of the controlled group had a
age rule. As a result, it is possible that transaction rules of §1.41–6(e) (re-desig-
stand-alone entity credit, none of the group
a member of a group that increases its nated in these temporary regulations as
credit would be allocated to the members
QREs by a relatively small amount, that §1.41–6(i)) to apply. Although the in-
of the controlled group.
is enough to make the group subject to a tent of the stand-alone entity credit rule is
To address these situations, these tem-
special rule, could be allocated proportion- to compute a credit that is similar to that
porary regulations modify the allocation
ately less credit than if the member had not to which a member would be entitled if
method of the 2003 proposed regulations
increased its QREs. Finally, by relying on there were no research credit aggregation
in cases in which the group credit exceeds
the group’s gross receipts and the group’s rules for controlled groups, the intent was
the sum of the members’ stand-alone en-
fixed-base percentage, the marginal contri- not to render the intra-group transaction
tity credits, including cases in which no
bution method appears to encourage plan- rules or the acquisition/disposition rules
member has a stand-alone entity credit. If
ning and shifting among group members, a of section 41(f)(3) inapplicable. There-
the group credit exceeds the sum of the
result that is inconsistent with the purpose fore, these temporary regulations specifi-
members’ stand-alone entity credits, each
of section 41(f). The Treasury Department cally provide that taxpayers must apply the
member is allocated an amount of group
and the IRS believe that an appropriate al- intra-group transaction rules and the ac-
credit equal to that member’s stand-alone
location method should encourage a mem- quisition/disposition rules when comput-
entity credit. The remaining, or excess,
ber to focus on incrementally increasing its ing the stand-alone entity credits. For ex-
amount of group credit is then allocated
own research efforts. ample, to the extent that a member’s gross
among all the members of the controlled
The Treasury Department and the IRS receipts and QREs have been reduced for
group based on the ratio of an individual
also decline to adopt an allocation rule purposes of computing the group credit
member’s QREs to the sum of all the mem-
that would permit the members of a con- as a result of the application of the ac-
bers’ QREs.
trolled group to use any reasonable method quisition/disposition rules, the member’s
to allocate the group credit. Neither the Computation of Stand-Alone Entity stand-alone entity credit must be computed
statute nor the legislative history indicates Credits using the same gross receipts and QREs.
that Congress intended the allocation of
the group credit to be based on any rea- Commentators questioned whether Special Allocation Rule for Consolidated
sonable method selected by a member in- members must use the same method, i.e., Groups
dividually or the controlled group collec- the method described in section 41(a)
tively. Furthermore, a rule permitting the (regular credit method) or the alterna- The preamble to the 2003 proposed
use of any reasonable method to allocate tive incremental research credit (AIRC) regulations states that the Treasury De-
the credit could result in continuing con- method described in section 41(c)(4), in partment and the IRS considered com-

2005–25 I.R.B. 1269 June 20, 2005


ments requesting a special allocation rule portion to the stand-alone entity credits of will continue to be the better method in
for consolidated groups, but decided not the members of the consolidated group. the future as well, unless the taxpayer has
to adopt such a rule. Several commenta- One commentator argued that separately a substantial change in its trade or busi-
tors further commented on that issue. One computing the stand-alone credit for each ness, such as the acquisition or disposition
commentator suggested that if the group member of a consolidated group would of an entire trade or business. If such a
credit were allocated in proportion to be prohibitively burdensome. The Trea- substantial change occurs, the Treasury
QREs, no special consolidated group rule sury Department and the IRS, however, do Department and the IRS believe that it
would be necessary. Given that this com- not believe that computing a stand-alone is appropriate to allow the taxpayer to
mentator’s proposed allocation method is entity credit for each member of a con- revoke its AIRC election. The IRS has
not the one adopted in these temporary solidated group imposes a greater burden received many requests for consent to
regulations, the Treasury Department and than computing a stand-alone entity credit revoke AIRC elections from taxpayers
the IRS are not persuaded that a special for a corporation that is not a member of in such situations. To reduce the burden
consolidated group rule is unnecessary. a consolidated group. Moreover, provid- on taxpayers, provide simplification, and
Another commentator suggested that a ing a rule for allocating the portion of the ease administrative burden, the Treasury
consolidated group should be treated as a group credit allocated to a consolidated Department and the IRS have determined
single member of a controlled group for group among its members that is differ- that it is appropriate to grant automatic
purposes of allocating the group credit and ent than the method used for allocating consent to revoke an AIRC election on a
that the failure to treat the consolidated the controlled group credit would create prospective basis in situations in which
group in such a manner would result in additional administrative complexity that a taxpayer makes the revocation on an
abuse. seems unwarranted. original return. The Treasury Department
The Treasury Department and the IRS and the IRS do not believe, however, that
believe that treating a consolidated group Alternative Incremental Research Credit allowing an AIRC election or revocation
as a single member of a controlled group on an amended return furthers the goal of
for purposes of allocating the group credit Section 41(c)(4) provides an election simplification and ease of administration.
is consistent with the treatment of a consol- to determine the research credit using the Therefore, these temporary regulations
idated group as a single taxpayer under a AIRC computation. Section 41(c)(4)(B) provide that a taxpayer that has made an
number of the consolidated return regula- provides that the election to use the AIRC AIRC election is deemed to have requested
tions. Therefore, these temporary regula- applies to all succeeding taxable years un- and been granted consent to revoke the
tions provide that, for purposes of allocat- less revoked with the consent of the Sec- election if the taxpayer completes the por-
ing the group credit, a consolidated group retary. Many issues have arisen regarding tion of Form 6765, “Credit for Increasing
whose members are members of a con- how the AIRC election is made in the case Research Activities,” relating to the regular
trolled group is treated as a single mem- of a consolidated group and in the case of credit and attaches the completed form to
ber of the controlled group. Accordingly, a controlled group, all members of which the taxpayer’s timely filed original return
a consolidated group whose members are are not included on a single consolidated for the year to which the revocation ap-
members of a controlled group is treated federal income tax return. These issues in- plies. This provision is similar to the pro-
as a single member of the controlled group clude: (1) how is an AIRC election made visions in the existing regulations for mak-
and a single stand-alone entity credit is by members of a controlled group for pur- ing an AIRC election, which require the
computed for the consolidated group. If poses of computing the group credit under taxpayer to complete the portion of Form
the consolidated group is the only mem- section 41(f)(1); (2) what happens when a 6765 relating to the AIRC and attach the
ber of the controlled group, the stand-alone controlled group has made an AIRC elec- completed form to the taxpayer’s timely
entity credit computed for the consolidated tion and a member leaves the group or a filed original return for the year to which
group is equal to the group credit. member that has not made an AIRC elec- the election applies. Once an election/re-
The portion of the group credit allo- tion enters the group; (3) what happens if vocation is made for a taxable year, the tax-
cated to a consolidated group must be al- a member that has made an AIRC elec- payer may not change the election/revoca-
located among the members of the consol- tion joins a controlled group that has not tion on an amended return.
idated group. The Treasury Department made an AIRC election; and (4) when will The temporary regulations provide spe-
and the IRS believe that the method of allo- a request to revoke an AIRC election be cial rules for controlled groups under sec-
cating among the members of the consoli- granted. tion 41(f)(1) (in which one or more of the
dated group the portion of the group credit Generally, the Treasury Department members do not join in filing a consoli-
allocated to the consolidated group should and the IRS assume that taxpayers will dated return). As discussed above, in this
be no different than the method of allocat- elect to use the AIRC method if the AIRC situation many questions have arisen re-
ing the group credit among members of the method provides more credit than the garding which members of a controlled
controlled group. Therefore, a stand-alone regular method, or if a taxpayer does not group must make (or revoke) an AIRC
entity credit is computed for each mem- have the books and records necessary to election to have a valid election (or revo-
ber of the consolidated group, and the por- compute the base amount under the reg- cation) for the controlled group. Attempt-
tion of the group credit allocated to the ular method. Once a taxpayer elects the ing to track elections across members of a
consolidated group is allocated among the AIRC method, the Treasury Department controlled group, in which one or more of
members of the consolidated group in pro- and the IRS believe that the AIRC method the members do not join in filing a consol-

June 20, 2005 1270 2005–25 I.R.B.


idated return would create additional ad- to prevent abuse. Because the Treasury of any other allocation method may de-
ministrative complexity and increase the Department and the IRS have decided to pend on the particular facts and circum-
potential for controversy. Thus, to re- retain the general rules for the compu- stances of that taxpayer, in general, the
duce the additional administrative com- tation and allocation of the group credit IRS, solely for purposes of what consti-
plexity created by the additional computa- contained in the 2003 proposed regula- tutes a reasonable method of allocating the
tion, these temporary regulations provide tions, with the modifications described group credit for taxable years ending be-
that in the case of a controlled group, all above, these regulations are being issued fore December 29, 1999, will treat as rea-
the members of which are not included on in temporary form and will be effective sonable a gross QREs method even if the
a single consolidated return, the designated for taxable years ending on or after May members of the controlled group use in-
member must make (or revoke) an AIRC 24, 2005. consistent allocation methods to claim, in
election on behalf of the members of the For taxable years prior to those covered the aggregate, more than 100 percent of
group. The election (or revocation) by the by these temporary regulations, a tax- the group credit. Such treatment of a gross
designated member is binding on all of the payer generally may use any reasonable QREs method as reasonable for such years
members of the group for the taxable year method of computing and allocating the is for administrative convenience only.
to which the election (or revocation) re- group credit. For the reasons set out in
lates. The temporary regulations provide the preamble to the 2003 proposed regu- Special Analyses
that the designated member is that mem- lations, the Treasury Department and the
ber of the group that is allocated the great- IRS believe that these temporary regu- It has been determined that this Trea-
est amount of the group credit. In the event lations should be retroactive in limited sury Department decision is not a signif-
the members of a group compute the group circumstances to prevent abuse. Accord- icant regulatory action as defined in Ex-
credit using different methods (either the ingly, paragraph (b) of these temporary ecutive Order 12866. Therefore, a regula-
regular method or the AIRC method) and regulations, relating to the computation tory assessment is not required. It also has
at least two members of the group qual- of the group credit, and paragraph (c) of been determined that section 553(b) of the
ify as the designated member, the desig- these temporary regulations, relating to Administrative Procedure Act (5 U.S.C.
nated member is the member that com- the allocation of the group credit, apply to chapter 5) does not apply to these regu-
putes the group credit using the method taxable years ending on or after December lations. For the applicability of the Reg-
that yields the greater group credit. The 29, 1999, if the members of a controlled ulatory Flexibility Act (5 U.S.C. chapter
Treasury Department and the IRS believe group, as a whole, claimed more than 100 6) refer to the Special Analyses section of
that these rules will simplify the election percent of the amount that would be allow- the preamble to the cross-reference notice
and revocation of the AIRC method. Fur- able under paragraph (b). In the case of a of the proposed rulemaking published in
thermore, granting automatic consent to controlled group whose members have dif- this issue of the Bulletin. Pursuant to sec-
revoke an AIRC election also simplifies ferent taxable years and whose members tion 7805(f) of the Code, these temporary
acquisitions and dispositions of members use inconsistent methods of allocation, regulations will be submitted to the Chief
of controlled groups. For example, when the members of the controlled group are Counsel for Advocacy of the Small Busi-
a new member joins a group, the member deemed to have, as a whole, claimed more ness Administration for comment on their
must use the method used by the controlled than 100 percent of the amount that would impact on small business.
group. In the taxable year after a mem- be allowable under paragraph (b).
Drafting Information
ber leaves a group, the member is free to Since the issuance of the 2003 proposed
use either method, assuming the member regulations, questions have arisen regard- The principal author of these regula-
has not joined another controlled group. ing what constitutes a reasonable method tions is Nicole R. Cimino, Office of As-
If all members of a controlled group are of allocating the group credit. Any alloca- sociate Chief Counsel (Passthroughs and
members of a single consolidated group, tion method used by a member of a con- Special Industries). However, personnel
the AIRC election is made by the agent trolled group that is consistent with either from the IRS and Treasury Department
of the consolidated group, determined pur- the 2000 proposed regulations, the 2003 participated in their development.
suant to the rules of §1.1502–77. proposed regulations, these temporary reg-
ulations, or subsequent final regulations *****
Effective Date will be accepted by the IRS as reasonable
Adoption of Amendments to the
if the same allocation method was used by
Regulations
The preamble to the 2003 proposed all members of the controlled group. In ad-
regulations stated that the Treasury De- dition, for taxable years ending before De- Accordingly, 26 CFR part 1 is amended
partment and the IRS intended to make cember 29, 1999, any such method will be as follows:
those regulations effective for taxable accepted by the IRS as reasonable regard-
years beginning on or after the date that less of the allocation method or methods PART 1—INCOME TAXES
final regulations are published in the Fed- used by other members of the controlled
eral Register. The preamble to the 2003 group and regardless of whether the mem- Paragraph 1. The authority citation for
proposed regulations also addressed the bers of the controlled group, in the aggre- part 1 is amended by adding an entry in
limited application of final regulations to gate, claimed more than 100 percent of the numerical order to read, in part, as follows:
taxable years prior to that effective date group credit. Although the reasonableness Authority: 26 U.S.C. 7805 * * *

2005–25 I.R.B. 1271 June 20, 2005


Section 1.41–6T also issued under 26 (b) Election. (v) Credit year. The term credit year
U.S.C. 1502. * * * (1) In general. means the taxable year for which the mem-
Par. 2. In §1.41–0, the table of con- (2) Time and manner of election. ber is computing the credit.
tents is amended by removing the entries (3) Revocation. (b) Computation of the group
for §1.41–6 and §1.41–8 and adding en- (4) Special rules for controlled groups. credit—(1) In general. All members
tries for §1.41–6T and §1.41–8T to read as (5) Effective date. of a controlled group are treated as a sin-
follows: gle taxpayer for purposes of computing
§1.41–6 [Removed] the research credit. The group credit is
§1.41–0 Table of contents. computed by applying all of the section 41
Par. 3. Section 1.41–6 is removed.
computational rules on an aggregate basis.
Par. 4. Section 1.41–6T is added to read
***** All members of a controlled group must
as follows:
use the same method of computation, ei-
§1.41–6T Aggregation of expenditures §1.41–6T Aggregation of expenditures ther the method described in section 41(a)
(temporary). (temporary). or the alternative incremental research
credit (AIRC) method described in section
(a) Controlled groups of corporations; (a) Controlled group of corporations; 41(c)(4), in computing the group credit for
trades or businesses under common con- trades or businesses under common con- a credit year.
trol. trol—(1) In general. To determine the (2) Start-up companies—(i) In gen-
(1) In general. amount of research credit (if any) allow- eral. For purposes of computing the group
(2) Consolidated groups. able to a trade or business that at the end credit, a controlled group is treated as a
(3) Definitions. of its taxable year is a member of a con- start-up company for purposes of section
(b) Computation of the group credit. trolled group, a taxpayer must— 41(c)(3)(B)(i) if—
(1) In general. (i) Compute the group credit in the man- (A) The first taxable year in which at
(2) Start-up companies. ner described in paragraph (b) of this sec- least one member of the group had gross
(c) Allocation of the group credit. tion; and receipts and at least one member of the
(1) In general. (ii) Allocate the group credit among the group had qualified research expenditures
(2) Stand-alone entity credit. members of the group in the manner de- (QREs) begins after December 31, 1983;
(d) Special rules for consolidated scribed in paragraph (c) of this section. or
groups. (2) Consolidated groups. For special (B) There were fewer than 3 taxable
(1) In general. rules relating to consolidated groups, see years beginning after December 31, 1983,
(2) Start-up company status. paragraph (d) of this section. and before January 1, 1989, in which at
(3) Special rule for allocation of group (3) Definitions. For purposes of this least one member of the group had gross
credit among consolidated group mem- section: receipts and at least one member of the
bers. (i) Trade or business. A trade or busi- group had QREs.
(e) Examples. ness is a sole proprietorship, a partnership, (ii) Example. The following exam-
(f) For taxable years beginning before a trust, an estate, or a corporation that is ple illustrates the principles of paragraph
January 1, 1990. carrying on a trade or business (within the (b)(2)(i) of this section:
(g) Tax accounting periods used. meaning of section 162). Any member Example. A, B, and C, all of which are calendar
(1) In general. of a commonly controlled group shall be year taxpayers, are members of a controlled group.
During the 1983 taxable year, A had QREs, but no
(2) Special rule when timing of research deemed to be carrying on a trade or busi- gross receipts; B had gross receipts, but no QREs;
is manipulated. ness if any other member of that group is and C had no QREs or gross receipts. The 1984 tax-
(h) Membership during taxable year in carrying on any trade or business. able year was the first taxable year for which each
more than one group. (ii) Controlled group. The terms group of A, B, and C had both QREs and gross receipts.
(i) Intra-group transactions. and controlled group mean a controlled Because the first taxable year for which each of A,
B, and C had both QREs and gross receipts began
(1) In general. group of corporations, as defined in sec- after December 31, 1983, each of A, B, and C is
(2) In-house research expenses. tion 41(f)(5), or a group of trades or a start-up company under section 41(c)(3)(B)(i) and
(3) Contract research expenses. businesses under common control. For each is a start-up company for purposes of computing
(4) Lease payments. rules for determining whether trades or the stand-alone entity credit. During the 1983 taxable
(5) Payment for supplies. businesses are under common control, see year, at least one member of the group, A, had QREs
and at least one member of the group, B, had gross
(j) Effective date. §1.52–1(b) through (g). receipts, thus, the group had both QREs and gross re-
(iii) Group credit. The term group ceipts in 1983. Therefore, the controlled group is not
***** credit means the research credit (if any) a start-up company because the first taxable year for
allowable to a controlled group. which the group had both QREs and gross receipts
§1.41–8T Special rules for taxable years (iv) Consolidated group. The term con- did not begin after December 31, 1983.
ending on or after January 3, 2001 solidated group has the meaning set forth (iii) First taxable year after December
(temporary). in §1.1502–1(h). 31, 1993, for which the controlled group
had QREs. In the case of a controlled
(a) Alternative incremental credit. group that is treated as a start-up company

June 20, 2005 1272 2005–25 I.R.B.


under section 41(c)(3)(B)(i) and paragraph for which D had QREs was 1994. The first taxable under paragraph (c)(2) of this section, such
(b)(2)(i) of this section, for purposes of de- year after December 31, 1993, for which E had QREs group credit shall be allocated among the
termining the group’s fixed-base percent- was 1995. The first taxable year after December 31, members of the controlled group in pro-
1993, for which F had QREs was 1996. Because the
age under section 41(c)(3)(B)(ii), the first 1994 taxable year was the first taxable year after De-
portion to the stand-alone entity credits of
taxable year after December 31, 1993, for cember 31, 1993, for which at least one member of the members of the controlled group, com-
which the group has QREs is the first tax- the group, D, had QREs, for purposes of determin- puted under paragraph (c)(2) of this sec-
able year in which at least one member of ing the group’s fixed-based percentage under section tion:
the group has QREs. 41(c)(3)(B)(ii), the 1994 taxable year was the first
taxable year after December 31, 1993, for which the
(iv) Example. The following exam- group had QREs.
ple illustrates the principles of paragraph (c) Allocation of the group credit—(1)
(b)(2)(iii) of this section: In general. (i) To the extent the group
Example. D, E, and F, all of which are calendar
year taxpayers, are members of a controlled group.
credit (if any) computed under paragraph
The group is treated as a start-up company under sec- (b) of this section does not exceed the sum
tion 41(c)(3)(B)(i) and paragraph (b)(2)(i) of this sec- of the stand-alone entity credits of all of the
tion. The first taxable year after December 31, 1993, members of a controlled group, computed

group credit that does not exceed sum of all the members’ member’s stand-alone entity credit
×
stand-alone entity credits
sum of all the members’ stand-alone entity credits.

(ii) To the extent that the group credit (if entity credits of all of the members of the shall be allocated among the members of a
any) computed under paragraph (b) of this controlled group, computed under para- controlled group in proportion to the QREs
section exceeds the sum of the stand-alone graph (c)(2) of this section, such excess of the members of the controlled group:

(group credit - sum of all the members’ stand-alone entity member’s QREs
×
credits)
sum of all the members’ QREs.

(2) Stand-alone entity credit. The of applying paragraph (c) of this section, However, for this purpose, the stand-alone
term stand-alone entity credit means the a consolidated group whose members are entity credit of a member of a consolidated
research credit (if any) that would be members of a controlled group is treated group is computed without regard to sec-
allowable to a member of a controlled as a single member of the controlled group tion 41(f)(1), but with regard to paragraph
group if the credit were computed as if and a single stand-alone entity credit is (i) of this section.
section 41(f)(1) did not apply, except that computed for the consolidated group. (e) Examples. The following exam-
the member must apply the rules pro- (2) Start-up company status. A consoli- ples illustrate the provisions of this section.
vided in paragraphs (d)(1) (relating to dated group’s status as a start-up company Unless otherwise stated, no members of a
consolidated groups) and (i) (relating to and the first taxable year after December controlled group are members of a consoli-
intra-group transactions) of this section. 31, 1993, for which a consolidated group dated group, and except as provided in Ex-
Each member’s stand-alone entity credit has QREs are determined in accordance ample 6, the group has not made an AIRC
for any credit year must be computed with the principles of paragraph (b)(2) of election:
under whichever method (the method de- this section. Example 1. Group credit is less than sum of mem-
bers’ stand-alone entity credits—(i) Facts. A, B, and
scribed in section 41(a) or the method (3) Special rule for allocation of group
C, all of which are calendar-year taxpayers, are mem-
described in section 41(c)(4)) results in credit among consolidated group mem- bers of a controlled group. Neither A, B, nor C made
the greater stand-alone entity credit for bers. The portion of the group credit any basic research payments for their taxable year
that member, without regard to the method that is allocated to a consolidated group ending December 31, 2004. For purposes of com-
used to compute the group credit. is allocated to the members of the con- puting the group credit for the 2004 taxable year (the
credit year), A, B, and C had the following:
(d) Special rules for consolidated solidated group in accordance with the
groups—(1) In general. For purposes principles of paragraph (c) of this section.

2005–25 I.R.B. 1273 June 20, 2005


A B C Group
Aggregate
Credit Year QREs $200x $20x $110x $330x
1984–1988 QREs $40x $10x $100x $150x
1984–1988 Gross Receipts $1,000x $350x $150x $1,500x
Average Annual Gross Receipts for 4 Years Preceding the $1,200x $200x $300x $1,700x
Credit Year

(ii) Computation of the group credit—(A) In gen- (2) Group’s minimum base amount. The group’s credit for that member. The stand-alone entity credit
eral. The research credit allowable to the group is minimum base amount is 50 percent of the group’s for each of A, B, and C is greater using the method
computed as if A, B, and C were one taxpayer. The aggregate credit year QREs. The group’s minimum described in section 41(a). Therefore, the stand-alone
group credit is equal to 20 percent of the excess of base amount is 0.50 × $330x, which equals $165x. entity credit for each of A, B, and C must be com-
the group’s aggregate credit year QREs ($330x) over (3) Group’s fixed-base percentage. The group’s puted using the method described in section 41(a).
the group’s base amount ($170x). The group credit is fixed-base percentage is the lesser of: the ratio that A’s stand-alone entity credit is $20x. B’s stand-alone
0.20 × ($330x - $170x), which equals $32x. the group’s aggregate QREs for the taxable years be- entity credit is $2x. C’s stand-alone entity credit is
(B) Group’s base amount—(1) Computation. ginning after December 31, 1983, and before January $11x. The sum of the members’ stand-alone entity
The group’s base amount equals the greater of: the 1, 1989, bear to the group’s aggregate gross receipts credits is $33x. Because the group credit of $32x
group’s fixed-base percentage (10 percent) mul- for the same period, or 16 percent (the statutory maxi- is less than the sum of the stand-alone entity credits
tiplied by the group’s aggregate average annual mum). The group’s fixed-base percentage, therefore, of all the members of the group ($33x), the group
gross receipts for the 4 taxable years preceding is 10 percent, which is the lesser of: $150x/$1,500x, credit is allocated among the members of the group
the credit year ($1,700x), or the group’s minimum which equals 10 percent, or 16 percent. based on the ratio that each member’s stand-alone
base amount ($165x). The group’s base amount, (iii) Allocation of the group credit. Under entity credit bears to the sum of the stand-alone entity
therefore, is $170x, which is the greater of: 0.10 × paragraph (c)(2) of this section, each member’s credits of all the members of the group. The $32x
$1,700x, which equals $170x, or $165x. stand-alone entity credit must be computed using the group credit is allocated as follows:
method that results in the greater stand-alone entity

A B C Total
Stand-Alone Entity Credit $20x $2x $11x $33x
Allocation Ratio (Stand-Alone Entity Credit/Sum of 20/33 2/33 11/33
Stand-Alone Entity Credits)
Multiplied by: Group Credit $32x $32x $32x
Equals: Credit Allocated to Member $19.39x $1.94x $10.67x $32x

Example 2. Group credit exceeds sum of mem- members of a controlled group. Neither D, E, F, nor of computing the group credit for the 2004 taxable
bers’ stand-alone entity credits—(i) Facts. D, E, F, G made any basic research payments for their tax- year (the credit year), D, E, F, and G had the follow-
and G, all of which are calendar-year taxpayers, are able year ending December 31, 2004. For purposes ing:

D E F G Group
Aggregate
Credit Year QREs $580x $10x $70x $15x $675x
1984–1988 QREs $500x $25x $100x $25x $650x
1984–1988 Gross Receipts $4,000x $5,000x $2,000x $10,000x $21,000x
Average Annual Gross Receipts for 4 Years Preceding the $5,000x $5,000x $2,000x $5,000x $17,000x
Credit Year

(ii) Computation of the group credit—(A) In gen- base amount ($337.50x). The group’s base amount, tory maximum). The group’s fixed-base percentage,
eral. The research credit allowable to the group is therefore, is $526.19x, which is the greater of: 0.031 therefore, is 3.10 percent, which is the lesser of:
computed as if D, E, F, and G were one taxpayer. The × $17,000x, which equals $526.19x, or $337.50x. $650x/$21,000x, which equals 3.10 percent, or 16
group credit is equal to 20 percent of the excess of the (2) Group’s minimum base amount. The group’s percent.
group’s aggregate credit year QREs ($675x) over the minimum base amount is 50 percent of the group’s (iii) Allocation of the group credit. Under
group’s base amount ($526.19x). The group credit is aggregate credit year QREs. The group’s minimum paragraph (c)(2) of this section, each member’s
0.20 × ($675x - $526.19x), which equals $29.76x. base amount is 0.50 × $675x, which equals $337.50x. stand-alone entity credit must be computed using
(B) Group’s base amount—(1) Computation. (3) Group’s fixed-base percentage. The group’s the method that results in the greater stand-alone
The group’s base amount equals the greater of: fixed-base percentage is the lesser of: the ratio that entity credit for that member. The stand-alone entity
the group’s fixed-base percentage (3.10 percent) the group’s aggregate QREs for the taxable years credits for D ($19.46x) and F ($1.71x) are greater
multiplied by the group’s aggregate average annual beginning after December 31, 1983, and before Jan- using the AIRC method. Therefore, the stand-alone
gross receipts for the 4 taxable years preceding the uary 1, 1989, bear to the group’s aggregate gross entity credits for D and F must be computed using
credit year ($17,000x), or the group’s minimum receipts for the same period, or 16 percent (the statu- the AIRC method. The stand-alone entity credit for

June 20, 2005 1274 2005–25 I.R.B.


G ($0.50x) is greater using the method described Because the group credit of $29.76x is greater than bers’ stand alone entity credits ($8.09x) is allocated
in section 41(a). Therefore, the stand-alone entity the sum of the stand-alone entity credits of all the among the members of the group based on the ratio
credit for G must be computed using the method de- members of the group ($21.67x), each member of that each member’s QREs bear to the sum of the
scribed in section 41(a). E’s stand-alone entity credit the group is allocated an amount of the group credit QREs of all the members of the group. The $29.76x
computed under either method is zero. The sum of equal to that member’s stand-alone entity credit. The group credit is allocated as follows:
the members’ stand-alone entity credits is $21.67x. excess of the group credit over the sum of the mem-

D E F G Total
Group Credit $29.76x
Minus: Sum of Stand-Alone Entity Credits $19.46x $0.00x $1.71x $0.50x $21.67x
Equals: Excess Group Credit $8.09x

Excess Group Credit $8.09x $8.09x $8.09x $8.09x


Multiplied By Allocation Ratio: QREs/Sum of QREs 580/675 10/675 70/675 15/675
Excess Group Credit Allocated $6.95x $0.12x $0.84x $0.18x
Plus: Stand-Alone Entity Credit $19.46x $0.00x $1.71x $0.50x
Equals: Credit Allocated to Member $26.41x $0.12x $2.55x $0.68x $29.76x

Example 3. Consolidated group within a con- computed using the method that results in the greater (C) Allocation of controlled group credit. Be-
trolled group—(i) Facts. The facts are the same as stand-alone entity credit for that member. The cause the group credit of $29.76x is greater than
in Example 2, except that D and E file a consolidated stand-alone entity credit for each of the DE consoli- the sum of the stand-alone entity credits of all the
return. dated group ($17.55x) and F ($1.71x) is greater using members of the group ($19.76x), each member of
(ii) Allocation of the group credit—(A) In gen- the AIRC method. Therefore, the stand-alone entity the group is allocated an amount of the group credit
eral. For purposes of allocating the controlled credit for each of the DE consolidated group and equal to that member’s stand-alone entity credit.
group’s research credit of $29.76x among the mem- F must be computed using the AIRC method. The The excess of the group credit over the sum of the
bers of the controlled group, D and E are treated as a stand-alone entity credit for G ($0.50x) is greater us- members’ stand-alone entity credits ($10.00x) is
single member of the controlled group. ing the method described in section 41(a). Therefore, allocated among the members of the group based on
(B) Computation of stand-alone entity credits. the stand-alone entity credit for G must be computed the ratio that each member’s QREs bear to the sum
The stand-alone entity credit for the consolidated using the method described in section 41(a). The of the QREs of all the members of the group. The
group is computed by treating D and E as a single sum of the members’ stand-alone entity credits is group credit of $29.76x is allocated as follows:
entity. Under paragraph (c)(2) of this section, the $19.76x.
stand-alone entity credit for each member must be

DE F G Total
Group Credit $29.76x
Minus: Sum of Stand-Alone Entity Credits $17.55x $1.71x $0.50x $19.76x
Equals: Excess Group Credit $10.00x

Excess Group Credit $10.00x $10.00x $10.00x


Multiplied By Allocation Ratio: QREs/Sum of QREs 590/675 70/675 15/675
Excess Group Credit Allocated $8.74x $1.04x $0.22x
Plus: Stand-Alone Entity Credit $17.55x $1.71x $0.50x
Equals: Credit Allocated to Member $26.29x $2.75x $0.72x $29.76x

(iii) Allocation of the group credit allocated to for D ($19.46x) is greater using the AIRC method. dated group is allocated to each member of the con-
consolidated group—(A) In general. The group Therefore, the stand-alone entity credit for D must be solidated group in an amount equal to the member’s
credit that is allocated to a consolidated group is computed using the AIRC method. The stand-alone stand-alone entity credit. The excess of the group
allocated among the members of the consolidated entity credit for E is zero under either method. The credit allocated to the consolidated group over the
group in accordance with the principles of paragraph sum of the stand-alone entity credits of the members sum of the consolidated group members’ stand alone
(c) of this section. of the consolidated group is $19.46x. entity credits ($6.83x) is allocated among the mem-
(B) Computation of stand-alone entity cred- (C) Allocation among members of consolidated bers of the consolidated group based on the ratio that
its. Under paragraph (c)(2) of this section, the group. Because the amount of the group credit al- each member’s QREs bear to the sum of the QREs
stand-alone entity credit for each member of the located to the consolidated group ($26.29x) is greater of all the members of the consolidated group. The
consolidated group must be computed using the than $19.46x, the sum of the stand-alone entity cred- group credit of $26.29x allocated to the DE consoli-
method that results in the greater stand-alone entity its of all the members of the consolidated group, the dated group is allocated between D and E as follows:
credit for that member. The stand-alone entity credit amount of the group credit allocated to the consoli-

2005–25 I.R.B. 1275 June 20, 2005


D E Total
Group Credit $26.29x
Minus: Sum of Stand-Alone Entity Credits $19.46x $0.00x $19.46x
Excess Group Credit $6.83x

Excess Group Credit $6.83x $6.83x


Multiplied By Allocation Ratio: QREs/Sum of QREs 580/590 10/590
Excess Group Credit Allocated $6.71x $0.12x
Plus: Stand-Alone Entity Credit $19.46x $0.00x
Equals: Credit Allocated to Member $26.17x $0.12x $26.29x

Example 4. Member is a start-up company—(i) a start-up company under section 41(c)(3)(B)(i). The basic research payments during the 2004 taxable year.
Facts. H, I, and J, all of which are calendar-year tax- first taxable year for which H and I had both QREs For purposes of computing the group credit for the
payers, are members of a controlled group. The first and gross receipts began before December 31, 1983, 2004 taxable year (the credit year), H, I, and J had
taxable year for which J has both QREs and gross re- therefore, H and I are not start-up companies under the following:
ceipts begins after December 31, 1983, therefore, J is section 41(c)(3)(B)(i). Neither H, I, nor J made any

H I J Group
Aggregate
Credit Year QREs $200x $20x $50x $270x
1984–1988 QREs $55x $15x $0x $70x
1984–1988 Gross Receipts $1,000x $400x $0x $1,400x
Average Annual Gross Receipts for 4 Years Preceding the $1,200x $200x $0x $1,400x
Credit Year

(ii) Computation of the group credit—(A) In gen- aggregate credit year QREs. The group’s minimum credit for each member of the group must be com-
eral. The research credit allowable to the group is base amount is 0.50 × $270x, which equals $135x. puted using the method that results in the greater
computed as if H, I, and J were one taxpayer. The (3) Group’s fixed-base percentage. Because the stand-alone entity credit for that member. The
group credit is equal to 20 percent of the excess of first taxable year in which at least one member of the stand-alone entity credits for H ($20x), I ($2x), and
the group’s aggregate credit year QREs ($270x) over group has QREs and at least one member of the group J ($5x) are greater using the method described in
the group’s base amount ($135x). The group credit is has gross receipts does not begin after December 31, section 41(a). Therefore, the stand-alone entity cred-
0.20 × ($270x - $135x), which equals $27x. 1983, the group is not a start-up company. There- its for each of H, I, and J must be computed using
(B) Group’s base amount—(1) Computation. fore, the group’s fixed-base percentage is the lesser the method described in section 41(a). The sum of
The group’s base amount equals the greater of: of: the ratio that the group’s aggregate QREs for the the stand-alone entity credits of the members of the
the group’s fixed-base percentage (5 percent) mul- taxable years beginning after December 31, 1983, and group is $27x. Because the group credit of $27x
tiplied by the group’s aggregate average annual before January 1, 1989, bear to the group’s aggregate is equal to the sum of the stand-alone entity credits
gross receipts for the 4 taxable years preceding gross receipts for the same period, or 16 percent (the of all the members of the group ($27x), the group
the credit year ($1,400x), or the group’s minimum statutory maximum). The group’s fixed-base per- credit is allocated among the members of the group
base amount ($135x). The group’s base amount, centage, therefore, is 5 percent, which is the lesser based on the ratio that each member’s stand-alone
therefore, is $135x, which is the greater of: 0.05 × of: $70x/$1,400x, which equals 5 percent, or 16 per- entity credit bears to the sum of the stand-alone entity
$1,400x, which equals $70x, or $135x. cent. credits of all the members of the group. The group
(2) Group’s minimum base amount. The group’s (iii) Allocation of the group credit. Under para- credit of $27x is allocated as follows:
minimum base amount is 50 percent of the group’s graph (c)(2) of this section, the stand-alone entity

H I J Total
Stand-Alone Entity Credit $20x $2x $5x $27x
Allocation Ratio (Stand-Alone Entity Credit/Sum of 20/27 2/27 5/27
Stand-Alone Entity Credits)
Multiplied by: Group Credit $27x $27x $27x
Equals: Credit Allocated to Member $20x $2x $5x $27x

Example 5. Group is a start-up company—(i) first taxable year in which each of K, L, and M had QREs and at least one member of the group had gross
Facts. K, L, and M, all of which are calendar-year both QREs and gross receipts. Therefore, the taxable receipts. The 2004 taxable year is the fifth taxable
taxpayers, are members of a controlled group. The year ending on December 31, 1999, is the first taxable year beginning after December 31, 1993, for which
taxable year ending on December 31, 1999, is the year in which at least one member of the group had at least one member of the group had QREs. Neither

June 20, 2005 1276 2005–25 I.R.B.


K, L, nor M made any basic research payments dur- the group credit for the 2004 taxable year (the credit
ing the 2004 taxable year. For purposes of computing year), K, L, and M had the following:

K L M Group
Aggregate
Credit Year QREs $255x $25x $100x $380x
1984–1988 QREs $0x $0x $0x $0x
1984–1988 Gross Receipts $0x $0x $0x $0x
Average Annual Gross Receipts for 4 Years Preceding the $1,600x $340x $300x $2,240x
Credit Year

(ii) Computation of the group credit—(A) In gen- (2) Group’s minimum base amount. The group’s credit for each member of the consolidated group
eral. The research credit allowable to the group is minimum base amount is 50 percent of the group’s must be computed using the method that results in
computed as if K, L, and M were one taxpayer. The aggregate credit year QREs. The group’s minimum the greater stand-alone entity credit for that member.
group credit is equal to 20 percent of the excess of base amount is 0.50 × $380x, which equals $190x. The stand-alone entity credit for each of K ($25.5x),
the group’s aggregate credit year QREs ($380x) over (3) Group’s fixed-base percentage. Because the L ($2.5x), and M ($10x) is greater using the method
the group’s base amount ($190x). The group credit is first taxable year in which at least one member of described in section 41(a). Therefore the stand-alone
0.20 × ($380x - $190x), which equals $38x. the group has QREs and at least one member of the entity credits for each of K, L, and M must be com-
(B) Group’s base amount—(1) Computation. group has gross receipts begins after December 31, puted using the method described in section 41(a).
The group’s base amount equals the greater of: 1983, the group is treated as a start-up company The sum of the stand-alone entity credits of all the
the group’s fixed-base percentage (3 percent) mul- under section 41(c)(3)(B)(i) and paragraph (b)(2)(i) members of the group is $38x. Because the group
tiplied by the group’s aggregate average annual of this section. Because the 2004 taxable year is credit of $38x is equal to sum of the stand-alone en-
gross receipts for the 4 taxable years preceding the fifth taxable year beginning after December 31, tity credits of all the members of the group ($38x), the
the credit year ($2,240x), or the group’s minimum 1993, for which at least one member of the group had group credit is allocated among the members of the
base amount ($190x). The group’s base amount, QREs, under section 41(c)(3)(B)(ii)(I), the group’s group based on the ratio that each member’s stand-
therefore, is $190x, which is the greater of: 0.03 × fixed-base percentage is 3 percent. alone entity credit bears to the sum of the stand-alone
$2,240x, which equals $67.20x, or $190x. (iii) Allocation of the group credit. Under para- entity credits of all the members of the group. The
graph (c)(2) of this section, the stand-alone entity $38x group credit is allocated as follows:

K L M Total
Stand-Alone Entity Credit $25.5x $2.5x $10x $38x
Allocation Ratio (Stand-Alone Entity Credit/Sum of 25.5/38 2.5/38 10/38
Stand-Alone Entity Credits)
Multiplied by: Group Credit $38x $38x $38x
Equals: Credit Allocated to Member $25.5x $2.5x $10x $38x

Example 6. Group alternative incremental re- allowable to the group for the 2004 taxable year be- tion 41(c)(4). For purposes of computing the group
search credit—(i) Facts. N, O, and P, all of which are cause the group’s aggregate QREs for the 2004 tax- credit for the 2004 taxable year (the credit year), N,
calendar-year taxpayers, are members of a controlled able year are less than the group’s base amount. The O, and P had the following:
group. The research credit under section 41(a) is not group credit is computed using the AIRC rules of sec-

N O P Group
Aggregate
Credit Year QREs $0x $20x $110x $130x
Average Annual Gross Receipts for 4 Years Preceding the $1,200x $200x $300x $1,700x
Credit Year

(ii) Computation of the group credit. The research such average. The group credit is [0.0265 × [($1,700x method. Therefore, the stand-alone entity credits for
credit allowable to the group is computed as if N, O, × 0.015) - ($1,700x × 0.01)]] + [0.032 × [($1,700x each of O and P must be computed using the AIRC
and P were one taxpayer. The group credit is equal × 0.02) - ($1,700x × 0.015)]] + [0.0375 × [$130x - method. The sum of the stand-alone entity credits
to the sum of: 2.65 percent of so much of the group’s ($1,700x × 0.02)]], which equals $4.10x. of the members of the group is $4.65x. Because the
aggregate QREs for the taxable year as exceeds 1 per- (iii) Allocation of the group credit. Under para- group credit of $4.10x is less than the sum of the
cent of the group’s aggregate average annual gross graph (c)(2) of this section, the stand-alone entity stand-alone entity credits of all the members of the
receipts for the 4 taxable years preceding the credit credit for each member of the group must be com- group ($4.65x), the group credit is allocated among
year, but does not exceed 1.5 percent of such aver- puted using the method that results in the greater the members of the group based on the ratio that each
age; 3.2 percent of so much of the group’s aggregate stand-alone entity credit for that member. The member’s stand-alone entity credit bears to the sum
QREs as exceeds 1.5 percent of such average but does stand-alone entity credit for N is zero under either of the stand-alone entity credits of all the members
not exceed 2 percent of such average; and 3.75 per- method. The stand-alone entity credit for each of O of the group. The $4.10x group credit is allocated as
cent of so much of such QREs as exceeds 2 percent of ($0.66x) and P ($3.99x) is greater using the AIRC follows:

2005–25 I.R.B. 1277 June 20, 2005


N O P Total
Stand-Alone Entity Credit $0.00x $0.66x $3.99x $4.65x
Allocation Ratio (Stand-Alone Entity Credit/Sum of 0/4.65 0.66/4.65 3.99/4.65
Stand-Alone Entity Credits)
Multiplied by: Group Credit $4.10x $4.10x $4.10x
Equals: Credit Allocated to Member $0.00x $0.58x $3.52x $4.10x

(f) For taxable years beginning before included for its preceding taxable year. If ber, those expenses may be taken into ac-
January 1, 1990. For taxable years begin- the business was not included for its pre- count as contract research expenses by an-
ning before January 1, 1990, see §1.41–6 ceding taxable year in any group in which other member of the group provided that
as contained in 26 CFR part 1, revised it could be included as of the end of its tax- the other member—
April 1, 2005. able year, the business shall designate in its (i) Reimburses the member paying or
(g) Tax accounting periods used—(1) timely filed (including extensions) return incurring the expenses; and
In general. The credit allowable to a mem- the group in which it is being included. If (ii) Carries on a trade or business to
ber of a controlled group is that member’s the return for a taxable year is due before which the research relates.
share of the group credit computed as of July 1, 1983, the business may designate (4) Lease Payments. The amount paid
the end of that member’s taxable year. In its group membership through an amended or incurred to another member of the group
computing the group credit for a group return for that year filed on or before June for the lease of personal property owned by
whose members have different taxable 30, 1983. If the business does not so desig- a member of the group is not taken into ac-
years, a member generally should treat the nate, then the appropriate Internal Revenue count for purposes of section 41. Amounts
taxable year of another member that ends Service official in the operating division paid or incurred to another member of the
with or within the credit year of the com- that has examination jurisdiction of the re- group for the lease of personal property
puting member as the credit year of that turn will determine the group in which the owned by a person outside the group shall
other member. For example, Q, R, and business is to be included. be taken into account as in-house research
S are members of a controlled group of (i) Intra-group transactions—(1) In expenses for purposes of section 41 only to
corporations. Both Q and R are calendar general. Because all members of a group the extent of the lesser of—
year taxpayers. S files a return using a under common control are treated as a (i) The amount paid or incurred to the
fiscal year ending June 30. For purposes single taxpayer for purposes of determin- other member; or
of computing the group credit at the end ing the research credit, transfers between (ii) The amount of the lease expenses
of Q’s and R’s taxable year on December members of the group are generally disre- paid to the person outside the group.
31, S’s fiscal year ending June 30, which garded. (5) Payment for supplies. Amounts paid
ends within Q’s and R’s taxable year, is (2) In-house research expenses. If one or incurred to another member of the group
treated as S’s credit year. member of a group performs qualified re- for supplies shall be taken into account as
(2) Special rule when timing of research search on behalf of another member, the in-house research expenses for purposes of
is manipulated. If the timing of research member performing the research shall in- section 41 only to the extent of the lesser
by members using different tax accounting clude in its QREs any in-house research of—
periods is manipulated to generate a credit expenses for that work and shall not treat (i) The amount paid or incurred to the
in excess of the amount that would be al- any amount received or accrued as fund- other member; or
lowable if all members of the group used ing the research. Conversely, the mem- (ii) The amount of the other member’s
the same tax accounting period, then the ber for whom the research is performed basis in the supplies.
appropriate Internal Revenue Service offi- shall not treat any part of any amount paid (j) Effective date. These temporary reg-
cial in the operating division that has ex- or incurred as a contract research expense. ulations are applicable for taxable years
amination jurisdiction of the return may re- For purposes of determining whether the ending on or after May 24, 2005. Gen-
quire each member of the group to calcu- in-house research for that work is quali- erally, a taxpayer may use any reasonable
late the credit in the current taxable year fied research, the member performing the method of computing and allocating the
and all future years as if all members of the research shall be treated as carrying on any credit for taxable years ending before May
group had the same taxable year and base trade or business carried on by the member 24, 2005. However, paragraph (b), relating
period as the computing member. on whose behalf the research is performed. to the computation of the group credit, and
(h) Membership during taxable year in (3) Contract research expenses. If a paragraph (c), relating to the allocation of
more than one group. A trade or business member of a group pays or incurs contract the group credit, will apply to taxable years
may be a member of only one group for a research expenses to a person outside the ending on or after December 29, 1999, if
taxable year. If, without application of this group in carrying on the member’s trade or the members of a controlled group, as a
paragraph, a business would be a member business, that member shall include those whole, claimed more than 100 percent of
of more than one group at the end of its expenses as QREs. However, if the ex- the amount that would be allowable under
taxable year, the business shall be treated penses are not paid or incurred in carry- paragraph (b). In the case of a controlled
as a member of the group in which it was ing on any trade or business of that mem- group whose members have different tax-

June 20, 2005 1278 2005–25 I.R.B.


able years and whose members use incon- a controlled group of corporations, all the Eric Solomon,
sistent methods of allocation, the members members of which are not included on a Acting Deputy Assistant Secretary
of the controlled group shall be deemed to single consolidated return, the designated of the Treasury.
have, as a whole, claimed more than 100 member must make (or revoke) an elec-
(Filed by the Office of the Federal Register on May 20, 2005,
percent of the amount that would be allow- tion under section 41(c)(4) on behalf of 8:45 a.m., and published in the issue of the Federal Register
able under paragraph (b). the members of the group. An election for May 24, 2005, 70 F.R. 29596)

(or revocation) by the designated member


§1.41–8 [Removed] under this paragraph (b)(4) of this section
shall be binding on all the members of Section 143.—Mortgage
Par. 5. Section 1.41–8 is removed.
the group for the credit year to which the Revenue Bonds: Qualified
Par. 6. Section 1.41–8T is added to read Mortgage Bond and
election (or revocation) relates.
as follows: Qualified Veterans’
(ii) Designated member. For purposes
§1.41–8T Special rules for taxable years of this paragraph (b)(4) of this section, for Mortgage Bond
ending on or after January 3, 2001 any credit year, the term designated mem-
26 CFR 1.143(g)–1: Requirements related to arbi-
(temporary). ber means that member of the group that is trage.
allocated the greatest amount of the group
(a) Alternative incremental credit. At credit under paragraph (c) of §1.41–6T. T.D. 9204
the election of the taxpayer, the credit de- If the members of a group compute the
termined under section 41(a)(1) equals the group credit using different methods (ei- DEPARTMENT OF
amount determined under section 41(c)(4). ther the method described in section 41(a)
THE TREASURY
(b) Election—(1) In general. A tax- or the AIRC method of section 41(c)(4))
payer may elect to apply the provisions of and at least two members of the group Internal Revenue Service
the alternative incremental research credit qualify as the designated member, then the 26 CFR Part 1
(AIRC) in section 41(c)(4) for any taxable term designated member means that mem-
year of the taxpayer beginning after June ber that computes the group credit using Mortgage Revenue Bonds
30, 1996. If a taxpayer makes an election the method that yields the greater group
AGENCY: Internal Revenue Service
under section 41(c)(4), the election applies credit. For example, A, B, C, and D are
(IRS), Treasury.
to the taxable year for which made and all members of a controlled group but are not
subsequent taxable years unless revoked in members of a consolidated group. For the ACTION: Final regulations.
the manner prescribed in paragraph (b)(3) 2005 taxable year, the group credit using
of this section. the method described in section 41(a) is SUMMARY: This document contains fi-
(2) Time and manner of election. An $10x. Under this method, A would be allo- nal regulations that provide guidance re-
election under section 41(c)(4) is made cated $5x of the group credit, which would garding the limitation on the effective rate
by completing the portion of Form 6765, be the largest share of the group credit un- of mortgage interest for purposes of mort-
“Credit for Increasing Research Activi- der this method. For the 2005 taxable year, gage revenue bonds issued by State and lo-
ties,” relating to the election of the AIRC, the group credit using the AIRC method is cal governments. These regulations pro-
and attaching the completed form to the $15x. Under the AIRC method, C would vide guidance to State and local govern-
taxpayer’s timely filed (including exten- be allocated $5x of the group credit, which ments that issue tax-exempt mortgage rev-
sions) original return for the taxable year is the largest share of the group credit enue bonds.
to which the election applies. An election computed using the AIRC method. Be-
under section 41(c)(4) may not be made cause the group credit is greater using the DATES: Effective Date: These regulations
on an amended return. AIRC method and C is allocated the great- are effective May 23, 2005.
(3) Revocation. An election under this est amount of credit under that method, C Applicability Date: For dates of appli-
section may not be revoked except with is the designated member. Therefore, C’s cability, see §1.143(g)–1(d) of these regu-
the consent of the Commissioner. A tax- section 41(c)(4) election is binding on all lations.
payer is deemed to have requested, and to the members of the group for the 2005 tax-
have been granted, the consent of the Com- able year. FOR FURTHER INFORMATION
missioner to revoke an election under sec- (5) Effective date. These temporary CONTACT: Michael P. Brewer, (202)
tion 41(c)(4) if the taxpayer completes the regulations are applicable for taxable years 622–3980 (not a toll-free number).
portion of Form 6765 relating to the regu- ending on or after May 24, 2005.
SUPPLEMENTARY INFORMATION:
lar credit and attaches the completed form
to the taxpayer’s timely filed (including Mark E. Matthews,
Background
extensions) original return for the year to Deputy Commissioner for
which the revocation applies. An election Services and Enforcement. This document amends the Income Tax
under section 41(c)(4) may not be revoked Regulations (26 CFR part 1) under section
Approved May 16, 2005.
on an amended return. 143(g) of the Internal Revenue Code by
(4) Special rules for controlled providing rules regarding the limitation
groups—(i) In general. In the case of on the effective rate of mortgage interest

2005–25 I.R.B. 1279 June 20, 2005


for purposes of mortgage revenue bonds 143(g)(2), all fees, charges, and other identical to section 143(g)(2)(B)(iii) of the
issued by State and local governments. On amounts borne by the mortgagor that are Code, §6a.103A–2(i)(2)(ii)(C) of the Tem-
November 5, 2003, the IRS published in attributable to the mortgage or the bond porary Income Tax Regulations provides
the Federal Register a notice of proposed issue are taken into account as additional the following: “For example, amounts
rulemaking (REG–146692–03, 2003–2 interest paid. paid for FHA, VA, or similar private
C.B. 1164 [68 FR 62549]) (the proposed Section 143(g)(2)(B)(ii) provides that, mortgage insurance on an individual’s
regulations). The proposed regulations for purposes of determining the effective mortgage need not be taken into account
would add §1.143(g)–1 to provide rules rate of mortgage interest, the following so long as such amounts do not exceed the
for calculating the effective rate of mort- items (among others) shall be treated as amounts charged in the area with respect
gage interest. A public hearing on the borne by the mortgagor: (1) All points or to a similar mortgage that is not financed
proposed regulations was scheduled for similar charges paid by the seller of the with qualified mortgage bonds. Premiums
January 28, 2004. The public hearing was property; and (2) the excess of the amounts charged for pool mortgage insurance will
cancelled because no requests to speak received from any person other than the be considered amounts in excess of the
were received. Written comments were mortgagor by any person in connection usual and reasonable amounts charged for
received regarding the proposed regula- with the acquisition of the mortgagor’s in- insurance in cases where owner financing
tions. After consideration of the written terest in the property over the usual and is not provided through the use of qual-
comments, the proposed regulations are reasonable acquisition costs of a person ac- ified mortgage bonds.” Pool mortgage
adopted by this Treasury decision with- quiring like property when owner-financ- insurance is not defined in the regulations.
out change (other than certain clarifying ing is not provided through the use of mort-
changes to the effective date provisions). gage revenue bonds. B. Qualified Guarantees
Section 143(g)(2)(B)(iii) provides that,
A. Mortgage Revenue Bonds for purposes of determining the effective Under §1.148–4(f), for purposes of
rate of mortgage interest, the following computing yield on an issue, fees paid
Section 103(a) of the Internal Revenue items shall not be taken into account: (1) for a qualified guarantee for the issue are
Code of 1986 (Code) provides that, gen- Any expected rebate of arbitrage profits; treated as additional interest on the issue.
erally, interest on any State or local bond and (2) any application fee, survey fee, In general, a guarantee is a qualified guar-
is not included in gross income. However, credit report fee, insurance charge, or simi- antee if: (1) As of the date the guarantee
this exclusion does not apply to any private lar amount to the extent such amount does is obtained, the issuer reasonably expects
activity bond that is not a qualified bond. not exceed amounts charged in such area that the present value of the fees for the
Section 141(e)(1) provides that a qual- in cases when owner-financing is not pro- guarantee will be less than the present
ified mortgage bond or a qualified veter- vided through the use of mortgage revenue value of the expected interest savings on
ans’ mortgage bond (together, mortgage bonds. The exclusion for application fees, the issue as a result of the guarantee; (2)
revenue bonds) issued under section 143 survey fees, credit report fees, insurance the arrangement creates a guarantee in sub-
may be a qualified bond. charges, or similar amounts does not ap- stance; and (3) the fees for the guarantee
Sections 143(a)(2)(A)(ii) and 143(b) ply to origination fees, points, or similar do not exceed a reasonable, arm’s-length
provide, in part, that for an issue to be amounts. charge for the transfer of credit risk. The
an issue of qualified mortgage bonds In the case of an issue 95 percent or regulations provide that the guarantee of a
or qualified veterans’ mortgage bonds, more of the net proceeds of which are to loan of proceeds of an issue, as opposed to
respectively, the issue must satisfy the be used to provide residences for veter- a guarantee of the issue, may constitute a
requirements of section 143(g). Section ans, section 143(g)(3) provides that certain qualified guarantee, but this rule does not
143(g)(1) provides that an issue will meet earnings on nonpurpose investments must apply to guarantees of mortgages financed
the requirements of section 143(g) if the either be paid or credited to mortgagors, or with mortgage revenue bonds.
issue satisfies the requirements of section paid to the United States, in certain circum- Explanation of Provisions
143(g)(2) and, in the case of an issue 95 stances.
percent or more of the net proceeds of In the Tax Reform Act of 1986, Public A. Pool Mortgage Insurance
which are to be used to provide residences Law 99–514 (the 1986 Act), Congress re-
for veterans, if the issue satisfies the re- organized sections 103 and 103A of the In- Prior to the issuance of the proposed
quirements of section 143(g)(3). ternal Revenue Code of 1954 (1954 Code) regulations, questions arose regarding
Section 143(g)(2)(A) provides that an regarding tax-exempt bonds into sections whether an issuer should be required to
issue will meet the requirements of section 103 and 141 through 150 of the Code. treat the portion of the interest payments
143(g)(2) only if the excess of (1) the ef- Congress intended that to the extent not on a pool of mortgages used to pay fees
fective interest rate on the mortgages pro- amended by the 1986 Act, all principles for a guarantee of a pass-through security
vided under the issue, over (2) the yield on of pre-1986 Act law would continue to ap- backed by the pool of mortgages as an
the issue, is not greater than 1.125 percent- ply to the reorganized provisions. 2 H.R. amount borne by the mortgagors that must
age points. Conf. Rep. No. 841, 99th Cong., 2d Sess. be taken into account in determining the
Section 143(g)(2)(B)(i) provides that in II–686 (1986), 1986–3 (Vol. 4) C.B. 686. effective rate of interest on the mortgages
determining the effective rate of interest Interpreting section 103A(i)(2)(B)(iii) for purposes of section 143(g). Taking
on any mortgage for purposes of section of the 1954 Code, which is substantially the guarantee fees into account results in

June 20, 2005 1280 2005–25 I.R.B.


a higher effective rate of interest on the quirements of §1.143(g)–1(b) only if the (for example, the Government National
mortgages than if the fees were not taken excess of (1) the effective rate of interest Mortgage Association, the Federal Na-
into account. on the mortgages financed by the issue, tional Mortgage Association, the Federal
The IRS and Treasury Department have over (2) the yield on the issue, is not greater Home Loan Mortgage Corporation, or
determined that the guarantee fees should over the term of the issue than 1.125 per- other mortgage insurer) to directly guar-
not be treated as amounts borne by the centage points. antee the pool of mortgages financed with
mortgagors that must be taken into account In determining the effective rate of in- the bonds, or to guarantee a pass-through
in determining the effective rate of inter- terest on any mortgage, the proposed reg- security backed by the pool of mortgages
est on the mortgages for purposes of sec- ulations provide that all fees, charges, and financed with the bonds.
tion 143(g). An issuer may achieve sub- other amounts borne by the mortgagor that The proposed regulations do not pro-
stantially the same result as not taking the are attributable to the mortgage or to the vide guidance regarding all aspects of
guarantee fees into account in computing bond issue are taken into account. Such the application of section 143(g)(2). The
the effective rate of interest on the mort- amounts include points, commitment fees, proposed regulations provide that to the
gages by substituting a qualified guarantee origination fees, servicing fees, and pre- extent not inconsistent with the 1986
on the bonds for the guarantee of the pool payment penalties paid by the mortgagor. Act or subsequent law, the provisions of
of mortgages. If an issuer does not take The proposed regulations provide that §6a.103A–2(i)(2) (other than paragraphs
the mortgage guarantee fees into account items that are treated as borne by the mort- (i)(2)(i) and (i)(2)(ii)(A) through (C)) ap-
in computing the effective rate of interest gagor and are taken into account in cal- ply to provide additional rules relating
on the mortgages, the difference between culating the effective rate of interest also to compliance with the requirement that
the bond yield and the effective rate on the include: (1) All points, commitment fees, the effective rate of mortgage interest not
mortgages is reduced because the effective origination fees, or similar charges borne exceed the bond yield by more than 1.125
rate on the mortgages is reduced. A qual- by the seller of the property; and (2) the ex- percentage points.
ified guarantee of the bonds accomplishes cess of any amounts received from any per- The proposed regulations also do not
the same result by increasing bond yield, son other than the mortgagor by any person provide guidance regarding the application
rather than reducing the effective rate of in connection with the acquisition of the of section 143(g)(3). The proposed reg-
interest on the mortgages. Issuers should mortgagor’s interest in the property over ulations provide that to the extent not in-
not be required to change the form of their the usual and reasonable acquisition costs consistent with the 1986 Act or subsequent
transactions in these circumstances. of a person acquiring like property where law, the provisions of §6a.103A–2(i)(4)
Accordingly, to the extent the amounts owner-financing is not provided through apply to provide guidance regarding the
charged for a guarantee of a pool of mort- the use of mortgage revenue bonds. application of section 143(g)(3).
gages do not exceed amounts charged in The proposed regulations further pro-
the area in cases when owner-financing is vide that the following items are not C. Final Regulations
not provided through the use of mortgage treated as borne by the mortgagor and are
revenue bonds, the proposed regulations not taken into account in calculating the All of the public comments expressed
would provide that such amounts are not effective rate of interest: (1) Any expected support for the proposed regulations as
treated as borne by the mortgagors and are rebate of arbitrage profit; and (2) any ap- proposed, and the proposed regulations are
not taken into account in determining the plication fee, survey fee, credit report fee, adopted by this Treasury decision without
effective rate of interest on the mortgages insurance charge or similar settlement or change other than certain changes to the
for purposes of section 143(g). financing cost to the extent such amount effective date provisions to reflect that the
does not exceed amounts charged in the regulations are being issued in final form.
B. Proposed Regulations area in cases where owner-financing is
not provided through the use of mortgage Effective Dates
The proposed regulations propose a revenue bonds.
new §1.143(g)–1. The proposed reg- With respect to insurance charges, The final regulations apply to bonds
ulations provide that an issue satisfies the proposed regulations provide that sold on or after May 23, 2005, that are sub-
the requirements of section 143(g) only amounts paid for Federal Housing Ad- ject to section 143. Issuers may apply the
if the issue meets the requirements of ministration, Veterans’ Administration, or final regulations in whole, but not in part,
§1.143(g)–1(b) and, in the case of an issue similar private mortgage insurance on an to bonds sold before May 23, 2005, that are
95 percent or more of the net proceeds individual’s mortgage, or amounts paid subject to section 143. Subject to the appli-
of which are to be used to provide resi- for pool mortgage insurance on a pool of cable effective dates for the corresponding
dences for veterans, the issue also meets mortgages, are not taken into account so statutory provisions, issuers may apply the
the requirements of §1.143(g)–1(c). The long as such amounts do not exceed the final regulations, in whole, but not in part,
requirements of section 143(g) and the amounts charged in the area with respect to to bonds that are subject to section 103A(i)
proposed regulations are applicable in ad- a similar mortgage, or pool of mortgages, of the Internal Revenue Code of 1954. To
dition to the requirements of section 148 that is not financed with mortgage rev- the extent that an issuer applies the final
and §§1.148–0 through 1.148–11. enue bonds. Moreover, for this purpose, regulations to bonds that were issued be-
The proposed regulations provide that amounts paid for pool mortgage insur- fore July 1, 1993, §6a.103A–2(i)(3) also
an issue shall be treated as meeting the re- ance include amounts paid to an entity applies.

2005–25 I.R.B. 1281 June 20, 2005


Special Analyses issue 95 percent or more of the net pro- example, amounts paid for Federal Hous-
ceeds of which are to be used to provide ing Administration, Veterans’ Administra-
It has been determined that this Trea- residences for veterans, such issue also tion, or similar private mortgage insurance
sury decision is not a significant regula- meets the requirements of paragraph (c) of on an individual’s mortgage, or amounts
tory action as defined in Executive Order this section. The requirements of section paid for pool mortgage insurance on a pool
12866. Therefore, a regulatory assessment 143(g) and this section are applicable in of mortgages, are not taken into account
is not required. It has also been deter- addition to the requirements of section 148 so long as such amounts do not exceed the
mined that section 553(b) of the Admin- and §§1.148–0 through 1.148–11. amounts charged in the area with respect to
istrative Procedure Act (5 U.S.C. chapter (b) Effective rate of mortgage interest a similar mortgage, or pool of mortgages,
5) does not apply to these regulations, and, not to exceed bond yield by more than that is not financed with mortgage revenue
because the regulations do not impose a 1.125 percentage points—(1) Maximum bonds. For this purpose, amounts paid for
collection of information on small entities, yield. An issue shall be treated as meet- pool mortgage insurance include amounts
the Regulatory Flexibility Act (5 U.S.C. ing the requirements of this paragraph (b) paid to an entity (for example, the Gov-
chapter 6) does not apply. Pursuant to sec- only if the excess of the effective rate of ernment National Mortgage Association,
tion 7805(f) of the Code, the notice of pro- interest on the mortgages financed by the the Federal National Mortgage Associ-
posed rulemaking preceding these regula- issue, over the yield on the issue, is not ation (FNMA), the Federal Home Loan
tions was submitted to the Chief Counsel greater over the term of the issue than Mortgage Corporation, or other mortgage
for Advocacy of the Small Business Ad- 1.125 percentage points. insurer) to directly guarantee the pool of
ministration for comment on its impact on (2) Effective rate of interest. (i) In de- mortgages financed with the bonds, or to
small business. termining the effective rate of interest on guarantee a pass-through security backed
any mortgage for purposes of this para- by the pool of mortgages financed with
Drafting Information graph (b), there shall be taken into account the bonds.
all fees, charges, and other amounts borne (C) The following example illustrates
The principal authors of these reg-
by the mortgagor that are attributable to the provisions of this paragraph (b)(2)(iii):
ulations are Timothy L. Jones and Example. Housing Authority X issues bonds in-
the mortgage or to the bond issue. Such
Michael P. Brewer, Office of Associate tended to be qualified mortgage bonds under sec-
amounts include points, commitment fees,
Chief Counsel (Tax-exempt and Gov- tion 143(a). At the time the bonds are issued, X
origination fees, servicing fees, and pre- enters into an agreement with a group of mortgage
ernment Entities), IRS. However, other
payment penalties paid by the mortgagor. lending institutions (lenders) under which the lenders
personnel from the IRS and Treasury
(ii) Items that shall be treated as borne agree to originate and service mortgages that meet
Department participated in their develop- certain specified requirements. After originating a
by the mortgagor and shall be taken into
ment. specified amount of mortgages, each lender issues a
account in calculating the effective rate of
“pass-though security” (each, a PTS) backed by the
***** interest also include— mortgages and sells the PTS to X. Under the terms
(A) All points, commitment fees, origi- of the PTS, the lender pays X an amount equal to
Adoption of Amendments to the nation fees, or similar charges borne by the the regular monthly payments on the mortgages (less
Regulations seller of the property; and certain fees), whether or not received by the lender
(B) The excess of any amounts received (plus any prepayments and liquidation proceeds in
Accordingly, 26 CFR part 1 is amended the event of a foreclosure or other disposition of any
from any person other than the mortgagor mortgages). FNMA guarantees the timely payment
as follows: by any person in connection with the ac- of principal and interest on each PTS. From the pay-
quisition of the mortgagor’s interest in the ments received from each mortgagor, the lender pays
PART 1—INCOME TAXES a fee to FNMA for its guarantee of the PTS. The
property over the usual and reasonable ac-
quisition costs of a person acquiring like amounts paid to FNMA do not exceed the amounts
Paragraph 1. The authority citation for charged in the area with respect to a similar pool of
part 1 continues to read in part as follows: property when owner-financing is not pro- mortgages that is not financed with mortgage revenue
Authority: 26 U.S.C. 7805 * * * vided through the use of mortgage revenue bonds. Under this paragraph (b)(2)(iii), the fees for
Par. 2. Section 1.143(g)–1 is added to bonds. the guarantee provided by FNMA are an insurance
(iii) The following items shall not be charge because the guarantee is pool mortgage insur-
read as follows: ance. Because the amounts charged for the guarantee
treated as borne by the mortgagor and shall
do not exceed the amounts charged in the area with
§1.143(g)–1 Requirements related to not be taken into account in calculating the respect to a similar pool of mortgages that is not fi-
arbitrage. effective rate of interest— nanced with mortgage revenue bonds, the amounts
(A) Any expected rebate of arbitrage charged for the guarantee are not taken into account
(a) In general. Under section 143, for profit under paragraph (c) of this section; in computing the effective rate of interest on the mort-
an issue to be an issue of qualified mort- and gages financed with X’s bonds.

gage bonds or qualified veterans’ mort- (B) Any application fee, survey fee, (3) Additional rules. To the extent
gage bonds (together, mortgage revenue credit report fee, insurance charge or not inconsistent with the Tax Reform Act
bonds), the requirements of section 143(g) similar settlement or financing cost to of 1986, Public Law 99–514 (the 1986
must be satisfied. An issue satisfies the re- the extent such amount does not exceed Act), or subsequent law, §6a.103A–2(i)(2)
quirements of section 143(g) only if such amounts charged in the area in cases when (other than paragraphs (i)(2)(i) and
issue meets the requirements of paragraph owner-financing is not provided through (i)(2)(ii)(A) through (C)) of this chapter
(b) of this section and, in the case of an the use of mortgage revenue bonds. For applies to provide additional rules relating

June 20, 2005 1282 2005–25 I.R.B.


to compliance with the requirement that Section 6050L.—Returns 1545–1932. Responses to this collection
the effective rate of mortgage interest not Relating to Certain Donated of information are required to obtain a tax
exceed the bond yield by more than 1.125 Property benefit.
percentage points. An agency may not conduct or spon-
26 CFR 1.6050L–2T: Information returns by donees
(c) Arbitrage and investment gains to sor, and a person is not required to respond
relating to qualified intellectual property contribu-
be used to reduce costs of owner-financ- tions (temporary). to, a collection of information unless the
ing. As provided in section 143(g)(3), cer- collection of information displays a valid
tain earnings on nonpurpose investments T.D. 9206 OMB control number. For further infor-
must either be paid or credited to mort- mation concerning this collection of infor-
gagors, or paid to the United States, in cer- DEPARTMENT OF mation, and where to submit comments on
tain circumstances. To the extent not in- THE TREASURY the collection of information and the accu-
consistent with the 1986 Act or subsequent racy of the estimated burden, and sugges-
law, §6a.103A–2(i)(4) of this chapter ap-
Internal Revenue Service tions for reducing this burden, please refer
plies to provide guidance relating to com- 26 CFR Parts 1 and 602 to the preamble to the cross referencing no-
pliance with this requirement. tice of proposed rulemaking published in
(d) Effective dates—(1) In general. Ex- Information Returns by this issue of the Bulletin.
cept as otherwise provided in this section, Donees Relating to Qualified Books or records relating to a collection
§1.143(g)–1 applies to bonds sold on or af- Intellectual Property of information must be retained as long
ter May 23, 2005, that are subject to sec- Contributions as their contents may become material in
tion 143. the administration of any internal revenue
(2) Permissive retroactive application AGENCY: Internal Revenue Service law. Generally, tax returns and return in-
in whole. Except as provided in paragraph (IRS), Treasury. formation are confidential, as required by
(d)(4) of this section, issuers may apply 26 U.S.C. 6103.
§1.143(g)–1, in whole, but not in part, to ACTION: Temporary regulations.
bonds sold before May 23, 2005, that are Explanation of Provisions
subject to section 143. SUMMARY: This document contains
temporary regulations that provide guid- This document contains temporary In-
(3) Bonds subject to the Internal Rev-
ance for the filing of information returns come Tax Regulations under the Amer-
enue Code of 1954. Except as provided in
by donees relating to qualified intellectual ican Jobs Creation Act of 2004 (Public
paragraph (d)(4) of this section and subject
property contributions. These temporary Law 108–357, 118 Stat. 1418) (the Act).
to the applicable effective dates for the cor-
regulations affect donees receiving net in- They are necessary to implement section
responding statutory provisions, an issuer
come from qualified intellectual property 882 of the Act, which directs that regula-
may apply §1.143(g)–1, in whole, but not
contributions made after June 3, 2004. tions be issued regarding information re-
in part, to bonds that are subject to section
The text of these temporary regulations turns by donees relating to qualified intel-
103A(i) of the Internal Revenue Code of
also serves as the text of the proposed lectual property contributions made after
1954.
regulations (REG–158138–04) set forth in June 3, 2004.
(4) Special rule for pre-July 1, 1993
the notice of proposed rulemaking on this The Act provides rules that under spec-
bonds. To the extent that an issuer applies
subject in this issue of the Bulletin. ified conditions enable taxpayers who
this section to bonds issued before July
donate qualified intellectual property to
1, 1993, §6a.103A–2(i)(3) of this chapter
DATES: Effective Date: These regulations receive additional charitable contribu-
also applies to the bonds.
are effective May 23, 2005. tion deductions if and when their donated
Mark E. Matthews, property produces net income for the
FOR FURTHER INFORMATION donee (qualified donee income). Section
Deputy Commissioner for
CONTACT: Donnell M. Rini-Swyers, 170(m)(2), (8), (9). Under the Act, a tax-
Services and Enforcement.
(202) 622–4910 (not a toll-free number). payer who contributes a “patent, copyright
Approved May 12, 2005. (other than a copyright described in section
SUPPLEMENTARY INFORMATION:
1221(a)(3) or 1231(b)(1)(C)), trademark,
Eric Solomon, trade name, trade secret, know-how, soft-
Paperwork Reduction Act
Acting Deputy Assistant Secretary ware (other than software described in sec-
of the Treasury. These temporary regulations are being tion 197(e)(3)(A)(i)), or similar property,
(Filed by the Office of the Federal Register on May 20, 2005, issued without prior notice and public pro- or applications or registrations of such
8:45 a.m., and published in the issue of the Federal Register cedure pursuant to the Administrative Pro- property,” to a donee described in section
for May 23, 2005, 70 F.R. 29447)
cedure Act (5 U.S.C. 553). For this reason, 170(c) (other than to a private foundation
the collection of information contained in referred to in section 170(e)(1)(B)(ii)) may
these regulations has been reviewed and, be allowed an initial charitable contribu-
pending receipt and evaluation of public tion deduction limited to the lesser of the
comments, approved by the Office of Man- taxpayer’s basis or the fair market value
agement and Budget under control number of the qualified intellectual property. In

2005–25 I.R.B. 1283 June 20, 2005


addition, the taxpayer may be permitted to Under these regulations, the donee private foundation (as defined in section
deduct certain additional amounts in the generally is required to file an informa- 509(a)), other than a private foundation
year of contribution or in subsequent tax- tion return (with a copy of such return described in section 170(b)(1)(E), that re-
able years based on a specified percentage to the donor) on or before the last day of ceives or accrues net income during a tax-
of the qualified donee income received the first full month following the close able year from any qualified intellectual
by the donee with respect to the qualified of the donee’s taxable year. See section property contribution (as defined in sec-
intellectual property. 7701(a)(23) for the definition of taxable tion 170(m)(8)) must make an annual in-
Section 882(c)(1) of the Act amended year. Transition rules are provided to take formation return on the form prescribed by
section 6050L to require donees to make into account these filing requirements be- the Internal Revenue Service. The infor-
an annual information return that reports fore a form is prescribed by the Internal mation return is required for any taxable
the qualified donee income for the taxable Revenue Service and for donees’ taxable year of the donee that includes any por-
year and other specified information relat- years ending prior to or on the date of tion of the 10-year period beginning on the
ing to qualified intellectual property con- issuance of these regulations. date of the contribution, but not for taxable
tributions. The Service expects to issue a years beginning after the expiration of the
new Form 8899 on which donees will re- Special Analyses legal life of the qualified intellectual prop-
port qualified donee income. erty.
It has been determined that these tem-
Under section 170(m)(8)(B), a donor (b) Information required to be provided
porary regulations are not a significant reg-
must notify the donee of the donor’s in- on return. The information return required
ulatory action as defined in Executive Or-
tent to treat a charitable contribution as by section 6050L and paragraph (a) of this
der 12866. Therefore, a regulatory assess-
a qualified intellectual property contribu- section shall include the following—
ment is not required. For the applicability
tion under sections 170(m) and 6050L. For (1) The name, address, taxable year,
of the Regulatory Flexibility Act (5 U.S.C.
rules relating to donor notification, see sec- and employer identification number of the
chapter 6) refer to the Special Analyses
tion 170(m)(8)(B) and Notice 2005–41, donee making the information return;
section of the preamble of the cross-refer-
2005–23 I.R.B. 1203, issued thereunder. (2) The name, address, and taxpayer
ence notice of proposed rulemaking pub-
Unless timely notice is provided, the donor identification number of the donor;
lished in this issue of the Bulletin. Pur-
has not made a qualified intellectual prop- (3) A description of the qualified intel-
suant to section 7805(f) of the Internal
erty contribution, and the donee has no re- lectual property in sufficient detail to iden-
Revenue Code, these regulations will be
porting obligation under section 6050L or tify the qualified intellectual property re-
submitted to the Chief Counsel for Advo-
these regulations. ceived by such donee;
cacy of the Small Business Administration
The donee is not required to make an (4) The date of the contribution to the
for comment on their impact on small busi-
information return if the qualified intellec- donee;
ness.
tual property produced no net income for (5) The amount of net income of the
the donee’s taxable year. Under section Drafting Information donee for the taxable year that is properly
170(m)(5) and (m)(6), income received or allocable to the qualified intellectual prop-
accrued during the donee’s taxable year The principal author of these regula- erty (determined without regard to para-
is not treated as allocated to qualified in- tions is Donnell M. Rini-Swyers, Office of graph (10)(B) of section 170(m) and with
tellectual property if such income is re- Associate Chief Counsel (Procedure and the modifications described in paragraphs
ceived or accrued after the 10-year period Administration). (5) and (6) of such section); and
beginning on the date of the contribution (6) Such other information as may be
*****
or after the expiration of the legal life of specified by the form or its instructions.
the qualified intellectual property. Thus, Amendments to the Regulations (c) Special rule—statement to be fur-
the donee is not required to make a re- nished to donors—(1) In general. Every
turn with regard to a qualified intellec- Accordingly, 26 CFR parts 1 and 602 donee making an information return under
tual property contribution for taxable years are amended as follows: section 6050L and this section with respect
beginning after the expiration of the le- to a qualified intellectual property contri-
gal life of such qualified intellectual prop- PART 1—INCOME TAXES bution shall furnish a copy of the infor-
erty. Additionally, section 6050L(b) re- mation return to the donor of the property.
Paragraph 1. The authority citation for
quires a return only for specified taxable The information return required by section
part 1 continues to read, in part, as follows:
years of the donee, which years are de- 6050L and this section shall be furnished
Authority: 26 U.S.C. 7805 * * *
fined in section 6050L(b)(2)(B) as any tax- to the donor on or before the date the donee
Par. 2. Section 1.6050L–2T is added to
able year any portion of which is part of is required to file the return with the Inter-
read as follows:
the 10-year period beginning on the date nal Revenue Service.
of contribution of the qualified intellectual §1.6050L–2T Information returns by (2) Before a form is prescribed by the
property. Therefore, the donee is not re- donees relating to qualified intellectual Internal Revenue Service. Before a form
quired to make a return for taxable years property contributions (temporary). is prescribed by the Internal Revenue Ser-
beginning more than 10 years after the date vice, every donee required to make an in-
of the qualified intellectual property con- (a) In general. Each donee organiza- formation return under section 6050L and
tribution. tion described in section 170(c), except a this section with respect to qualified in-

June 20, 2005 1284 2005–25 I.R.B.


tellectual property contributions shall fur- this section shall be filed with the Internal (e) Penalties. For penalties for failure
nish, in lieu of the prescribed form, a state- Revenue Service location listed on the pre- to comply with the requirements of this
ment to the donor that includes all informa- scribed form or in its instructions. section, see sections 6721 through 6724.
tion required by paragraphs (b)(1) through (2) Time for filing—(i) In general. A (f) Effective date. The rules of this sec-
(b)(5) of this section. This statement shall donee is required to file the return required tion apply to qualified intellectual property
be furnished to the donor on or before the by section 6050L and this section on or contributions made after June 3, 2004.
date the donee would have been required before the last day of the first full month
to file the return with the Internal Revenue following the close of the donee’s taxable PART 602—OMB CONTROL
Service under paragraph (d)(2)(i) of this year to which net income from the quali- NUMBERS UNDER THE PAPERWORK
section had a form been prescribed. fied intellectual property is properly allo- REDUCTION ACT
(3) Donee taxable years ending prior cable.
to or on the date of issuance of regula- (ii) Before a form is prescribed by the Par. 8. The authority citation for part
tions. If the donee’s taxable year to which Internal Revenue Service. If the informa- 602 continues to read as follows:
net income from the qualified intellectual tion return required by section 6050L and Authority: 26 U.S.C. 7805 * * *
property is properly allocable ends prior to this section is required to be filed before Par. 9. In §602.101, paragraph (b) is
or on May 23, 2005, the donee shall fur- a form is prescribed by the Internal Rev- amended by adding an entry to the table in
nish the information required under sec- enue Service, then an information return numerical order to read as follows:
tion 6050L and this section to the donor on for such taxable year shall be filed on or
or before August 22, 2005. before the last day of the second full month §602.101 OMB Control numbers.
(d) Place and time for filing information following the release of such prescribed
return—(1) Place for filing. The informa- form by the Internal Revenue Service. *****
tion return required by section 6050L and (b) * * *

CFR part or section where Current OMB


identified and described control No.
*****
1.6050L–2T ........................................................... 1545–1932
*****

Mark E. Matthews, Section 7701.—Definitions to have elected to be classified as associa-


Deputy Commissioner for tions taxable as corporations. These regu-
Services and Enforcement. 26 CFR 301.7701–3: Classification of certain busi- lations affect certain eligible entities filing
ness entities.
timely elections to be S corporations on or
Approved May 16, 2005. after July 20, 2004.
T.D. 9203
Eric Solomon, DATES: Effective Date: These regulations
Acting Deputy Assistant Secretary DEPARTMENT OF are effective July 20, 2004.
of the Treasury.
THE TREASURY
FOR FURTHER INFORMATION
(Filed by the Office of the Federal Register on May 20, 2005,
8:45 a.m., and published in the issue of the Federal Register
Internal Revenue Service CONTACT: Rebekah A. Myers,
for May 23, 2005, 70 F.R. 29450) 26 CFR Part 301 (202) 622–3050 (not a toll-free number).

Deemed Election To Be an SUPPLEMENTARY INFORMATION:


Association Taxable as a Background
Corporation for a Qualified
Electing S Corporation This document contains amendments to
26 CFR part 301. On July 20, 2004, tem-
AGENCY: Internal Revenue Service porary regulations (T.D. 9139, 2004–38
(IRS), Treasury. I.R.B. 495), relating to entity classifica-
tion elections for entities that elect to be S
ACTION: Final regulations and removal corporations under section 1362(a) were
of temporary regulations. published in the Federal Register (69 FR
43317). A notice of proposed rulemaking
SUMMARY: This document contains final (REG–131786–03, 2004–38 I.R.B. 500)
regulations that deem certain eligible enti- cross-referencing the temporary regula-
ties that file timely S corporation elections tions also was published in the Federal

2005–25 I.R.B. 1285 June 20, 2005


Register on July 20, 2004. No public to file a late S corporation election. How- Authority: 26 U.S.C. 7805 ***
hearing was requested or held. No writ- ever, Rev. Proc. 2004–48, 2004–32 I.R.B. Par. 2. Section 301.7701–3 is amended
ten or electronic comments responding to 172, provides relief for these entities in by revising paragraphs (c)(1)(v)(C) and
the notice of proposed rulemaking were some cases. (h)(3) to read as follows:
received. The proposed regulations are
adopted by this Treasury decision, and the Effective Dates §301.7701–3 Classification of certain
corresponding temporary regulations are business entities.
removed. These final regulations apply to elec-
Section 301.7701–3(a) provides that tions to be an S corporation filed on or af- *****
an eligible entity with two or more own- ter July 20, 2004. However, eligible enti- (c) ***
ers may elect to be classified as an as- ties that timely filed S elections before July (1) ***
sociation (and thus a corporation under 20, 2004, may also rely on the provisions (v) ***
§301.7701–2(b)(2)) or a partnership, and of the regulation. (C) S corporations. An eligible entity
an eligible entity with a single owner may that timely elects to be an S corpora-
Special Analysis tion under section 1362(a)(1) is treated
elect to be classified as an association or to
be disregarded as an entity separate from as having made an election under this
It has been determined that this Trea- section to be classified as an association,
its owner. Section 301.7701–3(b) provides sury decision is not a significant regula-
that, unless the entity elects otherwise, a provided that (as of the effective date
tory action as defined in Executive Order of the election under section 1362(a)(1))
domestic eligible entity is a partnership if 12866. Therefore a regulatory assessment
it has two or more owners or is disregarded the entity meets all other requirements
is not required. It has also been deter- to qualify as a small business corpora-
as an entity separate from its owner if it mined that section 553(b) of the Admin-
has a single owner. Section 301.7701–3(c) tion under section 1361(b). Subject to
istrative Procedure Act (5 U.S.C. chapter §301.7701–3(c)(1)(iv), the deemed elec-
describes the time and place for filing 5) does not apply to these regulations, and
an entity classification election. Section tion to be classified as an association will
because the regulations do not impose a apply as of the effective date of the S cor-
301.7701–3(c)(1)(i) provides that an eli- collection of information on small entities,
gible entity may elect to be classified as poration election and will remain in effect
the Regulatory Flexibility Act (5 U.S.C. until the entity makes a valid election, un-
other than its default classification or to chapter 6) does not apply. Pursuant to sec-
change its classification by filing Form der §301.7701–3(c)(1)(i), to be classified
tion 7805(f) of the Internal Revenue Code, as other than an association.
8832, “Entity Classification Election”, the notice of proposed rulemaking that pre-
with the service center designated on the ceded these regulations was submitted to *****
form. the Chief Counsel for Advocacy of the (h)***
A taxpayer whose default classification Small Business Administration for com- (3) Deemed elections for S corpora-
is a partnership or a disregarded entity ment on its impact on small business. tions. Paragraph (c)(1)(v)(C) of this sec-
may seek to be classified as an S corpo- tion applies to timely S corporation elec-
ration. For S elections that were filed Drafting Information tions under section 1362(a) filed on or after
prior to the effective date of these regu- July 20, 2004. Eligible entities that filed
lations, the taxpayer was required to elect The principal author of this regulation timely S elections before July 20, 2004,
to be classified as an association under is Rebekah A. Myers, Office of Associate may also rely on the provisions of the reg-
§301.7701–3(c)(1)(i) by filing Form 8832 Chief Counsel (Passthroughs and Special ulation.
and to elect to be an S corporation un- Industries). However, other personnel
der section 1362(a) by filing Form 2553, from the IRS and Treasury Department §301.7701–3T [Removed].
“Election by a Small Business Corpora- participated in their development.
tion.” These regulations simplify these pa- Par. 3. Section 301.7701–3T is re-
perwork requirements by eliminating, in ***** moved.
certain cases, the requirement that the en-
Adoption of Amendments to the Mark E. Matthews,
tity elect to be classified as an associa-
Regulations Deputy Commissioner for
tion. Instead, an eligible entity that makes
Services and Enforcement.
a timely and valid election to be classified Accordingly, 26 CFR part 301 is
as an S corporation will be deemed to have amended as follows: Approved May 12, 2005.
elected to be classified as an association
taxable as a corporation. PART 301—PROCEDURE AND Eric Solomon,
If the S election and the entity classi- ADMINISTRATION Acting Deputy Assistant Secretary
fication election are filed late, the entity for Tax Policy.
may need to submit a ruling request under Paragraph 1. The authority citation for
(Filed by the Office of the Federal Register on May 20, 2005,
§301.9100–3 to file a late entity classifica- part 301 continues to read, in part, as fol- 8:45 a.m., and published in the issue of the Federal Register
tion election and under section 1362(b)(5) lows: for May 23, 2005, 70 F.R. 29452)

June 20, 2005 1286 2005–25 I.R.B.


Part III. Administrative, Procedural, and Miscellaneous
Charitable Contributions of cash or fair market value of the property from the gross proceeds limitation and
Certain Motor Vehicles, Boats, transferred over the fair market value of certain certification requirements sales by
and Airplanes the goods or services the organization pro- the donee organization that are in direct
vides in return. See also United States furtherance of the organization’s charita-
Notice 2005–44 v. American Bar Endowment, 477 U.S. ble purpose. Section 170(f)(12)(F) also
105, 117–118 (1986); Rev. Rul. 67–246, provides that the Secretary shall prescribe
SECTION 1. PURPOSE 1967–2 C.B. 104. such regulations or other guidance as may
Section 170(f)(12)(A)(i) provides that be necessary to carry out the purposes of
This notice provides interim guidance no deduction is allowed under § 170(a) § 170(f)(12).
regarding section 884 of the American for a contribution of a qualified vehi-
Jobs Creation Act of 2004, Pub. L. No. cle the claimed value of which is more SECTION 3. DEDUCTIONS IN
108–357, 118 Stat. 1418 (2004), which than $500 unless the donor substantiates EXCESS OF $500
adds §§ 170(f)(12) and 6720 to the In- the contribution by a contemporaneous
ternal Revenue Code. Section 170(f)(12) written acknowledgment that meets the 3.01 General rule
contains rules for determining the amount requirements of § 170(f)(12)(B). Section If the claimed value of a donated qual-
that a donor may deduct for a charitable 170(f)(12)(A)(i) also provides that the ified vehicle exceeds $500, the amount
contribution of a qualified vehicle the substantiation rules of § 170(f)(8) do not of the deduction may be limited under
claimed value of which is more than $500, apply to a contribution of a qualified ve- § 170(f)(12), depending on the use of the
and related substantiation and information hicle the claimed value of which is more qualified vehicle by the donee organiza-
reporting requirements. Section 6720 im- than $500. tion (as described in section 3.02 of this
poses penalties on a donee organization In general, to meet the requirements notice). In addition, under § 170(f)(12)
that receives a contribution of a quali- of § 170(f)(12)(B), the acknowledgment the donor must obtain from the donee or-
fied vehicle subject to § 170(f)(12) and must include: the name and taxpayer iden- ganization an acknowledgment that meets
knowingly furnishes a false or fraudulent tification number of the donor; the vehi- the requirements of section 3.03 of this
acknowledgment of the contribution to cle identification number; and certain cer- notice, and include the acknowledgment
the donor, or knowingly fails to furnish tifications, depending on the use or dispo- with the tax return on which the deduction
the acknowledgment. Sections 170(f)(12) sition of the vehicle by the donee organi- is claimed.
and 6720 apply to contributions made af- zation. See section 3.03 of this notice for
ter December 31, 2004. This notice also all of the requirements applicable to ac- 3.02 Disposition or use by donee
invites comments from the public regard- knowledgments. To be considered con- organization
ing this notice and suggestions for future temporaneous, the acknowledgment must
guidance under §§ 170(f)(12) and 6720. be obtained within 30 days of the contri- (1) Qualified vehicle sold by donee
The rules provided in this notice apply bution or the disposition of the vehicle by organization
until regulations are effective. the donee organization, as applicable. See
§ 170(f)(12)(C) and section 3.03 of this no- If the qualified vehicle is sold by the
SECTION 2. BACKGROUND tice. A copy of the acknowledgment must donee organization without a significant
be included with the donor’s tax return on intervening use or material improvement
Section 170(a) allows as a deduction,
which the deduction is claimed. Section by the donee organization, then (except as
subject to certain limitations, any charita-
170(f)(12)(E) defines a qualified vehicle provided in section 3.02(3) of this notice)
ble contribution (as defined in § 170(c)),
as any (i) motor vehicle manufactured pri- the deduction claimed by the donor may
payment of which is made within the tax-
marily for use on public streets, roads, and not exceed the gross proceeds received
able year. Section 1.170A–1(c)(1) of the
highways, (ii) boat, or (iii) airplane, but from the sale of the qualified vehicle. In
Income Tax Regulations provides that if a
the term does not include any property de- no event may the deduction for a donated
charitable contribution is made in property
scribed in § 1221(a)(1) (e.g., property held vehicle exceed the amount that is other-
other than money, the amount of the contri-
primarily for sale to customers). wise allowable under § 170(a) (fair market
bution is the fair market value of the prop-
If a donee organization sells a qualified value). The donor must obtain from the
erty at the time of the contribution, reduced
vehicle without any significant intervening donee organization an acknowledgment
as provided in § 170(e) and §§ 1.170A–4
use or material improvement by the donee that meets the requirements of section 3.03
and 1.170A–4A.
organization, the deduction allowed under of this notice.
In general, § 1.170A–1(h) provides that
if a taxpayer transfers to a charitable or- § 170(a) may not exceed the gross pro-
(2) Significant intervening use of or
ganization cash or property that is partly a ceeds received from the sale, which must
material improvement to a qualified
charitable contribution and partly in con- be reported on the acknowledgment. See
vehicle
sideration for goods or services, the tax- § 170(f)(12)(A)(ii). Section 170(f)(12)(F)
payer is allowed a charitable contribution provides that the Secretary may prescribe If the donee organization makes a sig-
deduction for the excess, if any, of the regulations or other guidance that exempts nificant intervening use of (within the

2005–25 I.R.B. 1287 June 20, 2005


meaning of section 7.01(1) of this notice) All acknowledgments under § 170(f)(12) tended significant intervening use by the
or material improvement to (within the must include the name and taxpayer iden- donee organization and the intended dura-
meaning of section 7.01(2) of this notice) tification number of the donor, the vehicle tion of the use, or b) the intended material
a qualified vehicle, the donor is not sub- identification number, and the date of the improvement by the donee organization;
ject to the gross proceeds limitation in contribution. Additional information is re- and 2) a certification that the qualified ve-
section 3.02(1) of this notice. However, quired depending on the use of the qual- hicle will not be sold before completion of
the deduction claimed by the donor may ified vehicle by the donee organization, the use or improvement. The acknowledg-
not exceed the fair market value of the as described in sections 3.03(2) through ment is considered contemporaneous if the
qualified vehicle. The donor must obtain 3.03(4) of this notice. donee organization furnishes the acknowl-
from the donee organization an acknowl- edgment to the donor within 30 days of the
edgment that meets the requirements of (2) Qualified vehicle sold by donee date of the contribution.
section 3.03 of this notice. In addition, organization Example 2. On October 1, 2005, B contributes
the donor must substantiate the fair mar- a qualified vehicle to O, an organization that is de-
For a contribution of a qualified vehi- scribed in § 170(c). O intends to use the vehicle in
ket value as described in section 5 of this its charitable activities, and the intended use is a sig-
cle that is sold by the donee organization
notice. nificant intervening use within the meaning of sec-
without any significant intervening use or
tion 7.01(1) of this notice. On or before October 31,
(3) Qualified vehicle sold at a price material improvement by the donee or- 2005, O provides an acknowledgment to B containing
significantly below fair market value ganization in a sale that is not described B’s name and taxpayer identification number, the ve-
(or gratuitously transferred) to needy in section 3.02(3) of this notice, the ac- hicle identification number, a statement that the date
knowledgment also must contain the date of the contribution was October 1, 2005, a certifica-
individual in direct furtherance of donee tion stating that O intends to make a significant in-
organization’s charitable purpose the qualified vehicle was sold, a certifica-
tervening use of the qualified vehicle and stating the
tion that the qualified vehicle was sold in duration of this use, a detailed description of the sig-
Pursuant to § 170(f)(12)(F), the Inter- an arm’s length transaction between unre- nificant intervening use, and a certification that the
nal Revenue Service and the Treasury De- lated parties, a statement of the gross pro- qualified vehicle will not be transferred in exchange
partment hereby provide that the gross pro- ceeds from the sale, and a statement that for money, other property, or services before comple-
the deductible amount may not exceed the tion of the use by O. The acknowledgment meets the
ceeds limitation in section 3.02(1) does
requirements of § 170(f)(12).
not apply to a sale on or after January 1, amount of the gross proceeds. The ac-
2005, of a qualified vehicle to a needy in- knowledgment is considered contempora-
(4) Qualified vehicle sold at a price
dividual at a price significantly below fair neous if the donee organization furnishes
significantly below fair market value
market value, or a gratuitous transfer to a the acknowledgment to the donor no later
(or gratuitously transferred) to needy
needy individual, in direct furtherance of than 30 days after the date of the sale.
individual in direct furtherance of donee
a charitable purpose of the donee organi- Example 1. On October 1, 2005, A contributes a
qualified vehicle with a fair market value of $1,300 to organization’s charitable purpose
zation of relieving the poor and distressed
O, an organization that is described in § 170(c). On
or the underprivileged who are in need of December 1, 2005, the qualified vehicle is sold with- For a contribution of a qualified vehi-
a means of transportation. See H.R. Conf. out any significant intervening use or material im- cle that meets the requirements of section
Rep. No. 755, 108th Cong., 2d Sess. 750 provement in a sale not described in section 3.02(3) of
3.02(3) of this notice, the acknowledgment
(2004). Mere application of the proceeds this notice. Gross proceeds from the sale are $1,000.
On or before December 31, 2005, O provides an ac-
also must contain a certification that the
from the sale of a qualified vehicle to a donee organization will sell the qualified
knowledgment to A containing A’s name and tax-
needy individual to any charitable purpose payer identification number, the vehicle identifica- vehicle to a needy individual at a price
does not directly further a donee organiza- tion number, a statement that the date of the contribu- significantly below fair market value (or,
tion’s charitable purpose within the mean- tion was October 1, 2005, a statement that the date of
if applicable, that the donee organization
ing of this section. The donor must obtain the sale was December 1, 2005, a certification that the
qualified vehicle was sold in an arm’s length trans-
gratuitously will transfer the qualified ve-
from the donee organization an acknowl- hicle to a needy individual) and that the
action between unrelated parties, a statement that the
edgment that meets the requirements of gross proceeds of the sale are $1,000, and a statement sale (or transfer) will be in direct further-
section 3.03 of this notice. In addition, that the amount of A’s deduction may not exceed the ance of the donee organization’s charita-
the donor must substantiate the fair mar- amount of the gross proceeds. The acknowledgment
ble purpose of relieving the poor and dis-
ket value as described in section 5 of this meets the requirements of § 170(f)(12).
tressed or the underprivileged who are in
notice. need of a means of transportation. The ac-
(3) Significant intervening use of or
material improvement to a qualified knowledgment is considered contempora-
3.03 Contemporaneous written
vehicle neous if the donee organization furnishes
acknowledgment under § 170(f)(12)
the acknowledgment to the donor no later
(1) General rule For a contribution of a qualified vehi- than 30 days after the date of the contribu-
cle for which the donee organization in- tion.
Under § 170(f)(12), a donor must ob- tends a significant intervening use or ma- Example 3. On October 1, 2005, C contributes
a qualified vehicle to O, an organization that is de-
tain a contemporaneous written acknowl- terial improvement within the meaning of
scribed in § 170(c). O’s charitable purposes include
edgment from the donee organization, and section 7.01 of this notice, the acknowl- helping needy individuals who are unemployed de-
include the acknowledgment with the tax edgment also must contain: 1) a certifica- velop new job skills, finding job placements for these
return on which the deduction is claimed. tion and detailed description of a) the in- individuals, and providing transportation for these in-

June 20, 2005 1288 2005–25 I.R.B.


dividuals who need a means of transportation to jobs described in section 3.02(3) of this notice, similar options or accessories, and with the
in areas not served by public transportation. O deter- without any significant intervening use or same or substantially similar warranties or
mines that, in direct furtherance of its charitable pur- material improvement by the donee organ- guarantees, as the vehicle in question. See,
pose, O will sell the qualified vehicle at a price signif-
icantly below fair market value to a trainee who needs
ization, and the sale yields gross proceeds e.g., Rev. Rul. 2002–67, 2002–2 C.B. 873.
a means of transportation to a new workplace. On or of $500 or less, the donor may be allowed The Service and the Treasury Depart-
before October 31, 2005, O provides an acknowledg- a deduction equal to the lesser of the fair ment intend to issue regulations under
ment to C containing C’s name and taxpayer identi- market value of the qualified vehicle on § 170 clarifying that for purposes of § 170,
fication number, the vehicle identification number, a the date of the contribution or $500, sub- the dealer retail value listed in a used vehi-
statement that the date of the contribution was Octo-
ber 1, 2005, a certification that O will sell the qual-
ject to the terms and limitations of § 170. cle pricing guide for a particular vehicle is
ified vehicle to a needy individual at a price signifi- Under these circumstances, the donor must not an acceptable measure of fair market
cantly below fair market value, and a certification that substantiate the fair market value (see sec- value of a similar vehicle. The regulations
the sale is in direct furtherance of O’s charitable pur- tion 5 of this notice), and, if the fair market will clarify that, for purposes of § 170,
pose as described above. The acknowledgment meets value is $250 or more, must substantiate an acceptable measure of the fair market
the requirements of § 170(f)(12).
the contribution with an acknowledgment value of a vehicle, for contributions made
SECTION 4. DEDUCTIONS OF $500 that meets the requirements of § 170(f)(8). after June 3, 2005, and before the date reg-
Example 4. D, an individual who itemizes tax de- ulations become effective, is an amount
OR LESS ductions, contributes a qualified vehicle to O, an or- not in excess of the price listed in a used
ganization that is described in § 170(c). The qualified
4.01 Contemporaneous written vehicle is sold without any significant intervening use
vehicle pricing guide for a private party
acknowledgment required to substantiate or material improvement by O, and gross proceeds of sale of a similar vehicle. The regulations
a qualified vehicle contribution of $250 $400 are received. In accordance with section 5 of limiting the fair market value of a vehicle
this notice, D determined that the fair market value to an amount not in excess of the private
but not more than $500
of the qualified vehicle at the time of the contribu- party sale price will apply to contributions
tion was $800. Provided that D timely obtains a writ-
A contribution of a qualified vehicle ten acknowledgment that meets the requirements of
of vehicles made after June 3, 2005. In
with a claimed value of at least $250 (as § 170(f)(8) (see section 4.01 of this notice), and sub- addition, the Service and the Treasury
determined in accordance with section 5 ject to the terms and limitations of § 170, D may be Department will consider whether other
of this notice) must be substantiated by allowed a deduction not to exceed $500. values, such as the dealer trade-in value,
Example 5. The facts are the same as in Exam- are appropriate measures of the fair market
a contemporaneous written acknowledg- ple 4, except that in accordance with section 5 of
ment of the contribution by the donee or- this notice D determined that the fair market value
value of a vehicle for purposes of § 170.
ganization. For a qualified vehicle with a of the qualified vehicle at the time of the contribu- Any regulations limiting the fair market
claimed value of at least $250 but not more tion was $450. Provided that D timely obtains a writ- value of a vehicle to an amount less than
than $500, the acknowledgment must con- ten acknowledgment that meets the requirements of the private party sale value will not apply
§ 170(f)(8) (see section 4.01 of this notice), and sub- to contributions made prior to the date that
tain the following information as required ject to the terms and limitations of § 170, D may be
by § 170(f)(8): the amount of cash and a allowed a deduction not to exceed $450.
regulations to that effect become effective.
description (but not value) of any property
other than cash contributed; whether the SECTION 5. FAIR MARKET VALUE SECTION 6. QUALIFIED APPRAISAL
donee organization provided any goods or
A donor claiming a deduction for the A qualified appraisal is required for a
services in consideration, in whole or in
fair market value of a qualified vehicle deduction in excess of $5,000 for a qual-
part, for the cash or property contributed;
must be able to substantiate the fair market ified vehicle if the deduction is not lim-
and a description and good faith estimate
value. Section 1.170A–1(c)(2) provides ited to gross proceeds from the sale of the
of the value of any goods or services pro-
that fair market value is the price at which vehicle. See § 170(f)(11)(A)(ii)(I). For
vided by the donee organization in con-
the property would change hands between the definition of qualified appraisal, see
sideration for the contribution, or, if such
a willing buyer and a willing seller, neither § 1.170A–13.
goods or services consist solely of intan-
gible religious benefits, a statement to that being under any compulsion to buy or sell
SECTION 7. ACKNOWLEDGMENTS
effect. To meet the contemporaneous re- and each having reasonable knowledge of
BY DONEE ORGANIZATIONS
quirement of § 170(f)(8)(C), the acknowl- relevant facts.
edgment must be obtained by the donor on A reasonable method of determining 7.01 Requirements of significant
or before the earlier of the date on which the fair market value of a qualified vehicle intervening use; material improvement;
the donor files a return for the taxable year is by reference to an established used ve- sale or gratuitous transfer to needy
in which the contribution was made, or the hicle pricing guide. Many factors must be individual in direct furtherance of donee
due date (including extensions) of that re- taken into account when using a used vehi- organization’s charitable purpose
turn. cle pricing guide to determine fair market
value. A used vehicle pricing guide estab- As described in section 3.03 of this no-
4.02 Sale of qualified vehicle yields gross lishes the fair market value of a particular tice, the contents of the acknowledgment
proceeds of $500 or less vehicle only if the guide lists a sales price required under § 170(f)(12) depend upon
for a vehicle that is the same make, model, whether the donee organization sells a
If a donor contributes a qualified vehi- and year, sold in the same area, in the same qualified vehicle without any significant
cle that is subsequently sold, in a sale not condition, with the same or substantially intervening use or material improvement,

2005–25 I.R.B. 1289 June 20, 2005


intends to make a significant interven- (2) Material improvement 7.03 Penalties for false or fraudulent
ing use of or material improvement to a acknowledgments and for knowing failure
qualified vehicle prior to sale, or, in di- Material improvement includes a major to furnish proper acknowledgment
rect furtherance of a charitable purpose of repair or improvement that improves the
the organization of relieving the poor and condition of the qualified vehicle in a man- Section 6720 imposes penalties on
distressed or the underprivileged who are ner that significantly increases the value. any donee organization required under
in need of a means of transportation, in- Cleaning, minor repairs, and routine main- § 170(f)(12)(A) to furnish an acknowledg-
tends to sell a qualified vehicle to a needy tenance are not considered material im- ment to a donor that knowingly furnishes
individual at a price significantly below provements. See H.R. Conf. Rep. No. a false or fraudulent acknowledgment, or
fair market value, or gratuitously transfer 755, 108th Cong., 2d Sess. 751 (2004). knowingly fails to furnish an acknowl-
a qualified vehicle to a needy individ- To be a material improvement of a quali- edgment in the manner, at the time, and
ual. This section provides rules for donee fied vehicle, the improvement may not be showing the information required under
organizations to use in determining the funded by an additional payment to the § 170(f)(12) or regulations thereunder.
contents of the acknowledgments required donee organization from the donor of the An acknowledgment containing a certi-
under § 170(f)(12). qualified vehicle. fication described in section 3.03(3) or
For purposes of § 170(f)(12), services (4) of this notice shall be presumed to be
(1) Significant intervening use that are not considered material improve- false or fraudulent, and therefore subject
ments include: 1) application of paint to a penalty under § 6720, if the qualified
To constitute a significant intervening or other types of finishes (such as rust- vehicle is sold to a buyer, other than a
use, a donee organization must actually use proofing or wax); 2) removal of dents and needy individual as described in section
the qualified vehicle to substantially fur- scratches; 3) cleaning or repair of uphol- 7.01(3) of this notice, without a significant
ther the organization’s regularly conducted stery; and 4) installation of theft deterrent intervening use or material improvement
activities, and the use must be significant. devices. within six months of the date of the con-
Incidental use by an organization is not a tribution. The penalty applicable to an
significant intervening use. Whether a use (3) Sale or gratuitous transfer to needy acknowledgment relating to a qualified
is a significant intervening use depends on individual in direct furtherance of donee vehicle described in section 3.02(1) of
its nature, extent, frequency, and duration. organization’s charitable purpose this notice is the greater of (1) the prod-
See H.R. Conf. Rep. No. 755, 108th uct of the highest rate of tax specified in
Cong., 2d Sess. 750–751 (2004). For this As provided in section 3.02(3) of this
§ 1 (currently 35%) and the sales price
purpose, use by the donee organization in- notice, the gross proceeds limitation does
stated on the acknowledgment, or (2) the
cludes use of the qualified vehicle to pro- not apply to a sale of a qualified vehicle at a
gross proceeds from the sale of the qual-
vide transportation on a regular basis for a price significantly below fair market value
ified vehicle. The penalty applicable to
significant period of time or significant use (as described in section 5 of this notice), or
an acknowledgment relating to any other
directly related to instruction in vehicle re- a gratuitous transfer of a qualified vehicle,
qualified vehicle the claimed value of
pair. However, use by the donee organiza- to a needy individual if supplying a vehicle
which is more than $500 is the greater of
tion does not include use of the qualified to a needy individual is in direct further-
(1) the product of the highest rate of tax
vehicle to provide training in general busi- ance of a charitable purpose of the donee
specified in § 1 and the claimed value of
ness skills, such as marketing and sales. organization of relieving the poor and dis-
the qualified vehicle, or (2) $5,000.
Example 6. E contributes a qualified vehicle to O, tressed or the underprivileged who are in Example 9. O, an organization that is described
an organization that is described in § 170(c). As part need of a means of transportation. in § 170(c), receives a contribution of a qualified ve-
of its regularly conducted activities, O delivers meals hicle that is a subcompact car that has been driven
to needy individuals. O uses the qualified vehicle 7.02 Information reporting by donee more than 100,000 miles. The substance of O’s chari-
only a few times to deliver meals and then sells the organizations table activities involves regularly delivering food and
qualified vehicle. Because O’s use is infrequent and other needed goods to the rural poor at remote loca-
incidental, there is no significant intervening use. tions. For this purpose, O needs three large vehicles
Section 170(f)(12)(D) requires a donee
Example 7. The facts are the same as in Exam- suitable for delivering heavy loads across rugged ter-
ple 6, except that O uses the qualified vehicle to de- organization to provide to the Secre-
rain. Among many contributed qualified vehicles, O
liver meals every day for one year. Because O’s use is tary the information given to the donor has identified three suitable vehicles that O intends to
significant and substantially furthers a regularly con- in the acknowledgment required under use for this purpose. The subcompact car is not suit-
ducted activity of O, there is a significant intervening § 170(f)(12). The time and manner rules able for O’s use. O provides an acknowledgment to
use. the donor of the subcompact car in which O know-
for information reporting required under
Example 8. The facts are the same as in Exam- ingly makes a false certification of the intended use
ple 6, except that O does not use the qualified vehicle § 170(f)(12)(D) will be addressed in sep-
of the qualified vehicle and the duration of such in-
to deliver meals every day. However, O drives the arate guidance. See section 3.03 of this tended use. The donor of the qualified vehicle claims
qualified vehicle a total of 10,000 miles over a 1-year notice for guidance on the content of the a deduction of $2,300. O is subject to a penalty un-
period while delivering meals. Because O’s use is acknowledgment. der § 6720 for knowingly furnishing a false or fraud-
significant and substantially furthers a regularly con- ulent acknowledgment to the donor. The amount of
ducted activity of O, there is a significant intervening the penalty is $5,000, because that amount is greater
use. than $805, the product of the claimed value ($2,300)
and 35%.
Example 10. O, an organization that is described
in § 170(c), receives a contribution of a qualified ve-

June 20, 2005 1290 2005–25 I.R.B.


hicle. The qualified vehicle is sold without any sig- 8.02 Extension of time to obtain market value of vehicles for purposes of
nificant intervening use or material improvement by acknowledgments under § 170(f)(12) § 170, and for determining whether a sale
O. Gross proceeds from the sale are $300. O pro- for contributions made on or before was at a price significantly below fair mar-
vides an acknowledgment to the donor in which O
knowingly includes a false or fraudulent statement
September 1, 2005 ket value for purposes of sections 3.02(3)
that the gross proceeds from the sale of the vehi- and 7.01(3) of this notice. Commenta-
cle were $1,000. O is subject to a penalty under Pursuant to § 170(f)(12)(F), the Ser- tors already have suggested that the most
§ 6720 for knowingly furnishing a false or fraudu- vice and the Treasury Department have appropriate market for measuring the fair
lent acknowledgment to the donor. The amount of the determined that it is appropriate to pro- market value of vehicles is the market ei-
penalty is $350, the product of the sales price stated vide donors an extension of time to obtain
in the acknowledgment ($1,000) and 35%, because
ther for private party sales or for dealer
the contemporaneous written acknowledg- trade-in transactions. Comments should
that amount is greater than the gross proceeds from
the sale of the vehicle ($300). ment required by § 170(f)(12)(A). There- address the factors that distinguish private
fore, for contributions made on or before party sales and dealer trade-in transactions,
7.04 Sections 170(f)(12)(D) and 6720 September 1, 2005, a written acknowl- and which type of transaction is most sim-
inapplicable if donor claims deduction of edgment will be considered contempora- ilar to a charitable contribution. As dis-
$500 or less neous for purposes of § 170(f)(12)(C) if cussed in section 5 of this notice, any reg-
it is obtained within the time specified in ulations limiting the fair market value of
For contributions within the scope of § 170(f)(12)(C) or, if later, on or before a qualified vehicle for purposes of § 170
the rules described in section 4 of this no- October 1, 2005. will not require use of a value less than the
tice (regarding deductions of $500 or less),
private party sale value for contributions
§§ 170(f)(12)(D) and 6720 do not apply. 8.03 Form of acknowledgment
made before the date the regulations be-
SECTION 8. EFFECTIVE DATE AND A donee organization may provide an come effective, but may require use of a
INTERIM GUIDANCE FOR DONORS acknowledgment to a donor containing the value less than the private party sale value
AND DONEE ORGANIZATIONS information required under § 170(f)(12) after that date. Comments should refer
in any reasonable manner. The Service to Notice 2005–44 and be submitted by
8.01 Effective date and transition rules and the Treasury Department will be pro- September 1, 2005, to:
viding Form 1098–C for reporting to the
This notice generally is effective for Internal Revenue Service
Service the information required to be re-
contributions made on or after January P.O. Box 7604
ported under § 170(f)(12)(D). A copy of
1, 2005. However, the following tran- Ben Franklin Station
Form 1098–C may be used by a donee or-
sition rules are provided. A contempo- Washington, D.C. 20044
ganization to provide a contemporaneous
raneous written acknowledgment that is Attn: CC:PA:LPD:PR
written acknowledgment to a donor pur-
obtained on or before July 3, 2005, will Room 5203
suant to § 170(f)(12).
be treated as satisfying the requirements
of § 170(f)(12)(A) if the acknowledgment 8.04 Satisfaction of contemporaneous Alternatively, comments may be submit-
contains all of the information specified requirement for purposes of § 6720 ted electronically via e-mail to the follow-
in § 170(f)(12)(B), even if the acknowl- ing address: Notice.Comments@irscoun-
edgment does not include the date the Section 6720 imposes penalties on any sel.treas.gov. All comments will be avail-
qualified vehicle is sold (as required by donee organization that knowingly fails able for public inspection and copying.
section 3.03(2) of this notice), or a detailed to furnish an acknowledgment within the
description of the intended significant in- time required under § 170(f)(12) or the SECTION 10. PAPERWORK
tervening use or material improvement by regulations thereunder. See section 7.03 of REDUCTION ACT
the donee organization (as required by sec- this notice. A donee organization that pro-
The collections of information in this
tion 3.03(3) of this notice). In the case of vides a contemporaneous written acknowl-
notice have been reviewed and approved
contributions described in section 3.02(3) edgment that is treated as contemporane-
by the Office of Management and Bud-
of this notice regarding qualified vehicles ous under sections 8.01 and 8.02 of this no-
get (OMB) in accordance with the Paper-
sold at a price significantly below fair tice will be treated as having furnished the
work Reduction Act (44 U.S.C. 3507) un-
market value (or gratuitously transferred) acknowledgment within the time required
der control number 1545–1942.
to needy individuals, the requirement of under § 170(f)(12) for purposes of § 6720.
An agency may not conduct or sponsor,
section 3.03(4) of this notice that an ac-
SECTION 9. REQUEST FOR and a person is not required to respond
knowledgment contain the information
COMMENTS to, a collection of information unless the
described in that section is effective for
collection of information displays a valid
contributions made on or after January 1,
The Service and the Treasury Depart- OMB control number.
2005. For such contributions made on or
ment invite comments regarding this no- The collections of information in this
before September 1, 2005, the acknowl-
tice and suggestions for future guidance notice are in sections 3, 4, 7, and 8. The
edgment must be obtained by the donor on
under §§ 170(f)(12) and 6720. In particu- collections of information in sections 3,
or before October 1, 2005.
lar, comments are requested on which mar- 4, and 8 are required from donors to sat-
kets are appropriate for measuring the fair isfy the substantiation requirements of

2005–25 I.R.B. 1291 June 20, 2005


§ 170(f)(12). The collections of informa- 1 minute for donors and 5 hours for donee Accounting). For information regarding
tion are required from donors to obtain a organizations. The estimated number of whether a transfer is in direct further-
benefit. The likely respondents are indi- donors is 182,500 and the estimated num- ance of a donee organization’s charitable
vidual donors. ber of donee organizations is 4,300. purpose, contact Sean Barnett of the Tax
The collections of information in sec- The estimated annual frequency of re- Exempt and Government Entities Divi-
tions 3, 4, 7, and 8 are required from donee sponses (used for reporting requirements sion at (202) 283–8913. For information
organizations to satisfy the donee report- only) is annually. regarding penalties under § 6720, con-
ing requirements of § 170(f)(12) and avoid Books or records relating to a collection tact Donnell Rini-Swyers of the Office
the penalties in § 6720. The collections of of information must be retained as long of Associate Chief Counsel (Procedure
information are mandatory. The likely re- as their contents may become material in and Administration) at (202) 622–4910.
spondents are tax-exempt charitable orga- the administration of any internal revenue For information regarding information
nizations. law. Generally, tax returns and return in- reporting by a donee organization, contact
The estimated total annual reporting formation are confidential, as required by Mr. Barnett or Ms. Rini-Swyers. For
burden is 3,041 hours for donors and § 6103. further information regarding the remain-
21,500 hours for donee organizations. der of this notice, contact Ms. Zweibel at
The estimated annual burden per donor SECTION 11. DRAFTING (202) 622–5020 (not a toll-free call).
varies from 1 minute to 5 minutes. The INFORMATION
estimated annual burden per donee organi-
zation varies from 30 minutes to 16 hours, The principal author of this notice is
depending on individual circumstances. Patricia M. Zweibel of the Office of As-
The estimated average annual burdens are sociate Chief Counsel (Income Tax &

June 20, 2005 1292 2005–25 I.R.B.


Part IV. Items of General Interest
Notice of Proposed 2005. The public hearing will be held in the guideline single premium or the sum
Rulemaking and Notice of the IRS Auditorium (7th Floor), Internal of the guideline level premiums as of such
Public Hearing Revenue Building, 1111 Constitution Av- time. The guideline single premium is the
enue, NW, Washington, DC. premium that is needed at the time the pol-
icy is issued to fund the future benefits
Attained Age of the Insured FOR FURTHER INFORMATION under the contract based on the follow-
Under Section 7702 CONTACT: Concerning the regulations, ing three elements enumerated in section
Ann H. Logan, 202–622–3970. Concern- 7702(c)(3)(B):
REG–168892–03 ing submission of comments, the hearing, (i) Reasonable mortality charges that
or to be placed on the building access list meet the requirements (if any) prescribed
AGENCY: Internal Revenue Service to attend the hearing, LaNita Van Dyke of in regulations and that (except as provided
(IRS), Treasury. the Publication and Regulations Branch, in regulations) do not exceed the mortal-
202–622–7180 (not toll-free numbers). ity charges specified in the prevailing com-
ACTION: Notice of proposed rulemaking
missioners’ standard tables (as defined in
and notice of public hearing. SUPPLEMENTARY INFORMATION:
section 807(d)(5)) as of the time the con-
SUMMARY: This document contains pro- Background tract is issued;
posed regulations explaining how to deter- (ii) Any reasonable charges (other than
mine the attained age of an insured for pur- Section 7702(a) of the Internal Revenue mortality charges) that (on the basis of
poses of testing whether a contract qual- Code (Code) provides that, for a contract the company’s experience, if any, with re-
ifies as a life insurance contract for Fed- to qualify as a life insurance contract for spect to similar contracts) are reasonably
eral income tax purposes. This document Federal income tax purposes, the contract expected to be actually paid; and
also provides notice of a public hearing on must be a life insurance contract under the (iii) Interest at the greater of an annual
these proposed regulations. applicable law and must either (1) satisfy effective rate of six percent or the rate or
the cash value accumulation test of sec- rates guaranteed on issuance of the con-
DATES: Written or electronic comments tion 7702(b), or (2) both meet the guideline tract.
must be received by August 24, 2005. Re- premium requirements of section 7702(c) The guideline level premium is the
quests to speak and outlines of topics to be and fall within the cash value corridor of level annual amount, payable over a pe-
discussed at the public hearing scheduled section 7702(d). To determine whether riod not ending before the insured attains
for Wednesday, September 14, 2005, must a contract satisfies the cash value accu- age 95, computed on the same basis but
be received by August 24, 2005. mulation test, or meets the guideline pre- using a minimum interest rate of four
mium requirements and falls within the percent, rather than six percent. Like the
ADDRESSES: Send submissions to: cash value corridor, it is necessary to de- cash value accumulation test, the guide-
CC:PA:LPD:PR (REG–168892–03), room termine the attained age of the insured. line premium requirements are applied by
5203, Internal Revenue Service, POB A contract meets the cash value accu- deeming the maturity date of the contract
7604, Ben Franklin Station, Washing- mulation test of section 7702(b) if, by the to be no earlier than the day on which the
ton, DC 20044. Comments may be hand terms of the contract, the cash surrender insured attains age 95, and no later than
delivered Monday through Friday be- value of the contract may not at any time the day on which the insured attains age
tween the hours of 8 a.m. and 4 p.m. exceed the net single premium that would 100. The deemed maturity date generally
to CC:PA:LPD:PR (REG–168892–03), have to be paid at that time to fund future is the determination date set forth in the
Courier’s Desk, Internal Revenue Service, benefits under the contract. Under sec- contract or the end of the mortality table
1111 Constitution Avenue, NW, Washing- tion 7702(e)(1)(B), the maturity date of the (which, when section 7702 was enacted in
ton, DC, or submitted to the IRS web site at contract is deemed to be no earlier than the 1984, was age 100).
www.irs.gov/regs or via the Federal eRule- day on which the insured attains age 95, A contract falls within the cash value
making Portal at www.regulations.gov and no later than the day on which the in- corridor if the death benefit of the con-
(IRS-REG–168892–03). All comments sured attains age 100, for purposes of ap- tract at any time is not less than the ap-
will be available for public inspection and plying the cash value accumulation test. plicable percentage of the cash surrender
copying. Requests to speak, with outlines A contract meets the guideline premium value. The applicable percentage is deter-
of topics to be discussed, at the hearing requirements of section 7702(c) if the sum mined based on the attained age of the in-
scheduled for September 14, 2005, at 10 of the premiums paid under the contract sured as of the beginning of the contract
a.m., must be received by August 24, does not at any time exceed the greater of year, as follows:

2005–25 I.R.B. 1293 June 20, 2005


APPLICABLE PERCENTAGE
In the case of an insured with an attained age as of the beginning The applicable percentage shall decrease by a ratable portion
of the contract year of: for each full year:
More than: But not more than: From: To:
0 40 250 250
40 45 250 215
45 50 215 185
50 55 185 150
55 60 150 130
60 65 130 120
65 70 120 115
70 75 115 105
75 90 105 105
90 95 105 100

The Code does not define the attained plies with the guideline premium require- lations. Further, section 7702A(c)(6) pro-
age of the insured for purposes of apply- ments of section 7702(c), the cash value vides a specific computational rule that ap-
ing the cash value corridor, the guideline corridor of section 7702(d), and (by rea- plies to multiple life insurance contracts if
premium limitations, and the computa- son of the computational rules of section the death benefit under the contract is re-
tional rules of section 7702(e). The Senate 7702(e)) the cash value accumulation test duced.
Finance Committee explanation of the of section 7702(b) and the 7-pay test of Neither section 7702, section 7702A,
Deficit Reduction Act of 1984, Public section 7702A(b), as applicable. nor the legislative history of either provi-
Law 98–369 (98 Stat. 494), however, sion, addresses how an insured’s attained
states that the attained age of the insured Discussion age is determined for purposes of testing
means the insured’s age determined by a life insurance contract insuring multiple
Although most life insurance contracts
reference to contract anniversaries (rather lives under the cash value accumulation
insure the life of one person, some life
than the individual’s actual birthdays), so test of section 7702(b), the guideline pre-
insurance contracts insure multiple lives.
long as the age assumed under the contract mium requirements of section 7702(c), or
For example, a last-to-die life insurance
is within 12 months of the actual age. See the computational rules of section 7702(e).
contract (sometimes referred to as a sur-
S. Prt. No. 98–169, Vol. 1, at 576 (1984).
vivorship or second-to-die life insurance Explanation of Provision
Section 7702A defines a modified en-
contract) insures two or more lives and
dowment contract as a contract that meets
pays death benefits when the last insured This document contains proposed
the requirements of section 7702 (that is, a
dies. Such contracts are sometimes used in amendments to 26 CFR part 1 under
contract that is a life insurance contract),
connection with business continuation or section 7702. The proposed regulations
but that fails to meet the 7-pay test set
estate tax planning; the contracts typically provide guidance on how to determine the
forth in section 7702A(b). A contract fails
involve lower premiums than do contracts attained age of an insured individual under
to meet the 7-pay test if the accumulated
insuring a single life. a contract that is a life insurance contract
amount paid under the contract at any time
A first-to-die life insurance contract under the applicable law, for purposes of
during the first 7 contract years exceeds the
(sometimes referred to as a joint life in- testing whether the contract qualifies as a
sum of the net level premiums that would
surance contract) also insures two or more life insurance contract under section 7702
have been paid on or before that time if the
lives, but pays death benefits and termi- and is a MEC under section 7702A. Under
contract provided for paid-up future bene-
nates upon the death of the first insured. the proposed regulations, the attained age
fits after the payment of 7 level annual pre-
These contracts typically involve higher of the insured under a contract insuring
miums. Section 7702A(c)(1)(B) provides
risks and thus higher premiums than do the life of a single individual is either (i)
that, for purposes of this test, the compu-
contracts insuring a single life. First-to-die the insured’s age determined by reference
tational rules of section 7702(e) generally
life insurance contracts represent a small to the individual’s actual birthday as of
apply, including the contract’s deemed ma-
percentage of the multiple-life insurance the date of determination (actual age) or
turity no earlier than the day on which the
contracts that are issued. (ii) the insured’s age determined by refer-
insured attains age 95, and no later than the
Section 7702A, which defines the term ence to contract anniversary (rather than
day on which the insured attains age 100.
modified endowment contract (MEC), in- the individual’s actual birthday), so long
In sum, the attained age of an insured
corporates the computational rules of sec- as the age assumed under the contract
under a contract that is a life insurance con-
tion 7702, both in its initial determina- (contract age) is within 12 months of the
tract under the applicable law must be de-
tion of whether a contract is a life insur- actual age. The attained age of the insured
termined to test whether the contract com-
ance contract, and in its 7-pay test calcu- under a contract insuring multiple lives on

June 20, 2005 1294 2005–25 I.R.B.


a last-to-die basis is the attained age of the to the Chief Counsel for Advocacy of the Copies of the agenda will be available free
youngest insured. The attained age of the Small Business Administration for com- of charge at the hearing.
insured under a contract insuring multiple ment on their impact on small business.
lives on a first-to-die basis is the attained Drafting Information
age of the oldest insured. The Treasury Comments and Public Hearing
The principal author of these proposed
Department and the IRS understand that
Before these proposed regulations are regulations is Ann H. Logan, Office of
the approach of the proposed regulations
adopted as final regulations, considera- the Associate Chief Counsel (Financial In-
is consistent with the existing practice of
tion will be given to any written (a signed stitutions and Products), Office of Chief
many (but not all) issuers of both contracts
original and eight (8) copies) or electronic Counsel, Internal Revenue Service. How-
insuring a single life and contracts insuring
comments that are timely submitted to ever, personnel from other offices of the
multiple lives. In addition, by mandating
the IRS. In addition to comments on the IRS and the Treasury Department partic-
the use of a single, predictable age, the
proposed regulations more generally, the ipated in their development.
proposed regulations provide rules that are
IRS and Treasury Department specifically
straightforward for both issuers and the Adoption of Amendments to the
request comments on (i) the clarity of the
IRS to administer. Regulations
proposed regulations and how they can be
The proposed regulations generally
made easier to understand, (ii) the indus-
would be applicable for contracts issued Accordingly, 26 CFR part 1 is proposed
try’s existing practice for determining the
on or after the date that is one year af- to be amended as follows:
attained age to use under both last-to-die
ter the regulations are published as final
and first-to-die life insurance contracts, PART 1—INCOME TAXES
regulations in the Federal Register. This
(iii) the need for special rules for deter-
applicability date recognizes that some
mining the attained age of one or more Paragraph 1. The authority citation for
issuers will need time to conform their
insureds to calculate mortality charges un- part 1 is amended by adding entries in nu-
compliance system to the proposed stan-
der section 7702(c)(3)(B)(i), and (iv) the merical order to read as follows:
dard for the issuance of new contracts, to
effective date of the proposed regulations. Authority: 26 U.S.C. 7805 * * *
file policy forms with State authorities, or
All comments will be available for public Section 1.7702–3 also issued under 26
both. Taxpayers also would be permitted
inspection and copying. U.S.C. 7702(k). * * *
to apply the regulations retroactively for
A public hearing has been scheduled for Par. 2. Section 1.7702–0, proposed to
contracts issued before the date that is one
September 14, 2005, at 10 a.m., in the IRS be added at 56 FR 30720 and published on
year after the regulations are published
Auditorium (7th Floor), Internal Revenue July 15, 1991, and further proposed to be
as final regulations, provided they do
Building, 1111 Constitution Avenue, NW, amended at 57 FR 59321 and published on
not later determine qualification of those
Washington, DC. All visitors must present December 15, 1992, is further proposed to
contracts under section 7702 in a manner
a photo identification to enter the build- be revised to read as follows:
inconsistent with the regulations.
ing. Because of access restrictions, visitors
The proposed regulations defining the §1.7702–0 Table of contents.
must use the Constitution Avenue entrance
attained age for purposes of these provi-
and will not be admitted beyond the Inter-
sions are not intended to specify which This section lists the captions that
nal Revenue Building lobby more than 30
multiple-life actuarial methodologies are appear in §§1.7702–1, 1.7702–2, and
minutes before the hearing starts. For in-
appropriate to determine reasonable mor- 1.7702–3:
formation about having your name placed
tality charges under sections 7702 and
on the building access list to attend the §1.7702–1 Mortality charges.
7702A, or how any such methodology
hearing, see the “FOR FURTHER INFOR-
should be applied.
MATION CONTACT” section of this pre- (a) General rule.
Special Analyses amble. (b) Reasonable mortality charges.
The rules of 26 CFR 601.601(a)(3) ap- (1) Actually expected to be imposed.
It has been determined that this notice ply to the hearing. (2) Limit on charges.
of proposed rulemaking is not a significant Persons who wish to present oral com- (c) Safe harbors.
regulatory action as defined in Executive ments at the hearing must submit written (1) 1980 C.S.O. Basic Mortality Tables.
Order 12866. Therefore, a regulatory as- comments by August 24, 2005, and sub- (2) Unisex tables and smoker/non-
sessment is not required. It also has been mit an outline of the topics to be discussed smoker tables.
determined that section 553(b) of the Ad- and the time to be devoted to each topic (3) Certain contracts based on 1958
ministrative Procedure Act (5 U.S.C. chap- (a signed original and eight (8) copies) by C.S.O. table.
ter 5) does not apply to these regulations, that same date. (d) Definitions.
and because the regulations do not im- A period of 10 minutes will be allotted (1) Prevailing commissioners’ standard
pose a collection of information on small to each person(s) for making comments. tables.
entities, the Regulatory Flexibility Act (5 An agenda showing the scheduling of (2) Substandard risk.
U.S.C. chapter 6) does not apply. Pursuant the speakers will be prepared after the (3) Nonparticipating contract.
to section 7805(f) of the Code, the notice deadline for receiving outlines has passed. (4) Charge reduction mechanism.
of proposed rulemaking will be submitted (5) Plan of insurance.

2005–25 I.R.B. 1295 June 20, 2005


(e) Effective date. §1.7702–3 Attained age of the insured suring X’s life. January 1 is the contract anniversary
under a life insurance contract. date for all future years. Under the contract, X’s pre-
§1.7702–2 Definitions. miums are determined on an age-last-birthday basis.
(a) In general. This section provides X became 60 years old on May 1, 2007. Based on the
(a) In general. method used under the contract to determine age, X
guidance on determining the attained age
(b) Cash value. has an attained age of 60 for the first contract year, 61
of an insured under a contract that is a for the second contract year, and so on.
(1) In general. life insurance contract under the applica- (ii) Section 1.7702–3(b) provides that, if a con-
(2) Amounts excluded from cash value. ble law, for purposes of testing whether the tract insures the life of a single individual, the in-
(c) Death benefit. contract complies with the guideline pre- sured’s age may be determined by reference to con-
(1) In general. tract anniversary (rather than the individual’s actual
mium requirements of section 7702(c), the
(2) Qualified accelerated death benefit birthday), so long as the contract age is within 12
cash value corridor of section 7702(d), and months of the actual age. For each contract year, X’s
treated as death benefit. the computational rules of section 7702(e), contract age, determined on an age-last-birthday ba-
(d) Qualified accelerated death benefit. as applicable. sis, is within 12 months of X’s actual age. Accord-
(1) In general. (b) Contract insuring a single life. (1) ingly, provided it does so consistently from year to
(2) Determination of present value of year, IC may compute X’s attained age on an age-last-
If a contract insures the life of a single
the reduction in death benefit. birthday basis for purposes of testing whether a con-
individual, either of the following two ages tract complies with the guideline premium require-
(3) Examples. may be treated as the attained age of the ments of section 7702(c), the cash value corridor of
(e) Terminally ill defined. insured with respect to that contract— section 7702(d), and the computational rules of sec-
(f) Certain other additional benefits. (i) The insured’s age determined by ref- tion 7702(e), as applicable.
(1) In general. Example 2. (i) The facts are the same as in Ex-
erence to the individual’s actual birthday
(2) Examples. ample 1 except that, under the contract, X’s premi-
as of the date of determination (actual age); ums are determined on an age-nearest-birthday basis.
(g) Adjustments under section or X’s nearest birthday to January 1, 2008, is May 1,
7702(f)(7) (ii) The insured’s age determined by 2008, when X will become 61 years old. Based on
(h) Cash surrender value. reference to contract anniversary (rather the method used under the contract to determine age,
(1) In general. X has an attained age of 61 for the first contract year,
than the individual’s actual birthday), so
(2) For purposes of section 7702(f)(7). 62 for the second contract year, and so on.
long as the age assumed under the contract (ii) Section 1.7702–3(b) provides that, if a life in-
(i) Net surrender value. (contract age) is within 12 months of the surance contract insures the life of a single individ-
(j) Effective date and special rules. actual age. ual, the insured’s age may be determined by refer-
(1) In general. (2) Whichever attained age is used with ence to contract anniversary (rather than the individ-
(2) Provision of certain benefits before ual’s actual birthday), so long as the contract age is
respect to a contract must be used consis-
July 1, 1993. within 12 months of the actual age. For each contract
tently from year to year and consistently year, X’s contract age, determined on an age-near-
(i) Not treated as cash value. for purposes of sections 7702(c), 7702(d), est-birthday basis, is within 12 months of X’s actual
(ii) No effect on date of issuance. and 7702(e), as applicable. age. Accordingly, provided it does so consistently
(iii) Special rule for addition of benefit (c) Contract insuring multiple lives on from year to year, IC may compute X’s attained age
or loan provision after December 15, 1992. on an age-nearest-birthday basis for purposes of test-
a last-to-die basis. If a contract insures the
(3) Addition of qualified accelerated ing whether the contract complies with the guideline
lives of more than one individual on a last- premium requirements of section 7702(c), the cash
death benefit. to-die basis, the attained age of the insured value corridor of section 7702(d), and the computa-
(4) Addition of other additional bene- is determined by applying paragraph (b) of tional rules of section 7702(e), as applicable.
fits. this section as if the youngest individual Example 3. (i) The facts are the same as in Exam-
ple 1 except that in addition to X, the insurance con-
were the only insured under the contract.
§1.7702–3 Attained age of the insured tract also insures the life of Y. Y was born on Septem-
(d) Contract insuring multiple lives on ber 1, 1942. The death benefit will be paid when the
under a life insurance contract.
a first-to-die basis. If a contract insures the last of the two insureds dies.
(a) In general. lives of more than one individual on a first- (ii) Section 1.7702–3(c) provides that if a life in-
to-die basis, the attained age of the insured surance contract insures the lives of more than one
(b) Contract insuring a single life. individual on a last-to-die basis, the attained age of
(c) Contract insuring multiple lives on is determined by applying paragraph (b) of
the insured is determined by applying §1.7702–3(b)
a last-to-die basis. this section as if the oldest individual were as if the youngest individual were the only insured
(d) Contract insuring multiple lives on the only insured under the contract. under the contract. Because X is younger than Y, the
a first-to-die basis. (e) Examples. The following examples attained age of X must be used for purposes of test-
illustrate the determination of the attained ing whether the contract complies with the guideline
(e) Examples. premium requirements of section 7702(c), the cash
(f) Effective dates. age of the insured for purposes of testing
value corridor of section 7702(d), and the computa-
(1) In general. whether the contract complies with the tional rules of section 7702(e), as applicable. The at-
(2) Contracts issued before the general guideline premium requirements of sec- tained ages of X and Y are determined as set forth in
effective date. tion 7702(c), the cash value corridor of Example 1.
section 7702(d), and the computational Example 4. (i) The facts are the same as Example
Par. 3. Section 1.7702–3 is added to 1 except that in addition to X, the insurance contract
read as follows: rules of section 7702(e), as applicable.
also insures the life of Y. Y was born on September
The examples are as follows: 1, 1952. The death benefit will be paid when the first
Example 1. (i) X was born on May 1, 1947. On of the two insureds dies.
January 1, 2008, X purchases from IC a contract in-

June 20, 2005 1296 2005–25 I.R.B.


(ii) Section 1.7702–3(d) provides that if a life in- any other member of the affiliated group with copies to the Internal Revenue Ser-
surance contract insures the lives of more than one unless, to the extent provided in regula- vice, Attn: IRS Reports Clearance Officer,
individual on a first-to-die basis, the attained age of tions, such loss does not offset the income SE:W:CAR:MP:T:T:SP, Washington, DC
the insured is determined by applying §1.7702–3(b)
as if the oldest individual were the only insured under
of any foreign corporation. Similar rules 20224. Comments on the collection of
the contract. Because X is older than Y, the attained apply to losses of separate units of domes- information should be received by July
age of X must be used for purposes of testing whether tic corporations. The proposed regulations 25, 2005. Comments are specifically re-
the contract complies with the guideline premium re- address various dual consolidated loss is- quested concerning:
quirements of section 7702(c), the cash value corri- sues, including exceptions to the general Whether the proposed collection of in-
dor of section 7702(d), and the computational rules
of section 7702(e), as applicable. The attained ages
prohibition against using a dual consoli- formation is necessary for the proper per-
of X and Y are determined as set forth in Example 1. dated loss to reduce the taxable income of formance of the functions of the IRS, in-
(f) Effective dates—(1) In general. Ex- any other member of the affiliated group. cluding whether the information will have
cept as provided in paragraph (f)(2), these practical utility;
regulations are effective for contracts is- DATES: Written and electronic comments The accuracy of the estimated burden
sued on or after the date that is one year and outlines of topics to be discussed at the associated with the proposed collection of
after the regulations are published as final public hearing scheduled for September 7, information (see below);
regulations in the Federal Register. 2005, at 10:00 a.m., must be received by How the quality, utility, and clarity of
(2) Retroactive application. Pursuant to August 22, 2005. the information to be collected may be en-
section 7805(b)(7), a taxpayer may elect hanced;
ADDRESSES: Send submissions to How the burden of complying with the
to apply these regulations retroactively for
CC:PA:LPD:PR (REG–102144–04), proposed collection of information may be
contracts issued before the date that is one
room 5203, Internal Revenue Service, minimized, including through the appli-
year after the regulations are published as
P.O. Box 7604, Washington, DC 20044. cation of automated collection techniques
final regulations in the Federal Register,
Submissions may be hand delivered be- or other forms of information technology;
provided that the taxpayer does not later
tween the hours of 8 a.m. and 4 p.m. and
determine qualification of those contracts
to CC:PA:LPD:PR (REG–102144–04), Estimates of capital or start-up costs
in a manner that is inconsistent with these
Courier’s Desk, Internal Revenue Service, and costs of operation, maintenance, and
regulations.
1111 Constitution Avenue, NW, Wash- purchase of service to provide information.
Mark E. Matthews, ington, DC, or sent electronically via The collections of information
Deputy Commissioner for the IRS Internet site at www.irs.gov/regs in these proposed regulations are in
Services and Enforcement. or via the Federal eRulemaking Por- §§1.1503(d)–1(b)(14), 1.1503(d)–1(c)(1),
tal at www.regulations.gov/ (IRS and 1.1503(d)–2(d), 1.1503(d)–4(c)(2),
(Filed by the Office of the Federal Register on May 20, 2005, REG–102144–04). The public hearing 1.1503(d)–4(d), 1.1503(d)–4(e)(2),
8:45 a.m., and published in the issue of the Federal Register
for May 24, 2005, 70 F.R. 29671) will be held in the Auditorium of the Inter- 1.1503(d)–4(f)(2), 1.1503(d)–4(g),
nal Revenue Building, 1111 Constitution 1.1503(d)–4(h) and 1.1503(d)–4(i). The
Avenue, NW, Washington, DC. various information is required. First, it
notifies the IRS when the taxpayer asserts
Notice of Proposed FOR FURTHER INFORMATION
that it had reasonable cause for failing to
Rulemaking and Notice of CONTACT: Concerning the proposed
comply with certain filing requirements
Public Hearing regulations, Kathryn T. Holman, (202)
under the regulations. Second, it indi-
622–3840 (not a toll-free number); con-
cates when the taxpayer attempts to rebut
cerning submissions and the hearing,
Dual Consolidated Loss Robin Jones, (202) 622–3521 (not a
the amount of presumed tainted income.
Regulations Finally, it provides the IRS various in-
toll-free number).
formation regarding exceptions to the
REG–102144–04 SUPPLEMENTARY INFORMATION: domestic use limitation, including domes-
tic use elections, domestic use agreements,
AGENCY: Internal Revenue Service Paperwork Reduction Act triggering events and recapture.
(IRS), Treasury. The collection of information is in cer-
The collection of information contained tain cases required and in certain cases
ACTION: Notice of proposed rulemaking in this notice of proposed rulemaking has voluntary. The likely respondents will be
and notice of public hearing. been submitted to the Office of Manage- domestic corporations with foreign opera-
ment and Budget in accordance with the tions that generate losses.
SUMMARY: This document contains pro- Paperwork Reduction Act of 1995 (44 Estimated total annual reporting and/or
posed regulations under section 1503(d) USC 3507(d)). Comments on the collec- recordkeeping burden: 2,665 hours.
of the Internal Revenue Code (Code) re- tion of information should be sent to the Estimated average annual burden hours
garding dual consolidated losses. Section Office of Management and Budget, Attn: per respondent and/or recordkeeper: 1.5
1503(d) generally provides that a dual con- Desk Officer for the Department of the hours.
solidated loss of a dual resident corpora- Treasury, Office of Information and Reg- Estimated number of respondents
tion cannot reduce the taxable income of ulatory Affairs, Washington, DC 20503, and/or recordkeepers: 1,765.

2005–25 I.R.B. 1297 June 20, 2005


Estimated annual frequency of re- to foreign tax, but not U.S. tax (double- 1989 (T.D. 8261, 1989–2 C.B. 220). The
sponses: Annually. dip). temporary regulations generally provided
An agency may not conduct or sponsor, Congress was concerned that this dou- that, unless one of three limited excep-
and a person is not required to respond to, a ble-dip of a single economic loss could re- tions applied, a dual consolidated loss of
collection of information unless it displays sult in an undue tax advantage to certain a dual resident corporation could not off-
a valid control number assigned by the Of- foreign investors that made investments set the income of any other member of
fice of Management and Budget. in domestic corporations, and could cre- the dual resident corporation’s affiliated
Books or records relating to a collection ate an undue incentive for certain foreign group. The temporary regulations con-
of information must be retained as long corporations to acquire domestic corpora- tained similar rules for losses incurred by
as their contents may become material in tions and for domestic corporations to ac- separate units.
the administration of any internal revenue quire foreign rather than domestic assets. In response to comments that the tem-
law. Generally, tax returns and tax return Staff of Joint Committee on Taxation, 99th porary regulations were unnecessarily
information are confidential, as required Cong., 2nd Sess., General Explanation of restrictive, the IRS and Treasury issued
by 26 USC 6103. the Tax Reform Act of 1986, at 1064 – final regulations under section 1503(d)
1065 (1987). Through such double-dip- in 1992 (T.D. 8434, 1992–2 C.B. 240).
Background ping, worldwide economic income could These final regulations were updated and
be rendered partially or fully exempt from amended over the next 11 years (current
The United States taxes the worldwide
current taxation. Moreover, even if the for- regulations). The current regulations ap-
income of domestic corporations. A do-
eign income against which the loss was ply the section 1503(d) limitation more
mestic corporation is a corporation created
used would eventually be subject to U.S. narrowly than the temporary regulations.
or organized in the United States or un-
tax (upon a repatriation of earnings), there The current regulations adopt an actual
der the law of the United States or of any
were timing benefits of double dipping that use standard for permitting a dual consoli-
State. The United States allows certain do-
the statute was intended to prevent. Con- dated loss to offset income of members of
mestic corporations to file consolidated re-
gress responded to this concern by enact- the affiliated group. This standard, which
turns with other affiliated domestic corpo-
ing section 1503(d) as part of the Tax Re- applies to both dual resident corporations
rations. When two or more domestic cor-
form Act of 1986. and separate units, requires taxpayers to
porations file a consolidated return, losses
Section 1503(d) provides that a dual certify that no portion of the dual con-
that one corporation incurs generally may
consolidated loss of a corporation cannot solidated loss has been or will be used
reduce or eliminate tax on income that an-
reduce the taxable income of any other to offset the income of any other person
other corporation earns.
member of the corporation’s affiliated under the income tax laws of a foreign
Some countries use criteria other than
group. The statute defines a dual con- country. If such a certification is made and
place of incorporation or organization to
solidated loss as a net operating loss of a subsequent triggering event occurs, the
determine whether corporations are resi-
a domestic corporation that is subject to dual consolidated loss must be recaptured
dents for tax purposes. For example, some
an income tax of a foreign country on its in the year of the event (plus an applicable
countries treat corporations as residents for
income without regard to the source of its interest charge).
tax purposes if they are managed or con-
income, or is subject to tax on a residence This document proposes amendments
trolled in that country. If one of these
basis. The statute authorizes the issuance to the current regulations under section
countries determines a corporation to be a
of regulations permitting the use of a dual 1503(d). Conforming amendments are
resident, the corporation is generally sub-
consolidated loss to offset the income of a also proposed to related regulations under
ject to income tax of that foreign country
domestic affiliate if the loss does not offset sections 1502 and 6043.
on a residence basis. As a result, if such
the income of a foreign corporation under
a corporation is a domestic corporation for
foreign law. Overview
U.S. tax purposes, it is a dual resident cor-
Section 1503(d) further states that, to
poration and is subject to the income tax
the extent provided in regulations, similar In general, the proposed regulations ad-
of both the foreign country and the United
rules apply to any loss of a separate unit dress three fundamental concerns that arise
States on a residence basis.
of a domestic corporation as if such unit in connection with the current regulations.
Prior to the Tax Reform Act of 1986,
where a wholly owned subsidiary of the First, the IRS and Treasury believe that the
if a corporation was a resident of both a
corporation. Although the statute does not scope of application of the current regula-
foreign country and the United States, and
define the term separate unit, the legisla- tions should be modified. For example, the
the foreign country permitted the losses
tive history to the provision refers to the current regulations may apply to certain
of the corporation to be used to offset the
loss of any separate and clearly identifiable structures where there is little likelihood of
income of another person (for example, as
unit of a trade or business of a taxpayer and a double-dip. Moreover, the IRS and Trea-
a result of consolidation), then the dual
cites as an example a foreign branch of a sury understand that some taxpayers have
resident corporation could use any losses it
domestic corporation. See H.R. Rep. No. taken the position that the current regula-
generated twice: once to offset income that
795, 100th Cong., 2d Sess. July 26, 1988) tions do not apply to certain structures that
was subject to U.S. tax, but not foreign tax,
at 293. provide taxpayers the benefits of the type
and a second time to offset income subject
The IRS and Treasury issued tempo- of double-dip that section 1503(d) is in-
rary regulations under section 1503(d) in tended to deny. Accordingly, the proposed

June 20, 2005 1298 2005–25 I.R.B.


regulations are designed to minimize these the proposed effective date of the proposed units where appropriate, treat separate
cases of potential over- and under-applica- regulations. units as domestic corporations only for
tion. In addition to the proposed regula- limited purposes, and modify the oper-
Second, the IRS and Treasury recog- tory amendments under section 1503(d), ative rules where necessary to take into
nize that there are many unresolved issues the proposed regulations also include account differences between dual resident
that arise when applying the current reg- conforming proposed amendments to corporations and separate units.
ulations, particularly in light of the adop- §1.1502–21 and §1.6043–4T.
tion of the entity classification regulations 2. Application of section 1503(d) to
under §§301.7701–1 through 301.7701–3. B. Definitions and Special Rules for S corporations
Thus, the proposed regulations modernize Filings under Section 1503(d) —
the dual consolidated loss regime to take §1.1503(d)–1 Section 1.1503–2(c)(2) of the current
into account the entity classification reg- regulations provides that an S corporation,
1. Treatment of a separate unit as a as defined in section 1361, is not a dual
ulations and to resolve the related issues
domestic corporation and a dual resident resident corporation. The preamble to the
so that the rules can be applied by taxpay-
corporation current regulations explains that S corpo-
ers and the Commissioner with greater cer-
tainty. rations are so excluded because an S cor-
Section 1.1503–2(c)(3) and (4) of poration cannot have a domestic corpora-
Finally, the IRS and Treasury believe the current regulations defines a sepa-
that, in many cases, the current regulations tion as one of its shareholders. The current
rate unit of a domestic corporation as a regulations do not, however, explicitly ex-
are administratively burdensome to both foreign branch, within the meaning of
taxpayers and the Commissioner. Accord- clude separate units owned by an S corpo-
§1.367(a)–6T(g), (foreign branch separate ration from the definition of a dual resident
ingly, the proposed regulations reduce, to unit) and an interest in a partnership, trust
the extent possible, the administrative bur- corporation. As a result, the current regu-
or hybrid entity. The current regulations lations can be read to provide that an S cor-
den imposed on taxpayers and the Com- also provide that any separate unit of a
missioner. poration, although it cannot itself be a dual
domestic corporation is treated as a sep- resident corporation, could own a separate
arate domestic corporation for purposes unit that would be a dual resident corpora-
Explanation of Provisions
of applying the dual consolidated loss tion.
A. Structure of the Proposed Regulations rules. Section 1.1503–2(c)(2). In addi- The IRS and Treasury believe that such
tion, the current regulations provide that, a result is inappropriate because an S cor-
The proposed regulations are set forth unless otherwise indicated, any reference poration cannot have a domestic corpora-
in six sections. Section 1.1503(d)–1 con- to a dual resident corporation refers also tion as one of its shareholders and gener-
tains definitions and special rules for fil- to a separate unit. As a result of these ally is not taxable at the entity level. Ac-
ings. Section 1.1503(d)–2 sets forth oper- rules, certain provisions of the current cordingly, the proposed regulations pro-
ating rules, which include the general rule regulations only refer to dual resident cor- vide that for purposes of the dual consol-
that prohibits the domestic use of a dual porations, and therefore apply to separate idated loss rules, an S corporation is not
consolidated loss (subject to certain ex- units because they are treated as domestic treated as a domestic corporation. This
ceptions discussed below), a rule that lim- corporations and dual resident corpora- modification clarifies that the dual consol-
its the use of dual consolidated losses fol- tions. However, other provisions of the idated loss regulations do not apply to the
lowing certain transactions, an anti-avoid- current regulations refer to both dual res- S corporation itself, or to foreign branches
ance provision that prevents dual consoli- ident corporations and separate units (for or interests in certain flow-through entities
dated losses from offsetting income from example, see §1.1503–2(g)(2)(iii)(A)). owned by an S corporation.
assets acquired in certain nonrecognition The IRS and Treasury believe that, in The IRS and Treasury request com-
transactions or contributions to capital, and certain cases, treating separate units as do- ments as to whether regulated investment
rules for computing foreign tax credit limi- mestic corporations creates uncertainty in companies (as defined in section 851) or
tations. Section 1.1503(d)–3 contains spe- applying the current regulations. This may real estate investment trusts (as defined in
cial rules for accounting for dual consol- occur, for example, as a result of certain section 856) should be similarly excluded
idated losses. These special rules deter- rules applying to separate units because from the application of the dual consoli-
mine the amount of a dual consolidated they are treated as domestic corporations dated loss rules.
loss, determine the effect of a dual con- or dual resident corporations, while other
solidated loss on domestic affiliates, and rules apply explicitly to separate units 3. Losses of a foreign insurance company
provide special basis adjustments. Sec- themselves. Accordingly, the proposed treated as a domestic corporation
tion 1.1503(d)–4 provides exceptions to regulations do not contain a general rule
the general rule that prohibits the domes- that treats separate units as domestic cor- Section 953(d) generally provides that
tic use of a dual consolidated loss, in- porations or dual resident corporations a foreign corporation that would qual-
cluding a domestic use election. Section for all purposes of applying the dual con- ify to be taxed as an insurance company
1.1503(d)–5 contains examples that illus- solidated loss regulations. Instead, the if it were a domestic corporation may,
trate the application of the proposed reg- proposed regulations explicitly refer to under certain circumstances, elect to be
ulations. Finally, §1.1503(d)–6 contains dual resident corporations and separate treated as a domestic corporation. Section

2005–25 I.R.B. 1299 June 20, 2005


953(d)(3) provides that if a corporation for example, if a partnership owns a (b) Separate Unit Combination Rule
elects to be treated as a domestic corpo- foreign branch within the meaning of
ration pursuant to section 953(d) and is §1.367(a)–6T(g), a domestic corporate Section 1.1503–2(c)(3)(ii) of the cur-
treated as a member of an affiliated group, partner’s interest in such partnership, and rent regulations provides that if two or
any loss of such corporation is treated as its indirect interest in a portion of the more foreign branches located in the same
a dual consolidated loss for purposes of foreign branch owned through the partner- foreign country are owned by a single do-
section 1503(d), without regard to section ship, each constitutes a separate unit. mestic corporation and the losses of each
1503(d)(2)(B) (grant of regulatory author- Under the current regulations, an inter- branch are made available to offset the
ity to exclude losses which do not offset est in a non-hybrid entity partnership or income of the other branches under the
the income of foreign corporations from a non-hybrid entity grantor trust is also tax laws of the foreign country, then the
the definition of a dual consolidated loss). treated as a separate unit, regardless of branches are treated as one separate unit.
Therefore, losses of such corporations are whether the partnership or grantor trust has The combination rule in the current regu-
treated as dual consolidated losses regard- any nexus with a foreign jurisdiction. This lations does not apply to interests in hybrid
less of whether the corporation is subject rule can result in the application of the dual entity separate units or to dual resident cor-
to an income tax of a foreign country on its consolidated loss rules when there may be porations.
worldwide income or on a residence basis. little opportunity for a double-dip. For ex- Although a disregarded entity is treated
The current regulations do not address ample, if two domestic corporations each as a branch of its owner for various pur-
the application of section 953(d)(3). How- own 50 percent of a domestic partnership poses of the Code, the current regula-
ever, the definition of a dual resident cor- that generates losses attributable to activi- tions distinguish a hybrid entity sepa-
poration contained in the proposed regu- ties conducted solely in the United States, rate unit that is disregarded as an en-
lations includes a foreign insurance com- the corporate partners would be techni- tity separate from its owner from a
pany that makes an election to be treated cally subject to the dual consolidated loss foreign branch separate unit. Compare
as a domestic corporation pursuant to sec- rules and therefore would not be allowed §1.1503–2(c)(3)(i)(A) and (c)(4); see also
tion 953(d) and is a member of an affili- to offset their income with such losses, un- §1.1503–2(g)(2)(vi)(C). Accordingly, the
ated group, regardless of how such entity less an exception applied. In such a case, combination rule under the current reg-
is taxed by the foreign country. however, it may be unlikely that the losses ulations does not apply to an interest in
would be available to offset income of an- a hybrid entity separate unit, even if the
4. Definition of a separate unit other person under the income tax laws of hybrid entity is disregarded as an entity
a foreign country. separate from its owner.
(a) Interests in Non-Hybrid Entity The IRS and Treasury believe that in- The combination rule in the current reg-
Partnerships and Interests in Non-Hybrid cluding an interest in a non-hybrid entity ulations also requires the foreign branches
Entity Grantor Trusts partnership and an interest in a non-hy- to be owned by a single domestic corpora-
brid entity grantor trust in the definition of tion. Thus, for example, the current reg-
Section 1.1503–2(c)(4) of the current a separate unit may not be necessary and ulations do not permit the combination of
regulations defines a separate unit to in- is administratively burdensome. In such foreign branches owned by different do-
clude an interest in a hybrid entity (hy- cases, it may be unlikely that deductions mestic corporations, even if such corpo-
brid entity separate unit). The current reg- and losses solely attributable to activities rations are members of the same consol-
ulations define a hybrid entity as an en- of the partnership or grantor trust, that do idated group. In addition, in some cases
tity that is not taxable as an association not rise to the level of a taxable presence in the current regulations do not allow the
for U.S. income tax purposes, but is sub- a foreign jurisdiction, can be used to off- combination of foreign branches that are
ject to income tax in a foreign jurisdiction set income of another person under the in- owned indirectly by a single domestic cor-
as a corporation (or otherwise at the en- come tax laws of a foreign country. As poration through other separate units be-
tity level) either on its worldwide income a result, the proposed regulations elimi- cause, as discussed above, such other sepa-
or on a residence basis. This definition nate from the definition of a separate unit rate units are generally treated as domestic
includes an interest in such an entity that an interest in a non-hybrid entity partner- corporations for purposes of applying the
is treated for U.S. tax purposes as a part- ship and an interest in a non-hybrid en- dual consolidated loss regulations. As a re-
nership (hybrid entity partnership) or as a tity grantor trust. It should be noted, how- sult, such foreign branches are not treated
grantor trust (hybrid entity grantor trust). ever, that the proposed regulations retain as being owned by a single domestic cor-
An interest in an entity that is treated as the rule contained in the current regula- poration.
a partnership or a grantor trust for both tions that a domestic corporation can own The IRS and Treasury believe that the
U.S. and foreign tax purposes (non-hybrid a separate unit indirectly through both hy- application of the combination rule should
entity partnership and non-hybrid entity brid entity and non-hybrid entity partner- not be restricted to foreign branch separate
grantor trust, respectively) also is treated ships, and through both hybrid entity and units. In addition, the IRS and Treasury
as a separate unit under the current regula- non-hybrid entity grantor trusts. believe that the combination rule should
tions. §1.1503–2(c)(3)(i). not be limited to those cases where the do-
The current regulations also apply to a mestic corporation owns the separate units
separate unit owned indirectly through directly. Therefore, provided certain re-
a partnership or grantor trust. Thus, quirements are satisfied, the proposed reg-

June 20, 2005 1300 2005–25 I.R.B.


ulations adopt a broader combination rule 5. Exception to the definition of a dual manner that is inconsistent with the princi-
that combines all separate units that are di- consolidated loss ples of section 1503(d).
rectly or indirectly owned by a single do-
mestic corporation. Section 1.1503–2(c)(5)(ii)(A) of the 7. Domestic use of a dual consolidated
In order for separate units to be com- current regulations provides a very lim- loss
bined under the proposed regulations, the ited exception to the definition of a dual
Section 1.1503–2(b)(1) of the current
losses of each separate unit must be made consolidated loss where the income tax
regulations states that, except as otherwise
available to offset the income of the other laws of a foreign country do not permit
provided, a dual consolidated loss cannot
separate units under the tax laws of a sin- the dual resident corporation to either: (1)
offset the taxable income of any domes-
gle foreign country. In addition, if the sep- use its losses, expenses, or deductions to
tic affiliate, regardless of whether the loss
arate unit is a foreign branch separate unit, offset the income of any other person in
offsets income of another person under the
it must be located in the foreign country the same taxable year; or (2) carry over or
income tax laws of a foreign country, and
that allows its losses to be made available carry back its losses, expenses, or deduc-
regardless of whether the income that the
to offset income of each separate unit; if tions to be used, by any means, to offset
loss may offset in the foreign country is,
the separate unit is a hybrid entity separate the income of any other person in other
has been, or will be subject to tax in the
unit, the hybrid entity must be subject to taxable years. This exception only applies
United States. Section 1.1503–2(c)(13)
tax in the foreign country that allows losses in rare and unusual cases where the in-
defines the term domestic affiliate to mean
to be made available to each separate unit come tax laws of the foreign country do
any member of an affiliated group, without
either on its worldwide income or on a res- not allow any portion of the dual consol-
regard to exceptions contained in section
idence basis. idated loss to be used to offset income of
1504(b) (other than section 1504(b)(3)) re-
The combination rule in the proposed another person under any circumstances.
lating to includible corporations.
regulations does not combine separate The IRS and Treasury understand that
The proposed regulations retain the
units owned by different domestic corpo- some taxpayers have improperly inter-
general prohibition against using a dual
rations, even if the domestic corporations preted this provision in a manner inconsis-
consolidated loss to offset income of do-
are included in the same consolidated tent with the policies of the dual consoli-
mestic affiliates contained in the current
group. The IRS and Treasury believe dated loss rules. As a result, the proposed
regulations, with modifications, and re-
this approach is consistent with section regulations eliminate this exception to the
fer to such usage as a domestic use of
1503(d)(3), which provides that, to the definition of a dual consolidated loss. As
a dual consolidated loss. This general
extent provided in regulations, a loss of a discussed below, however, the proposed
prohibition is subject to a number of ex-
separate unit of a domestic corporation is regulations contain a new exception to the
ceptions, discussed below. In addition,
subject to the dual consolidated loss rules general rule restricting the use of a dual
because the proposed regulations do not
as if it were a wholly owned subsidiary of consolidated loss to offset income of a
treat separate units as domestic corpora-
such domestic corporation. In addition, domestic affiliate. In general, this new ex-
tions and dual resident corporations (other
the combination rule contained in the pro- ception applies when there is no possibility
than for limited purposes) the proposed
posed regulations only applies to separate that any portion of the dual consolidated
regulations expand the definition of a do-
units and therefore does not apply to dual loss can be double-dipped, and operates
mestic affiliate to include separate units.
resident corporations. in a manner that is similar to the manner
This expanded definition is necessary for
The IRS and Treasury, however, request in which the exception to the definition of
purposes of applying the domestic use
comments as to whether there is author- a dual consolidated loss contained in the
limitation rule.
ity to expand the combination rule and, if current regulations operates.
so, whether the combination rule should 8. Foreign use of a dual consolidated loss
be expanded to include separate units that 6. Partnership special allocations
are owned directly or indirectly by domes- (a) General Rule
tic corporations that are members of the Section 1.1503–2(c)(5)(iii) of the cur-
same consolidated group. Similarly, com- rent regulations reserves on the treatment Section 1.1503–2T(g)(2)(i) of the cur-
ments are requested as to whether the com- of dual consolidated losses of separate rent regulations provides that, in order to
bination rule should be extended to apply units that are partnership interests, in- elect relief from the general limitation on
to dual resident corporations. Further, the cluding interests in hybrid entities. The the use of a dual consolidated loss to off-
IRS and Treasury request comments on the preamble to the current regulations ex- set income of a domestic affiliate with re-
application of the operative provisions of plains that the reservation was principally spect to a dual consolidated loss ((g)(2)(i)
the proposed regulations to combined sep- the result of concerns regarding partner- election), the taxpayer must, among other
arate units owned by different domestic ship special allocations. things, certify that no portion of the losses,
corporations (for example, the SRLY lim- The proposed regulations no longer re- expenses, or deductions taken into account
itation under §1.1503(d)–3(c)). serve on the treatment of separate units that in computing the dual consolidated loss
are partnership interests. However, the has been, or will be, used to offset the in-
IRS will continue to challenge structures come of any other person under the income
that attempt to use special allocations in a tax laws of a foreign country. If, contrary

2005–25 I.R.B. 1301 June 20, 2005


to this certification, there is such a use, whether such items are recognized under able years. Under this approach, the por-
the dual consolidated loss subject to the U.S. tax principles. This condition ensures tion of the loss carryforward or carryback
(g)(2)(i) election generally must be recap- that there will not be a foreign use unless that was taken into account in computing
tured and reported as gross income. all or a portion of the dual consolidated the dual consolidated loss would need to
The IRS and Treasury understand that loss offsets or reduces, or is made avail- be identified and tracked, which would re-
issues arise involving the application of the able to offset or reduce, income or gain for quire detailed ordering rules for determin-
use rule contained in the current regula- foreign tax purposes. ing when such losses were used. Timing
tions. For example, issues may arise where The second condition is satisfied if and base differences between the U.S. and
items of income, gain, deduction and loss items that are (or could be) offset pursuant foreign jurisdiction would further compli-
are treated as being generated or incurred to the first condition are considered, under cate such an approach.
by different persons under U.S. and for- U.S. tax principles, to be items of: (1) a Because of the administrative complex-
eign law. Similarly, issues may arise due foreign corporation; or (2) a direct or indi- ities discussed above, the foreign use def-
to different definitions of a person under rect (for example, through a partnership) inition contained in the proposed regula-
U.S. and foreign law. These issues have owner of an interest in a hybrid entity, tions retains the available for use standard.
become more prevalent since the adoption provided such interest is not a separate However, because the available for use
of the entity classification regulations un- unit. This condition is intended to limit standard is retained, there are many cases
der §§301.7701–1 through 301.7701–3. a foreign use to situations where the for- in which a foreign use of a dual consol-
The IRS and Treasury also understand eign income that is (or could be) offset by idated loss attributable to interests in hy-
that taxpayers have taken positions under the dual consolidated loss is not currently brid entity partnerships and hybrid entity
the current regulations regarding the use subject to U.S. corporate income tax. In grantor trusts, and separate units owned in-
of a dual consolidated loss that are incon- general, if the foreign income that is off- directly through partnerships and grantor
sistent with the policies underlying sec- set is currently subject to U.S. corporate trusts, occurs, even though no portion of
tion 1503(d). On the other hand, the IRS income tax, there is no double-dip of the any item of deduction or loss compris-
and Treasury believe that, under the cur- dual consolidated loss. ing the dual consolidated loss is double-
rent regulations, a use can be deemed to dipped. In the case of interests in hy-
occur in certain cases where there may be (b) Exception to Foreign Use if no Dilution brid entity partnerships and hybrid entity
little likelihood of the type of double-dip of an Interest in a Separate Unit grantor trusts, a portion of the dual con-
that section 1503(d) was intended to pre- solidated loss attributable to an interest in
vent. Section 1.1503–2(c)(15) of the current such entity in many cases would be made
For the reasons discussed above, the regulations employs a so-called actual use available to offset income or gain of a di-
proposed regulations modify the defini- standard for determining whether there has rect or indirect owner of an interest in such
tion of use and provide a rule based on been a use of a dual consolidated loss to hybrid entity, provided such interest is not
foreign use. These modifications are in- offset the income of another person under a separate unit. This typically would oc-
tended to minimize the potential over- and the laws of a foreign country. Although cur because under foreign law the hybrid
under-application of the dual consolidated referred to as an actual use standard, this entity is taxed as a corporation (or other-
loss rules that can occur under the cur- rule provides that a use is considered to oc- wise at the entity level) and its net losses
rent regulations. Under the proposed reg- cur in the year in which a loss, expense or may be carried forward or carried back. A
ulations, the foreign use definition is in- deduction taken into account in computing similar result may occur in the case of a
tended to minimize the opportunity for a the dual consolidated loss is made avail- separate unit owned indirectly through a
double-dip. However, the new definition able for such an offset, unless an excep- non-hybrid entity partnership or a non-hy-
is also intended to minimize the situations tion applies. The fact that the other person brid entity grantor trust because of timing
in which a foreign use will occur in cases does not have sufficient income in that year and base differences between the laws of
where there may be little likelihood of a to benefit from such an offset is not taken the United States and the foreign jurisdic-
double-dip. into account. tion.
The proposed regulations provide that a The available component of the actual The IRS and Treasury believe this is an
foreign use is deemed to occur only if two use standard was adopted because of the inappropriate result in many cases. For
conditions are satisfied. The first condi- administrative complexity that would re- example, the IRS and Treasury believe
tion is satisfied if any portion of a loss or sult from having a use occur only when that if there is no dilution of the domestic
deduction taken into account in computing income is actually offset. For example, if owner’s interest in the separate unit, it is
the dual consolidated loss is made avail- in the year that a portion of the dual con- unlikely that any portion of the dual con-
able under the income tax laws of a for- solidated loss is made available to be used solidated loss attributable to such separate
eign country to offset or reduce, directly by another person, the other person itself unit can be put to a foreign use (other than
or indirectly, any item that is recognized generates a loss (or has a loss carryover), through an election to consolidate or sim-
as income or gain under such laws (includ- then in many cases the portion of the dual ilar method, discussed below). Therefore,
ing items of income or gain generated by consolidated loss would become part of the the proposed regulations include three new
the dual resident corporation or separate loss carryover. Such loss therefore would exceptions to the definition of a foreign
unit itself), regardless of whether income be available to be carried forward or car- use where there is no dilution of an in-
or gain is actually offset, and regardless of ried back to offset income in different tax- terest in a separate unit. The new excep-

June 20, 2005 1302 2005–25 I.R.B.


tions to foreign use apply to dual consol- other means an interest in such partner- dual resident corporation to offset income
idated losses attributable to two types of ship or grantor trust, unless the taxpayer of an affiliate in only one country. Staff
separate units: (1) interests in hybrid entity demonstrates, to the satisfaction of the of the Joint Committee on Taxation, Gen-
partnerships and interests in hybrid entity Commissioner, that the other person that eral Explanation of the Tax Reform Act of
grantor trusts; and (2) separate units owned acquired the interest in the partnership or 1986, at 1066. The mirror rule was specif-
indirectly through partnerships and grantor grantor trust was a domestic corporation. ically held to be valid by the Court of Ap-
trusts. The exceptions to foreign use should not peals for the Federal Circuit. British Car
The first exception to foreign use pro- apply when a person (other than a domes- Auctions, Inc. v. United States, 35 Fed.
vides that, in general, no foreign use shall tic corporation) acquires an interest in the Cl. 123 (1996), aff’d without op., 116 F.3d
be considered to occur with respect to a separate unit because the dilution would 1497 (Fed. Cir. 1997).
dual consolidated loss attributable to an in- typically result in an actual foreign use. The mirror legislation rule contained in
terest in a hybrid entity partnership or a Second, the exceptions do not apply if the current regulations provides that if the
hybrid entity grantor trust, solely because the availability does not arise solely from laws of a foreign country deny the use of
an item of deduction or loss taken into ac- the ownership in such partnership or trust a loss of a dual resident corporation (or
count in computing such dual consolidated and the allocation of the item of deduction separate unit) to offset the income of an-
loss is made available, under the income or loss, or the offsetting by such deduc- other person because the dual resident cor-
tax laws of a foreign country, to offset or tion or loss, of an item of income or gain poration (or separate unit) is also subject
reduce, directly or indirectly, any item that of the partnership or trust. For example, to tax by another country on its worldwide
is recognized as income or gain under such the exception does not apply in the case income or on a residence basis, the loss
laws and is considered under U.S. tax prin- where the item of loss or deduction is made is deemed to be used against the income
ciples to be an item of the direct or indirect available through a foreign consolidation of another person in such foreign country
owner of an interest in such hybrid entity regime. such that no (g)(2)(i) election can be made
that is not a separate unit. The IRS and Treasury request com- with respect to such loss. This rule is in-
The second exception to foreign use ments on the issues discussed above in tended to prevent the foreign jurisdiction
provides that, in general, no foreign use connection with the availability compo- from enacting legislation that gives tax-
shall be considered to occur with respect nent of the foreign use definition. Com- payers no choice but to use the dual consol-
to a dual consolidated loss attributable to ments are specifically requested as to idated loss to offset income in the United
or taken into account by a separate unit whether the dilution rules are appropriate States. This result is contrary to the gen-
owned indirectly through a partnership or and, if so, whether a de minimis exception eral policy underlying the structure of the
grantor trust solely because an item of de- should be provided. current regulations that provides taxpayers
duction or loss taken into account in com- the choice of using the dual consolidated
puting such dual consolidated loss is made 9. Mirror legislation rule loss to either offset income in the United
available, under the income tax laws of States or income in the foreign jurisdiction
a foreign country, to offset or reduce, di- Section 1.1503–2(c)(15)(iv) of the cur- (but not both).
rectly or indirectly, any item that is recog- rent regulations contains a mirror legisla- As a result of the consistency rule (dis-
nized as income or gain under such laws tion rule that addresses legislation enacted cussed below), the deemed use of a dual
and is considered under U.S. tax principles by foreign jurisdictions that operates in a consolidated loss pursuant to the mirror
to be an item of a direct or indirect owner manner similar to the dual consolidated legislation rule may also restrict the ability
of an interest in such partnership or trust. loss rules. This rule was designed to pre- to use other dual consolidated losses to off-
Finally, the proposed regulations pro- vent the revenue gain resulting from the set the income of domestic affiliates, even
vide a similar exception for combined sep- disallowance of the double-dip benefit of a if such losses are not subject to the mirror
arate units that include individual separate dual consolidated loss from inuring solely legislation.
units to which one of the other dilution ex- to the foreign jurisdiction (to the detriment Subsequent to the issuance of the cur-
ceptions would apply, but for the separate of the United States). Staff of the Joint rent regulations, several foreign juris-
unit combination rule. Committee on Taxation, General Explana- dictions enacted various forms of mirror
The new exceptions to foreign use are tion of the Tax Reform Act of 1986, at legislation that, absent the mirror legisla-
subject to certain limitations, however. 1065–66 (J. Comm. Print 1987). tion rule, would have the effect of forcing
First, the exceptions will not apply if there Congress recognized that mirror legis- certain taxpayers to use dual consolidated
has been a dilution of the interest in the lation in a foreign jurisdiction, in conjunc- losses to offset income of domestic affil-
separate unit. That is, the exception will tion with a mirror legislation rule such as iates.
not apply if during any taxable year the that contained in the current regulations, Given the relevant legislative history
domestic owner’s percentage interest in could result in the disallowance of a dual and British Car Auctions, the IRS and
the separate unit, as compared to its in- consolidated loss in both the United States Treasury believe that the mirror legisla-
terest in the separate unit as of the last and in the foreign jurisdiction. In such a tion rule remains necessary. This is par-
day of the taxable year in which such dual case, Congress intended that Treasury pur- ticularly true in light of the prevalence of
consolidated loss was incurred, is reduced sue with the appropriate authorities in the mirror legislation in foreign jurisdictions.
as a result of another person acquiring foreign jurisdiction a bilateral agreement As a result, the proposed regulations retain
through sale, exchange, contribution or that would allow the use of the loss of a the mirror legislation rule. The proposed

2005–25 I.R.B. 1303 June 20, 2005


regulations modify the mirror legislation and Treasury believe that these concerns In determining whether the taxpayer
rule, however, to address its proper appli- may not be significant, however, where has reasonable cause, the Director of Field
cation with respect to mirror legislation there is only a deemed foreign use of a dual Operations shall consider whether the
enacted subsequent to the issuance of the consolidated loss as a result of the mirror taxpayer acted reasonably and in good
current regulations, and to modify its ap- legislation rule. Accordingly, the mirror faith. Whether the taxpayer acted reason-
plication to better take into account the legislation rule contained in the proposed ably and in good faith will be determined
policies underlying the consistency rule. regulations provides that a deemed for- after considering all the facts and circum-
In general, the mirror legislation rule eign use is not treated as a foreign use for stances. The Director of Field Operations
contained in the proposed regulations ap- purposes of applying the consistency rule. shall notify the person in writing within
plies when the opportunity for a foreign 120 days of the filing if it is determined
use is denied because: (1) the loss is in- 10. Reasonable cause exception that the failure to comply was not due to
curred by a dual resident corporation that reasonable cause, or if additional time will
is subject to income taxation by another The current regulations require various be needed to make such determination.
country on its worldwide income or on a filings to be included on a timely filed tax
residence basis; (2) the loss may be avail- return. In addition, taxpayers that fail to C. Operating Rules — §1.1503(d)–2
able to offset income other than income of include such filings on a timely filed tax
the dual resident corporation or separate return must request an extension of time to 1. Application of rules to multiple tiers
unit under the laws of another country; or file under §301.9100–3. of separate units
(3) the deductibility of any portion of a loss The IRS and Treasury believe that Section 1.1503–2(b)(3) of the current
or deduction taken into account in comput- requiring taxpayers to request relief regulations provides that if a separate unit
ing the dual consolidated loss depends on for an extension of time to file under of a domestic corporation is owned indi-
whether such amount is deductible under §301.9100–3 results in an unnecessary rectly through another separate unit, limi-
the laws of another country. administrative burden on both taxpay- tations on the dual consolidated losses of
The IRS and Treasury understand that ers and the Commissioner. The IRS and the separate units apply as if the upper-tier
there may be uncertainty as to the applica- Treasury believe that a reasonable cause separate unit were a subsidiary of the do-
tion of the mirror legislation rule in a given standard, similar to that used in other in- mestic corporation, and the lower-tier sep-
case when the mirror legislation is lim- ternational provisions of the Code (such arate unit were a lower-tier subsidiary. In
ited in its application. Mirror legislation as sections 367(a) and 6038B), is a more light of changes made to other provisions
may or may not apply to a particular dual appropriate and less burdensome means of the proposed regulations, this rule is no
resident corporation or separate unit de- for taxpayers to cure compliance defects longer necessary. As a result, the proposed
pending on various factors, including the under section 1503(d). As a result, the regulations do not contain this provision.
type of entity or structure that generates the proposed regulations adopt a reasonable
loss, the ownership of the operation or en- cause standard. Moreover, extensions 2. Tainted income
tity that generates the loss, the manner in of time under §301.9100–3 will not be
which the operation or entity is taxed in granted for filings under these proposed Section 1.1503–2(e) of the current reg-
another jurisdiction, or the ability of the regulations. See §301.9100–1(d). ulations prevents the dual consolidated
losses to be deducted in another jurisdic- Under the reasonable cause standard, if loss of a dual resident corporation that
tion. As a result, the proposed regulations a person that is permitted or required to file ceases being a dual resident corporation
clarify that the mere existence of mirror an election, agreement, statement, rebut- from offsetting tainted income of such
legislation, regardless of whether it applies tal, computation, or other information un- corporation. Subject to certain exceptions,
to the particular dual resident corporation, der the regulations fails to make such a fil- tainted income is defined as income de-
may not result in a deemed foreign use. ing in a timely manner, such person shall rived from assets that are acquired by a
For example, see §1.1503(d)–5(c) Exam- be considered to have satisfied the timeli- dual resident corporation in a nonrecog-
ple 23. ness requirement with respect to such fil- nition transaction, or as a contribution to
The proposed regulations also clarify ing if the person is able to demonstrate, capital, at any time during the three tax-
that the absence of an affiliate in the for- to the satisfaction of the Director of Field able years immediately preceding the tax
eign jurisdiction, or the failure to make an Operations having jurisdiction of the tax- year in which the corporation ceases to
election to enable a foreign use, does not payer’s tax return for the taxable year, that be a dual resident corporation, or at any
prevent the opportunity for a foreign use. such failure was due to reasonable cause time thereafter. The current regulations
Thus, for example, the mirror legislation and not willful neglect. Once the person also contain a rule that, absent proof to
rule may apply even if there are no affili- becomes aware of the failure, the person the contrary, presumes an amount of in-
ates of the dual resident corporation in the must make this demonstration and comply come generated during a taxable year as
foreign jurisdiction or, even where there by attaching all the necessary filings to an being tainted income. Such amount is the
is such an affiliate, no election is made to amended tax return (that amends the tax re- corporation’s taxable income for the year
consolidate. turn to which the filings should have been multiplied by a fraction, the numerator
As discussed below, the consistency attached), and including a written state- of which is the fair market value of the
rule is intended to promote uniformity and ment explaining the reasons for the failure tainted assets at the end of the year, and the
reduce administrative burdens. The IRS to comply. denominator of which is the fair market

June 20, 2005 1304 2005–25 I.R.B.


value of the total assets owned by each tion that is a dual resident corporation, us- separate units, and the treatment of certain
domestic corporation at the end of each ing only those items of income, expense, income inclusions on stock.
year. deduction, and loss that are otherwise at-
The tainted income rule is intended to tributable to such separate unit. (b) General Rules
prevent taxpayers from obtaining a dou- The current regulations do not provide
ble-dip with respect to a dual consolidated any guidance for determining the items of The proposed regulations clarify that
loss by stuffing assets into a dual resident income, gain, deduction and loss that are only existing tax accounting items of in-
corporation after, or in certain cases be- otherwise attributable to a separate unit. come, gain, deduction and loss (translated
fore, it terminates its status as a dual resi- The IRS and Treasury understand that the into U.S. dollars) should be taken into ac-
dent corporation. A double-dip may be ob- absence of such guidance has resulted in count for purposes of calculating the dual
tained in such case because the income that considerable uncertainty. For example, consolidated loss of a separate unit. In
offsets the dual consolidated loss generally commentators have questioned whether all other words, treating a separate unit as
would not be subject to tax in the foreign or any portion of the interest expense of a a separate domestic corporation does not
jurisdiction after the dual resident status of domestic owner is attributable to a separate cause items that are disregarded for U.S.
the corporation terminates. unit. tax purposes (for example, interest paid by
The proposed regulations retain the It is also unclear the extent to which a a disregarded entity on an obligation held
tainted income rule, subject to the follow- separate unit is treated as a separate do- by its owner) to be regarded for purposes
ing modifications. The proposed regula- mestic corporation under this rule. For of calculating a separate unit’s dual con-
tions clarify that tainted income includes example, commentators have questioned solidated loss.
both income or gain recognized on the whether a transaction between a separate The proposed regulations also clarify
sale or other disposition of tainted assets unit and its owner that is generally disre- that in the case of tiered separate units,
and income derived as a result of holding garded for federal tax purposes (for exam- each separate unit must calculate its own
tainted assets. The proposed regulations ple, interest paid by a disregarded entity on dual consolidated loss and no item of in-
also modify the rule defining the amount an obligation held by its owner) can create come, gain, deduction and loss may be
of income presumed to be tainted income. an item of income, gain, deduction or loss taken into account in determining the tax-
The proposed regulations clarify that the for purposes of calculating a dual consoli- able income or loss of more than one sep-
presumptive rule only applies to income dated loss. arate unit. Similarly, the proposed regula-
derived as a result of holding tainted as- Commentators have also questioned tions clarify that items of one separate unit
sets; income or gain recognized on the whether each separate unit in a tiered cannot offset or otherwise be taken into ac-
sale or other disposition of tainted assets separate unit structure (that is, where one count by another separate unit for purposes
should be readily determinable such that separate unit owns another separate unit) of calculating a dual consolidated loss (un-
the presumptive rule need not apply. The must separately determine whether it has less the separate unit combination rule ap-
proposed regulations also provide that a dual consolidated loss, or whether such plies). These rules ensure that the dual
the numerator in the presumptive income separate units are combined for this pur- consolidated loss calculation is computed
fraction is the fair market value of tainted pose. separately for each separate unit, which is
assets determined at the time such assets The proposed regulations provide more necessary to prevent deductions and losses
were acquired by the corporation, as op- definitive rules for determining the amount from being double-dipped.
posed to being determined at the end of of a dual consolidated loss (or income) of a
the taxable year. The IRS and Treasury separate unit. These rules apply solely for (c) Foreign Branch Separate Unit
believe that this approach is more admin- purposes of section 1503(d) and, therefore,
istrable because value should be more do not apply for other purposes of the Code The proposed regulations provide that
readily determinable on the acquisition (for example, section 987). The proposed the asset use and business activities princi-
date. In addition, this approach does not regulations first provide general rules that ples of section 864(c) apply for purposes of
require tainted assets to be traced over apply for purposes of calculating dual con- determining the items of income, gain, de-
time. solidated losses (or income) for both for- duction (other than interest) and loss that
eign branch separate units and hybrid en- are taken into account in determining the
D. Special Rules for Accounting for Dual tity separate units. The proposed regu- taxable income or loss of a foreign branch
Consolidated Losses — §1.1503(d)–3 lations provide additional rules for calcu- separate unit. For this purpose, the trad-
lating the dual consolidated losses (or in- ing safe harbors of section 864(b) do not
1. Items attributable to a separate unit
come) of foreign branch separate units, apply for purposes of determining whether
(a) Overview hybrid entity separate units, and separate a trade or business exists within a for-
units owned indirectly through other sep- eign country or whether income may be
Section 1.1503–2(d)(1)(ii) of the cur- arate units, non-hybrid entity partnerships, treated as effectively connected to a for-
rent regulations provides a rule for deter- or non-hybrid entity grantor trusts. Finally, eign branch separate unit. In addition, the
mining whether a separate unit has a dual the proposed regulations provide special limitations on effectively connected treat-
consolidated loss. Under this rule, the sep- rules that apply to tiered separate units, ment of foreign source related-party in-
arate unit must compute its taxable income combined separate units, dispositions of come under section 864(c)(4)(D) do not
as if it were a separate domestic corpora- apply.

2005–25 I.R.B. 1305 June 20, 2005


The proposed regulations further pro- (d) Hybrid Entity nize as being attributable to the entity. For
vide that the principles of §1.882–5, as example, it is likely that a foreign juris-
modified, apply for purposes of determin- The proposed regulations provide rules diction would recognize and take into ac-
ing the items of interest expense that are for attributing items of income, gain, de- count as being attributable to a hybrid en-
taken into account in determining the tax- duction and loss to a hybrid entity. These tity the interest expense properly reflected
able income or loss of a foreign branch rules are necessary to determine the items on the books and records of the hybrid en-
separate unit. The rules provide that a tax- that are attributable to an interest in a hy- tity; however, it is unlikely that a foreign
payer must use U.S. tax principles to deter- brid entity that constitutes a separate unit. jurisdiction would recognize, and take into
mine both the classification and amounts The proposed regulations provide that, account as being attributable to a hybrid
of the assets and liabilities when the ac- in general, the items of income, gain, de- entity, interest expense of a domestic cor-
tual worldwide ratio is used. The valua- duction and loss that are attributable to a poration that owns an interest in the hybrid
tion of assets must be determined under the hybrid entity are those items that are prop- entity.
same methodology the taxpayer uses un- erly reflected on its books and records,
der §1.861–9T(g) for purposes of allocat- as adjusted to conform to U.S. tax princi- (e) Interest in a Disregarded Hybrid Entity
ing and apportioning interest expense un- ples. The principles of §1.988–4(b)(2) ap-
der section 864(e). Further, and solely for ply for purposes of making this determi- The proposed regulations provide that,
these purposes, the domestic owner of the nation. These principles generally provide except to the extent otherwise provided un-
foreign branch separate unit is treated as that the determination is a question of fact der special rules (discussed below), items
a foreign corporation, the foreign branch and must be consistently applied. These that are attributable to an interest in a hy-
separate unit is treated as a trade or busi- principles also provide that the Commis- brid entity that is disregarded as an entity
ness within the United States, and assets sioner may allocate items of income, gain, separate from its owner are those items that
other than those of the foreign branch sep- deduction and loss between the domes- are attributable to such hybrid entity itself.
arate unit are treated as assets that are not tic corporation (and intervening entities, if
U.S. assets. Accordingly, only the interest any) that own the hybrid entity separate (f) Interests in Hybrid Entity Partnerships,
expense of the domestic owner of the for- unit, and the hybrid entity separate unit, if Interests in Hybrid Entity Grantor Trusts,
eign branch separate unit is subject to allo- such items are not properly reflected on the and Separate Units Owned Indirectly
cation for purposes of computing the dual books and records of the hybrid entity. Through Partnerships and Grantor Trusts
consolidated loss. The IRS and Treasury The proposed regulations also provide
believe that the application of these prin- that if a hybrid entity owns an interest The proposed regulations provide rules
ciples will better harmonize the borrowing in either a non-hybrid entity partnership for determining the extent to which: (1)
rate and effective interest costs that both or a non-hybrid entity grantor trust, items items of income, gain, deduction and loss
the United States and the foreign country of income, gain, deduction and loss that that are attributable to a hybrid entity that
take into account in determining the dual are properly reflected on the books and is a partnership are attributable to an inter-
consolidated loss, as compared to the use records of such partnership or grantor trust est in such hybrid entity partnership; and
of §1.861–9T. (under the principles of §1.988–4(b)(2), as (2) items of income, gain, deduction and
The IRS and Treasury believe that adjusted to conform to U.S. tax principles), loss of a separate unit that is owned in-
taking items into account in determining are treated as being properly reflected on directly through a partnership are taken
the taxable income or loss of a foreign the books and records of the hybrid en- into account by a partner in such partner-
branch separate unit under these standards tity. However, such items are treated as ship. These items are taken into account to
is administrable because of the existing being properly reflected on the books and the extent they are includible in the part-
guidance provided under these provi- records of the hybrid entity only to the ex- ner’s distributive share of the partnership
sions. In addition, the IRS and Treasury tent they are taken into account by the hy- income, gain, deduction or loss, as deter-
believe that this approach furthers the pol- brid entity under principles of subchapter mined under the rules and principles of
icy underlying section 1503(d) because it K, chapter 1 of the Code, or the principles subchapter K, chapter 1 of the Code.
serves as a reasonable approximation of of subpart E, subchapter J, chapter 1 of the The proposed regulations also provide
the items that the foreign jurisdiction may Code, as the case may be. rules for determining the extent to which:
recognize as being taken into account in The IRS and Treasury believe that at- (1) items of income, gain, deduction and
determining the taxable income or loss of tributing items to a hybrid entity under this loss attributable to a hybrid entity that is
a branch or permanent establishment of a standard is administrable because it is gen- a grantor trust are attributable to an inter-
non-resident corporation in such jurisdic- erally consistent with the accounting treat- est in such hybrid entity grantor trust; and
tion. Nevertheless, the IRS and Treasury ment of the items. The IRS and Treasury (2) the items of income, gain, deduction
solicit comments on these provisions and also believe that this standard furthers the and loss of a separate unit owned indirectly
whether other administrable approaches policy underlying section 1503(d) because through a grantor trust are taken into ac-
(that approximate the items taken into ac- the items that are properly reflected on the count by an owner of such grantor trust.
count by the foreign jurisdiction) should books and records of the hybrid entity (as These items are taken into account to the
be considered. adjusted to conform to U.S. tax principles) extent they are attributable to trust prop-
represent the best approximation of items erty that the holder of the trust interest is
that the foreign jurisdiction would recog- treated as owning under the rules and prin-

June 20, 2005 1306 2005–25 I.R.B.


ciples of subpart E, subchapter J, chapter 1 tion would recognize as being taken into come, gain, deduction and loss recognized
of the Code. account by a taxable presence in such ju- on the disposition of a separate unit (or an
risdiction. interest in a partnership or grantor trust that
(g) Allocation of Items Between Certain Finally, the proposed regulations pro- directly or indirectly owns a separate unit),
Indirectly Owned Separate Units vide that items generally attributable to an are attributable to or taken into account by
interest in a hybrid entity are not taken into the separate unit to the extent of the gain
The proposed regulations provide spe- account to the extent they are taken into or loss that would have been recognized
cial rules for allocating items of income, account by a foreign branch separate unit had such separate unit sold all its assets
gain, deduction and loss to foreign branch owned, directly or indirectly (other than in a taxable exchange, immediately before
separate units that are owned, directly or through a hybrid entity separate unit), by the disposition of the separate unit, for an
indirectly (other than through a hybrid en- the hybrid entity. This rule prevents two amount equal to their fair market value.
tity separate unit) by hybrid entities. In or more separate units from taking into ac- The proposed regulations clarify that for
such a case, only items that are attributable count the same item of income, gain, de- this purpose items of income and gain in-
to the hybrid entity that owns such sepa- duction or loss under different rules. clude loss recapture income or gain under
rate unit (and intervening entities, if any, section 367(a)(3)(C) or 904(f)(3).
that are not themselves separate units) are (h) Combined Separate Units The proposed regulations also address
taken into account. situations where more than one separate
As discussed above, the proposed regu-
This rule is intended to minimize the unit is disposed of in the same transaction
lations combine separate units owned, di-
items taken into account by a foreign and items of income, gain, deduction and
rectly or indirectly, by a single domestic
branch separate unit that the foreign ju- loss recognized on such disposition are at-
corporation, provided certain requirements
risdiction would not recognize as being tributable to more than one separate unit.
are satisfied. Because different rules may
so taken into account. This may occur in In such a case, items of income, gain, de-
apply for purposes of attributing items to
these cases because the foreign jurisdiction duction and loss are attributable to or taken
individual separate units that may be com-
taxes the hybrid entity as a corporation (or into account by each such separate unit
bined into a single separate unit, special
otherwise at the entity level) and therefore based on the gain or loss that would have
rules are necessary to attribute items to
likely would not take into account items been recognized by each separate unit if
combined separate units.
of its owner. For example, if a domestic it had sold all of its assets in a taxable
The proposed regulations provide that
corporation indirectly owns a Country exchange, immediately before the dispo-
in the case of a combined separate unit,
X foreign branch separate unit through sition of the separate unit, for an amount
items are first attributable to, or otherwise
a Country Y hybrid entity, Country X equal to their fair market value.
taken into account by, the individual sep-
likely would take into account items of
arate units composing the combined sep-
the Country Y hybrid entity as being items (j) Income Inclusion on Stock
arate unit, without regard to the combina-
of the Country X branch. It is unlikely,
tion rule. The combined separate unit then
however, that Country X would take into The current regulations do not indicate
takes into account all of the items attrib-
account items of the domestic corporation whether an amount included in income
utable to, or taken into account by, the in-
as items of the Country X branch because arising from the ownership of stock in a
dividual separate units that compose such
Country X views the owner of the Country foreign corporation (income inclusion) is
combined separate unit.
X branch (the Country Y hybrid entity) as attributable to or taken into account by a
a corporation. Therefore, only the items (i) Gain or Loss Recognized on separate unit that owns the stock that gave
of income, gain, deduction and loss of the Dispositions of Separate Units rise to the income inclusion. For exam-
Country Y hybrid entity (and not items of ple, if a domestic corporation has a sec-
the domestic corporation) should be taken The current regulations do not indicate tion 951(a) inclusion attributable to stock
into account for purposes of determining whether items of income, gain, deduction of a controlled foreign corporation that is
the dual consolidated loss of the Country and loss recognized on the sale or disposi- owned by a hybrid entity separate unit, it
X branch. tion of a separate unit, or of an interest in a is not clear under the current regulations
The proposed regulations also provide partnership or grantor trust through which whether such income inclusion is taken
that only income and assets of such hybrid a separate unit is indirectly owned, is at- into account for purposes of calculating the
entity are taken into account for purposes tributable to or taken into account by such dual consolidated loss of the hybrid entity
of applying the principles of section 864(c) separate unit for purposes of calculating separate unit.
and §1.882–5, as modified, in determining the dual consolidated loss of the separate The IRS and Treasury believe that,
the items taken into account by the foreign unit for the year of the sale (or for purposes solely for purposes of applying the dual
branch separate unit; thus, other income of reducing the amount of recapture as a re- consolidated loss rules, it is appropriate to
and assets of the domestic owner, for ex- sult of a triggering event). treat income inclusions arising from the
ample, are not taken into account for these The IRS and Treasury believe that it is ownership of stock in the same manner
purposes. This rule is also intended to en- appropriate to take into account items of that dividend income is treated. Accord-
sure that the principles under these provi- income, gain, deduction and loss recog- ingly, the proposed regulations provide
sions are applied in a way that best approx- nized on these dispositions. Thus, the pro- that income inclusions are taken into ac-
imates the items that the foreign jurisdic- posed regulations provide that items of in- count for purposes of calculating the dual

2005–25 I.R.B. 1307 June 20, 2005


consolidated loss of a separate unit if an affiliate, the consolidated group of which limitation that is subsequently absorbed
actual dividend from such foreign cor- the dual resident corporation is a member in a carryover or carryback year. Finally,
poration would have been so taken into must compute its taxable income without the rules provide that there is no basis
account. taking into account the items of income, increase for recapture income recognized
gain, deduction or loss taken into account as a result of a triggering event. Similar
(k) Section 987 Gain or Loss in computing the dual consolidated loss. rules apply to separate units arising from
The current regulations contain a similar ownership of an interest in a partnership.
Section 987 provides that if a taxpayer
rule for separate units. These special basis adjustment rules are
has one or more qualified business units
These rules do not exclude only the dual generally intended to prevent an indirect
with a functional currency other than the
consolidated loss in computing taxable in- deduction of a dual consolidated loss.
dollar, the taxpayer must make proper ad-
come, but instead provide that none of the The proposed regulations retain the spe-
justments to take into account foreign cur-
gross tax accounting items that compose cial stock basis adjustment rules, as modi-
rency gain or loss on certain transfers of
the dual consolidated loss are taken into fied, to prevent the indirect use of a dual
property between such qualified business
account. While this approach has the same consolidated loss. In addition, the pro-
units.
effect on net income as would excluding posed regulations retain the rules address-
In 1991, the IRS and Treasury issued
only the dual consolidated loss, removing ing the effect of a dual consolidated loss on
proposed regulations under section 987
all gross items of income, gain, deduction a partner’s adjusted basis in its partnership
that included rules for determining the
and loss may have a distortive effect on interest in cases where the partnership in-
amount of foreign currency gain or loss
other federal tax calculations. terest is a separate unit, or a separate unit
recognized on certain transfers of prop-
The IRS and Treasury believe that is owned indirectly through a partnership.
erty between qualified business units.
this distortive effect will be minimized if These rules require the partner to adjust its
On April 3, 2000, the IRS and Treasury
only the dual consolidated loss itself is basis in accordance with the principles of
issued Notice 2000–20, 2000–14 I.R.B.
not taken into account. Accordingly, the section 705, subject to certain modifica-
851, announcing that the IRS and Treasury
proposed regulations provide that only a tions.
intend to review and possibly replace the
pro rata portion of each item of deduction The IRS and Treasury recognize that
proposed regulations issued under section
and loss taken into account in computing these rules may lead to harsh results, par-
987. The IRS and Treasury have opened a
the dual consolidated loss are excluded in ticularly in light of the fact that the in-
regulations project under section 987 and
computing taxable income. In addition, direct use of the dual consolidated loss
expect to issue new section 987 regula-
to the extent that a dual consolidated loss would only arise through the disposition
tions in the future.
is carried over or carried back and, sub- of the stock of a dual resident corpora-
The current regulations do not provide
ject to §1.1502–21(c) (as modified in the tion (or a partnership interest) that may
specific rules that indicate whether section
proposed regulations), is made available not occur for many years after the dual
987 gains or losses of a domestic owner
to offset income generated by the dual consolidated loss is incurred. In addition,
are attributable to, or taken into account
resident corporation or separate unit, the upon such subsequent disposition the re-
by, a separate unit for purposes of cal-
proposed regulations treat items compos- sulting deduction or loss would generally
culating the separate unit’s dual consol-
ing the dual consolidated loss as being be capital in nature, and the definition of
idated loss. Because the IRS and Trea-
used on a pro rata basis. a dual consolidated loss excludes capital
sury have an open regulations project un-
losses incurred by the dual resident cor-
der section 987 and expect to issue new
3. Basis adjustments poration or separate unit. As a result, the
regulations under section 987, the IRS and
IRS and Treasury request comments re-
Treasury do not believe it is appropriate
Section 1.1503–2(d)(3) of the cur- garding concerns over these types of in-
to address this issue in the proposed reg-
rent regulations contains special basis direct uses and whether the special basis
ulations. The IRS and Treasury request
adjustment rules that override the nor- rules should be retained. These comments
comments on whether section 987 gains
mal investment adjustment rules under should consider whether the policies un-
and losses of a domestic owner should be
§1.1502–32 for stock of affiliated dual derlying section 1503(d) require basis ad-
attributable to, or taken into account by,
resident corporations or affiliated domes- justment rules that differ from other ba-
a separate unit, particularly with respect
tic owners owned by other members of sis adjustment rules that apply to non-cap-
to section 987 gains and losses attribut-
the consolidated group. These rules pro- ital, non-deductible expenses (for exam-
able to, or taken into account by, separate
vide that stock basis is reduced by a dual ple, rules under sections 705 and 1367, and
units owned indirectly through hybrid en-
consolidated loss, even though such loss §1.1502–32(b))
tity separate units.
is subject to the general limitation on the
2. Effect of a dual consolidated loss use of a dual consolidated loss to offset E. Exceptions to the Domestic Use
income of a domestic affiliate. To avoid Limitation Rule — §1.1503(d)–4
Section 1.1503–2(d)(2) of the current reducing the stock basis a second time
regulations provides that if a dual resident for the same dual consolidated loss, the 1. No possibility of foreign use
corporation has a dual consolidated loss rules also provide that no negative adjust-
that is subject to the general rule restricting ment shall be made for the amount of dual The proposed regulations provide a new
it from offsetting the income of a domestic consolidated loss subject to the general exception to the general rule prohibiting

June 20, 2005 1308 2005–25 I.R.B.


the domestic use of a dual consolidated Under this exception, the consolidated the IRS and Treasury believe that requiring
loss. To qualify under this exception, the group, unaffiliated dual resident corpora- taxpayers to comply with the dual consol-
consolidated group, unaffiliated dual resi- tion, or unaffiliated domestic owner must idated loss regulations, including the need
dent corporation, or unaffiliated domestic enter into an agreement ((g)(2)(i) agree- to monitor potential triggering events and
owner must: (1) demonstrate, to the sat- ment) certifying, among other things, that to comply with the various filing require-
isfaction of the Commissioner, that there no portion of the deductions or losses ments, for a 15-year period is unnecessar-
can be no foreign use of the dual consol- taken into account in computing the dual ily burdensome to both taxpayers and the
idated loss at any time; and (2) prepare a consolidated loss have been, or will be, Commissioner. As a result, the proposed
statement and attach it to its tax return for used to offset the income of any other per- regulations reduce the certification period
the taxable year in which the dual consoli- son under the income tax laws of a foreign from 15 years to seven years with respect
dated loss is incurred. This statement must country. to a domestic use election.
include an analysis, in reasonable detail The proposed regulations retain this
and specificity, supported with an official elective exception, with modifications, 4. Consistency rule
or certified English translation of the rele- and refer to it as a domestic use election.
Section 1.1503–2(g)(2)(ii) of the cur-
vant provisions of foreign law, of the treat- In addition, the proposed regulations re-
rent regulations contains a consistency
ment of the losses and deductions compos- fer to the consolidated group, unaffiliated
rule. Under this rule, if any losses, ex-
ing the dual consolidated loss, and the rea- dual resident corporation, or unaffiliated
penses, or deductions taken into account
sons supporting the conclusion that there domestic owner, as the case may be, that
in computing the dual consolidated loss of
cannot be a foreign use of the dual consol- makes a domestic use election as an elec-
a dual resident corporation or separate unit
idated loss by any means at any time. tor. In order to elect relief under this
are used to offset the income of another
This exception is intended to re- exception, the proposed regulations re-
person under the laws of a single foreign
place the exception to the definition of quire the elector to enter into a domestic
country while the dual resident corporation
a dual consolidated loss contained in use agreement, which is similar to the
or separate unit is owned by the domes-
§1.1503–2(c)(5)(ii)(A) of the current (g)(2)(i) agreement required by the current
tic owner or member of the consolidated
regulations. Thus, under the proposed regulations.
group, the losses, expenses, or deductions
regulations the question of foreign use
3. Certification period taken into account in computing the dual
is not relevant to the definition of a dual
consolidated losses of other dual resident
consolidated loss; the issue will instead
Under the current regulations, a corporations or separate units owned by
be whether an exception to the domestic
(g)(2)(i) agreement generally provides the same consolidated group (or other
use limitation applies. Consistent with
that if there is a triggering event during separate units owned by the unaffiliated
the exception to the definition of a dual
the 15-year period following the year domestic owner of the first separate unit)
consolidated loss contained in the current
in which the dual consolidated loss was in that year are deemed to offset income of
regulations, the IRS and Treasury believe
incurred (certification period), the tax- another person in the same foreign coun-
that this new exception to the domestic
payer must recapture and report as in- try. This rule only applies, however, if
use limitation rule contained in the pro-
come the amount of the dual consolidated such losses, expenses, or deductions are
posed regulations will apply only in rare
loss, and pay an interest charge. See recognized in the foreign country in the
and unusual circumstances due to the
§1.1503–2(g)(2)(iii)(A). same taxable year. Moreover, this rule
definition of foreign use and general prin-
Commentators have questioned does not apply if, under foreign law, the
ciples of foreign law. For example, if the
whether under the current regulations the other dual resident corporation or separate
foreign jurisdiction recognizes any item
15-year certification period applies only unit cannot use its losses, expenses, or
of deduction or loss composing the dual
to the use triggering event, or whether deductions to offset income of another
consolidated loss (regardless of whether
it applies to all triggering events. These person in such taxable year.
recognized currently or deferred, for ex-
commentators note that, under this inter- The consistency rule is intended to en-
ample, by being reflected in the basis of
pretation, triggering events other than use sure that a consolidated group or domes-
assets), and such item is available for for-
could occur after the expiration of the cer- tic owner treats uniformly all dual consol-
eign use through a form of consolidation,
tification period. The IRS and Treasury idated losses of dual resident corporations
carryover or carryback, or a transaction
believe that the certification period ap- or separate units that it owns that are avail-
(for example, a merger, basis carryover
plies to all triggering events. Accordingly, able for use in a foreign country in a given
transaction, or entity classification elec-
the proposed regulations clarify that all year. The rule is also intended to minimize
tion), then the exception will not apply.
triggering events are subject to the certifi- the administrative burden associated with
2. Domestic use election and agreement cation period and, therefore, a triggering identifying the items of loss or deduction
event cannot occur after the expiration of of a particular dual consolidated loss that
As discussed above, the current regula- the certification period. are used to offset income of another per-
tions provide an exception to the general The IRS and Treasury also believe that son under the income tax laws of a foreign
rule prohibiting the use of a dual consoli- a 15-year certification period is not re- country.
dated loss to offset the income of a domes- quired to deter and monitor double-dip-
tic affiliate if a (g)(2)(i) election is made. ping of losses and deductions. Moreover,

2005–25 I.R.B. 1309 June 20, 2005


Commentators have questioned the 6. Triggering events Separate Unit or Stock of a Dual Resident
need for the consistency rule, noting that Corporation
it can lead to harsh results. (a) In General
The IRS and Treasury believe that, de- The current regulations provide that
Section 1.1503–2(g)(2)(iii) of the cur-
spite concerns raised by commentators, the certain sales or other dispositions of 50
rent regulations provides rules relating to
consistency rule continues to be necessary percent or more of the assets of a sep-
certain events which require the recapture
to promote the uniform treatment of dual arate unit or dual resident corporation
of previously allowed dual consolidated
consolidated losses of dual resident cor- are deemed to be triggering events. See
losses. Under these rules, if a consoli-
porations and separate units owned by the §1.1503–2(g)(2)(iii)(A)(4) and (5). For
dated group, unaffiliated dual resident cor-
consolidated group or domestic owner, and this purpose, an interest in a separate unit
poration, or unaffiliated domestic owner,
to minimize administrative burdens. As a and stock of a dual resident corporation
as the case may be, makes a (g)(2)(i) elec-
result, the proposed regulations retain the are treated as assets of the separate unit or
tion, the dual resident corporation or sep-
consistency rule, as modified. dual resident corporation. One commen-
arate unit must recapture, and the con-
In addition, the proposed regulations tator stated that, as a result of this rule, the
solidated group, unaffiliated dual resident
clarify that the consistency rule only ap- disposition of an interest in one separate
corporation or unaffiliated domestic owner
plies to a dual consolidated loss that is sub- unit by another separate unit may inap-
must report as income the amount of the
ject to a domestic use agreement (other propriately result in a triggering event for
dual consolidated loss (and pay an inter-
than a new domestic use agreement). In both separate units. Accordingly, the com-
est charge) if a triggering event occurs
other words, the proposed regulations clar- mentator suggested that the disposition of
during the certification period. Taxpay-
ify that the consistency rule does not ap- the interest in the lower-tier separate unit
ers may, however, rebut these triggering
ply to a foreign use of a dual consolidated should not result in a triggering event with
events upon making certain showings to
loss that occurs subsequent to a trigger- respect to dual consolidated losses of the
the satisfaction of the Commissioner.
ing event that terminates the domestic use separate unit that disposed of such interest.
The proposed regulations generally re-
agreement filed with respect to such dual The IRS and Treasury believe that the
tain the triggering event rules contained in
consolidated loss. disposition of an interest in a lower-tier
the proposed regulations, as modified, if a
separate unit (or the shares of a dual res-
5. Restrictions on domestic use elections taxpayer makes a domestic use election.
ident corporation) by an upper-tier sepa-
(b) Carryover of Losses, Deductions, and rate unit (or dual resident corporation) typ-
The current regulations do not explic-
Basis ically will not result in the carryover of
itly address situations where a triggering
the dual consolidated loss of the upper-
event (discussed below) with respect to a
Under the current regulations, certain tier separate unit (or dual resident corpo-
dual consolidated loss occurs in the year
asset transfers by a dual resident corpora- ration) under the laws of the foreign juris-
in which the dual consolidated loss is in-
tion that result, under the laws of a foreign diction such that it could be put to a foreign
curred. The proposed regulations, how-
country, in a carryover of losses, expenses, use. Therefore, the proposed regulations
ever, make clear that a domestic use elec-
or deductions are triggering events. The provide that for purposes of determining
tion cannot be made for a dual consoli-
current regulations contain a similar rule whether 50 percent or more of the sepa-
dated loss incurred in the same year in
for such transfers by separate units. See rate unit’s or dual resident corporation’s
which a triggering event with respect to
§1.1503–2(g)(2)(iii)(A)(4) and (5). assets is disposed of, an interest in a sep-
such loss occurs.
The proposed regulations retain these arate unit and the stock of a dual resident
The current regulations also do not ex-
triggering events, as modified, and com- corporation shall not be treated as assets of
plicitly address the application of section
bine them into a single triggering event. the separate unit or dual resident corpora-
953(d)(3) (limiting losses of foreign insur-
The proposed regulations also clarify that tion making such disposition. The IRS and
ance companies that elect to be treated as
certain asset transfers that result in the car- Treasury request comments as to other as-
domestic corporations). The proposed reg-
ryover of basis in assets under the laws of sets the disposition of which should be ex-
ulations, however, provide that a foreign
a foreign country also qualify as triggering cluded from the 50 percent test under this
insurance company that has elected to be
events. This is the case because asset basis triggering event.
treated as a domestic corporation pursuant
generally will, at some point in the future,
to section 953(d) may not make a domes- (d) Fifty Percent Threshold for Asset
be converted into a loss or deduction as a
tic use election. This rule is consistent with Transfer Triggering Events
result of the depreciation, amortization or
section 953(d)(3), which broadly prohibits
disposition of the asset. Accordingly, un-
regulatory exceptions to the general prohi- Section 1.1503–2(g)(2)(iii)(A)(7) of
der foreign law, a transaction that results in
bition on the domestic use of dual consol- the current regulations provides that a trig-
the carryover of asset basis generally has
idated losses in such cases. gering event occurs if, within a 12-month
the same effect as a transaction that results
in the carryover of losses or deductions and period, the domestic owner of a separate
therefore should be treated similarly. unit disposes of 50 percent or more (by
voting power or value) of the interest in
(c) Disposition by a Separate Unit or Dual the separate unit that was owned by the
Resident Corporation of an Interest in a domestic owner on the last day of the

June 20, 2005 1310 2005–25 I.R.B.


taxable year in which the dual consoli- consolidated loss elects to be an S corpo- is contrary to the principles underlying the
dated loss was incurred. As noted above, ration pursuant to section 1362(a), such triggering events. Accordingly, the pro-
the current regulations also provide that election results in a triggering event be- posed regulations clarify that such transac-
a triggering event occurs if a domestic cause it terminates the consolidated group tions do not constitute group termination
owner of a separate unit transfers assets and the affiliated dual resident corpora- triggering events. See §1.1503(d)–5(c)
of the separate unit in a transaction that tion or affiliated domestic owner ceases Example 47.
results, under the laws of a foreign coun- to be a member of a consolidated group.
try, in a carryover of the separate unit’s See §1.1503–2(g)(2)(iii)(A)(2). The cur- 7. Rebuttal of triggering events
losses, expenses, or deductions. Section rent regulations do not, however, address
Under the current regulations, taxpay-
1.1503–2(g)(2)(iii)(A)(5). Moreover, the an election to be an S corporation by ei-
ers may rebut all but two of the trigger-
current regulations deem such an asset ther an unaffiliated dual resident corpora-
ing events such that there is no dual con-
transfer to be a triggering event if 50 per- tion or an unaffiliated domestic owner that
solidated loss recapture (or related inter-
cent or more of the separate unit’s assets has made a (g)(2)(i) election.
est charge) as a result of a putative trig-
(measured by fair market value at the The IRS and Treasury believe that the
gering event. In general, under the cur-
time of transfer) are disposed of within a election by an unaffiliated dual resident
rent regulations, a triggering event is re-
12-month period. corporation or unaffiliated domestic owner
butted if the taxpayer demonstrates to the
One commentator noted that the two to be an S corporation should be treated
satisfaction of the Commissioner that, de-
triggering events discussed above operate in the same manner as an election by an
pending on the triggering event, either:
differently in that any transfer of assets of affiliated dual resident corporation or af-
(1) the losses, expenses or deductions of
a separate unit may constitute a triggering filiated domestic owner that is a member
the dual resident corporation (or separate
event, while the transfer of an interest in a of a consolidated group. Accordingly, the
unit) cannot be used to offset income of
separate unit constitutes a triggering event proposed regulations add as a new trigger-
another person under the laws of a for-
only if a 50 percent threshold is met. ing event the election of either an unaffil-
eign country or; (2) the transfer of as-
The IRS and Treasury believe that these iated dual resident corporation or unaffil-
sets did not result in a carryover under
two triggering events should operate in a iated domestic owner to be an S corpora-
foreign law of the losses, expenses, or
consistent manner. As a result, the pro- tion.
deductions of the dual resident corpora-
posed regulations provide that both the as-
(f) Consolidated Group Remains in tion (or separate unit) to the transferee of
set transfer triggering event and the sepa-
Existence the assets. See §1.1503–2(g)(2)(iii)(A)(2)
rate unit interest transfer triggering event
through (7). The policies underpinning
occur only if a 50 percent threshold is sat-
As stated above, and subject to excep- the dual consolidated loss rules do not re-
isfied. It should be noted, however, that
tions, the current regulations provide that quire recapture or an interest charge in
transfers of assets of a dual resident corpo-
a triggering event occurs with respect to a such cases because there is no opportu-
ration or separate unit, and transfers of in-
dual consolidated loss of an affiliated dual nity for any portion of the dual consoli-
terests of separate units, in many cases will
resident corporation or affiliated domestic dated loss to be used to offset income of
subsequently result in a foreign use trig-
owner if such dual resident corporation any other person under the income tax laws
gering event, even though the 50 percent
or affiliated domestic owner ceases to be of a foreign country.
threshold for the asset transfer triggering
a member of the consolidated group of The rebuttal rules impose a standard
event and the separate unit interest trans-
which it was a member when the dual con- of proof on taxpayers that in many cases
fer triggering event are not satisfied. For
solidated loss was incurred. The current is difficult and burdensome to meet, even
example, if a domestic owner of an inter-
regulations also provide that an affili- though there may be little likelihood that
est in a hybrid entity separate unit transfers
ated dual resident corporation or affiliated any portion of the dual consolidated loss
25 percent of its interest in the hybrid en-
domestic owner is considered to cease could be used to offset the income of any
tity separate unit to a foreign corporation,
to be a member of a consolidated group other person under the income tax laws of
all or a portion of a dual consolidated loss
if the consolidated group ceases to ex- a foreign country. For example, demon-
attributable to such separate unit in a prior
ist (group termination triggering event) strating that no portion of the dual consol-
year may be available to offset subsequent
because, for example, the common par- idated loss can be used by another person
income of the owner of the transferred in-
ent is no longer in existence. Section as a result of typical loss carryover trans-
terest (that is not a separate unit after such
1.1503–2(g)(2)(iii)(A)(2). actions under foreign law may not satisfy
transfer because it is held by a foreign cor-
One commentator stated that language the burden if there is some potential that
poration) and therefore may result in a for-
contained in Revenue Procedure 2000–42, any portion of losses or deductions com-
eign use triggering event.
2000–2 C.B. 394, may imply that there is posing the dual consolidated loss could be
(d) S Corporation Conversion a group termination triggering event if the so used as a result of a transaction that is
common parent of a consolidated group rare, commercially impractical, or not rea-
Under the current regulations, if either that made a (g)(2)(i) election ceases to sonably foreseeable. In addition, because
an affiliated dual resident corporation or an exist, or is a party to a reverse acquisi- there are often significant differences be-
affiliated domestic owner that has filed a tion, even though the consolidated group tween U.S. and foreign law, ruling out the
(g)(2)(i) agreement with respect to a dual remains in existence. This interpretation various types of transactions that under

2005–25 I.R.B. 1311 June 20, 2005


U.S. law would allow all or a portion of payers that result in triggering events will burden associated with rebutting the trig-
the dual consolidated loss to be used by an- be significantly reduced, as compared to gering events, while ensuring that there
other person also may not be sufficient to the current regulations, because of the sig- is little or no likelihood that a significant
rebut a triggering event. nificant reduction in the term of the certi- portion of the dual consolidated loss can
Commentators have noted that under fication period. Nevertheless, the IRS and be put to a foreign use.
the current regulations it may not be pos- Treasury believe that the current rebuttal
sible to rebut certain triggering events if standard may exceed that required to ad- 8. Triggering event exception for
the tax basis of a single asset carries over dress adequately the concern that all or a acquisition by an unaffiliated domestic
to another person under foreign law, even portion of a dual consolidated loss could corporation or a new consolidated group
though as a result of the transaction recog- be put to a foreign use. Moreover, the IRS
nized losses and accrued deductions gen- and Treasury believe that more definitive Section 1.1503–2(g)(2)(iv)(B)(1) of the
erally do not carry over to another person and administrable rebuttal rules should be current regulations provides that if certain
under foreign law. This is the case because provided to assist taxpayers and the Com- requirements are satisfied, the following
the person that receives the carryover asset missioner in determining whether the trig- events do not constitute triggering events:
basis may at some point in the future enjoy gering event has been rebutted, and to min- (1) an affiliated dual resident corporation
the benefit of a loss or deduction as a result imize situations where there is recapture or affiliated domestic owner becomes an
of the depreciation, amortization or dispo- of a dual consolidated loss even though unaffiliated domestic corporation or a
sition of the asset. As a result, the carry- it may be unlikely that a significant por- member of a new consolidated group (un-
over of a nominal amount of asset tax basis tion of the dual consolidated loss could be less such transaction also qualifies under
causes the entire dual consolidated loss to put to a foreign use. Therefore, it is an- another exception); (2) assets of a dual
be recaptured. Similar issues arise in con- ticipated that, prior to the finalization of resident corporation or a separate unit
nection with assumptions of liabilities that, these proposed regulations, a revenue pro- are acquired by an unaffiliated domestic
for example, result in deductions for U.S. cedure will be issued that will provide safe corporation or a member of a new consol-
tax purposes on an accrual basis, but are harbors whereby triggering events will be idated group; or (3) a domestic owner of
deductible under the laws of the foreign ju- deemed to be rebutted if the taxpayer satis- a separate unit transfers its interest in the
risdiction at a later time when paid. This fies various conditions. The revenue pro- separate unit to an unaffiliated domestic
result is consistent with the all or nothing cedure may be issued in proposed form and corporation or to a member of a new con-
principle, discussed below. then made final contemporaneously with solidated group.
The IRS and Treasury recognize that these regulations. The first requirement necessary for this
in some of these cases the use of a por- It is anticipated that the conditions con- exception to apply is that the consolidated
tion of a dual consolidated loss may be tained in the revenue procedure would group, unaffiliated dual resident corpora-
denied in both the United States and the include the requirement that taxpayers tion, or unaffiliated domestic owner that
foreign jurisdiction. Further, commenta- demonstrate, to the satisfaction of the made the (g)(2)(i) election, and the unaf-
tors have stated that denying a loss or de- Commissioner, that there can be no for- filiated domestic corporation or new con-
duction from offsetting income in both the eign use of any significant portion of the solidated group must enter into a clos-
United States and the foreign jurisdiction dual consolidated loss as a result of cer- ing agreement with the IRS providing that
generally is inconsistent with the princi- tain enumerated transactions. It is also both parties will be jointly and severally li-
ples underlying section 1503(d) because anticipated that the revenue procedure will able for the total amount of the recapture
the statute’s purpose is to prevent the use address, and in some cases provide relief of the dual consolidated loss and interest
of the same loss or deduction to offset in- for, transactions that result in a de minimis charge upon a subsequent triggering event.
come in multiple jurisdictions. carry over of asset basis under foreign law Second, the unaffiliated domestic corpora-
The proposed regulations retain the and are difficult or impossible to rebut tion or new consolidated group must agree
rebuttal standard contained in the current under the current regulations. Finally, the to treat any potential recapture as unre-
regulations, with modifications. Taxpay- revenue procedure may provide relief for alized built-in gain for purposes of sec-
ers may rebut a triggering event under the triggering events resulting from the as- tion 384, subject to any applicable excep-
proposed regulations if it can be demon- sumption of liabilities in connection with tions thereunder. Finally, the unaffiliated
strated, to the satisfaction of the Commis- the acquisition of a trade or business as a domestic corporation or new consolidated
sioner, that there can be no foreign use of result of liabilities incurred in the ordinary group must file with its timely filed income
the dual consolidated loss. In addition, course of business being deductible at dif- tax return for the year in which the event
unlike the current regulations that have ferent times under U.S. law and the law of occurs a (g)(2)(i) agreement (new (g)(2)(i)
different standards for different triggering the foreign jurisdiction. agreement), whereby it assumes the same
events, the proposed regulations apply The IRS and Treasury request com- obligations with respect to the dual consol-
the same standard to all triggering events ments regarding the transactions that idated loss as the corporation or consoli-
(other than a foreign use triggering event, should be included in the revenue proce- dated group that filed the original (g)(2)(i)
which cannot be rebutted). dure, approaches to address basis carry- agreement with respect to that loss.
The IRS and Treasury believe that when over transactions and liabilities assumed On July 30, 2003, the IRS and Trea-
the proposed regulations are finalized the in the ordinary course of business, and sury issued final regulations (T.D. 9084,
number of transactions undertaken by tax- other ways to minimize the administrative 2003–2 C.B. 742) (2003 regulations), pub-

June 20, 2005 1312 2005–25 I.R.B.


lished in the Federal Register at 68 FR Pursuant to the new domestic use agree- corporation or a hybrid entity separate
44616, that limited the need for closing ment, the subsequent elector must: (1) unit, the consolidated group, unaffiliated
agreements to avoid triggering events to agree to assume the same obligations with dual resident corporation, or unaffiliated
only those three transactions described respect to the dual consolidated loss as the domestic owner, as the case may be, must
above. The preamble to the 2003 reg- original elector had pursuant to its domes- file with its tax return an annual certifica-
ulations explained that in certain cases tic use agreement; (2) agree to treat any po- tion during the certification period. This
the requirement for a closing agreement tential recapture of the dual consolidated filing certifies that the losses or deductions
resulted in an unnecessary administra- loss at issue as unrealized built-in gain pur- that make up the dual consolidated loss
tive burden because the several liability suant to section 384, subject to any appli- have not been used to offset the income of
imposed by §1.1502–6, in conjunction cable exceptions thereunder; (3) agree to another person under the tax laws of a for-
with the original (g)(2)(i) agreement and be subject to the successor elector rules, eign country. The filing also warrants that
a new (g)(2)(i) agreement, provided for discussed below; and (4) identify the orig- arrangements have been made to ensure
liability sufficiently comparable to that inal elector (and subsequent electors, if that there will be no such use of the dual
imposed under a closing agreement. Ac- any). Pursuant to the statement filed by the consolidated loss and that the taxpayer
cordingly, the 2003 regulations provided original elector, the original elector must will be informed if any such use were to
that if a new (g)(2)(i) agreement is filed by agree to be subject to the subsequent elec- occur. The current regulations do not,
the unaffiliated domestic corporation or tor rules and must identify the subsequent however, require annual certifications for
new consolidated group, a closing agree- elector. dual consolidated losses of foreign branch
ment is not required in the following two separate units.
instances: (1) an unaffiliated dual resi- 9. Triggering event exception — private The IRS and Treasury believe that an-
dent corporation or unaffiliated domestic letter ruling and closing agreement option nual certifications of dual consolidated
owner that filed a (g)(2)(i) agreement losses improve taxpayer compliance with
becomes a member of a consolidated Under the current regulations, only spe- the dual consolidated loss rules and are
group; and (2) a consolidated group that cific triggering events can qualify for an beneficial to the Commissioner in mon-
filed a (g)(2)(i) agreement ceases to exist exception as a result of the parties enter- itoring such compliance. The IRS and
as a result of a transaction described in ing into a closing agreement. Therefore, Treasury also believe that foreign branch
§1.1502–13(j)(5)(i) (unless a member of the IRS will not consider entering into a separate units, hybrid entity separate units,
the terminating group, or successor-in-in- closing agreement in other circumstances, and dual resident corporations should, to
terest of such member, is not a member of even though the government’s interests the extent possible, be treated consistently
the surviving group immediately after the may be adequately protected in such cir- to reduce complexity. As a result, the
terminating group ceases to exist). cumstances such that recapture may not proposed regulations expand the annual
The preamble to the 2003 regulations be necessary. certification requirement to include dual
noted that the IRS and Treasury were con- Although the proposed regulations consolidated losses of foreign branch sep-
tinuing to consider other alternatives to eliminate the need for a closing agreement arate units. However, the reduction in the
further reduce the administrative and com- to qualify for an exception to trigger- certification period from 15 years to seven
pliance burdens under section 1503(d). ing events, discussed above, the IRS and years should substantially reduce the over-
After further consideration, the IRS and Treasury are considering whether in lim- all compliance burden of this requirement.
Treasury believe that, as a result of various ited cases it may be appropriate for the
requirements contained in the proposed Commissioner, in its sole discretion and 11. Amount of recapture
regulations, there are sufficient protec- subject to the taxpayer satisfying condi-
tions specified by the Commissioner, to As stated above, under the current reg-
tions, independent of a closing agreement,
enter into closing agreements with taxpay- ulations a triggering event (other than a
in all cases in which a closing agreement
ers such that certain other events would foreign use) generally can be rebutted
is otherwise required under the current
not be triggering events. Comments are only if no portion of the dual consolidated
regulations. As a result, the proposed
requested as to the specific and limited loss can be used by (or carries over to)
regulations eliminate the closing agree-
types of triggering events that may be suit- another person under foreign law. See
ment requirement contained in the current
able for this exception, taking into account §1.1503–2(g)(2)(iii)(A)(2) through (7).
regulations and provide an exception to
the policies underlying section 1503(d), Thus, if even a de minimis portion of the
triggering events in all such cases (subse-
administrative burdens, and the general dual consolidated loss can be used by (or
quent elector events) if: (1) the unaffiliated
interests of the U.S. government. carries over to) another person, the trigger-
domestic corporation or new consolidated
ing event cannot be rebutted. Similarly,
group (subsequent elector) enters into a
10. Annual certification reporting §1.1503–2(g)(2)(vii)(A) of the current
domestic use agreement (new domestic
requirement regulations provides that if a triggering
use agreement); and (2) the corporation or
event occurs, the entire dual consolidated
consolidated group that filed the original
Section 1.1503–2T(g)(2)(vi)(B) of loss subject to the (g)(2)(i) agreement (re-
domestic use agreement (original elector)
the current regulations provides that if a duced by income earned subsequently by
files a statement with its tax return for the
(g)(2)(i) election is made with respect to the dual resident corporation or separate
year of the event.
a dual consolidated loss of a dual resident unit) is recaptured and reported as income,

2005–25 I.R.B. 1313 June 20, 2005


regardless of the amount of the dual con- general framework of the proposed regula- sequent elector must calculate the recap-
solidated loss used by the other person. tions and would be administrable. ture tax amount with respect to the dual
Thus, even a de minimis foreign use will consolidated loss subject to the new do-
cause the entire amount of the dual consol- 12. Subsequent elector rules mestic use agreement and include it, along
idated loss to be recaptured and reported with an identification of the dual consoli-
as income. Neither the current regulations nor Rev. dated losses at issue and the original elec-
This so-called all or nothing principle Proc. 2000–42, 2000–2 C.B. 394, ex- tor, on a statement attached to its tax re-
is included in the current regulations pri- plicitly address the consequences result- turn. The subsequent elector calculates
marily due to administrative concerns. In ing from a triggering event (to which no the recapture tax amount based on a with
many cases, the exact amount of the dual exception applies) with respect to a dual and without calculation. The recapture tax
consolidated loss that is used by another consolidated loss that was not recaptured amount equals the excess (if any) of the in-
person cannot be readily determined. This due to an earlier triggering event as a re- come tax liability of the subsequent elector
inability is due, in part, to differences be- sult of the parties entering into a closing for the taxable year of the subsequent trig-
tween U.S. and foreign law. For exam- agreement. In such a case, both parties gering event, over the income tax liability
ple, there may be temporary and perma- are jointly and severally liable for the to- of the subsequent elector for such taxable
nent differences in the treatment of items tal amount of the recapture of the dual year computed by excluding the amount of
of income, gain, deduction and loss. There consolidated loss and interest charge re- recapture and related interest charge with
may also be differences in loss carryover sulting from such a subsequent triggering respect to the dual consolidated losses at
provisions. These concerns are exacer- event. However, it is unclear which tax- issue.
bated by the principle that certain deduc- payer must report the recapture income In addition, the proposed regulations
tions are fungible and, therefore, cannot (and related interest charge) on its tax re- provide rules regarding tax assessment and
easily be traced to a particular loss incurred turn upon the subsequent triggering event. collection procedures. The proposed regu-
in a particular year. In addition, there is little or no procedural lations provide that an assessment identi-
Commentators have noted that in some guidance outlining how, pursuant to a clos- fying an income tax liability of the subse-
cases the all or nothing principle results in ing agreement, the IRS would collect re- quent elector is considered an assessment
a disallowance of deductions in both the capture tax and the related interest charge of the recapture tax amount where such
United States and the foreign jurisdiction. from the parties to the closing agreement. amount is part of the income tax liabil-
Nevertheless, the IRS and Treasury be- Accordingly, the proposed regulations ity being assessed and the recapture tax
lieve that making a precise determination contain rules regarding subsequent elec- amount is reflected in the statement at-
as to the amount of the dual consolidated tors. These rules apply when, subsequent tached to the subsequent elector’s tax re-
loss put to a foreign use would require the to an event that is not a triggering event turn. The recapture tax amount is con-
Commissioner and taxpayers to analyze because the unaffiliated domestic corpora- sidered to be properly assessed as an in-
foreign law in great detail and, in some tion or new consolidated group enters into come tax liability of the original elector,
cases, compare the treatment of items un- a new domestic use agreement and satis- and each prior subsequent elector, if any,
der foreign law with their treatment under fies other requirements (excepted event), on the same date the income tax liability
U.S. law. Such an analysis, however, is a triggering event occurs, and no excep- of the subsequent elector was properly as-
inconsistent with the principle underlying tion applies to such event (subsequent trig- sessed. This liability is joint and several.
the regulations that, to the extent possible, gering event). The proposed regulations The proposed regulations also provide
the Commissioner and taxpayers should also provide rules that apply in the case procedures pursuant to which any unpaid
not be required to analyze foreign law. of multiple subsequent electors (when sub- balance of the recapture tax amount may
Moreover, departing from the all or noth- sequent to an excepted event, another ex- be collected from the original elector and
ing principle would likely require detailed cepted event occurs). the prior subsequent elector, if any. Such
ordering, stacking, and tracing rules to de- The proposed regulations first provide amounts may be collected from the orig-
termine the amount and nature of dual con- that, except to the extent provided under inal elector, and/or any prior subsequent
solidated losses that are recaptured upon the subsequent elector rules, the original elector, if each of the following conditions
a use. Such rules would add considerable elector (and in the case of multiple ex- is satisfied: (1) the Commissioner has
complexity to the regulations. As a result, cepted events, any prior subsequent elec- properly assessed the recapture amount;
the proposed regulations retain the all or tor) is not subject to the general recapture (2) the Commissioner has issued a notice
nothing rule contained in the current reg- and interest charge rules provided under and demand for payment of the recapture
ulations. However, the IRS and Treasury the regulations. As a result, only the sub- tax amount to the subsequent elector; (3)
request comments regarding administrable sequent elector that owns the dual resident the subsequent elector has failed to pay all
alternatives to the all or nothing rule that corporation or separate unit at the time of of the recapture tax amount by the date
would not involve substantial analyses of the subsequent triggering event is subject specified in such notice and demand; and
foreign law. For example, comments are to the general recapture and interest charge (4) the Commissioner has issued a notice
requested as to whether a pro rata recap- rules. and demand for payment of the unpaid
ture rule with respect to dispositions of The proposed regulations also provide portion of the recapture tax amount to
separate units would be consistent with the that, upon a subsequent triggering event the original elector and prior subsequent
to which no exception applies, the sub- electors, if any. If the subsequent elector’s

June 20, 2005 1314 2005–25 I.R.B.


income tax liability for a taxable period attempts to simplify the rules and make circumstances; for example, the Commis-
includes a recapture amount, and if such them more administrable, rather than pro- sioner may consider applying the accu-
income tax liability is satisfied in part viding comprehensive stacking, ordering, racy-related penalty of section 6662. In
by payment, credit, or offset, such amount and tracing rules that track the ultimate use addition, the IRS and Treasury will con-
shall be allocated first to that portion of the of such items, which would be complex. tinue to consider whether a penalty provi-
income tax liability that is not attributable sion, similar to the one contained in the
to the recapture tax amount, and then to 14. Failure to comply with recapture current regulations, is appropriate, espe-
that portion of the income tax liability that provisions cially in cases of repeated non-compliance.
is attributable to the recapture tax amount.
Under the current regulations, if the tax- F. Effective Date — §1.1503(d)–6
Finally, the proposed regulations con-
payer fails to comply with the recapture
tain rules regarding the refund of an in-
provisions upon the occurrence of a trig- The proposed regulations are proposed
come tax liability that includes a recapture
gering event, the dual resident corporation to apply to dual consolidated losses in-
tax amount.
or separate unit that incurred the dual con- curred in taxable years beginning after the
13. Character and source of recapture solidated loss (or successor-in-interest) is date that these proposed regulations are
income not eligible to enter into a (g)(2)(i) agree- published as final regulations in the Fed-
ment with respect to any dual consolidated eral Register.
Section 1.1503–2(g)(2)(vii)(D) of the losses incurred in the five taxable years be- The IRS and Treasury request com-
current regulations provides that recapture ginning with the taxable year in which re- ments on the application of the regula-
income is treated as ordinary income hav- capture is required. The current regula- tions, including comments as to whether
ing the same source and falling within the tions contain two exceptions to this rule the proposed regulations, when finalized,
same separate category under section 904 that apply unless the triggering event is an should contain an election that would al-
as the dual consolidated loss being recap- actual use of the dual consolidated loss. low taxpayers to apply all or a portion of
tured. The current regulations do not, how- Under the first exception, the rule does not the regulations retroactively. In addition,
ever, provide an explicit rule to identify the apply if the failure to comply is due to rea- comments are requested as to possible
items that compose the dual consolidated sonable cause. Under the second excep- transition rules that may apply, including
loss. As a result, it is unclear under the tion, the rule does not apply if the taxpayer the application of the proposed regula-
current regulations how to determine the unsuccessfully attempted to rebut the trig- tions, when finalized, to existing (g)(2)(i)
source and separate category of recapture gering event by timely filing a rebuttal agreements.
income. In addition, the current regula- statement with its tax return.
tions do not explicitly state how the recap- This provision is intended to encour- Effect on Other Documents
ture income is treated for purposes of the age taxpayers to carefully monitor poten-
When these proposed regulations are
Code other than section 904. tial triggering events and properly comply
adopted as final regulations, Rev. Proc.
The proposed regulations clarify that with the recapture provisions upon the oc-
2000–42, 2000–2 C.B. 394, will be ob-
the character (to the extent consistent with currence of a triggering event.
solete with respect to dual consolidated
the recapture income being ordinary in- The IRS and Treasury believe that the
losses incurred in taxable years beginning
come in all cases) and source of the re- failure to comply penalty contained in the
after the date that these proposed regula-
capture income is determined based on the current regulations often does not oper-
tions are published as final regulations in
character and source of a pro rata portion ate in a manner that encourages compli-
the Federal Register.
of the deductions that were taken into ac- ance with the dual consolidated loss reg-
count in calculating the dual consolidated ulations. For example, if a taxpayer sells Special Analyses
loss. As discussed above, the dual consol- a dual resident corporation to a third party
idated loss is composed of a pro rata por- that is treated as a triggering event, but the It has been determined that this notice
tion of all items of deduction and loss that taxpayer fails to comply with the recap- of proposed rule making is not a signifi-
are taken into account in computing such ture rules, the rule contained in the cur- cant regulatory action as defined in Exec-
dual consolidated loss. Moreover, the pro- rent regulations prevents the purchaser of utive Order 12866. Therefore, a regulatory
posed regulations clarify that the determi- the dual resident corporation from entering assessment is not required. It is hereby cer-
nation of the character and source of such into a (g)(2)(i) agreement with respect to tified that these regulations will not have
income is not limited to section 904, but dual consolidated losses of the dual resi- a significant economic impact on a sub-
applies for all purposes of the Code (for ex- dent corporation for five years; it does not stantial number of small entities. This cer-
ample, section 856(c)(2) and (3)). adversely affect the taxpayer that failed to tification is based on the fact that these
Under the proposed regulations, the properly comply with the recapture provi- regulations will primarily affect affiliated
character and source of losses and de- sions. As a result, the proposed regulations groups of corporations that also have a for-
ductions composing the dual consolidated do not include this penalty provision. eign affiliate, which tend to be larger busi-
loss should be identified during the year Although the proposed regulations do nesses. Moreover, the number of taxpay-
in which they are incurred, rather than not retain this penalty provision, the Com- ers affected and the average burden are
the year in which they are ultimately used missioner may consider applying other ap- minimal. Therefore, a Regulatory Flexi-
to offset income or gain. This approach plicable penalty provisions in appropriate bility Analysis is not required. Pursuant to

2005–25 I.R.B. 1315 June 20, 2005


section 7805(f) of the Code, these regula- Paragraph 1. The authority citation for (i) Dilution of an interest in a separate
tions will be submitted to the Chief Coun- part 1 is amended by adding entries in nu- unit.
sel for Advocacy of the Small Business merical order to read as follows: (ii) Consolidation and other prohibited
Administration for comment on their im- Authority: 26 USC 7805 * * * uses.
pact on small business. §1.1503(d) also issued under 26 U.S.C. (iv) Ordering rules for determining the
953(d) and 26 U.S.C. 1502 foreign use of losses.
Comments and Public Hearing Par. 2. In §1.1502–21, paragraph (v) Mirror legislation rule.
(c)(2)(v) is amended by removing (15) Grantor trust.
A public hearing has been scheduled for the language “§1.1503–2” and adding (c) Special rules for filings under sec-
September 7, 2005, at 10 a.m., in the Au- “§§1.1503(d)–1 through 1.1503(d)–6” in tion 1503(d).
ditorium of the Internal Revenue Building, its place. (1) Reasonable cause exception.
1111 Constitution Avenue, NW, Washing- Par. 3. New §§1.1503(d)–0 through (2) Signature requirement.
ton, DC. Because of access restrictions, 1.1503(d)–6 are added to read as follows:
visitors must enter at the main entrance, §1.1503(d)–2 Operating rules.
located at 1111 Constitution Avenue, NW. §1.1503(d)–0 Table of contents.
All visitors must present photo identifica- (a) In general.
tion to enter the building. Because of ac- This section lists the captions contained (b) Limitation on domestic use of a dual
cess restrictions, visitors will not be admit- in §§1.1503(d)–1 through 1.1503(d)–6. consolidated loss.
ted beyond the immediate entrance more (c) Elimination of a dual consolidated
§1.1503(d)–1 Definitions and special loss after certain transactions.
than 30 minutes before the hearing starts.
rules for filings under section 1503(d). (1) General rules.
For information about having your name
placed on the building access list to attend (i) Dual resident corporation.
(a) In general.
hearing, see the “FOR FURTHER INFOR- (ii) Separate unit.
(b) Definitions.
MATION CONTACT” portion of this pre- (A) General rule.
(1) Domestic corporation.
amble. (B) Combined separate unit.
(2) Dual resident corporation.
The rules of 26 CFR 601.601(a)(3) ap- (2) Exceptions.
(3) Hybrid entity.
ply to the hearing. Persons who wish to (i) Certain section 368(a)(1)(F) reorga-
(4) Separate unit.
present oral comments must submit writ- nizations.
(i) In general.
ten or electronic comments and an outline (ii) Acquisition of a dual resident cor-
(ii) Separate unit combination rule.
of the topic to be discussed and time to be poration by another dual resident corpora-
(iii) Indirectly.
devoted to each topic (preferably a signed tion.
(5) Dual consolidated loss.
original and eight (8) copies) by August (iii) Acquisition of a separate unit by a
(6) Subject to tax.
22, 2005. A period of 10 minutes will be domestic corporation.
(7) Foreign country.
allotted to each person for making com- (d) Special rule denying the use of a
(8) Consolidated group.
ments. An agenda showing the scheduling dual consolidated loss to offset tainted in-
(9) Domestic owner.
of the speakers will be prepared after the come.
(10) Affiliated dual resident corpora-
deadline for receiving outlines has passed. (1) In general.
tion and affiliated domestic owner.
Copies of the agenda will be available free (2) Tainted income.
(11) Unaffiliated dual resident corpo-
of charge at the hearing. (i) Definition.
ration, unaffiliated domestic corporation,
(ii) Income presumed to be derived
and unaffiliated domestic owner.
Drafting Information from holding tainted assets.
(12) Domestic affiliate.
(3) Tainted assets defined.
(13) Domestic use.
The principal author of these regula- (4) Exceptions.
(14) Foreign use.
tions is Kathryn T. Holman of the Of- (e) Computation of foreign tax credit
(i) In general.
fice of Associate Chief Counsel (Interna- limitation.
(ii) Available for use.
tional). However, other personnel from the (iii) Exceptions.
IRS and Treasury Department participated §1.1503(d)–3 Special rules for accounting
(A) No election to enable foreign use. for dual consolidated losses.
in their development. (B) Presumed use where no foreign
***** country rule for determining use. (a) In general.
(C) No dilution of an interest in a sepa- (b) Determination of amount of dual
Proposed Amendments to the rate unit. consolidated loss.
Regulations (1) General rules. (1) Affiliated dual resident corporation.
(i) Interest in a hybrid entity partnership (2) Separate unit.
Accordingly, 26 CFR part 1 is proposed or hybrid entity grantor trust. (i) General rules.
to be amended as follows: (ii) Indirectly owned separate units. (ii) Foreign branch separate unit.
(iii) Combined separate unit. (A) In general.
PART 1—INCOME TAXES (2) Exceptions. (B) Principles of §1.882–5.

June 20, 2005 1316 2005–25 I.R.B.


(iii) Hybrid entity. (b) Elective agreement in place between (iii) Recapture tax amount and required
(A) General rule. the United States and a foreign country. statement.
(B) Interest in a non-hybrid partnership (c) No possibility of foreign use. (A) In general.
and a non-hybrid grantor trust. (1) In general. (B) Recapture tax amount.
(iv) Interest in a disregarded hybrid en- (2) Statement. (iv) Tax assessment and collection pro-
tity. (d) Domestic use election. cedures.
(v) Items attributable to an interest in (1) In general. (A) In general.
a hybrid entity partnership and a separate (2) Consistency rule. (1) Subsequent elector.
unit owned indirectly through a partner- (3) Restrictions on domestic use elec- (2) Original elector and prior subse-
ship. tion. quent electors.
(vi) Items attributable to an interest in a (i) Triggering event in year of dual con- (B) Collection from original elector and
hybrid entity grantor trust and a separate solidated loss. prior subsequent electors; joint and several
unit owned indirectly through a grantor (ii) Losses of a foreign insurance com- liability.
trust. pany treated as a domestic corporation. (C) Allocation of partial payments of
(vii) Special rules. (e) Triggering events requiring the re- tax.
(A) Allocation of items between certain capture of a dual consolidated loss. (D) Refund.
tiered separate units. (1) Events. (v) Definition of income tax liability.
(B) Combined separate unit. (i) Foreign use. (vi) Example.
(C) Gain or loss on the direct or indirect (ii) Disaffiliation. (4) Computation of taxable income in
disposition of a separate unit. (iii) Affiliation. year of recapture.
(D) Income inclusion on stock. (iv) Transfer of assets. (i) Presumptive rule.
(3) Foreign tax treatment disregarded. (v) Transfer of an interest in a separate (ii) Rebuttal of presumptive rule.
(4) Items generated or incurred while a unit. (5) Character and source of recapture
dual resident corporation or a separate unit. (vi) Conversion to a foreign corpora- income.
(c) Effect of a dual consolidated loss on tion. (6) Reconstituted net operating loss.
a domestic affiliate. (vii) Conversion to an S corporation. (i) Termination of domestic use agree-
(1) Dual resident corporation. (viii) Failure to certify. ment and annual certifications.
(2) Separate unit. (2) Rebuttal. (1) Rebuttal of triggering event.
(3) SRLY limitation. (f) Exceptions. (2) Exception to triggering event.
(4) Items of a dual consolidated loss (1) Acquisition by a member of the con- (3) Recapture of dual consolidated loss.
used in other taxable years. solidated group. (4) Termination of ability for foreign
(d) Special basis adjustments. (2) Acquisition by an unaffiliated do- use.
(1) Affiliated dual resident corporation mestic corporation or a new consolidated (i) In general.
or affiliated domestic owner. group. (ii) Statement.
(i) Dual consolidated loss subject to do- (i) Subsequent elector events.
mestic use limitation. (ii) Non-subsequent elector events. §1.1503(d)–5 Examples.
(ii) Dual consolidated loss absorbed in (iii) Requirements.
carryover or carryback year. (A) New domestic use agreement. (a) In general.
(iii) Recapture income. (B) Statement filed by original elector. (b) Presumed facts for examples.
(2) Interests in hybrid entities that are (3) Subsequent triggering events. (c) Examples.
partnerships or interests in partnerships (g) Annual certification reporting re- §1.1503(d)–6 Effective date.
through which a separate unit is owned quirement.
indirectly. (h) Recapture of dual consolidated loss §1.1503(d)–1 Definitions and special
(i) Scope. and interest charge. rules for filings under section 1503(d).
(ii) Determination of basis of partner’s (1) Presumptive rules.
interest. (i) Amount of recapture. (a) In general. This section and
(A) Dual consolidated loss subject to (ii) Interest charge. §§1.1503(d)–2 through 1.1503(d)–6 pro-
domestic use limitation. (2) Reduction of presumptive recapture vide general rules concerning the determi-
(B) Dual consolidated loss absorbed in amount and presumptive interest charge. nation and use of dual consolidated losses
carryover or carryback year. (i) Amount of recapture. pursuant to section 1503(d). This section
(C) Recapture income. (ii) Interest charge. provides definitions that apply for pur-
(3) Examples. (3) Rules regarding subsequent elec- poses of this section and §§1.1503(d)–2
tors. through 1.1503(d)–6. This section also
§1.1503(d)–4 Exceptions to the domestic (i) In general. provides a reasonable cause exception and
use limitation rule. (ii) Original elector and prior subse- a signature requirement for filings under
quent electors not subject to recapture or this section and §§1.1503(d)–2 through
(a) In general. interest charge. 1.1503(d)–4.

2005–25 I.R.B. 1317 June 20, 2005


(b) Definitions. The following defini- (A) If the individual separate unit is a (11) Unaffiliated dual resident corpo-
tions apply for purposes of this section and foreign branch separate unit, it is located ration, unaffiliated domestic corporation,
§§1.1503(d)–2 through 1.1503(d)–6: in such foreign country; and and unaffiliated domestic owner. The
(1) Domestic corporation. The term (B) If the individual separate unit is a terms unaffiliated dual resident corpora-
domestic corporation means an entity hybrid entity separate unit, the hybrid en- tion, unaffiliated domestic corporation,
classified as a domestic corporation under tity (an interest in which is the hybrid en- and unaffiliated domestic owner mean a
section 7701(a)(3) and (4) or otherwise tity separate unit) is subject to an income dual resident corporation, domestic corpo-
treated as a domestic corporation by the tax of such foreign country either on its ration, and domestic owner, respectively,
Internal Revenue Code, including, but worldwide income or on a residence basis. that is not a member of a consolidated
not limited to, sections 269B, 953(d), and See §1.1503(d)–5(c) Example 1. group.
1504(d). However, solely for purposes of (iii) Indirectly. The term indirectly, (12) Domestic affiliate. The term do-
Section 1503(d), the term domestic corpo- when used in reference to ownership of a mestic affiliate means—
ration does not include an S corporation, separate unit, means ownership through (i) A member of an affiliated group,
as defined in section 1361. a separate unit, through an entity classi- without regard to the exceptions contained
(2) Dual resident corporation. The fied as a partnership under §§301.7701–1 in section 1504(b) (other than section
term dual resident corporation means a through –3 of this chapter, or through 1504(b)(3)) relating to includible corpora-
domestic corporation that is subject to an a grantor trust (as defined in paragraph tions;
income tax of a foreign country on its (b)(15) of this section), regardless of (ii) A domestic owner; or
worldwide income or on a residence ba- whether the partnership or grantor trust is (iii) A separate unit.
sis. A corporation is taxed on a residence a U.S. person. (13) Domestic use. A domestic use of
basis if it is taxed as a resident under the (5) Dual consolidated loss. The term a dual consolidated loss shall be deemed
laws of the foreign country. The term dual dual consolidated loss means— to occur when the dual consolidated loss is
resident corporation also means a foreign (i) In the case of a dual resident corpo- made available to offset, directly or indi-
insurance company that makes an election ration, the net operating loss (as defined in rectly, the taxable income of any domestic
to be treated as a domestic corporation section 172(c) and the regulations thereun- affiliate of the dual resident corporation or
pursuant to section 953(d) and is treated der) incurred in a year in which the corpo- separate unit (that incurred the dual con-
as a member of an affiliated group for pur- ration is a dual resident corporation; and solidated loss) in the taxable year in which
poses of chapter 6, even if such company (ii) In the case of a separate unit, the dual consolidated loss is recognized,
is not subject to an income tax of a foreign the net loss attributable to, or taken or in any other taxable year, regardless of
country on its worldwide income or on a into account by, the separate unit un- whether the dual consolidated loss offsets
residence basis. See section 953(d)(3). der §1.1503(d)–3(b)(2). income under the income tax laws of a for-
(3) Hybrid entity. The term hybrid en- (6) Subject to tax. For purposes of de- eign country and regardless of whether any
tity means an entity that is not taxable as an termining whether a domestic corporation income that the dual consolidated loss may
association for U.S. income tax purposes or hybrid entity is subject to an income tax offset in the foreign country is, has been, or
but is subject to an income tax of a foreign of a foreign country on its income, the fact will be subject to tax in the United States.
country as a corporation (or otherwise at that it has no actual income tax liability to A domestic use shall be deemed to occur
the entity level) either on its worldwide in- the foreign country for a particular taxable in the year the dual consolidated loss is in-
come or on a residence basis. year shall not be taken into account. cluded in the computation of the taxable
(4) Separate unit—(i) In general. The (7) Foreign country. The term foreign income of a consolidated group or an unaf-
term separate unit means either of the fol- country includes any possession of the filiated domestic owner, even if no tax ben-
lowing that is owned, directly or indirectly, United States. efit results from such inclusion in that year.
by a domestic corporation— (8) Consolidated group. The term See §1.1503(d)–5(c) Examples 2 through
(A) A foreign branch, as defined in consolidated group means a consolidated 5.
§1.367(a)–6T(g) (foreign branch separate group, as defined in §1.1502–1(h), that (14) Foreign use—(i) In general. A for-
unit); or includes either a dual resident corporation eign use of a dual consolidated loss shall be
(B) An interest in a hybrid entity (hy- or a domestic owner. deemed to occur when any portion of a loss
brid entity separate unit). (9) Domestic owner. The term domestic or deduction taken into account in com-
(ii) Separate unit combination rule. If owner means a domestic corporation that puting the dual consolidated loss is made
two or more separate units (individual sep- owns, directly or indirectly, one or more available under the income tax laws of a
arate units) are owned, directly or indi- separate units. foreign country to offset or reduce, directly
rectly, by a single domestic corporation, (10) Affiliated dual resident corpora- or indirectly, any item that is recognized as
and the losses of each individual separate tion and affiliated domestic owner. The income or gain under such laws and that is
unit are made available to offset the in- terms affiliated dual resident corporation considered under U.S. tax principles to be
come of the other individual separate units and affiliated domestic owner mean a dual an item of—
under the income tax laws of a single for- resident corporation and a domestic owner, (A) A foreign corporation as defined in
eign country, then such individual separate respectively, that is a member of a consol- section 7701(a)(3) and (a)(5); or
units shall be treated as one separate unit idated group. (B) A direct or indirect owner of
(combined separate unit), provided that— an interest in a hybrid entity, provided

June 20, 2005 1318 2005–25 I.R.B.


such interest is not a separate unit. See the direct or indirect owner of an interest as a result of another person acquiring
§1.1503(d)–5(c) Examples 6 through 11. in such hybrid entity that is not a separate through sale, exchange, contribution or
(ii) Available for use. A foreign use unit. See §1.1503(d)–5(c) Examples 8 and other means, an interest in the partnership
shall be deemed to occur in the year in 14 through 16. or grantor trust. The previous sentence
which any portion of a loss or deduction (ii) Indirectly owned separate units. shall not apply, however, if the unaf-
taken into account in computing the dual Except as provided in paragraph filiated domestic owner or consolidated
consolidated loss is made available for an (b)(14)(iii)(C)(2) of this section, no for- group, as the case may be, demonstrates,
offset described in paragraph (b)(14)(i) of eign use shall be considered to occur with to the satisfaction of the Commissioner,
this section, regardless of whether it actu- respect to a dual consolidated loss attribut- that the other person that acquired the
ally offsets or reduces any items of income able to or taken into account by a separate interest in the partnership or grantor trust
or gain under the income tax laws of the unit owned indirectly through a partner- was a domestic corporation. Such demon-
foreign country in such year and regardless ship or grantor trust solely because an item stration must be made on a statement that
of whether any of the items that may be so of deduction or loss taken into account in is attached to, and filed by the due date
offset or reduced are regarded as income computing such dual consolidated loss (including extensions) of, its U.S. income
under U.S. tax principles. is made available, under the income tax tax return for the taxable year in which the
(iii) Exceptions—(A) No election to en- laws of a foreign country, to offset or re- ownership interest of the domestic owner
able foreign use. Where the laws of a duce, directly or indirectly, any item that is is reduced. See §1.1503(d)–5(c) Examples
foreign country provide an election that recognized as income or gain under such 14 through 16 and 19.
would enable a foreign use, a foreign use laws, and that is considered under U.S. (ii) Consolidation and other prohibited
shall be considered to occur only if the tax principles, to be an item of a direct uses. Paragraph (b)(14)(iii)(C)(1) of this
election is made. or indirect owner of an interest in such section shall not apply if the availability
(B) Presumed use where no foreign partnership or trust. See §1.1503(d)–5(c) described in such section does not arise
country rule for determining use. If the Examples 17 and 18. solely from the ownership in such partner-
losses or deductions composing the dual (iii) Combined separate unit. This ship or grantor trust and the allocation of
consolidated loss are made available under paragraph (b)(14)(iii)(C)(1)(iii) applies the item of deduction or loss, or the offset-
the laws of a foreign country both to offset to a dual consolidated loss attributable ting by such deduction or loss, of an item of
income that would constitute a foreign to or taken into account by a combined income or gain of the partnership or trust.
use and to offset income that would not separate unit that includes an individ- For example, paragraph (b)(14)(iii)(C)(1)
constitute a foreign use, and the laws of ual separate unit to which paragraph of this section shall not apply in the case
the foreign country do not provide appli- (b)(14)(iii)(C)(1)(i) or (ii) of this section where the item of loss or deduction is made
cable rules for determining which income would apply, but for the application of the available through a foreign consolidation
is offset by the losses or deductions, then separate unit combination rule provided regime. See §1.1503(d)–5(c) Examples 17
for purposes of paragraph (b)(14) of this under §1.1503(d)–1(b)(4)(ii). Except as and 18.
section, the losses or deductions shall be provided in paragraph (b)(14)(iii)(C)(2) of (iv) Ordering rules for determining the
deemed to be made available to offset this section, paragraph (b)(14)(iii)(C)(1)(i) foreign use of losses. If the laws of a for-
income that does not constitute a foreign or (ii), as applicable, shall apply to eign country provide for the foreign use of
use, to the extent of such income, before the portion of the dual consolidated a dual consolidated loss, but do not provide
being considered to be made available to loss of such combined separate unit applicable rules for determining the order
offset the income that does constitute a that is attributable, as provided under in which such losses are used in a taxable
foreign use. See §1.1503(d)–5(c) Exam- §1.1503(d)–3(b)(2)(vii)(B)(1), to the year, the following rules shall govern—
ples 12 and 14. individual separate unit (otherwise de- (A) Any net loss, or net income, that the
(C) No dilution of an interest in a sep- scribed in paragraph (b)(14)(iii)(C)(1)(i) dual resident corporation or separate unit
arate unit—(1) General rules—(i) Interest or (ii) of this section) that is a compo- has in a taxable year shall first be used to
in a hybrid entity partnership or hybrid en- nent of the combined separate unit. See offset net income, or loss, recognized by its
tity grantor trust. Except as provided in §1.1503(d)–5(c) Example 19. affiliates in the same taxable year before
paragraph (b)(14)(iii)(C)(2) of this section, (2) Exceptions—(i) Dilution of an any carryover of its losses is considered
no foreign use shall be considered to occur interest in a separate unit. Paragraph to be used to offset any income from the
with respect to a dual consolidated loss at- (b)(14)(iii)(C)(1) of this section shall not taxable year;
tributable to an interest in a hybrid entity apply with respect to any item of deduc- (B) If under the laws of the foreign
partnership or a hybrid entity grantor trust, tion or loss that is taken into account in country the dual resident corporation or
solely because an item of deduction or loss computing a dual consolidated loss at- separate unit has losses from different tax-
taken into account in computing such dual tributable to or taken into account by a able years, it shall be deemed to use first
consolidated loss is made available, under separate unit if during any taxable year the losses from the earliest taxable year
the income tax laws of a foreign country, to the domestic owner’s percentage interest from which a loss may be carried forward
offset or reduce, directly or indirectly, any in such separate unit, as compared to its or back for foreign law purposes; and
item that is recognized as income or gain interest in the separate unit as of the last (C) Where different losses or deduc-
under such laws and, that is considered un- day of the taxable year in which such dual tions (for example, capital losses and ordi-
der U.S. tax principles, to be an item of consolidated loss was incurred, is reduced nary losses) of a dual resident corporation

2005–25 I.R.B. 1319 June 20, 2005


or separate unit incurred in the same tax- amends the return to which the documents (ii) Separate unit—(A) General rule.
able year are available for foreign use, the should have been attached under the rules Except as provided in paragraph (c)(2) of
different losses shall be deemed to be used of this section or §§1.1503(d)–2 through this section, a dual consolidated loss of a
on a pro rata basis. See §1.1503(d)–5(c) 1.1503(d)–4. In determining whether the separate unit shall not carry over as a result
Example 13. taxpayer has reasonable cause, the Di- of a transaction in which the separate unit
(v) Mirror legislation rule. Except to rector of Field Operations shall consider ceases to be a separate unit of its domes-
the extent §1.1503(d)–4(b) applies, and whether the taxpayer acted reasonably tic owner (for example, as a result of a ter-
other than for purposes of the consistency and in good faith. Whether the taxpayer mination, dissolution, liquidation, sale or
rule under §1.1503(d)–4(d)(2), a foreign acted reasonably and in good faith will other disposition of the separate unit) and,
use shall be deemed to occur if and when be determined after considering all the as a result, shall be eliminated.
the income tax laws of a foreign country facts and circumstances. The Director of (B) Combined separate unit. This para-
deny any opportunity for the foreign use Field Operations shall notify the person graph (c)(1)(ii)(B) applies to an individ-
of the dual consolidated loss for any of the in writing within 120 days of the filing if ual separate unit that is a component of a
following reasons— it is determined that the failure to comply combined separate unit that would, but for
(A) The loss is incurred by a dual res- was not due to reasonable cause, or if ad- the separate unit combination rule, cease
ident corporation or separate unit that ditional time will be needed to make such to be a separate unit of its domestic owner.
is subject to income taxation by another determination. In such a case, and except as provided in
country on its worldwide income or on a (2) Signature requirement. When an paragraph (c)(2) of this section, the portion
residence basis; election, agreement, statement, rebuttal, of the dual consolidated loss of the com-
(B) The loss may be available to offset computation, or other information is re- bined separate unit that is attributable to,
income (other than income of the dual resi- quired under this section or §§1.1503(d)–2 or taken into account by, as provided under
dent corporation or separate unit) under the through 1.1503(d)–4 to be attached to and §1.1503(d)–3(b)(2)(vii)(B)(1), such indi-
laws of another country; or filed by the due date (including extensions) vidual separate unit shall not carry over
(C) The deductibility of any portion of a U.S. tax return and signed under penal- and, as a result, shall be eliminated.
of a loss or deduction taken into account ties of perjury by the person who signs the (2) Exceptions—(i) Certain section
in computing the dual consolidated loss return, the attachment and filing of an un- 368(a)(1)(F) reorganizations. Paragraph
depends on whether such amount is de- signed copy is considered to satisfy such (c)(1)(i) of this section shall not apply
ductible under the laws of another country. requirement, provided the taxpayer retains to a reorganization described in section
See §1.1503(d)–5(c) Examples 20 through the original in its records in the manner 368(a)(1)(F) in which the resulting corpo-
23. specified by §1.6001–1(e). ration is a domestic corporation.
(15) Grantor trust. The term grantor (ii) Acquisition of a dual resident cor-
trust means a trust, any portion of which §1.1503(d)–2 Operating rules. poration by another dual resident cor-
is treated as being owned by the grantor poration. If a dual resident corporation
or another person under subpart E of sub- (a) In general. This section provides transfers its assets to another dual resident
chapter J of this chapter. operating rules relating to dual consoli- corporation in a transaction described in
(c) Special rules for filings under sec- dated losses, including a general rule pro- section 381(a), and the transferee corpo-
tion 1503(d)—(1) Reasonable cause ex- hibiting the domestic use of a dual consol- ration is a resident of (or is taxed on its
ception. If a person that is permitted idated loss, a rule that eliminates a dual worldwide income by) the same foreign
or required to file an election, agree- consolidated loss following certain trans- country of which the transferor was a
ment, statement, rebuttal, computation, actions, an anti-abuse rule for tainted in- resident (or was taxed on its worldwide in-
or other information under the provisions come, and rules for computing foreign tax come), then income generated by the trans-
of this section or §§1.1503(d)–2 through credit limitations. feree may be offset by the carryover dual
1.1503(d)–4 and that fails to make such (b) Limitation on domestic use of a dual consolidated losses of the transferor, sub-
filing in a timely manner, shall be con- consolidated loss. Except as provided in ject to the limitations of §1.1503(d)–3(c)
sidered to have satisfied the timeliness §1.1503(d)–4, the domestic use of a dual applied as if the transferee generated the
requirement with respect to such filing if consolidated loss is not permitted. See dual consolidated loss. Dual consolidated
the person is able to demonstrate, to the §1.1503(d)–5(c) Examples 2 through 4 and losses of the transferor may not, however,
Director of Field operations having juris- 5. be used to offset income of separate units
diction of the taxpayer’s tax return for the (c) Elimination of a dual consolidated owned by the transferee because such
taxable year, that such failure was due to loss after certain transactions—(1) Gen- separate units constitute domestic affili-
reasonable cause and not willful neglect. eral rules—(i) Dual resident corporation. ates of the transferee as provided under
The previous sentence shall only apply Except as provided in paragraph (c)(2) of §1.1503(d)–1(b)(12)(iii).
if, once the person becomes aware of the this section, a dual consolidated loss of a (iii) Acquisition of a separate unit by a
failure, the person attaches all documents dual resident corporation shall not carry domestic corporation. If a domestic owner
that should have been filed previously, as over to another corporation in a transaction transfers ownership of a separate unit to a
well as a written statement setting forth described in section 381(a) and, as a result, domestic corporation in a transaction de-
the reasons for the failure to timely com- shall be eliminated. See §1.1503(d)–5(c) scribed in section 381(a), and the trans-
ply, to an amended income tax return that Example 24. feree is a domestic owner of the sepa-

June 20, 2005 1320 2005–25 I.R.B.


rate unit immediately following the trans- the total assets owned by the corporation at vides rules for determining the effect of a
fer, then income generated by the separate the end of such taxable year. To establish dual consolidated loss on domestic affili-
unit following the transfer may be offset by the actual amount of income that is attrib- ates and for making special basis adjust-
the carryover dual consolidated losses of utable to holding tainted assets, documen- ments.
the separate unit, subject to the limitations tation must be attached to, and filed by the (b) Determination of amount of dual
of §1.1503(d)–3(c) applied as if the sep- due date (including extensions) of, the do- consolidated loss—(1) Affiliated dual res-
arate unit of the transferee generated the mestic corporation’s tax return or the con- ident corporation. For purposes of deter-
dual consolidated loss. In addition, if a solidated tax return of an affiliated group mining whether an affiliated dual resident
domestic owner transfers ownership of a of which it is a member, as the case may be, corporation has a dual consolidated loss
separate unit to a domestic corporation in for the taxable year in which the income is for the taxable year, the dual resident cor-
a transaction described in section 381(a), generated. See §1.1503(d)–5(c) Example poration shall compute its taxable income
the transferee is a domestic owner of the 26. (or loss) in accordance with the rules set
separate unit immediately following the (3) Tainted assets defined. For purposes forth in the regulations under section 1502
transfer, and the transferred separate unit is of paragraph (d)(2) of this section, tainted governing the computation of consolidated
combined with another separate unit of the assets are any assets acquired by a domes- taxable income, taking into account only
transferee immediately after the transfer tic corporation in a nonrecognition trans- the dual resident corporation’s items of in-
as provided under §1.1503(d)–1(b)(4)(ii), action, as defined in section 7701(a)(45), come, gain, deduction, and loss for the
then income generated by the combined or any assets otherwise transferred to the year. However, for purposes of this com-
separate unit may be offset by the carry- corporation as a contribution to capital, at putation, the following items shall not be
over dual consolidated losses of the trans- any time during the three taxable years taken into account—
ferred separate unit, subject to the limita- immediately preceding the taxable year in (i) Any net capital loss of the dual resi-
tions of §1.1503(d)–3(c) applied as if the which the corporation ceases to be a dual dent corporation; and
combined separate unit of the transferee resident corporation or at any time there- (ii) Any carryover or carryback losses.
generated the dual consolidated loss. See after. (2) Separate unit—(i) General rules.
§1.1503(d)–5(c) Example 25. (4) Exceptions. Income derived from Paragraph (b)(2) of this section applies for
(d) Special rule denying the use of a assets acquired by a domestic corporation purposes of determining whether a sepa-
dual consolidated loss to offset tainted in- shall not be subject to the limitation de- rate unit has a dual consolidated loss for
come—(1) In general. Dual consolidated scribed in paragraph (d)(1) of this section, the taxable year. The taxable income (or
losses incurred by a dual resident corpora- if— loss) in U.S. dollars of a separate unit shall
tion shall not be used to offset income it (i) For the taxable year in which the as- be computed as if it were a separate do-
earns after it ceases to be a dual resident sets were acquired, the corporation did not mestic corporation and a dual resident cor-
corporation to the extent that such income have a dual consolidated loss (or a carry- poration in accordance with the provisions
is tainted income. forward of a dual consolidated loss to such of paragraph (b)(1) of this section, using
(2) Tainted income—(i) Definition. For year); or only those existing items of income, gain,
purposes of paragraph (d)(1) of this sec- (ii) The assets were acquired as replace- deduction, and loss (translated into U.S.
tion, the term tainted income means— ment property in the ordinary course of dollars) that are attributable to or taken
(A) Income or gain recognized on the business. into account by such separate unit. Treat-
sale or other disposition of tainted assets; (e) Computation of foreign tax credit ing a separate unit as a separate domes-
and limitation. If a dual resident corporation or tic corporation of the domestic owner un-
(B) Income derived as a result of hold- separate unit is subject to §1.1503(d)–3(c) der this paragraph shall not cause items
ing tainted assets. (addressing the effect of a dual consoli- of income, gain, deduction and loss that
(ii) Income presumed to be derived from dated loss on a domestic affiliate), the con- are otherwise disregarded for U.S. Fed-
holding tainted assets. In the absence of solidated group or unaffiliated domestic eral tax purposes to be regarded for pur-
evidence establishing the actual amount owner shall compute its foreign tax credit poses of calculating a dual consolidated
of income that is attributable to holding limitation by applying the limitations of loss. Paragraph (b)(2) of this section shall
tainted assets, the portion of a corpora- §1.1503(d)–3(c). Thus, the items consti- apply separately to each separate unit and
tion’s income in a particular taxable year tuting the dual consolidated loss are not an item of income, gain, deduction, or loss
that is treated as tainted income derived as taken into account until the year in which shall not be considered attributable to or
a result of holding tainted assets shall be such items are absorbed. taken into account by more than one sep-
an amount equal to the corporation’s tax- arate unit. Items of income, gain, deduc-
able income for the year (other than in- §1.1503(d)–3 Special rules for accounting tion, and loss of one separate unit shall
come described in paragraph (d)(2)(i)(A) for dual consolidated losses. not offset items of income, gain, deduc-
of this section) multiplied by a fraction, tion, and loss, or otherwise be taken into
the numerator of which is the fair market (a) In general. This section provides account by, another separate unit for pur-
value of all tainted assets acquired by the special rules for determining the amount of poses of calculating a dual consolidated
corporation (determined at the time such income or loss of a dual resident corpora- loss. But see the separate unit combination
assets were so acquired) and the denomi- tion or separate unit for purposes of sec- rule in §1.1503(d)–1(b)(4)(ii). See also
nator of which is the fair market value of tion 1503(d). In addition, this section pro- §1.1503(d)–5(c) Example 27.

2005–25 I.R.B. 1321 June 20, 2005


(ii) Foreign branch separate unit—(A) pense for the taxable year under section able to a hybrid entity that is a partnership
In general. For purposes of determin- 864(e); (as provided in paragraph (b)(2)(iii) of this
ing the items of income, gain, deduction (4) Asset values shall be determined section) are attributable to an interest in
(other than interest), and loss that are taken pursuant to §1.861–9T(g)(2); and such hybrid entity partnership; and
into account in determining the taxable in- (5) For purposes of determining the (2) The extent to which items of in-
come or loss of a foreign branch separate step-two U.S. connected liabilities, the come, gain, deduction and loss of a sep-
unit, the principles of section 864(c)(2) amounts of worldwide assets and liabilities arate unit that is owned indirectly through
and (c)(4) as set forth in §1.864–4(c) and under §1.882–5(c)(2)(iii) and (iv), must a partnership are taken into account by a
§1.864–6 shall apply. The principles apply be determined in accordance with U.S. partner in such partnership.
without regard to limitations imposed on tax principles rather than substantially in (B) Items of income, gain, deduction
the effectively connected treatment of in- accordance with U.S. tax principles. and loss are taken into account by the
come, gain or loss under the trade or busi- (iii) Hybrid entity—(A) General rule. owner of such interest, or separate unit,
ness safe harbors in section 864(b) and the The items of income, gain, deduction to the extent such items are includible
limitations for treating foreign source in- and loss attributable to a hybrid entity in the owner’s distributive share of the
come as effectively connected under sec- are those items that are properly reflected partnership income, gain, deduction and
tion 864(c)(4)(D). For purposes of deter- on its books and records under the prin- loss, as determined under the rules and
mining the interest expense that is taken ciples of §1.988–4(b)(2), to the extent principles of subchapter K of this chapter.
into account in determining the taxable in- consistent with U.S. tax principles. See See §1.1503(d)–5(c) Example 30.
come or loss of a foreign branch separate §1.1503(d)–5(c) Example 28. (vi) Items attributable to an interest in a
unit, the principles of §1.882–5, subject (B) Interest in a non-hybrid partner- hybrid entity grantor trust and a separate
to paragraph (b)(2)(ii)(B) of this section, ship and a non-hybrid grantor trust. If a unit owned indirectly through a grantor
shall apply. When applying the principles hybrid entity owns, directly or indirectly trust—(A) This paragraph (b)(2)(vi) ap-
of section 864(c) and §1.882–5 (subject to (other than through a hybrid entity sepa- plies for purposes of determining—
paragraph (b)(2)(ii)(B) of this section), the rate unit), an interest in either a partner- (1) The extent to which items of in-
domestic corporation that owns, directly ship that is not a hybrid entity or a grantor come, gain, deduction and loss attributable
or indirectly, the foreign branch separate trust that is not a hybrid entity, items of in- to a hybrid entity that is a grantor trust
unit shall be treated as a foreign corpora- come, gain, deduction or loss that are prop- (as provided in paragraph (b)(2)(iii) of this
tion, the foreign branch separate unit shall erly reflected on the books and records section) are attributable to an interest in
be treated as a trade or business within the of such partnership or grantor trust (under such grantor trust; and
United States, and the other assets of the the principles of §1.988–4(b)(2), to the ex- (2) The extent to which the items of
domestic corporation shall be treated as as- tent consistent with U.S. tax principles), income, gain, deduction and loss of a
sets that are not U.S. assets. to the extent provided under paragraphs separate unit owned indirectly through a
(B) Principles of §1.882–5. For pur- (b)(2)(v) or (b)(2)(vi) of this section, re- grantor trust are taken into account by an
poses of paragraph (b)(2)(ii)(A) of this spectively, shall be treated as being prop- owner of such grantor trust.
section, the principles of §1.882–5 shall erly reflected on the books and records (B) Items of income, gain, deduction
be applied subject to the following— of the hybrid entity for purposes of para- and loss are taken into account to the extent
(1) Except as otherwise provided in this graph (b)(2)(iii)(A) of this section. See such items are attributable to trust property
section, only the assets, liabilities and in- §1.1503(d)–5(c) Example 30. that the holder of the trust interest is treated
terest expense of the domestic owner shall (iv) Interest in a disregarded hybrid as owning under the rules and principles of
be taken into account in the §1.882–5 for- entity. Except as provided in paragraph subpart E of subchapter J of this chapter.
mula; (b)(2)(vii) of this section, for purposes of (vii) Special rules. The following spe-
(2) Except as provided under paragraph determining the items of income, gain, cial rules shall apply for purposes of at-
(b)(2)(ii)(B)(3) of this section, a taxpayer deduction and loss that are attributable tributing items under paragraphs (b)(2)(i)
may use the alternative tax book value to an interest in a hybrid entity that is through (vi) of this section:
method under §1.861–9T(i) for purposes disregarded as an entity separate from (A) Allocation of items between certain
of determining the value of its U.S. assets its owner (for example, as a result of an tiered separate units—(1) When a hybrid
pursuant to §1.882–5(b)(2) and its world- election made pursuant to §301.7701–3(c) entity owns, directly or indirectly (other
wide assets pursuant to §1.882–5(c)(2); of this chapter), those items described in than through a hybrid entity separate unit),
(3) For purposes of determining paragraph (b)(2)(iii) of this section shall be a foreign branch separate unit, for purposes
the value of a U.S. asset pursuant to taken into account. See §1.1503(d)–5(c) of determining items of income, gain, de-
§1.882–5(b)(2), and worldwide assets Example 30. duction and loss that are taken into ac-
pursuant to §1.882–5(c)(2), the taxpayer (v) Items attributable to an interest in count in determining the taxable income
must use the same methodology under a hybrid entity partnership and a separate or loss of such foreign branch separate
§1.861–9T(g) (that is, tax book value, unit owned indirectly through a partner- unit, only items of income, gain, deduction
alternative tax book value, or fair market ship—(A) This paragraph (b)(2)(v) applies and loss that are attributable to the hybrid
value) that the taxpayer uses for purposes for purposes of determining— entity as provided in paragraph (b)(2)(iii)
of allocating and apportioning interest ex- (1) The extent to which the items of of this section (and intervening entities, if
income, gain, deduction and loss attribut- any, that are not themselves separate units)

June 20, 2005 1322 2005–25 I.R.B.


shall be taken into account. Items of the attributable to or taken into account by (c) Effect of a dual consolidated loss
hybrid entity (including assets and liabili- the separate unit to the extent of the gain on a domestic affiliate. For any taxable
ties) are taken into account for purposes of or loss that would have been recognized year in which a dual resident corporation
determining the taxable income or loss of had such separate unit sold all its assets or separate unit has a dual consolidated
the foreign branch separate unit pursuant in a taxable exchange, immediately be- loss to which §1.1503(d)–2(b) applies, the
to paragraph (b)(2)(ii) of this section. See fore the disposition of the separate unit, following rules shall apply:
§1.1503(d)–5(c) Example 30. for an amount equal to their fair market (1) Dual resident corporation. If the
(2) For purposes of determining items value. If, as a result of the sale, exchange dual resident corporation is a member of a
of income, gain, deduction and loss or other disposition of a separate unit (or consolidated group, the group shall com-
that are attributable to an interest in interest in a partnership or grantor trust) pute its consolidated taxable income (or
the hybrid entity described in paragraph more than one separate unit is, directly or loss) by taking into account the dual res-
(b)(2)(vii)(A)(1) of this section, the items indirectly, disposed of, items of income, ident corporation’s items of gross income,
attributable to the hybrid entity in para- gain, deduction, and loss recognized on gain, deduction, or loss taken into account
graph (b)(2)(iii) of this section shall not such disposition are attributable to or in computing the dual consolidated loss,
be taken into account to the extent they taken into account by each such separate other than those items of deduction and
are also taken into account in determining, unit (under the rules of this paragraph loss that compose the dual resident corpo-
under the rules of paragraph (b)(2)(ii) of (b)(2)(vii)(C)) based on the gain or loss ration’s dual consolidated loss. The dual
this section, the taxable income or loss of a that would have been recognized by each consolidated loss shall be treated as com-
foreign branch separate unit that is owned, separate unit if it had sold all of its assets posed of a pro rata portion of each item of
directly or indirectly (other than through a in a taxable exchange, immediately before deduction and loss of the dual resident cor-
hybrid entity separate unit), by the hybrid the disposition of the separate unit, for an poration taken into account in calculating
entity separate unit. See §1.1503(d)–5(c) amount equal to their fair market value. the dual consolidated loss. The dual con-
Example 30. See §1.1503(d)–5(c) Examples 31 through solidated loss is subject to the limitations
(B) Combined separate unit. If 34. on its use contained in paragraph (c)(3)
two or more separate units defined in (D) Income inclusion on stock. Any of this section and, subject to such limita-
§1.1503(d)–1(b)(4)(i) are treated as amount included in income of a U.S. per- tion, may be carried over or back for use in
one combined separate unit pursuant to son arising from ownership of stock in other taxable years as a separate net operat-
§1.1503(d)–1(b)(4)(ii), the items of in- a foreign corporation (for example, un- ing loss carryover or carryback of the dual
come, gain, deduction and loss that are der section 951) through a separate unit resident corporation arising in the year in-
attributable to or taken into account in shall be taken into account for purposes curred.
determining the taxable income of the of calculating the dual consolidated loss (2) Separate unit. The unaffiliated do-
combined separate unit shall be deter- of the separate unit if an actual dividend mestic owner of a separate unit, or the
mined as follows— from such foreign corporation would consolidated group of an affiliated domes-
(1) Items of income, gain, deduction have been so taken into account. See tic owner of a separate unit, shall com-
and loss are first attributed to, or taken §1.1503(d)–5(c) Example 29. pute its taxable income (or loss) by tak-
into account by, each individual separate (3) Foreign tax treatment disregarded. ing into account the separate unit’s items
unit, as defined in §1.1503(d)–1(b)(4)(i) The fact that a particular item taken into of gross income, gain, deduction and loss
without regard to §1.1503(d)–1(b)(4)(ii), account in computing a dual resident cor- taken into account in computing the dual
pursuant to the rules of paragraph (b)(2) of poration’s net operating loss, or a sepa- consolidated loss, other than those items of
this section; and rate unit’s loss, is not taken into account deduction and loss that compose the sep-
(2) The combined separate unit then in computing income subject to a foreign arate unit’s dual consolidated loss. The
takes into account all of the items of in- country’s income tax shall not cause such dual consolidated loss shall be treated as
come, gain, deduction and loss attribut- item to be excluded from the calculation of composed of a pro rata portion of each
able to, or taken into account by, the in- the dual consolidated loss. item of deduction and loss of the separate
dividual separate units pursuant to para- (4) Items generated or incurred while unit taken into account in calculating the
graph (b)(2)(vii)(B)(1) of this section. See a dual resident corporation or a sepa- dual consolidated loss. The dual consoli-
§1.1503(d)–5(c) Example 30. rate unit. For purposes of determining dated loss is subject to the limitations con-
(C) Gain or loss on the direct or in- the amount of the dual consolidated loss tained in paragraph (c)(3) of this section as
direct disposition of a separate unit. For of a dual resident corporation or a sep- if the separate unit that generated the dual
purposes of calculating a dual consolidated arate unit for the taxable year, only the consolidated loss were a separate domes-
loss of a separate unit, items of income items of income, gain, deduction and loss tic corporation that filed a consolidated re-
or gain (including loss recapture income generated or incurred during the period turn with its unaffiliated domestic owner
or gain under section 367(a)(3)(C) or the dual resident corporation or separate or with the consolidated group of its affili-
904(f)(3)), deduction and loss recognized unit qualified as such shall be taken into ated domestic owner. Subject to such lim-
on the sale, exchange or other disposi- account. The allocation of items to such itation, the dual consolidated loss may be
tion of a separate unit (or an interest in period shall be made under the principles carried over or back for use in other tax-
a partnership or grantor trust that owns, of §1.1502–76(b). able years as a separate net operating loss
directly or indirectly, a separate unit), are

2005–25 I.R.B. 1323 June 20, 2005


carryover or carryback of the separate unit member owning stock in the dual resident amount of a dual consolidated loss subject
arising in the year incurred. corporation or domestic owner shall adjust to §§1.1503(d)–2(b) and 1.1503(d)–3(c)
(3) SRLY limitation. The dual consoli- the basis of the stock in accordance with that is absorbed in a carryover or carry-
dated loss shall be treated as a loss incurred the principles of §1.1502–32(b), subject to back taxable year.
by the dual resident corporation or separate the following: (C) Recapture income. The adjusted
unit in a separate return limitation year and (i) Dual consolidated loss subject to do- basis shall not be increased for any
shall be subject to all of the limitations of mestic use limitation. There shall be a neg- amount included in income pursuant to
§1.1502–21(c) (SRLY limitation), subject ative adjustment under §1.1502–32(b)(2) §1.1503(d)–4(h).
to the following— for any amount of a dual consolidated loss (3) Examples. See §1.1503(d)–5(c) Ex-
(i) Notwithstanding §1.1502–1(f)(2)(i), of the dual resident corporation (or, in the amples 36 and 37.
the SRLY limitation is applied to any dual case of a domestic owner, of separate units
consolidated loss of a common parent; of such domestic owner) that is not ab- §1.1503(d)–4 Exceptions to the domestic
(ii) The SRLY limitation is applied sorbed as a result of the application of use limitation rule.
without regard to §1.1502–21(c)(2) (SRLY §§1.1503(d)–2(b) and 3(c).
subgroup limitation) and 1.1502–21(g) (ii) Dual consolidated loss absorbed (a) In general. This section provides
(overlap with section 382); in carryover or carryback year. There certain exceptions to the domestic use lim-
(iii) For purposes of calculating shall be no negative adjustment under itation rule of §1.1503(d)–2(b).
the general SRLY limitation under §1.1502–32(b)(2) for the amount of a (b) Elective agreement in place be-
§1.1502–21(c)(1)(i), the calculation of dual consolidated loss of the dual resident tween the United States and a foreign
aggregate consolidated taxable income corporation (or, in the case of a domestic country. The domestic use limitation rule
shall only include items of income, gain, owner, of separate units of such domestic of §1.1503(d)–2(b) shall not apply to a
deduction or loss generated— owner) subject to §§1.1503(d)–2(b) and dual consolidated loss to the extent the
(A) In the case of a dual resident cor- 1.1503(d)–3(c) that is absorbed in a carry- consolidated group, unaffiliated dual resi-
poration or hybrid entity separate unit, in over or carryback taxable year. dent corporation, or unaffiliated domestic
years in which the dual resident corpora- (iii) Recapture income. There owner, as the case may be, elects to deduct
tion or hybrid entity (whose interest con- shall be no positive adjustment under the loss in the United States pursuant to an
stitutes the separate unit) is resident (or §1.1502–32(b)(2) for any amount in- agreement entered into between the United
is taxed on its worldwide income) in the cluded in income by the dual resident States and a foreign country that puts into
same foreign country in which it was res- corporation or domestic owner pursuant to place an elective procedure through which
ident (or was taxed on its worldwide in- §1.1503(d)–4(h). losses offset income in only one country.
come) during the year in which the dual (2) Interests in hybrid entities that are (c) No possibility of foreign use—(1)
consolidated loss was generated; and partnerships or interests in partnerships In general. The domestic use limitation
(B) In the case of a foreign branch sep- through which a separate unit is owned in- rule of §1.1503(d)–2(b) shall not apply to
arate unit, items of income, gain, deduc- directly—(i) Scope. This paragraph (d)(2) a dual consolidated loss if the consolidated
tion or loss generated in years in which the applies for purposes of determining the ad- group, unaffiliated dual resident corpora-
foreign branch qualified as a separate unit; justed basis of an interest in: tion, or unaffiliated domestic owner, as the
and (A) A hybrid entity that is a partnership; case may be—
(iv) For purposes of calculating and (i) Demonstrates, to the satisfaction of
the general SRLY limitation under (B) A partnership through which a do- the Commissioner, that no foreign use of
§1.1502–21(c)(1)(i), the calculation of mestic owner indirectly owns a separate the dual consolidated loss occurred in the
aggregate consolidated taxable income unit. year in which it was incurred, and no such
shall not include any amount included (ii) Determination of basis of partner’s use can occur in any other year by any
in income pursuant to §1.1503(d)–4(h) interest. The adjusted basis of an inter- means; and
(relating to the recapture of a dual consol- est in a hybrid entity that is a partnership, (ii) Prepares a statement described in
idated loss). or a partnership through which a domes- paragraph (c)(2) of this section that is at-
(4) Items of a dual consolidated loss tic owner indirectly owns a separate unit, tached to, and filed by the due date (in-
used in other taxable years. A pro rata shall be adjusted in accordance with sec- cluding extensions) of, its U.S. income tax
portion of each item of deduction or loss tion 705 of this chapter, except as other- return for the taxable year in which the
that composes the dual consolidated loss wise provided in this paragraph (d)(2)(ii). dual consolidated loss is incurred. See
shall be considered to be used when the (A) Dual consolidated loss subject to §1.1503(d)–5(c) Examples 38 through 40.
dual consolidated loss is used in other tax- domestic use limitation. The adjusted ba- (2) Statement. The statement described
able years. See §1.1503(d)–5(c) Example sis shall be decreased for any amount of in this section must be signed under penal-
35. the dual consolidated loss that is not ab- ties of perjury by the person who signs
(d) Special basis adjustments—(1) Af- sorbed as a result of the application of the tax return. The statement must be la-
filiated dual resident corporation or affil- §§1.1503(d)–2(b) and 1.1503(d)–3(c). beled No Possibility of Foreign Use of
iated domestic owner. If a dual resident (B) Dual consolidated loss absorbed Dual Consolidated Loss Statement at the
corporation or domestic owner is a mem- in carryover or carryback year. The ad- top of the page and must include the fol-
ber of a consolidated group, each other justed basis shall not be decreased for the lowing items, in paragraphs labeled to cor-

June 20, 2005 1324 2005–25 I.R.B.


respond with the items set forth in para- provided separately with respect to each that is subject to a domestic use agree-
graphs (c)(2)(i) through (iv) of this section: dual consolidated loss. The domestic use ment (but not a new domestic use agree-
(i) A statement that the document agreement must be labeled Domestic Use ment, defined in paragraph (f)(2)(iii)(A) of
is submitted under the provisions of Election and Agreement at the top of the this paragraph), then a foreign use shall be
§1.1503(d)–4(c); page and must include the following items, deemed to occur for the following other
(ii) The name, address, tax identifica- in paragraphs labeled to correspond with dual consolidated losses (if any), but only
tion number, and place and date of incor- the following: if the income tax laws of the foreign coun-
poration of the dual resident corporation, (i) A statement that the document sub- try permit a foreign use of such other dual
and the country or countries that tax the mitted is an election and an agreement un- consolidated losses in the same taxable
dual resident corporation on its worldwide der the provisions of §1.1503(d)–4(d); year—
income or on a residence basis, or, in the (ii) The name, address, tax identifica- (i) Any dual consolidated loss of a dual
case of a separate unit, identification of tion number, and place and date of incor- resident corporation that is a member of
the separate unit, including the name un- poration of the dual resident corporation, the same consolidated group of which the
der which it conducts business, its princi- and the country or countries that tax the first dual resident corporation or domestic
pal activity, and the country in which its dual resident corporation on its worldwide owner is a member, if any deduction or loss
principal place of business is located; income or on a residence basis, or, in the taken into account in computing such dual
(iii) A statement of the amount of the case of a separate unit, identification of consolidated loss is recognized under the
dual consolidated loss at issue; and the separate unit, including the name un- income tax laws of such foreign country in
(iv) An analysis, in reasonable detail der which it conducts business, its princi- the same taxable year; and
and specificity, supported with official or pal activity, and the country in which its (ii) Any dual consolidated loss of a
certified English translations of the rele- principal place of business is located; separate unit that is owned directly or
vant provisions of foreign law, of the treat- (iii) An agreement by the elector to indirectly by the same domestic owner
ment of the losses and deductions compos- comply with all of the provisions of para- that owns the first separate unit, or that
ing the dual consolidated loss under the graphs (d) through (h) of this section, as is owned directly or indirectly by any
laws of the foreign jurisdiction and the rea- applicable; member of the same consolidated group of
sons supporting the conclusion that no for- (iv) A statement of the amount of the which the first dual resident corporation
eign use of the dual consolidated loss oc- dual consolidated loss covered by the or domestic owner is a member, if any
curred in the year in which it was incurred, agreement; deduction or loss taken into account in
and no such use can occur in any other year (v) A certification that there has not computing such dual consolidated loss is
by any means. been, and will not be, a foreign use of the recognized under the income tax laws of
(d) Domestic use election—(1) In gen- dual consolidated loss in any taxable year such foreign country in the same taxable
eral. The domestic use limitation rule of up to and including the seventh taxable year. See §1.1503(d)–5(c) Examples 41
§1.1503(d)–2(b) shall not apply to a dual year following the year in which the dual and 42.
consolidated loss if an election to be bound consolidated loss that is the subject of the (3) Restrictions on domestic use elec-
by the provisions of this paragraph (d) agreement filed under paragraph (d) of this tion—(i) Triggering event in year of dual
of this section (domestic use election) is section was incurred (certification period); consolidated loss. Except as otherwise
made by the consolidated group, unaffili- (vi) A certification that arrangements provided in this section, if an event de-
ated dual resident corporation, or unaffil- have been made to ensure that there will be scribed in paragraphs (e)(1)(i) through
iated domestic owner, as the case may be no foreign use of the dual consolidated loss (vii) of this section occurs during the year
(elector). In order to elect relief under this during the certification period, and that the in which a dual resident corporation or
paragraph (d) of this section, an agreement elector will be informed of any such for- separate unit incurs a dual consolidated
described in this paragraph (d)(1) of this eign use of the dual consolidated loss dur- loss (including a dual consolidated loss
section (domestic use agreement) must be ing such period; resulting, in whole or in part, from the
attached to, and filed by the due date (in- (vii) If applicable, a notification that an occurrence of the triggering event itself),
cluding extensions) of, the U.S. income tax excepted triggering event under paragraph the consolidated group, unaffiliated dual
return of the elector for the taxable year (f)(2)(i) of this section has occurred with resident corporation, or unaffiliated do-
in which the dual consolidated loss is in- respect to the dual consolidated loss within mestic owner, as the case may be, may not
curred. The domestic use agreement must the taxable year covered by the elector’s make a domestic use election with respect
be signed under penalties of perjury by the tax return and providing the name, tax- to the dual consolidated loss and such loss
person who signs the return. If dual con- payer identification number, and address therefore is subject to the domestic use
solidated losses of more than one dual res- of the subsequent elector (within the mean- limitation rule of §1.1503(d)–2(b). See
ident corporation or separate unit are sub- ing of paragraph (f)(2)(iii)(A) of this sec- §1.1503(d)–5(c) Example 32. See also
ject to the rules of this paragraph (d) which tion) that will be filing future certifications §1.1503(d)–2(c) for rules that eliminate a
requires the filing of domestic use agree- with respect to such dual consolidated loss. dual consolidated loss after certain trans-
ments by the same elector, the agreements (2) Consistency rule. If under the laws actions.
may be combined in a single document, of a particular foreign country there is a (ii) Losses of a foreign insurance com-
but the information required by paragraphs foreign use of a dual consolidated loss of pany treated as a domestic corporation.
(d)(1)(ii) and (iv) of this section must be a dual resident corporation or separate unit A foreign insurance company that has

2005–25 I.R.B. 1325 June 20, 2005


elected to be treated as a domestic corpo- resident corporation or unaffiliated domes- ted under the provisions of this section
ration pursuant to section 953(d) may not tic owner becomes a member of the con- §1.1503(d)–4(e)(2). The statement must
make a domestic use election. See section solidated group. set forth an analysis, in reasonable detail
953(d)(3). (iv) Transfer of assets. Fifty percent or and specificity, supported with official or
(e) Triggering events requiring the re- more of the dual resident corporation’s or certified English translations of the rel-
capture of a dual consolidated loss—(1) separate unit’s gross assets (measured by evant provisions of foreign law, of the
Events. The elector must agree that, except the fair market value of the assets at the treatment of the losses and deductions
as provided under paragraphs (e)(2) and (f) time of such transfer (or for multiple trans- composing the dual consolidated loss un-
of this section, if there is a triggering event actions, at the time of the first transfer)) der the facts of the event in question. The
described in this paragraph (e) during the are sold or otherwise disposed of in either statement must be attached to, and filed
certification period, the elector will recap- a single transaction or a series of transac- by the due date (including extensions)
ture and report as income the amount of the tions within a twelve-month period. For of, the elector’s income tax return for the
dual consolidated loss as provided in para- purposes of this paragraph, the interest in taxable year in which the presumed trig-
graph (h) of this section on its tax return a separate unit and the shares of a dual res- gering event occurs. See §1.1503(d)–5(c)
for the taxable year in which the trigger- ident corporation shall not be treated as as- Examples 43 through 45.
ing event occurs (or, when the triggering sets of a dual resident corporation or a sep- (f) Exceptions—(1) Acquisition by a
event is a foreign use of the dual consol- arate unit. member of the consolidated group. The
idated loss, the taxable year that includes (v) Transfer of an interest in a separate following events shall not constitute trig-
the last day of the foreign tax year dur- unit. Fifty percent or more of the interest in gering events, requiring the recapture of
ing which such use occurs). In addition, a separate unit (measured by voting power the dual consolidated loss under paragraph
the elector must pay any applicable inter- or value) owned directly or indirectly by (h) of this section—
est charge required by paragraph (h) of this the domestic owner on the last day of the (i) An affiliated dual resident corpora-
section. For purposes of this section, ex- taxable year in which the dual consoli- tion or affiliated domestic owner ceases
cept as provided under paragraphs (e)(2) dated loss was incurred is sold or other- to be a member of a consolidated group
and (f) of this section, any of the following wise disposed of either in a single trans- solely by reason of a transaction in which
events shall constitute a triggering event: action or a series of transactions within a a member of the same consolidated group
(i) Foreign use. A foreign use of twelve-month period. succeeds to the tax attributes of the dual
the dual consolidated loss (includ- (vi) Conversion to a foreign corpora- resident corporation or domestic owner
ing a deemed foreign use pursuant to tion. An unaffiliated dual resident corpo- under the provisions of section 381.
the mirror legislation rule set forth in ration, unaffiliated domestic owner, or hy- (ii) Assets of an affiliated dual resi-
§1.1503(d)–1(b)(13)(ii)(D) or the consis- brid entity an interest in which is a sepa- dent corporation or assets of a separate unit
tency rule set forth in paragraph (d)(2) of rate unit, becomes a foreign corporation by owned by an affiliated domestic owner are
this section). means of a transaction (for example, a re- acquired in any other transaction by—
(ii) Disaffiliation. An affiliated dual organization, or an election to be classified (A) One or more members of its consol-
resident corporation or affiliated domestic as a corporation under §301.7701–3(c) of idated group; or
owner ceases to be a member of the con- this chapter) that, for foreign tax purposes, (B) A partnership, a grantor trust, or
solidated group that made the domestic use is not treated as involving a transfer of as- a hybrid entity, but only if 100 percent
election. For purposes of this paragraph sets (and carryover of losses) to a new en- of such entity’s interests are owned, di-
(e)(1)(ii), a dual resident corporation or do- tity. rectly or indirectly, by such affiliated dual
mestic owner shall be considered to cease (vii) Conversion to an S corporation. resident corporation or affiliated domestic
to be a member of the consolidated group An unaffiliated dual resident corporation owner, as the case may be, or by members
if it is no longer a member of the group or unaffiliated domestic owner elects to of its consolidated group.
within the meaning of §1.1502–1(b), or be an S corporation pursuant to section (iii) Assets of a separate unit are ac-
if the group ceases to exist (for example, 1362(a). quired in any other transaction by its
when the group no longer files a consoli- (viii) Failure to certify. The elector fails domestic owner or by a hybrid entity or
dated return). See §1.1503(d)–5(c) Exam- to file a certification required under para- grantor trust, but only if 100 percent of
ple 47. graph (g) of this section. such entity’s interest is owned by the do-
(iii) Affiliation. An unaffiliated dual (2) Rebuttal. An event described in mestic owner.
resident corporation or unaffiliated domes- paragraphs (e)(1)(ii) through (viii) of this (iv) The interest of a hybrid entity sep-
tic owner becomes a member of a consol- section shall not constitute a triggering arate unit, or an indirectly owned sepa-
idated group. Any consequences resulting event if the elector demonstrates, to the rate unit, owned by an affiliated domestic
from this triggering event (for example, re- satisfaction of the Commissioner, that owner, is transferred to—
capture of a dual consolidated loss) shall there can be no foreign use of the dual (A) A member of its consolidated
be taken into account in the tax return of consolidated loss at any time during the group; or
the unaffiliated dual resident corporation remaining certification period. The elec- (B) A partnership, a grantor trust, or a
or unaffiliated domestic owner for the tax- tor must prepare a statement, labeled hybrid entity, but only if 100 percent of
able year that ends immediately before the Rebuttal of Triggering Event at the top of such entity’s interests are owned, directly
taxable year in which the unaffiliated dual the page, that indicates that it is submit- or indirectly, by such affiliated domestic

June 20, 2005 1326 2005–25 I.R.B.


owner, or by members of its consolidated of such member, is not a member of the (1) A statement that the document sub-
group. surviving group immediately after the mitted is an election and agreement under
(2) Acquisition by an unaffiliated do- terminating group ceases to exist). See the provisions of §1.1503(d)–4(f)(2);
mestic corporation or a new consolidated §1.1503(d)–5(c) Example 46. (2) An agreement to be subject to the
group—(i) Subsequent elector events. If (iii) Requirements—(A) New domestic successor elector rules as provided in para-
all the requirements of paragraph (f)(2)(iii) use agreement. The unaffiliated domestic graph (h)(3) of this section; and
of this section are met, the following corporation or new consolidated group (3) The name, U.S. taxpayer identifica-
events shall not constitute triggering (subsequent elector) must file an agree- tion number, and address of the subsequent
events requiring the recapture of the dual ment described in paragraph (d)(1) of this elector.
consolidated loss under paragraph (h) of section (new domestic use agreement). (3) Subsequent triggering events. Any
this section— The new domestic use agreement must be triggering event described in paragraph (e)
(A) An affiliated dual resident corpora- labeled New Domestic Use Agreement at of this section that occurs subsequent to
tion or affiliated domestic owner becomes the top of the page, and must be attached one of the transactions described in para-
an unaffiliated domestic corporation or to and filed by the due date (including graph (f)(1) or (2) of this section, and that
a member of a new consolidated group extensions) of, the subsequent elector’s itself does not fall within the exceptions
(other than in a transaction described in income tax return for the taxable year in provided in paragraph (f)(1) or (2) of this
paragraph (f)(2)(ii)(B) of this section); which the event described in paragraph section, shall require recapture under para-
(B) Assets of a dual resident corpora- (f)(2)(i) or (f)(2)(ii) of this section occurs. graph (h) of this section.
tion or a separate unit are acquired by— The new domestic use agreement must (g) Annual certification reporting re-
(1) An unaffiliated domestic corpora- be signed under penalties of perjury by quirement. Except as provided in para-
tion; the person who signs the return and must graph (i) of this section, the elector must
(2) One or more members of a new con- include the following items— file a certification, labeled Certification of
solidated group; or (1) A statement that the document sub- Dual Consolidated Loss at the top of the
(3) A partnership, a grantor trust, or a mitted is an election and agreement under page, that is attached to, and filed by the
hybrid entity, but only if 100 percent of the provisions of §1.1503(d)–4(f)(2); due date (including extensions) of, its in-
such entity’s interests are owned, directly (2) An agreement to assume the same come tax return for each taxable year dur-
or indirectly, by members of a new consol- obligations with respect to the dual consol- ing the certification period. The certifi-
idated group. idated loss as the corporation or consoli- cation must certify that there has been no
(C) The interest of a hybrid entity sep- dated group that filed the original domestic foreign use of such dual consolidated loss.
arate unit, or an indirectly owned separate use agreement (original elector) with re- The certification must identify the dual
unit, owned by a domestic owner is trans- spect to that loss; consolidated loss to which it pertains by
ferred to— (3) An agreement to treat any potential setting forth the elector’s year in which the
(1) An unaffiliated domestic corpora- recapture amount under paragraph (h) of loss was incurred and the amount of such
tion; this section with respect to the dual consol- loss. In addition, the certification must
(2) One or more members of a new con- idated loss as unrealized built-in gain for warrant that arrangements have been made
solidated group; or purposes of section 384(a), subject to any to ensure that there will be no foreign use
(3) A partnership, a grantor trust, or a applicable exceptions thereunder; of the dual consolidated loss and that the
hybrid entity, but only if 100 percent of (4) An agreement to be subject to the elector will be informed of any such for-
such entity’s interests is owned, directly or successor elector rules as provided in para- eign use. If dual consolidated losses of
indirectly, by members of a new consoli- graph (h)(3) of this section; and more than one taxable year are subject to
dated group. (5) The name, U.S. taxpayer identifica- the rules of this paragraph (g) of this sec-
(ii) Non-subsequent elector events. tion number, and address of the original tion, the certification for those years may
If the requirements of paragraph elector and prior subsequent electors with be combined in a single document but each
(f)(2)(iii)(A) of this section are met, the respect to the dual consolidated losses, if dual consolidated loss must be separately
following events also shall not constitute any. identified.
triggering events requiring the recapture (B) Statement filed by original elector. (h) Recapture of dual consolidated
of the dual consolidated loss under para- The original elector must file a statement loss and interest charge—(1) Presumptive
graph (h) of this section— that is attached to and filed by the due date rules—(i) Amount of recapture. Except as
(A) An unaffiliated dual resident corpo- (including extensions) of its income tax re- otherwise provided in this section, upon
ration or unaffiliated domestic owner be- turn for the taxable year in which the event the occurrence of a triggering event de-
comes a member of a consolidated group; described in paragraph (f)(2)(i) of this sec- scribed in paragraph (e)(1) of this section
or tion occurs. The statement must be la- that falls outside the exceptions provided
(B) A consolidated group that filed a beled Original Elector Statement at the top in paragraph (f)(1) or (2) of this section,
domestic use agreement ceases to exist of the page, must be signed under penal- the dual resident corporation or separate
as a result of a transaction described in ties of perjury by the person who signs the unit shall recapture, and the elector shall
§1.1502–13(j)(5)(i) (other than a transac- tax return, and must include the following report, as gross income the total amount
tion in which any member of the termi- items— of the dual consolidated loss to which the
nating group, or the successor-in-interest triggering event applies on its income tax

2005–25 I.R.B. 1327 June 20, 2005


return for the taxable year in which the mitted only if the elector demonstrates signs the elector’s tax return, and must
triggering event occurs (or, when the trig- to the satisfaction of the Commissioner be attached to, and filed by the due date
gering event is a foreign use of the dual that the dual resident corporation or sep- (including extensions) of, the elector’s in-
consolidated loss, the taxable year that in- arate unit, as the case may be, qualified come tax return for the taxable year in
cludes the last day of the foreign tax year as such (with respect to the same foreign which the triggering event occurs. See
during which such foreign use occurs). country in which the dual consolidated §1.1503(d)–5(c) Examples 51 and 52.
(ii) Interest charge. In connection with loss was generated) in the taxable years (3) Rules regarding subsequent elec-
the recapture, the elector shall pay an inter- such income was generated. An elector tors—(i) In general. The rules of this para-
est charge. Except as otherwise provided utilizing this rebuttal rule must prepare graph (h)(3) apply when, subsequent to an
in this section, such interest shall be deter- a separate accounting showing that the event described in paragraph (e)(1) of this
mined under the rules of section 6601(a) income for each year that offsets the dual section with respect to which the require-
as if the additional tax owed as a result resident corporation or separate unit’s re- ments of paragraph (f)(2)(i) of this section
of the recapture had accrued and been due capture amount is attributable only to the were met (excepted event), a triggering
and owing for the taxable year in which dual resident corporation or separate unit. event under paragraph (e) of this section
the losses or deductions taken into account The separate accounting must be signed occurs, and no exception applies to such
in computing the dual consolidated loss under penalties of perjury by the person triggering event under paragraph (f) of this
gave rise to a tax benefit for U.S. income who signs the elector’s tax return, must be section (subsequent triggering event).
tax purposes. For purposes of this para- labeled Reduction of Recapture Amount (ii) Original elector and prior subse-
graph (h)(1)(ii), a tax benefit shall be con- at the top of the page, and must indicate quent electors not subject to recapture or
sidered to have arisen in a taxable year in that it is submitted under the provisions of interest charge—(A) Except to the extent
which such losses or deductions reduced paragraph (h)(2)(i) of this section. The ac- provided in paragraph (h)(3) of this sec-
U.S. taxable income. See §1.1503(d)–5(c) counting must be attached to, and filed by tion, neither the original elector nor any
Example 51. the due date (including extensions) of, the prior subsequent elector shall be subject to
(2) Reduction of presumptive recapture elector’s income tax return for the taxable the rules of paragraph (h) of this section
amount and presumptive interest charge year in which the triggering event occurs. with respect to dual consolidated losses
—(i) Amount of recapture. The amount (ii) Interest charge. The interest charge subject to the original domestic use agree-
of dual consolidated loss that must be imposed under this section may be ap- ment.
recaptured under paragraph (h) of this propriately reduced if the elector demon- (B) In the case of a dual consolidated
section may be reduced if the elector strates, to the satisfaction of the Commis- loss with respect to which multiple ex-
demonstrates, to the satisfaction of the sioner, that the net interest owed would cepted events have occurred, only the sub-
Commissioner, the offset permitted by have been less than that provided in para- sequent elector that owns the dual resident
this paragraph (h)(2)(i). The reduction in graph (h)(1)(ii) of this section if the elec- corporation or separate unit at the time of
the amount of recapture is the amount by tor had filed an amended return for the tax- the subsequent triggering event shall be
which the dual consolidated loss would able year in which the loss was incurred, subject to the recapture rules of paragraph
have offset other taxable income reported and for any other affected taxable years (h) of this section. For purposes of para-
on a timely filed U.S. income tax return for up to and including the taxable year of graph (h) of this section, the term prior
any taxable year up to and including the recapture, treating the dual consolidated subsequent elector refers to all other sub-
taxable year of the triggering event if such loss as a loss subject to the restrictions of sequent electors.
loss had been subject to the restrictions of §1.1503(d)–2(b) (and therefore subject to (iii) Recapture tax amount and re-
§1.1503(d)–2(b) (and therefore subject to the limitations under §1.1503(d)–3(c)(3)). quired statement—(A) In general. If a
the limitation under §1.1503(d)–3(c)(3)). In the case of a separate unit, the prior subsequent triggering event occurs, the
In the case of a separate unit, the prior sentence is applied as if the separate unit subsequent elector must prepare a state-
sentence is applied as if the separate unit were a separate domestic corporation that ment that computes the recapture tax
were a separate domestic corporation filed a consolidated return with its unaffil- amount, as provided under paragraph
that filed a consolidated return with its iated domestic owner. An elector utilizing (h)(3)(iii)(B) of this section, with respect
unaffiliated domestic owner or with the this rebuttal rule must prepare a compu- to the dual consolidated loss subject to
consolidated group of its affiliated domes- tation demonstrating the reduction in the the new domestic use agreement. This
tic owner. For purposes of determining net interest owed as a result of treating statement must be attached to, and filed by
the reduction in the amount of recapture the dual consolidated loss as a loss sub- the due date (including extensions) of, the
pursuant to this paragraph, the rules under ject to the restrictions of §1.1503(d)–2(b) subsequent elector’s income tax return for
§1.1503(d)–3(b) shall apply. Any reduc- (and therefore subject to the limitations the taxable year in which the subsequent
tion to recapture pursuant to this paragraph under §1.1503(d)–3(c)(3)). The computa- triggering event occurs. The statement
that is attributable to income generated in tion must be labeled Reduction of Interest must be signed under penalties of per-
taxable years prior to the year in which the Charge at the top of the page and must in- jury by the person who signs the return.
dual consolidated loss was generated, sub- dicate that it is submitted under the pro- The statement must be labeled Statement
ject to the restrictions of §1.1503(d)–2(b) visions of paragraph (h)(2)(ii) of this sec- Identifying Secondary Liability at the top
(and therefore subject to the limitation tion. The computation must be signed un- and, in addition to the calculation of the
under §1.1503(d)–3(c)(3)), shall be per- der penalties of perjury by the person who recapture tax amount, must include the

June 20, 2005 1328 2005–25 I.R.B.


following items, in paragraphs labeled several liability. If the subsequent elector nal elector and prior subsequent elector(s),
to correspond with the items set forth in does not pay in full any of the income with each such elector receiving an amount
paragraphs (h)(3)(iii)(A)(1) through (3) of tax liability that includes a recapture tax of such refund on a pro rata basis, not to
this section: amount, the Commissioner may collect exceed the amount of recapture tax paid by
(1) A statement that the document that portion of the unpaid balance of such and/or collected from such elector.
is submitted under the provisions of income tax liability attributable to the (2) The Commissioner shall pay any
§1.1503(d)–4(h)(3)(iii); recapture tax amount in full or in part balance of such refund, if any, to the sub-
(2) A statement identifying the amount from the original elector and/or from any sequent elector.
of the dual consolidated losses at issue and prior subsequent elector, provided that (v) Definition of income tax liability.
the taxable year in which they were used; the following conditions are satisfied with Solely for purposes of paragraph (h)(3) of
(3) The name, address, and tax identi- respect to such elector— this section, the term income tax liabil-
fication number of the original elector and (1) The Commissioner properly has as- ity means the income tax liability imposed
all prior subsequent electors. sessed the recapture tax amount pursuant on a domestic corporation under Title 26
(B) Recapture tax amount. The recap- to paragraph (h)(3)(iv)(A)(1) of this sec- of the United States Code for a taxable
ture tax amount equals the excess (if any) tion; year, including additions to tax, additional
of— (2) The Commissioner has issued a no- amounts, penalties, and any interest charge
(1) The income tax liability of the sub- tice and demand for payment of the re- related to such income tax liability.
sequent elector for the taxable year of the capture tax amount to the subsequent elec- (vi) Example. See §1.1503(d)–5(c) Ex-
subsequent triggering event; over tor in accordance with §301.6303–1 of this ample 49.
(2) The income tax liability of the sub- chapter; (4) Computation of taxable income in
sequent elector for the taxable year of the (3) The subsequent elector has failed to year of recapture—(i) Presumptive rule.
subsequent triggering event, computed by pay all of the recapture tax amount by the Except to the extent provided in paragraph
excluding the amount of recapture and re- date specified in such notice and demand; (h)(4)(ii) of this section, for purposes of
lated interest charge with respect to the and computing the taxable income for the year
dual consolidated losses that are recap- (4) The Commissioner has issued a no- of recapture, no current, carryover or car-
tured as a result of the subsequent trigger- tice and demand for payment of the un- ryback losses of the dual resident corpora-
ing event, as provided under paragraphs paid portion of the recapture tax amount tion or separate unit, of other members of
(h)(1) and (h)(2) of this section. to the original elector, or prior subsequent the consolidated group, or of the domestic
(iv) Tax assessment and collection pro- elector (as the case may be), in accor- owner that are not attributable to the sepa-
cedures—(A) In general—(1) Subsequent dance with §301.6303–1 of this chapter. rate unit, may offset and absorb the recap-
elector. An assessment identifying an The liability imposed under this paragraph ture amount.
income tax liability of the subsequent (h)(3)(iv)(B) on the original elector and (ii) Rebuttal of presumptive rule. The
elector is considered an assessment of the each prior subsequent elector shall be joint recapture amount included in gross income
recapture tax amount where the recapture and several. may be offset and absorbed by that por-
tax amount is part of the income tax li- (C) Allocation of partial payments of tion of the elector’s (consolidated or sepa-
ability being assessed and the recapture tax. If the subsequent elector’s income tax rate) net operating loss carryover that is at-
tax amount is reflected in a statement at- liability for a taxable period includes a re- tributable to the dual consolidated loss be-
tached to the subsequent elector’s income capture tax amount, and if such income ing recaptured, if the elector demonstrates,
tax return as provided under paragraph tax liability is satisfied in part by payment, to the satisfaction of the Commissioner,
(h)(3)(iii) of this section. credit, or offset, such payment, credit or the amount of such portion of the carry-
(2) Original elector and prior subse- offset shall be allocated first to that portion over. An elector utilizing this rebuttal rule
quent electors. The assessment of the of the income tax liability that is not at- must prepare a computation demonstrating
recapture tax amount as set forth in para- tributable to the recapture tax amount, and the amount of net operating loss carryover
graph (h)(3)(iv)(A)(1) of this section shall then to that portion of the income tax li- that, under this paragraph (h)(4)(ii) of this
be considered as having been properly ability that is attributable to the recapture section, may absorb the recapture amount
assessed as an income tax liability of the tax amount. included in gross income. Such computa-
original elector and of each prior subse- (D) Refund. If the Commissioner tion must be signed under penalties of per-
quent elector, if any. The date of such makes a refund of any income tax liability jury and attached to and filed by the due
assessment shall be the date the income that includes a recapture tax amount, the date (including extensions) of, the income
tax liability of the subsequent elector was Commissioner shall allocate and pay the tax return for the taxable year in which the
properly assessed. The Commissioner refund to each elector who paid a portion triggering event occurs.
may collect all or a portion of such recap- of such income tax liability as follows: (5) Character and source of recap-
ture tax amount from the original elector (1) The Commissioner shall first deter- ture income. The amount recaptured
and/or the prior subsequent electors under mine the total amount of recapture tax paid under paragraph (h) of this section shall
the circumstances set forth in paragraph by and/or collected from the original elec- be treated as ordinary income. Except
(h)(3)(iv)(B) of this section. tor and from any prior subsequent elec- as provided in the prior sentence, such
(B) Collection from original elector tor(s). The Commissioner shall then al- income shall be treated, as applicable,
and prior subsequent electors; joint and locate and pay such refund to the origi- as income from the same source, having

2005–25 I.R.B. 1329 June 20, 2005


the same character, and falling within the any dual consolidated losses that would certified English translations of the rele-
same separate category, for all purposes have been recaptured as a result of the vant provisions of foreign law, of the treat-
of the Internal Revenue Code, includ- event, but for the application of paragraph ment of the losses and deductions compos-
ing sections 856(c)(2) and (3), 904(d), (f)(2)(i) or (f)(2)(ii) of this section, shall ing the dual consolidated loss under the
and 907, to which the items of deduction terminate and have no further effect. See laws of the foreign jurisdiction and the rea-
or loss composing the dual consolidated §1.1503(d)–5(c) Examples 46 and 49. sons supporting the conclusion that no for-
loss were allocated and apportioned, as (3) Recapture of dual consolidated loss. eign use of the dual consolidated loss can
provided under sections 861(b), 862(b), If a dual consolidated loss is recaptured occur in any year by any means.
863(a), 864(e), 865 and the regulations pursuant to paragraph (h) of this section,
thereunder. See §1.1503(d)–5(c) Example then the domestic use agreement filed with §1.1503(d)–5 Examples.
50. respect to such recaptured dual consoli-
(6) Reconstituted net operating loss. dated loss shall terminate and have no fur- (a) In general. This section provides
Commencing in the taxable year immedi- ther effect. See §1.1503(d)–5(c) Examples examples that illustrate the application of
ately following the year in which the dual 49 through 52. §§1.1503(d)–1 through 1.1503(d)–4. This
consolidated loss is recaptured, the dual (4) Termination of ability for foreign section also provides facts that are pre-
resident corporation or separate unit (but use—(i) In general. A domestic use agree- sumed for such examples.
only if such separate unit is owned, directly ment filed with respect to a dual consoli- (b) Presumed facts for examples. For
or indirectly, by a domestic corporation) dated loss shall terminate and have no fur- purposes of the examples in this section,
shall be treated as having a net operating ther effect as of the end of a taxable year if unless otherwise indicated, the following
loss in an amount equal to the amount the elector— facts are presumed:
actually recaptured under paragraph (h) of (A) Demonstrates, to the satisfaction of (1) Each entity has only a single class
this section. This reconstituted net operat- the Commissioner, that as of the end of of equity outstanding, all of which is held
ing loss shall be subject to the restrictions such taxable year no foreign use of the dual by a single owner.
of §1.1503(d)–2(b) (and therefore, the consolidated loss can occur in any year by (2) P, a domestic corporation and the
restrictions of §1.1503(d)–3(c)(3)), with- any means; and common parent of the P consolidated
out regard to the exceptions contained in (B) Prepares a statement described in group, owns S, a domestic corporation and
paragraphs (b) through (d) of this section. paragraph (i)(4)(ii) of this section that is a member of the P consolidated group.
The net operating loss shall be available attached to, and filed by the due date (in- (3) DRCX, a domestic corporation, is
only for carryover, under section 172(b), cluding extensions) of, its U.S. income tax subject to Country X tax on its worldwide
to taxable years following the taxable year return for such taxable year. income or on a residence basis, and is a
of recapture. For purposes of determin- (ii) Statement. The statement described dual resident corporation.
ing the remaining carryover period, the in this paragraph (i)(4)(ii) must be signed (4) DE1X and DE2X are both Country X
loss shall be treated as if it had been rec- under penalties of perjury by the person entities, subject to Country X tax on their
ognized in the taxable year in which the who signs the return. The statement must worldwide income or on a residence basis,
dual consolidated loss that is the basis of be labeled Termination of Ability for For- and disregarded as entities separate from
the recapture amount was incurred. See eign Use at the top of the page and must their owners for U.S. tax purposes. DE3Y
§1.1503(d)–5(c) Example 52. include the following items, in paragraphs is a Country Y entity, subject to Country
(i) Termination of domestic use agree- labeled to correspond with the following: Y tax on its worldwide income or on a
ment and annual certifications—(1) Re- (A) A statement that the document residence basis, and disregarded as an en-
buttal of triggering event. If, pursuant to is submitted under the provisions of tity separate from its owner for U.S. tax
paragraph (e)(2) of this section, an elec- §1.1503(d)–4(i)(4). purposes. The interests in DE1X, DE2X,
tor is able to rebut the presumption of a (B) The name, address, tax identifica- and DE3Y constitute hybrid entity separate
triggering event described in paragraphs tion number, and place and date of incor- units.
(e)(1)(ii) through (ix) of this section, in- poration of the dual resident corporation, (5) FBX is a foreign branch, as defined
cluding complying with the related report- and the country or countries that tax the in §1.367(a)–6T(g), and is a Country X
ing requirements, then the domestic use dual resident corporation on its worldwide foreign branch separate unit.
agreement filed with respect to any dual income or on a residence basis, or, in the (6) Neither the assets nor the activities
consolidated losses that would have been case of a separate unit, identification of of an entity constitutes a foreign branch
recaptured as a result of the event, but for the separate unit, including the name un- separate unit.
the rebuttal, shall terminate and have no der which it conducts business, its princi- (7) FSX is a Country X entity that is sub-
further effect. See §1.1503(d)–5(c) Exam- pal activity, and the country in which its ject to Country X tax on its worldwide in-
ple 43. principal place of business is located. come or on a residence basis and is clas-
(2) Exception to triggering event. If (C) A statement of the amount of the sified as a foreign corporation for U.S. tax
an event described in paragraph (e)(1) of dual consolidated loss at issue and the year purposes.
this section is not a triggering event as in which such dual consolidated loss was (8) The applicable foreign jurisdiction
a result of the application of paragraph incurred. has a consolidation regime that—
(f)(2)(i) or (ii) of this section, then the do- (D) An analysis, in reasonable detail (i) Includes as members of a consol-
mestic use agreement filed with respect to and specificity, supported with official or idated group any commonly controlled

June 20, 2005 1330 2005–25 I.R.B.


branches and permanent establishments cordingly, unless an exception under §1.1503(d)–4 Country X tax purposes. The $100x Year 1 loss of
in such jurisdiction, and entities that are applies (such as a domestic use election), the Year 1 DE1 is attributable to P’s interest in DE1 and is a
X X
subject to tax in such jurisdiction on their dual consolidated loss of P’s Country X permanent dual consolidated loss. FSX earns $200x of income
establishment is subject to the domestic use limita- in Year 1 for Country X tax purposes. DE1 and FS
worldwide income or on a residence basis; tion rule of §1.1503(d)–2(b). As a result, the Year 1
X
file a Country X consolidated tax return. For Country
X

and dual consolidated loss cannot offset income of P that X purposes, the Year 1 $100x loss of DE1X is used to
(ii) Allows the losses of members of is not from its Country X foreign branch separate offset $100x of Year 1 income generated by FS .
X
consolidated groups to offset income of unit, or income from any other domestic affiliate of (ii) Result. DE1 ’s $100x loss offsets FS ’s
X X
other members. such foreign branch separate unit. income under the laws of Country X. In addition,
Example 3. Domestic use limitation—no foreign under U.S. tax principles, such income is an item
(9) There is no mirror leg- consolidation regime. (i) Facts. The facts are the of FS , a foreign corporation. As a result, under
X
islation, within the meaning of same as in Example 2, except that Country X does not §1.1503(d)–1(b)(14)(i), there has been a foreign
§1.1503(d)–1(b)(14)(v), in the appli- have a consolidation regime that includes as members use of the Year 1 dual consolidated loss attribut-
cable foreign jurisdiction. of consolidated groups Country X branches or perma- able to P’s interest in DE1 . Therefore, P cannot
X
(10) There is no elective agreement nent establishments. make a domestic use election with respect to the
(ii) Result. The result is the same as Example Year 1 dual consolidated loss of DE1 as provided
described in §1.1503(d)–4(b) between the 2. The dual consolidated loss rules apply even in
X
under §1.1503(d)–4(d)(3)(i), and such loss will
United States and the applicable foreign the absence of a consolidation regime in the foreign be subject to the domestic use limitation rule of
jurisdiction. country because it is possible that all or a portion of a §1.1503(d)–2(b). The result would be the same even
(11) If a domestic use election, within dual consolidated loss can be put to a foreign use by if FS , under Country X laws, had no income against
X
the meaning of §1.1503(d)–4(d), is made, other means, such as through an acquisition or similar which the dual consolidated loss of DE1X could be
transaction. offset (unless FS ’s ability to use the loss under
all the necessary filings related to such Example 4. Domestic use limitation—foreign
X
Country X laws requires an election, and no such
election are properly completed on a branch separate unit owned through a partnership. election is made).
timely basis. (i) Facts. P and S organize a partnership, PRS ,
X
Example 7. Foreign use—foreign reverse hybrid
(12) If there is a triggering event requir- under the laws of Country X. PRS is treated as a structure. (i) Facts. P owns DE1 . DE1 owns 99%
X X X
ing recapture of a dual consolidated loss, partnership for both U.S. and Country X income tax and S owns 1% of FRHX, a Country X partnership
purposes. PRS owns FB . PRS earns U.S. source that elected to be treated as a corporation for U.S.
the amount of recapture is not reduced pur- X X X
income that is unconnected with its FB branch tax purposes. FRH conducts an active business in
X X
suant to §1.1503(d)–4(h)(2). operations and such income, therefore, is not subject Country X. The 99% interest in FRHX is the only
(c) Examples. The following examples to tax by Country X. asset owned by DE1 . DE1 ’s sole item of income,
X X
illustrate the application of §§1.1503(d)–1 (ii) Result. Under §1.1503(d)–1(b)(4)(i), P’s and gain, deduction, or loss in Year 1 for purposes of cal-
through 1.1503(d)–4: S’s shares of FBX owned indirectly through their in- culating a dual consolidated loss attributable to P’s
terests in PRS are foreign branch separate units. Un- interest in DE1 is interest expense incurred on a loan
Example 1. Separate unit combination rule. X X
less an exception under §1.1503(d)–4 applies, any from an unrelated party. DE1 ’s Year 1 interest ex-
(i) Facts. P owns DE3 which, in turn, owns X
Y dual consolidated loss incurred by FBX cannot off- pense constitutes a dual consolidated loss. In Year
DE1 . DE1 owns FB . Domestic partnership PRS,
X X X set income of P or S (other than income attributable 1, for Country X income tax purposes, DE1 took
owned 50% by P and 50% by an unrelated for- X
to FB ), including their distributive share of the U.S. into account its distributive share of income gener-
eign person, conducts operations in Country X that X
source income earned through their interests in PRS , ated by FRHX and offset such income with its interest
constitute a foreign branch within the meaning of X
or income of any other domestic affiliates of FB . expense.
§1.367(a)–6T(g). S owns DE2 . X
X Example 5. Domestic use limitation—interest in (ii) Result. In year 1, the dual consolidated loss
(ii) Result. Pursuant to §1.1503(d)–1(b)(4)(ii),
the interest in DE1 , FB , and P’s share of the Coun- hybrid entity partnership and indirectly owned for- attributable to P’s interest in DE1X, offsets income
X X eign branch separate unit. (i) Facts. HPS is a Coun- recognized in Country X and under U.S. tax prin-
try X branch owned by PRS, which is owned by P in- X
try X entity that is subject to Country X tax on its ciples the income is considered to be income of
directly through its interest in PRS, are combined and
worldwide income. HPS is classified as a partner- FRH , a foreign corporation. Accordingly, pur-
treated as one separate unit owned by P. P’s interest X X
ship for U.S. tax purposes. P, S, and F , an unrelated suant to §1.1503(d)–1(b)(14)(i), there is a foreign
in DE3 , however, is another separate unit because X
Y Country X corporation, are the sole partners of HPS . use of the dual consolidated loss. Therefore, P
it is subject to tax in Country Y, rather than Country X
For U.S. tax purposes, P, S, and F each has an equal cannot make a domestic use election with respect
X. S’s interest in DE2 also is another separate unit X
X interest in each item of HPS ’s profit or loss. HPS to DE1 ’s Year 1 dual consolidated loss, as pro-
because it is owned by S, a different domestic corpo- X X X
conduct operations in Country Y that, if carried on vided under §1.1503(d)–4(d)(3)(i), and such loss
ration.
by a U.S. person, would constitute a foreign branch will be subject to the domestic use limitation rule of
Example 2. Domestic use limitation—foreign
within the meaning of §1.367(a)–6T(g). §1.1503(d)–2(b).
branch separate unit. (i) Facts. P conducts op-
(ii) Result. Under §1.1503(d)–1(b)(4)(i), the part- Example 8. Foreign use—inapplicability of no di-
erations in Country X that constitute a permanent
nership interests in HPSX held by P and S are hybrid lution exception to foreign reverse hybrid structure.
establishment under the Country X income tax laws.
entity separate units. In addition, P’s and S’s share of (i) Facts. The facts are the same as in Example 7,
In Year 1, P’s Country X permanent establishment
the Country Y branch owned indirectly through their except as follows. Instead of owning DE1 , P owns
has a loss, as determined under §1.1503(d)–3(b)(2). X
interests in HPSX are foreign branch separate units. 75% of HPSX, a Country X entity subject to Country
(ii) Result. Under §1.1503(d)–1(b)(4)(i) and
Unless an exception under §1.1503(d)–4 applies, dual X tax on its worldwide income. F , an unrelated for-
§1.367(a)–6T(g)(1), P’s Country X permanent estab- X
consolidated losses attributable to P’s and S’s inter- eign corporation, owns the remaining 25% of HPS .
lishment constitutes a foreign branch separate unit. X
ests in HPSX can only be used to offset income attrib- HPSX is classified as a partnership for U.S. income
Therefore, the Year 1 loss of the foreign branch sepa-
utable to their respective interests in HPS (other than tax purposes. HPS owns 99% and S owns 1% of
rate unit constitutes a dual consolidated loss pursuant X X
income of HPS ’s Country Y foreign branch separate FRH . HPS incurs the Year 1 interest expense and
to §1.1503(d)–1(b)(5)(ii). The dual consolidated loss X X X
unit). Similarly, dual consolidated losses of P’s and P’s interest in HPSX, therefore, has a dual consoli-
rules apply even though there is no affiliate of the
S’s interests in the Country Y branch of HPS can dated loss in Year 1.
foreign branch separate unit in Country X because X
only be used to offset income attributable to their re- (ii) Result. In year 1, the dual consolidated loss
it is still possible that all or a portion of the dual
spective interests in the Country Y branch. attributable to P’s interest in HPSX offsets income
consolidated loss can be put to a foreign use. For ex-
Example 6. Foreign use—general rule. (i) Facts. recognized under Country X law and under U.S. tax
ample, there may be a foreign use with respect to an
P owns DE1 . DE1 owns FS . In Year 1, DE1 principles the income is considered to be income of
affiliate acquired in a year subsequent to the year in X X X X
incurs a $100x net operating loss for both U.S. and FRH , a foreign corporation. Accordingly, pursuant
which the dual consolidated loss was generated. Ac- X

2005–25 I.R.B. 1331 June 20, 2005


to §1.1503(d)–1(b)(14)(i), there is a foreign use of the pursuant to §1.1503(d)–4(d)(3)(i). As a result, such solidated loss. DRC also incurs a net operating loss
X
dual consolidated loss. In addition, the exception to loss will be subject to the domestic use limitation of $80x in Year 1. FS generates $60x of capital gain
X
foreign use under §1.1503(d)–1(b)(14)(iii)(C)(1)(i) rule of §1.1503(d)–2(b). in Year 1 which, for Country X purposes, can be off-
does not apply because the foreign use is not solely Example 11. Foreign use—parent hybrid entity. set by capital losses and net operating losses. DRC
X
the result of the dual consolidated loss being made (i) Facts. The facts are the same as Example 10, ex- elects to use $60x of its total Year 1 loss of $160x
available under Country X laws to offset an item of cept that FPX is classified as a partnership for U.S. to offset the $60x of capital gain generated by FSX
income or gain recognized under Country X laws tax purposes. in Year 1; the remaining $100x of Year 1 loss car-
that is considered, under U.S. tax principles, to be an (ii) Result. The dual consolidated loss of DRC ries forward. In Year 2, DRC incurs a net operating
X X
item of FX. Instead, the income that is offset is, under offsets the income of FPX under the laws of Coun- loss of $100x, while FSX incurs a net operating loss
U.S. tax principles, income of FRH , a foreign cor- try X. Pursuant to §1.1503(d)–1(b)(14)(i), such off- of $50x. DRC ’s $100x loss is a dual consolidated
X X
poration. Therefore, P cannot make a domestic use set constitutes a foreign use because the items con- loss. Because DRC does not elect under the laws
X
election with respect to the Year 1 dual consolidated stituting such income are considered under U.S. tax of Country X to use all or a portion of its Year 2 net
loss attributable to its interest in HPS , and such loss principles to be items of F1 and F2, the owners of in- operating loss of $100x to offset the income of other
X
will be subject to the domestic use limitation rule of terests in FP (a hybrid entity), that are not separate members of the Country X consolidated group, P is
X
§1.1503(d)–2(b). units. Therefore, DRCX cannot make a domestic use permitted to make (and in fact does make) a domestic
Example 9. Foreign use—dual resident corpora- election with respect to its Year 1 dual consolidated use election with respect to the Year 2 dual consoli-
tion with hybrid entity joint venture. (i) Facts. P owns loss pursuant to §1.1503(d)–4(d)(3)(i). As a result, dated loss of DRC . In Year 3, DRC has a net op-
X X
DRC , a member of the P consolidated group. DRC such loss will be subject to the domestic use limita- erating loss of $10x and FSX generates $60x of cap-
X X
owns 80% of HPS , a Country X entity that is subject tion rule of §1.1503(d)–2(b). The result would be the ital gains. Country X law permits, upon an election,
X
to Country X tax on its worldwide income. HPS is same if F1 and F2 owned their interests in FP indi- FS ’s $60x of capital gain generated in Year 3 to be
X X X
classified as a partnership for U.S. tax purposes. FX, rectly through another partnership. offset by losses (including carryover losses from prior
an unrelated foreign corporation, owns the remaining Example 12. No foreign use—absence of foreign years) of other group members. Accordingly, in Year
20% of HPS . In Year 1, DRC generates a $100x loss allocation rules. (i) Facts. P owns DE1 and 3, DRC elects to use $60x of its accumulated losses
X X X X
net operating loss. Also in Year 1, HPSX generates DRCX. DRCX is a member of the P consolidated to offset the $60x of Year 3 capital gain generated by
$100x of income for Country X tax purposes. DRC group and owns FS . In Year 1, DRC incurs a $200x FS .
X X X X
and HPS file a consolidated tax return for Country X net operating loss for both U.S. and Country X tax (ii) Result. (A) DRC ’s $80x Year 1 net oper-
X X
tax purposes, and HPSX offsets its $100x of income purposes, while DE1X recognizes $200x of income ating loss is a dual consolidated loss. Under the or-
with the $100x loss generated by DRC . in Year 1 under the tax laws of each country. The dering rules of §1.1503(d)–1(b)(14)(iv)(C), a pro rata
X
(ii) Result. The $100x Year 1 net operating loss $200x loss of DRC is a dual consolidated loss. FS amount of DRC ’s Year 1 net operating loss ($30x)
X X X
incurred by DRC is a dual consolidated loss. In ad- also earns $200x of income in Year 1 for Country X and capital loss ($30x) is considered to be used to off-
X
dition, HPS is a hybrid entity and DRC ’s interest in tax purposes. DRC , DE1 , and FS file a Country set FS ’s Year 1 $60x capital gain. As a result, P will
X X X X X X
HPS is a hybrid entity separate unit; however, there X consolidated tax return. However, Country X has not be able to make a domestic use election with re-
X
is no dual consolidated loss attributable to such sepa- no applicable rules for determining which income is spect to DRCX’s Year 1 $80x dual consolidated loss.
rate unit in Year 1. DRC ’s Year 1 dual consolidated offset by DRC ’s Year 1 $200x loss. (B) DRC ’s $10x Year 3 net operating loss is also
X X X
loss offsets $100x of income for Country X purposes, (ii) Result. Under §1.1503(d)–1(b)(14)(iii)(B), a dual consolidated loss. Under the ordering rules of
and $20x of such amount is (under U.S. tax princi- DRC ’s $200x loss shall be treated as having been
X
§1.1503(d)–1(b)(14)(iv)(A), such loss is considered
ples) income of F , which owns an interest in HPS made available to offset DE1 ’s $200x of income. to be used to offset $10x of FS ’s Year 3 $60x capi-
X X X X
that is not a separate unit. As a result, pursuant to DE1 is not, under U.S. tax principles, a foreign cor- tal gain. Consequently, P will not be able to make a
X
§1.1503(d)–1(b)(14)(i), there is a foreign use of the poration, and there is no interest in DE1 that is not domestic use election with respect to such loss. Un-
X
Year 1 dual consolidated loss of DRC , and P cannot a separate unit. As a result, DRC ’s loss being made der the ordering rules of §1.1503(d)–1(b)(14)(iv)(B),
X X
make a domestic use election with respect to such loss available to offset the income of DE1 is not consid- $50x of loss carryover from Year 1 will be consid-
X
pursuant to §1.1503(d)–4(d)(3)(i). Therefore, such ered a foreign use of such loss. Therefore, P can make ered to offset the remaining $50x of Year 3 income
loss will be subject to the domestic use limitation rule a domestic use election with respect to DRC ’s Year because the income is deemed to have been offset by
X
of §1.1503(d)–2(b). 1 dual consolidated loss. losses from the earliest taxable year from which a loss
Example 10. Foreign use—foreign parent corpo- Example 13. No foreign use—absence of for- can be carried forward or back for foreign law pur-
ration. (i) Facts. F1 and F2, nonresident alien indi- eign loss usage ordering rules. (i) Facts. (A) P poses. Thus, none of DRC ’s $100x Year 2 net oper-
X
viduals, each own 50% of FP , a Country X entity owns DRC , a member of the P consolidated group. ating loss will be deemed to offset FS ’s remaining
X X X
that is subject to Country X tax on its worldwide in- DRC owns FS . Under the Country X consolida- $50x of Year 3 income. As a result, such offset will
X X
come. FP is classified as a corporation for U.S. tax tion regime, a consolidated group may elect in any not constitute a foreign use of DRC ’s Year 2 dual
X X
purposes. FP owns DRC . DRC is the parent of given year to use all or a portion of the losses of one consolidated loss.
X X X
a consolidated group that includes as a member DS, consolidated group member to offset income of other Example 14. No foreign use—no dilution of an
a domestic corporation. In Year 1, DRC generates consolidated group members. If no such election is interest in a separate unit. (i) Facts. (A) P owns 50%
X
a dual consolidated loss of $100x and, for Country made in a year in which losses are generated by a con- of HPS , a Country X entity subject to Country X
X
X tax purposes, FPX generates $100x of income. In solidated member, such losses carry forward and are tax on its worldwide income. FX, an unrelated for-
Year 1, FP elects to consolidate with DRC , and the available, at the election of the consolidated group, eign corporation, owns the remaining 50% of HPS .
X X X
$100x Year 1 loss of DRC is used to offset the in- to offset income of consolidated group members in HPS is classified as a partnership for U.S. income
X X
come of FPX under the laws of Country X. For U.S. subsequent tax years. Country X law does not pro- tax purposes.
tax purposes, the items of FP do not constitute items vide ordering rules for determining when a loss from (B) The United States and Country X recognize
X
of income in Year 1. a particular tax year is used because, under Country the same items of income, gain, deduction and loss
(ii) Result. The Year 1 dual consolidated loss X law, losses never expire. Similarly, Country X law in Years 1 and 2. In Year 1, HPSX incurs a loss of
of DRC offsets the income of FP under the laws does not provide ordering rules for determining when $100x. Under §1.1503(d)–1(b)(4)(i)(B), P’s interest
X X
of Country X. Pursuant to §1.1503(d)–1(b)(14)(i), a particular type of loss (for example, capital or ordi- in HPS is a separate unit and P’s interest in HPS
X X
the offset constitutes a foreign use because the items nary) is used. The United States and Country X rec- has a dual consolidated loss of $50x in Year 1. P
constituting such income are considered under U.S. ognize the same items of income, gain, deduction and makes a domestic use election with respect to such
tax principles to be items of a foreign corporation. loss in each year. In addition, neither DRC nor FS dual consolidated loss. In Year 2, HPS generates
X X X
This is the case even though the United States does has items of income or loss for the taxable year other $50x of income. Under Country X income tax laws,
not recognize such items as income in Year 1. There- than those stated below. the $100x of Year 1 loss incurred by HPS is carried
X
fore, DRC cannot make a domestic use election (B) In Year 1, DRC incurs a capital loss of $80x forward and offsets the $50x of income generated by
X X
with respect to its Year 1 dual consolidated loss which, under §1.1503(d)–3(b)(1), is not a dual con- HPS in Year 2; the remaining $50x of loss is carried
X

June 20, 2005 1332 2005–25 I.R.B.


forward and is available to offset income generated by chase, P’s interest in HPS decreases from 50% to under Country X law to consolidate with the Country
X
HPS in subsequent years. P and F maintain their 40%. X branch of HPS .
X X Y
50% ownership interests in HPSX throughout Years 1 (ii) Result. At the beginning of Year 2, P’s (ii) Result. Because FX does not elect to con-
and 2. interest in HPS has been reduced as a result of a solidate under foreign law, P’s dual consolidated
X
(ii) Result. In Year 2, under the laws of Country person acquiring an interest in HPS . Accordingly, loss of $20x is not made available to offset F ’s
X X
X, the $100x of Year 1 loss, which includes the §1.1503(d)–1(b)(14)(iii)(C)(1)(i) generally does not income, other than as a result of FX’s owner-
$50x dual consolidated loss attributable to P’s in- apply, and there would be a foreign use of the $50x ship of HPS . Accordingly, because there has
Y
terest in HPS , is made available to offset income Year 1 dual consolidated loss attributable to P’s been no dilution of P’s interest in the Country X
X
of HPSX. Such income would be attributable to P’s interest in HPS . However, if P demonstrates, to the
X
branch of HPS , there has been no foreign use of
Y
interest in HPS , which is a separate unit. Such satisfaction of the Commissioner, that S is a domes- P’s $20x Year 1 dual consolidated loss pursuant
X
income would also be income of F , an owner of tic corporation in a statement attached to, and filed §1.1503(d)–1(b)(14)(iii)(C)(1)(ii).
X
an interest in HPSX, which is not a separate unit. by the due date (including extensions) of P’s U.S. Example 19. No foreign use—combination rule.
Under §1.1503(d)–1(b)(14)(iii)(B), because Country income tax return for the taxable year in which the (i) Facts. (A) P and F , an unrelated foreign corpo-
X
X does not have applicable rules for determining ownership interest of P was reduced, the exception to ration, form PRS . P and F each own 50 percent
X X
which Year 2 income of HPS is offset by the $100x foreign use under §1.1503–1(b)(14)(iii)(C)(1)(i) will of PRSX throughout Years 1 and 2. PRSX is treated
X
loss carried forward from year 1, the $50x dual apply. In such a case, there will be no foreign use of as a partnership for both U.S. and Country X income
consolidated loss is deemed to first have been made the $50x Year 1 dual consolidated loss attributable to tax purposes. PRS owns DE . DE is a Country
X Y Y
available to offset the $25x of income attributable P’s interest in HPS . The result would be the same if Y entity subject to Country Y tax on its worldwide
X
to P’s interest in HPS . However, because only S were unrelated to P, or if S acquired its interest in income and disregarded as an entity separate from its
X
$25x of income is attributable to P’s interest in HPS through the contribution of property to HPS owner for U.S. tax purposes. PRS does not have any
X X X
HPS , a portion of the remaining $25x of the dual in exchange for equity (rather than as a purchase of items of income, gain, deduction, or loss from sources
X
consolidated loss is made available (under U.S. tax a portion of P’s interest). other than DE . P also owns FB , a Country Y for-
Y Y
principles) to offset income of F . As a result, a Example 17. Foreign use—foreign consolidation. eign branch separate unit. Pursuant to Country Y law,
X
portion of the $50x dual consolidated loss is made (i) Facts. (A) P and FX, an unrelated Country X cor- the losses of DEY are available to offset the income
available to offset income of the owner of an interest poration, organize HPS . P owns 20% of HPS and of FB , and vice versa. Under §1.1503(d)–1(b)(4)(i),
Y Y Y
in a hybrid entity that is not a separate unit and, F owns 80% of HPS . HPS is classified as a part- P’s interest in DE , owned indirectly through PRS ,
X Y Y Y X
under the general rule of §1.1503(d)–1(b)(14)(i), nership for U.S. income tax purposes and is a Country is a hybrid entity separate unit. In addition, under
there would be a foreign use of P’s $50x Year 1 Y entity subject to Country Y tax on its worldwide in- §1.1503(d)–1(b)(4)(ii), FB and P’s indirect interest
Y
dual consolidated loss (there would also be a foreign come. HPS conducts operations in Country X that, in DE are treated as a combined separate unit.
Y Y
use in this case because FX is a foreign corpora- if carried on by a U.S. person, would constitute a for- (B) The United States and Country Y recog-
tion). However, pursuant to the exception to foreign eign branch within the meaning of §1.367(a)–6T(g). nize the same items of income, gain, deduction
use under §1.1503(d)–1(b)(14)(iii)(C)(1)(i), there (B) In Year 1, the Country X branch of and loss in Years 1 and 2. In year 1, DE incurs
Y
is no foreign use of the Year 1 dual consolidated HPSY has a loss of $100x as determined under a $100x loss and FBY incurs a $200x loss. Under
loss in Year 2. In addition, the exceptions under §1.1503(d)–3(b)(2). Under §1.1503(d)–1(b)(4)(i), §1.1503(d)–3(b)(vii)(B), the dual consolidated loss
§1.1503(d)–1(b)(14)(iii)(C)(2) do not apply because P’s interest in HPS is a separate unit, and P’s indi- attributable to P’s combined separate unit is $250x
Y
P’s interest in HPSX as of the end of Year 1 has rect interest in a portion of the Country X branch of ($50x loss attributable to P’s indirect interest in DEY
not been reduced, and the portion of the $50x dual HPS is also a separate unit. As a result, P has a dual plus $200x loss of FB ). In Year 2, DE generates
Y Y Y
consolidated loss was made available for a foreign consolidated loss of $20x in Year 1 attributable to its no income or loss.
use in Year 2 solely as a result of FX’s ownership in interest in the Country X branch owned indirectly (ii) Result. Under Country Y law, the $100x of
HPS and by the offsetting of income attributable to through HPS . HPS conducts no other activities Year 1 loss incurred by DE is carried forward and
X Y Y Y
HPS , the partnership in which F holds an interest. in Year 1 and has no other items of income, gain, is available to offset income of DE in Year 2. As a
X X Y
Therefore, there is no foreign use of the Year 1 dual deduction or loss. Accordingly, there is no dual result, a portion of such loss will be available to off-
consolidated loss in Year 2. The result would be consolidated loss attributable to P’s interest in HPS . set income of DE that is attributable to P’s interest
Y Y
the same if F owned its interest in HPS indirectly Under Country X income tax laws, F elects to con- in DE owned indirectly through PRS . A portion
X X X Y X
through a partnership. solidate with the Country X branch of HPS . As a of such loss will also be available to offset income
Y
Example 15. Foreign use—dilution of an interest result, the $100x Year 1 loss of the Country X branch of DE that is attributable to F ’s indirect ownership
Y X
in a separate unit. (i) Facts. The facts are the same as of HPS is available to offset the income of F under of DE . Accordingly, under §1.1503(d)–1(b)(14)(i),
Y X Y
Example 14, except that at the beginning of Year 2, F the laws of Country X through consolidation. there would be a foreign use of a portion of P’s $250x
X
contributes cash to HPS in exchange for additional (ii) Result. Pursuant to §1.1503(d)–1(b) Year 1 dual consolidated loss because it is available
X
equity of HPS . As a result of the contribution, F ’s (14)(iii)(C)(1)(ii), P’s Year 1 $20x dual consoli- to offset an item of income of the owner of an in-
X X
interest in HPSX increases from 50% to 60%, and P’s dated loss attributable to its indirect ownership of the terest in a hybrid entity, which is not a separate unit
interest in HPS decreases from 50% to 40%. Country X branch of HPS would not generally be (there would also be a foreign use in this case be-
X Y
(ii) Result. At the beginning of Year 2, P’s considered to be made available, under the laws of cause F is a foreign corporation). However, under
X
interest in HPSX has been reduced as a result Country X, to reduce or offset an item of income or §1.1503(d)–1(b)(14)(iii)(C)(1)(ii) and (iii), and be-
of a person other than a domestic corporation gain that is considered under U.S. tax principles to cause there has been no dilution of P’s interest in DE
Y
acquiring an interest in HPS . Accordingly, be income of F . However, F elected to consolidate (and no consolidation of DE ), no foreign use occurs
X X X Y
pursuant to §1.1503(d)–1(b)(14)(iii)(C)(2)(i), with the Country X branch under Country X law such as a result of the carryforward.
the exception to foreign use provided under that the $20x dual consolidated loss attributable to Example 20. Mirror legislation rule—dual resi-
§1.1503(d)–1(b)(14)(iii)(C)(1)(i) does not apply. P’s interest in such separate unit is available to offset dent corporation. (i) Facts. P owns DRC , a mem-
X
Therefore, in Year 2 there is a foreign use of the income under the laws of Country X as described in ber of the P consolidated group. DRCX owns FSX. In
$50x Year 1 dual consolidated loss attributable to P’s §1.1503(d)–1(b)(14)(iii)(C)(2)(ii). As a result, the Year 1, DRC generates a $100x net operating loss
X
interest in HPS . Such foreign use constitutes a trig- exception under §1.1503(d)–1(b)(14)(iii)(C)(1)(ii) that is a dual consolidated loss. To prevent corpora-
X
gering event and the $50x Year 1 dual consolidated shall not apply and there is a foreign use of the $20x tions like DRCX from offsetting losses both against
loss is recaptured. Year 1 dual consolidated loss attributable to P’s income of affiliates in Country X and against income
Example 16. No foreign use—dilution by a do- interest in the Country X branch of HPS . of foreign affiliates under the tax laws of another
Y
mestic corporation. (i) Facts. The facts are the same Example 18. No foreign use—no election to con- country, Country X mirror legislation prevents a cor-
as Example 14, except that at the beginning of Year 2, solidate under foreign law. (i) Facts. The facts are the poration that is subject to the income tax of another
instead of F contributing cash to HPS , S purchases same as in Example 17, except that F does not elect country on its worldwide income or on a residence
X X X
20% of P’s interest in HPS . As a result of the pur-
X
basis from using the Country X form of consolida-

2005–25 I.R.B. 1333 June 20, 2005


tion. Accordingly, the Country X mirror legislation Example 24. Dual consolidated loss limitation ated on the sale of asset A, DRC generated $100x
Z
prevents the loss of DRC from being made avail- after section 381 transaction—disposition of assets of operating income in Year 5. At the end of Year 5,
X
able to offset income of FSX. and subsequent liquidation of dual resident corpo- the fair market value of all the assets of DRCZ was
(ii) Result. Under §1.1503(d)–1(b)(14)(v), be- ration. (i) Facts. P owns DRC , a member of the $400x.
X
cause the losses of DRC are subject to Country X’s P consolidated group. In Year 1, DRC incurs a (ii) Result. DRC ceased being a dual resident
X X Z
mirror legislation, there shall, other than for purposes dual consolidated loss and P does not make a do- corporation at the end of Year 1. Therefore, its Year
of the consistency rule under §1.1503(d)–4(d)(2), mestic use election with respect to such loss. Under 1 dual consolidated loss cannot be offset by tainted
be a deemed foreign use of DRC ’s Year 1 dual §1.1503(d)–2(b), DRC ’s Year 1 dual consolidated income. Asset A is a tainted asset because it was
X X
consolidated loss. Therefore, P will not be able loss may not be used to offset the income of P or S (or acquired in a nonrecognition transaction after DRC
Z
to make a domestic use election with respect to the income of any other domestic affiliate of DRC ) ceased being a dual resident corporation (and was
X
DRC ’s Year 1 dual consolidated loss pursuant to on the group’s consolidated U.S. income tax return. not replacement property acquired in the ordinary
X
§1.1503(d)–4(d)(3)(i). At the beginning of Year 2, DRCX sells all of its as- course of business). As a result, the $50x of income
Example 21. Mirror legislation rule—standalone sets and discontinues its business operations. DRC recognized by DRC on the disposition of asset
X Z
foreign branch separate unit. (i) Facts. P owns FB . is then liquidated into P pursuant to section 332. A is tainted income and cannot be offset by the
X
In Year 1, FBX incurs a dual consolidated loss of (ii) Result. Typically, under section 381, P Year 1 dual consolidated loss of DRC . In addition,
Z
$100x. Under Country X tax laws, FB also gen- would succeed to, and be permitted to utilize, absent evidence establishing the actual amount of
X
erates a loss. Country X enacted mirror legislation DRC ’s net operating loss carryover. However, tainted income, $25x of the $100x Year 5 operating
X
to prevent Country X branches of nonresident corpo- §1.1503(d)–2(c)(1)(i) prohibits the dual consolidated income of DRC (($100x/$400x) x $100x) also is
Z
rations from offsetting losses both against income of loss of DRC from carrying over to P. Therefore, treated as tainted income and cannot be offset by
X
Country X affiliates and against other income of its DRC ’s Year 1 net operating loss carryover is elimi- the Year 1 dual consolidated loss of DRC under
X Z
owner (or foreign affiliate thereof) under the tax laws nated. §1.1503(d)–2(d)(2)(ii). Therefore, $75x of the $150x
of another country. The Country X mirror legislation Example 25. Dual consolidated loss limitation af- Year 5 income of DRC constitutes tainted income
Z
prevents a Country X branch of a nonresident corpo- ter section 381 transaction—liquidation of dual res- and may not be offset by the Year 1 dual consoli-
ration from offsetting its losses against the income of ident corporation. (i) Facts. The facts are the same dated loss of DRCZ; however, the remaining $75x of
Country X affiliates if such losses may be deductible as in Example 24, except as follows. DRC ’s activi- Year 5 income of DRC may be offset by such dual
X Z
against income (other than income of the Country X ties constitute a foreign branch within the meaning of consolidated loss.
branch) under the laws of another country. §1.367(a)–6T(g) and therefore are a foreign branch Example 27. Treatment of disregarded item. (i)
(ii) Result. Under §1.1503(d)–1(b)(14)(v), be- separate unit. In addition, DRC ’s foreign branch Facts. P owns DE1 . In Year 1, DE1 incurs interest
X X X
cause the losses of FB are subject to Country X’s separate unit incurs the Year 1 dual consolidated loss, expense attributable to a loan made from P to DE1 .
X X
mirror legislation, there shall, other than for purposes rather than DRC itself. Finally, DRC does not sell
X X
DE1X has no other items of income, gain, deduction,
of the consistency rule under §1.1503(d)–4(d)(2), its assets and, following the liquidation of DRC , P or loss in Year 1. Because DE1 is disregarded as an
X X
be a deemed foreign use of FB ’s Year 1 dual con- continues to operate DRC ’s business as a foreign entity separate from its owner, however, the interest
X X
solidated loss. This is the result even though P branch separate unit. expense is disregarded for federal tax purposes.
has no Country X affiliates. Therefore, P cannot (ii) Result. Pursuant to §1.1503(d)–2(c)(2)(iii), (ii) Result. Even though DE1 is treated as a sep-
X
make a domestic use election with respect to the DRC ’s Year 1 loss carryover is available to offset arate domestic corporation for purposes of determin-
X
Year 1 dual consolidated loss of FBX pursuant to P’s income generated by the foreign branch separate ing the amount of dual consolidated loss pursuant to
§1.1503(d)–4(d)(3)(i). unit previously owned by DRC (and now owned by §1.1503(d)–3 (b)(2)(i), such treatment does not cause
X
Example 22. Mirror legislation rule—absence of P), subject to the limitations of §1.1503(d)–3(c) ap- the interest expense incurred on the loan from P to
election to file consolidated return under local law. plied as if the separate unit of P generated the dual DE1X that is disregarded for federal tax purposes to
(i) Facts. The facts are the same as in Example 21, consolidated loss. be regarded for purposes of calculating the Year 1
except that P also owns FS and no election is made Example 26. Tainted income. (i) Facts. P owns dual consolidated loss, if any, of DE1 . Therefore,
X X
under Country X law to consolidate FBX and FSX. 100% of DRCZ, a domestic corporation that is in- P’s interest in DE1X does not have a dual consoli-
(ii) Result. The result is the same as Example 21, cluded as a member of the P consolidated group. The dated loss in Year 1.
even though FB has a Country X affiliate and no P consolidated group uses the calendar year as its tax- Example 28. Hybrid entity books and records. (i)
X
election is made under Country X law to consolidate able year. During Year 1, DRC was managed and Facts. P owns DE1 . In Year 1, P incurs interest ex-
Z X
FB and FS . controlled in Country Z and therefore was subject to pense attributable to a loan from a third party. The
X X
Example 23. Mirror legislation rule—inapplica- tax as a resident of Country Z and was a dual resi- third party loan and related interest expense are prop-
bility to particular dual resident corporation or sep- dent corporation. In Year 1, DRCZ generated a dual erly recorded on the books and records of P (and not
arate unit. (i) Facts. The facts are the same as in Ex- consolidated loss of $200x, and P did not make a do- on the books and records of DE1 ).
X
ample 21, except as follows. Rather than conducting mestic use election with respect to such loss. As a (ii) Result. The interest expense on P’s loan from
operations in Country X through a foreign branch, P result, such loss is subject to the domestic use lim- the third party is not properly recorded on the books
owns DE1 . In Year 1, DE1 incurs a loss of $100x itation rule of §1.1503(d)–2(b). At the end of Year and records of DE1 . No portion of the interest ex-
X X X
and also generates a loss for Country X tax purposes. 1, DRC moved its management and control from pense on such loan is attributable to DE1 pursuant to
Z X
The $100x Year 1 loss of DE1X is a dual consolidated Country Z to the United States and therefore ceased §1.1503(d)–3(b)(2)(iii) and (iv). Therefore, no por-
loss attributable to P’s interest in DE1 . being a dual resident corporation. At the beginning of tion of the interest expense is taken into account for
X
(ii) Result. The Country X mirror legislation only Year 2, P transferred asset A, a non-depreciable asset, purposes of calculating the Year 1 dual consolidated
applies to Country X branches owned by non-resident to DRCZ in exchange for common stock in a transac- loss, if any, attributable to P’s interest in DE1X pur-
corporations and therefore does not apply to losses tion that qualified for nonrecognition under section suant to §1.1503(d)–3(b)(2).
generated by DE1 . Thus, if DE1 had a Country 351. At the time of the transfer, P’s tax basis in asset Example 29. Dividend income attributable to a
X X
X affiliate, it would be permitted under the laws of A equaled $50x and the fair market value of asset A separate unit. (i) Facts. P owns DE1X. DE1X owns
Country X to use its loss to offset income of such af- equaled $100x. The tax basis of asset A in the hands DE3 . DE3 owns CFC, a controlled foreign corpo-
Y Y
filiate, notwithstanding the Country X mirror legis- of DRC immediately after the transfer equaled $50x ration. P’s interest in DE1 would otherwise have
Z X
lation. As a result, the mirror legislation rule under pursuant to section 362. Asset A did not constitute a dual consolidated loss of $75x (without regard to
§1.1503(d)–1(b)(14)(v) does not apply with respect replacement property acquired in the ordinary course Year 1 dividend income or section 78 gross-up re-
to the Year 1 dual consolidated loss of P’s interest of business. DRC did not generate income or gain ceived from CFC) in Year 1. In Year 1, CFC dis-
Z
in DE1X. Therefore, a domestic use election can be during Years 2, 3 or 4. On June 30, Year 5, DRCZ sold tributes $50x to DE3Y that is taxable as a dividend.
made with respect to such loss (provided the condi- asset A to a third party for $100x, its fair market value DE3 distributes the same amount to DE1 . P com-
Y X
tions for such an election are otherwise satisfied). at the time of the sale, and recognized $50x of income putes foreign taxes deemed paid on the dividend un-
on such sale. In addition to the $50x income gener-

June 20, 2005 1334 2005–25 I.R.B.


der section 902 of $25x and includes that amount in to DE1 and, therefore, attributable to P’s interest in would have recognized $75x of income. In addition,
X
gross income under section 78 as a dividend. DE1 , only those items that are properly reflected on if DE3 had sold its assets in a taxable transaction
X Y
(ii) Result. The $75x of dividend income ($50x the books and records of DE1X, as adjusted to con- immediately before the sale of P’s interest in DE1X,
distribution plus $25x section 78 gross-up) is prop- form to U.S. tax principles, are taken into account. DE3 would have recognized a $50x loss.
Y
erly recorded on the books and records of DE3 , as For this purpose, DE1 ’s distributive share of the (ii) Result. Pursuant to §1.1503(d)–3(b)
Y X
adjusted to conform to U.S. tax principles. Accord- items of income, gain, deduction and loss that are (2)(vii)(C), the $75x of income and $50x of loss
ingly, for purposes of determining whether the inter- properly reflected on the books and records of PRS , must be allocated to the interests of DE1 and DE3
Z X Y
est in DE3 has a dual consolidated loss, the $75x as adjusted to conform to U.S. tax principles, are based on the amount of gain or loss that would
Y
dividend income from CFC is an item of income at- treated as being reflected on the books and records of be recognized if such entities sold their assets in a
tributable to DE3 , a disregarded entity, and therefore DE1 , except to the extent such items are taken into taxable exchange for an amount equal to their fair
Y X
is an item attributable to the interest in DE3 . The account by the Country X branch of PRS , as pro- market value immediately before P sold its interest
Y Z
distribution of $50x from DE3Y to DE1X is generally vided above. in DE1X. Therefore, $75x of gain and $50x of loss
not regarded for tax purposes and therefore does not (D) Pursuant to §1.1503(d)–3(b)(2)(vii)(B)(2), recognized by P on the sale of its interest DE1
X
give rise to an item that is taken into account for pur- the combined Country X separate unit of P calculates are attributable to the interests in DE1 and DE3 ,
X Y
poses of calculating a dual consolidated loss. As a its dual consolidated loss by taking into account all respectively. As a result, such items will be taken
result, the dual consolidated loss of $75x attributable the items of income, gain deduction and loss that into account in determining whether an interest in
to P’s interest in DE1 in Year 1 is not reduced by the were separately taken into account by P’s interest either entity has a dual consolidated loss in the year
X
amount of dividend income attributable to the inter- in DE1 and the Country X branch of PRS owned
X Z
of the sale and for purposes of rebutting the amount
est in DE3 . indirectly by P. of recapture of any dual consolidated loss (for which
Y
Example 30. Items attributable to a combined Example 31. Sale of branch by domestic owner. a domestic use election was made) of DE1 from a
X
separate unit. (i) Facts. P owns DE1X. DE1X owns a (i) Facts. P owns FBX. FBX has a $100x dual consol- prior year, if any, pursuant to §1.1503(d)–4(h)(2)(i).
50% interest in PRS , a Country Z entity that is clas- idated loss in Year 1. P makes a domestic use election Example 34. Gain on sale of tiered separate units.
Z
sified as a partnership both for Country Z tax pur- with respect to such dual consolidated loss. In Year (i) Facts. P owns 75% of HPS , a Country X en-
X
poses and for U.S. tax purposes. FZ, a Country Z 2, P sells FBX and recognizes $75x of gain as a result tity subject to Country X tax on its worldwide in-
corporation unrelated to P, owns the remaining 50% of such sale. The sale is a triggering event of the Year come. F , an unrelated foreign corporation, owns
X
interest in PRS . PRS conducts operations in Coun- 1 dual consolidated loss under §1.1503(d)–4(e)(1). the remaining 25% of HPS . HPS is classified as
Z Z X X
try X that, if owned by a U.S. person, would consti- (ii) Result. Pursuant to §1.1503(d)–3(b) a partnership for U.S. income tax purposes. HPSX
tute a foreign branch as defined in §1.367(a)–6T(g). (2)(vii)(C), the gain on the sale of FB is attrib- owns operations in Country Y that, if owned by a U.S.
X
Therefore, P’s share of the Country X branch owned utable to FB for purposes of calculating the Year 2 person, would constitute a foreign branch within the
X
by PRS constitutes a foreign branch separate unit. dual consolidated loss (if any) of FBX, and for pur- meaning of §1.367(a)–6T(g). HPSX also owns assets
Z
PRS also owns assets that do not constitute a part of poses of determining FB ’s Year 2 taxable income that do not constitute a part of its Country Y branch.
Z X
its Country X branch. for purposes of rebutting the amount of the Year 1 P’s indirect interest in the Country Y branch owned
(ii) Result. (A) Pursuant to §1.1503(d)–1 dual consolidated loss to be recaptured pursuant to by HPSX, and P’s interest in HPSX, are each sepa-
(b)(4)(ii), P’s interest in DE1 , and P’s indirect own- §1.1503(d)–4(h)(2)(i). Assuming FB has no other rate units. P sells its interest in HPS and recognizes
X X X
ership of a portion of the Country X branch of PRS , items of income, gain, deduction and loss in Year 2, a gain of $150x on such sale. Immediately prior to
Z
are combined and treated as one Country X separate only $25x of the Year 1 dual consolidated loss must P’s sale of its interest in HPSX, P’s indirect interest
unit. Pursuant to §1.1503(d)–3(b)(2)(vii)(B)(1), for be recaptured. in HPS ’s Country Y branch had a net built-in gain
X
purposes of determining P’s items of income, gain, Example 32. Sale of separate unit by another sep- of $200x, and P’s pro rata portion of HPS ’s other
X
deduction and loss taken into account by its com- arate unit. (i) Facts. P owns DE1X. DE1X owns assets had a net built-in gain of $100x.
bined separate unit, the items of P are first attributed DE3 . DE1 sells its interest in DE3 at the end of (ii) Result. Pursuant to §1.1503(d)–3(b)
Y X Y
to each separate unit that compose the combined Year 1 to an unrelated third party. The sale resulted in (2)(vii)(C), $100x of the total $150x of gain rec-
Country X separate unit. an ordinary loss of $30x. Without regard to the sale ognized ($200x/$300x x $150x) is taken into account
(B) Pursuant to §1.1503(d)–3(b)(2)(ii)(A), the of DE3 , no items of income, gain, deduction or loss for purposes of determining the taxable income of P’s
Y
principles of section 864(c)(2), as modified, apply are attributable to the interest of DE3 in Year 1. indirect interest in its share of the Country Y branch
Y
for purposes of determining P’s items of income, (ii) Result. Pursuant to §1.1503(d)–3(b) owned by HPSX. Thus, such amount will be taken
gain, deduction (other than interest expense) and (2)(vii)(C), the $30x loss recognized on the sale into account in determining whether it has a dual con-
loss that are taken into account in determining the is attributable to the interest in DE3 , and not the solidated loss in the year of the sale and for purposes
Y
taxable income or loss of P’s indirect interest in interest in DE1 . In addition, the loss attributable
X
of rebutting the amount of dual consolidated loss
the Country X foreign branch owned by PRS . For to the sale creates a Year 1 dual consolidated loss recapture, if any, pursuant to §1.1503(d)–4(h)(2)(i).
Z
purposes of determining interest expense taken into attributable to the interest in DE3 . Pursuant to Similarly, $50x of such gain ($100x/$300x x $150x)
Y
account in determining the taxable income or loss §1.1503(d)–4(d)(3)(i), P cannot make a domestic use is attributable to P’s interest in HPSX and will be
of P’s indirect interest in the Country X foreign election with respect to the Year 1 dual consolidated taken into account in determining whether it has a
branch owned by PRS , the principles of §1.882–5, loss attributable to the interest in DE3 because dual consolidated loss in the year of sale, and for
Z Y
subject to §1.1503(d)–3(b)(2)(ii)(B). For purposes the sale of the interest in DE3Y is described in purposes of rebutting the amount of recapture, if any,
of applying the principles of section 864(c) and §1.1503(d)–4(e)(1). As a result, although the Year 1 pursuant to §1.1503(d)–4(h)(2)(i).
§1.882–5, P is treated as a foreign corporation, the dual consolidated loss would otherwise be subject to Example 35. Effect on domestic affiliate. (i)
Country X branch of PRSZ is treated as a trade or the domestic use limitation rule of §1.1503(d)–2(b), Facts. (A) P owns DE1X. In Years 1 and 2, the
business within the United States, and the assets it is eliminated pursuant to §1.1503(d)–2(c)(1)(ii). items of income, gain, deduction, and loss that
of P (other than those of FB ) are treated as assets Example 33. Gain and loss on sale of tiered sep- are attributable to P’s interest in DE1 for pur-
X X
that are not U.S. assets. In addition, pursuant to arate units. (i) Facts. P owns DE1X. DE1X owns poses of determining whether such interest has a
§1.1503(d)–3(b)(2)(vii)(A)(1), only the items of DE3 . P sells its interest in DE1 to an unrelated third dual consolidated loss for each year, pursuant to
Y X
DE1 and PRS are taken into account for purposes party. As a result of this sale, P recognizes $25x of §1.1503(d)–3(b)(2), are as follows:
X Z
of this determination. net gain, consisting of $75 of income and $50 of loss.
(C) For purposes of determining the items of in- If DE1 sold its assets in a taxable transaction imme-
X
come, gain, deduction and loss that are attributable diately before the sale of P’s interest in DE1 , DE1
X X

2005–25 I.R.B. 1335 June 20, 2005


Item Year 1 Year 2
Sales income $100x $160x
Salary expense ($75x) ($75x)
Research and experimental expense ($50x) ($50x)
Interest expense ($25x) ($25x)
Income/(dual consolidated loss) ($50x) ($10x)

(B) P does not make a domestic use election with unrelated corporations that are not members of the P the consolidated taxable income of the consolidated
respect to DE1 ’s Year 1 dual consolidated loss. consolidated group. group is $200x (the sum of $200x of separate taxable
X
Pursuant to §§1.1503(d)–2(b) and 1.1503(d)–3(c)(2), (B) At the beginning of Year 1, P has a basis of income earned by S1, plus $90x of capital gain earned
DE1 ’s Year 1 dual consolidated loss of $50x $1,000x in the stock of S. S has a $500x basis in the by S1, minus $90x of capital loss incurred by DRC ).
X X
is treated as a loss incurred by a separate cor- stock of DRC . The $40x gain of DRC upon the sale of item u to S1,
X X
poration and is subject to the limitations under (C) In Year 1, DRC incurs interest expense in the
X
and the $100x loss of DRC upon the sale of item v
X
§1.1503(d)–3(c)(3). amount of $100x. In addition, DRC sells a noncap- to S1, are deferred pursuant to §1.1502–13(c).
X
(ii) Result. (A) P must compute its taxable income ital asset, u, in which it has a basis of $10x, to S1 for (B) Pursuant to §1.1503(d)–3(d)(1)(i), S must
for Year 1 without taking into account the $50x dual $50x. DRCX also sells a noncapital asset, v, in which make a negative adjustment under §1.1502–32(b)(2)
consolidated loss attributable to P’s interest in DE1 . it has a basis of $200x, to S1 for $100x. The sales to its basis in the stock of DRC for the $100x
X X
Such amount consists of a pro rata portion of the ex- of u and v are intercompany transactions described dual consolidated loss incurred by DRC . In ad-
X
penses that were taken into account by DE1X in cal- in §1.1502–13. DRCX also sells a capital asset, z, in dition, S must make a negative adjustment under
culating its Year 1 dual consolidated loss. Thus, the which it has a basis of $180x, to Y for $90x. In Year §1.1502–32(b)(2) in the basis of the DRC stock for
X
items of the dual consolidated loss that are not taken 1, S1 earns $200x of separate taxable income, calcu- DRC ’s $90x capital loss because the loss has been
X
into account by P in computing its taxable income lated in accordance with §1.1502–12, as well as $90x absorbed by the consolidated group. Thus, S must
are as follows: $25x of salary expense ($75x/$150x x of capital gain from a sale of an asset to W. P and S make a $190x net negative adjustment to its basis in
$50x); $16.67x of research and experimental expense have no items of income, gain, deduction or loss for the stock of DRC , reducing its basis from $500x
X
($50x/$150x x $50x); and $8.33x of interest expense Year 1. to $310x. As provided in §1.1502–32(a)(3)(iii), the
($25x/$150x x $50x). The remaining amounts of (D) In Year 1, DRC has a dual consolidated loss adjustments in the DRC stock made by S are taken
X X
each of these items, together with the $100x of sales of $100x (attributable to its interest expense). The into account in determining P’s basis in its S stock.
income, are taken into account by P in computing its sale of non-capital assets u and v to S1, which are in- Since S has no items of income, gain, deduction or
taxable income for Year 1 as follows: $50x of salary tercompany transactions, are not taken into account in loss for the taxable year, P must only make a negative
expense ($75x - $25x); $33.33x of research and ex- calculating DRC ’s dual consolidated loss. Pursuant adjustment to its basis in the stock of S to account
X
perimental expense ($50x - $16.67x); and $16.67x of to §1.1503(d)–3(b)(1), DRCX’s $90x capital loss also for the tiering-up of adjustments for the taxable year
interest expense ($25x - $8.33x). is not included in the computation of the dual consol- pursuant to §1.1502–32(a)(3)(iii). Thus, P must
(B) Subject to the limitations provided under idated loss. Instead, DRC ’s capital loss is included make a $190x net negative adjustment to its basis in
X
§1.1503(d)–3(c)(3), the $50x dual consolidated loss in the computation of the consolidated group’s capi- S stock, reducing its basis from $1,000x to $810x.
generated by DE1 in Year 1 is carried forward and tal gain net income under §1.1502–22(c) and is used Example 37. Basis adjustment rule—subsequent
X
is available to offset the $10x of income generated to offset S1’s $90x capital gain. income of dual resident corporation. (i) Facts. (A)
by DE1X in Year 2. A pro rata portion of each item (E) For Country X tax purposes, DRCX’s $100x The facts are the same as in Example 36, except as
of deduction or loss included in such dual consol- loss is available to offset the income of FS , a for- follows. In Year 2, S1 sells items u and v to W for no
X
idated loss is considered to be used to offset the eign corporation, and therefore constitutes a foreign gain or loss. The disposition of items u and v outside
$10x of income, as follows: $5x of salary expense use. As a result, DRCX is not eligible to make a of the P consolidated group causes the intercompany
($25x/$50x x $10x); $3.33x of research and experi- domestic use election pursuant to §1.1503(d)–4(d), gain and loss of DRC attributable to u and v to be
X
mental expense ($16.67x/$50x x $10x); and $1.67x and the $100x Year 1 dual consolidated loss of taken into account pursuant to §1.1502–13(c). DRC
X
of interest expense ($8.33x/$50x x $10x). The re- DRC is subject to the domestic use limitation rule
X
also incurs $100x of interest expense in Year 2. In
maining amount of each item shall continue to be of §1.1503(d)–2(b). addition, DRC sells a noncapital asset, r, in which it
X
subject to the limitations under §1.1503(d)–3(c)(3). (ii) Result. (A) Because DRC has a dual con- has a basis of $100x, to Y for $300x. P and S have no
X
Example 36. Basis adjustment rule—year of dual solidated loss for the year, the consolidated taxable items of income, loss, or deduction for Year 2.
consolidated loss. (i) Facts. (A) In addition to S, P income of the consolidated group is calculated with- (B) DRC has $40x of separate taxable income in
X
owns S1, a domestic corporation. S owns DRC and out regard to DRC ’s items of loss or deduction taken Year 2, computed as follows:
X X
DRCX, in turn, owns FSX. S, S1 and DRCX are each into account in computing its dual consolidated loss
members of the P consolidated group. W and Y are (that is, the $100x of interest expense). Therefore,

Interest Expense ($100x)


Sale of Item v to S1 ($100x)
Sale of Item u to S1 $40x
Sale of Item r to Y $200x
Net Income/(Loss) $40x

(C) Since DRC does not have a dual consoli- consolidated taxable income of the group, computed $40x. Thus, the P group has no consolidated taxable
X
dated loss for Year 2, the group’s consolidated tax- without regard to DRCX’s dual consolidated loss car- income for the year.
able income for the year is calculated in accordance ryover, is $40x. (B) Pursuant to §1.1503(d)–3(d)(1)(ii), S does not
with the general rule of §1.1502–11, and not in ac- (ii) Result. (A) As provided under §1.1503(d)– make a negative adjustment to its basis in DRC
X
cordance with §1.1503(d)–3(c). In addition, DRCX 3(c), the portion of the $100x dual consolidated loss stock for the $40x of Year 1 dual consolidated loss
is the only member of the consolidated group that has arising in Year 1 that is included in the group’s con- that is absorbed in Year 2. However, pursuant to
any income or loss for the taxable year. Thus, the solidated net operating loss deduction for Year 2 is §1.1502–32(b), S does make a $40x net positive ad-

June 20, 2005 1336 2005–25 I.R.B.


justment to its basis in DRC stock, increasing its ba- use. P could, however, make a domestic use election $100x. P makes a domestic use election with respect
X
sis from $310x to $350x. In addition, as provided in pursuant to §1.1503(d)–4(d) with respect to the Year to DRC ’s Year 1 dual consolidated loss and such
X
§1.1502–32(a)(3)(iii), the adjustments in the DRCX 1 dual consolidated loss. loss therefore is included in the computation of the
stock made by S are taken into account in determin- Example 40. No exception to domestic use limi- P group’s consolidated taxable income. DRC has
X
ing P’s basis in its S stock. Since S has no other tation—inability to demonstrate no possibility of for- no income or loss in Year 2 through Year 6. In Year
items of income, gain, deduction or loss for the tax- eign use because items are deferred and not deducted 7, P sells the stock of DRCX to an unrelated party.
able year, P must only make a positive adjustment to or capitalized under foreign law. (i) Facts. P owns At the time of the sale of the stock of DRC , all of
X
its basis in the stock of S for to account for the tier- DE1 . In Year 1, the sole items of income, gain, de- the losses and deductions that were included in the
X
ing-up of adjustments for the taxable year pursuant to duction or loss attributable to P’s interest in DE1X as computation of the Year 1 dual consolidated loss of
§1.1502–32(a)(3)(iii). Thus, P must make a $40x net provided in §1.1503(d)–3(b)(2) are $75x of sales in- DRC had expired for Country X purposes because
X
positive adjustment to its basis in S stock, increasing come, $100x of interest expense and $25x of depre- the laws of Country X only provide for a five year
its basis from $810x to $850x. ciation expense. For Country X tax purposes, DE1X carryover period of such items.
Example 38. Exception to domestic use limita- generates $75x of sales income in Year 1, but the (ii) Result. The sale of DRC to the unrelated
X
tion—no possibility of foreign use because items are $100x interest expense is treated as a repayment of party generally would be a triggering event un-
not deducted or capitalized under foreign law. (i) principal and therefore cannot be deducted (at any der §1.1503(d)–4(e)(1)(ii), which would require
Facts. P owns DE1 . In Year 1, the sole item of in- time) or capitalized. In addition, for Country X tax the recapture of the Year 1 dual consolidated loss
X
come, gain, deduction or loss attributable to P’s in- purposes the $25x of depreciation expense is not de- (and an applicable interest charge). However, upon
terest in DE1 as provided under §1.1503(d)–3(b)(2) ductible in Year 1, but is deductible in Year 2. adequate documentation that the losses and deduc-
X
is $100x of interest expense. For Country X tax pur- (ii) Result. The Year 1 $50x net loss of DE1 tions have expired for Country X purposes, P can
X
poses, the $100x interest expense attributable to P’s constitutes a dual consolidated loss attributable rebut the presumption that a triggering event has
interest in DE1 in Year 1 is treated as a repayment to P’s interest in DE1X. Even though the $100x occurred pursuant to §1.1503(d)–4(e)(2). Pursuant
X
of principal and therefore cannot be deducted (at any interest expense, a nondeductible and noncapital to §1.1503(d)–4(i)(1), if the triggering event pre-
time) or capitalized. item for Country X tax purposes, exceeds the $50x sumption is rebutted, the domestic use agreement
(ii) Result. The $100x of interest expense attribut- Year 1 dual consolidated loss of DE1X, P cannot filed by the P consolidated group with respect to the
able to P’s interest in DE1 constitutes a dual consol- demonstrate that there is no possibility of foreign Year 1 dual consolidated loss of DRC is terminated
X X
idated loss. However, because the sole item constitut- use of the dual consolidated loss as provided under and has no further effect (absent a rebuttal, the do-
ing the dual consolidated loss cannot be deducted or §1.1503(d)–4(c)(1)(i). P cannot make such a demon- mestic use agreement would terminate pursuant to
capitalized for Country X tax purposes, P can demon- stration because the $25x depreciation expense, an §1.1503(d)–4(i)(3)).
strate that there can be no foreign use of the dual item of deduction or loss composing the Year 1 dual Example 44. Inability to rebut triggering
consolidated loss at any time. As a result, pursuant consolidated loss, is deductible under Country X law event—tax basis carryover transaction. (i) Facts.
to §1.1503(d)–4(c)(1), if P prepares a statement de- (in Year 2) and, therefore, may be available to offset (A) P owns DE1 . DE1 ’s sole asset is A, which it
X X
scribed in §1.1503(d)–4(c)(2) and attaches it to its or reduce income for Country X purposes that would acquired at the beginning of Year 1 for $100x. DE1
X
timely filed tax return, the Year 1 dual consolidated constitute a foreign use. P could, however, make a does not have any liabilities. For U.S. tax purposes,
loss of DE1 will not be subject to the domestic use domestic use election pursuant to §1.1503(d)–4(d) DE1 ’s tax basis in A at the beginning of Year 1
X X
limitation rule of §1.1503(d)–2(b). with respect to the Year 1 dual consolidated loss. is $100x and DE1 ’s sole item of income, gain,
X
Example 39. No exception to domestic use lim- Example 41. Consistency rule—deemed foreign deduction and loss for Year 1 is a $20x depreciation
itation—inability to demonstrate no possibility of use. (i) Facts. P owns DRC , a member of the P deduction attributable to A. As a result, DE1 ’s
X X
foreign use because items are deferred under for- consolidated group, FB , and FS . In Year 1, DRC Year 1 $20x depreciation deduction constitutes a
X X X
eign law. (i) Facts. P owns DE1X. In Year 1, the incurs a dual consolidated loss, which is used to off- dual consolidated loss attributable to P’s interest in
sole items of income, gain, deduction or loss attrib- set the income of FS under the Country X form of DE1 . P makes a domestic use election with respect
X X
utable to P’s interest in DE1 as provided under consolidation. FB also incurs a dual consolidated to DE1 ’s Year 1 dual consolidated loss.
X X X
§1.1503(d)–3(b)(2) are $75x of sales income and loss in Year 1. However, P elects not to use the FBX (B) For Country X tax purposes, DE1X has a
$100x of depreciation expense. For Country X tax loss on a Country X consolidated return to offset the $100x tax basis in A at the beginning of Year 1, but
purposes, DE1 also generates $75x of sales income income of Country X affiliates. A is not a depreciable asset. As a result, DE1 does
X X
in Year 1, but the $100x of depreciation expense is (ii) Result. The use of DRCX’s dual consoli- not have any items of income, gain, deduction or loss
not deductible in Year 1. Instead, for Country X dated loss to offset the income of FS for Country in Year 1 for Country X tax purposes.
X
tax purposes the $100x of depreciation expense is X purposes constitutes a foreign use. Pursuant to (C) At the beginning of Year 2, P sells its in-
deductible in Year 2. P does not make a domestic use §1.1503(d)–4(d)(2), this foreign use results in a terest in DE1 to F, an unrelated foreign person,
X
election with respect to the Year 1 dual consolidated foreign use of the dual consolidated loss of FB . for $80x. P’s disposition of its interest in DE1
X X
loss attributable to P’s interest in DE1 . Therefore, the dual consolidated loss attributable to constitutes a presumptive triggering event under
X
(ii) Result. The Year 1 $25x net loss of DE1X FBX is subject to the domestic use limitation rule of §1.1503(d)–4(e)(1) requiring the recapture of the
constitutes a dual consolidated loss attributable to P’s §1.1503(d)–2(b), and P cannot make a domestic use $20x dual consolidated loss (plus the applicable
interest in DE1 . In addition, even though DE1 has election with respect to such loss. interest charge). For Country X tax purposes, DE1
X X X
positive income in Year 1 for Country X tax purposes, Example 42. Consistency rule—no foreign use retains its tax basis of $100x in A following the sale.
P cannot demonstrate that there is no possibility of permitted. (i) Facts. The facts are the same as in Ex- (ii) Result. The Year 1 dual consolidated loss is
foreign use of its dual consolidated loss as provided ample 41, except that the income tax laws of Country a result of the $20x depreciation deduction attribut-
under §1.1503(d)–4(c)(1)(i). P cannot make such a X do not permit Country X branches of foreign cor- able to A. Although no item of loss or deduction was
demonstration because the depreciation expense, an porations to file consolidated income tax returns with recognized by DE1 by the time of the sale for Coun-
X
item composing the Year 1 dual consolidated loss, is Country X affiliates. try X tax purposes, the deduction composing the dual
deductible (in a later year) for Country X tax purposes (ii) Result. The consistency rule does not apply consolidated loss was retained by DE1X after the sale
and, therefore, may be available to offset or reduce in- with respect to the dual consolidated loss of FB be- in the form of tax basis in A. As a result, a portion
X
come for Country X purposes that would constitute a cause the income tax laws of Country X do not permit of the dual consolidated loss may offset income for
foreign use. For example, if DE1X elected to be clas- a foreign use for such dual consolidated loss. There- Country X purposes in a manner that would constitute
sified as a corporation pursuant to §301.7701–3(c) of fore, P may make a domestic use election for the dual a foreign use. For example, if DE1 were to dispose
X
this chapter effective as of the end of Year 1, and consolidated loss attributable to FB . of A, the amount of gain recognized by DE1 would
X X
the deferred depreciation expense were available for Example 43. Triggering event rebuttal—expira- be reduced and, therefore, an item composing the dual
Country X tax purposes to offset Year 2 income of tion of losses in foreign country. (i) Facts. P owns consolidated loss would reduce foreign income of an
DE1 , an entity treated as a foreign corporation in DRC , a member of the P consolidated group. In owner of an interest in a hybrid entity that is not a
X X
Year 2 for U.S. tax purposes, there would be a foreign Year 1, DRC incurs a dual consolidated loss of
X
separate unit. Thus, P cannot demonstrate pursuant to

2005–25 I.R.B. 1337 June 20, 2005


§1.1503(d)–4(e)(2) that there can be no foreign use of by the P consolidated group with respect to the Year taxable year. In Year 1, DRC incurs a dual consoli-
X
the Year 1 dual consolidated loss following the trig- 1 dual consolidated loss of DRC is terminated and dated loss and P makes a domestic use election with
X
gering event and must recapture the Year 1 dual con- has no further effect. respect to such loss. No member of the P consoli-
solidated loss. Pursuant to §1.1503(d)–4(i)(3), the (iii) If a triggering event occurs on December dated group incurs a dual consolidated loss in Year 2.
domestic use agreement filed by the P consolidated 31, Year 3, the T consolidated group must recapture On December 31, Year 2, T, the parent of the T con-
group with respect to the Year 1 dual consolidated of the dual consolidated loss that DRCX incurred in solidated group that also uses the calendar year as its
DE1 is terminated and has no further effect. Year 1 (and pay an interest charge), as provided in taxable year, acquires all the stock of DRC for cash.
X X
Example 45. Ability to rebut triggering §1.1503(d)–4(h). Each member of the T consolidated (ii) Result. (A) Under §1.1503(d)–4(f)(2)(i)(A),
event—taxable asset sale. (i) Facts. The facts group, including DRC and any former members
X
the acquisition by T of DRCX is not an event de-
are the same as Example 44, except that instead of of the P consolidated group, is severally liable for scribed in §1.1503(d)–4(e)(1) requiring the recapture
P selling its interests in DE1 to F, DE1 sells asset the additional tax (and the interest charge) due upon of the Year 1 dual consolidated loss of DRC (and
X X X
A to F for $80x. Such sale constitutes a presump- the recapture of the dual consolidated loss of DRCX. the payment of an interest charge), provided: (1)
tive triggering event under §1.1503(d)–4(e)(1). For In addition, pursuant to §1.1503(d)–4(i)(3), the new the T consolidated group files a new domestic use
Country X tax purposes, F’s tax basis in A is $80x. domestic use agreement filed by the T group with agreement described in §1.1503(d)–4(f)(2)(iii)(A)
(ii) Result. The Year 1 dual consolidated loss at- respect to the Year 1 dual consolidated loss of DRC
X
with respect to the Year 1 dual consolidated loss of
tributable to P’s interest in DE1 is a result of the is terminated and has no further effect. DRC ; and (2) the P consolidated group files a state-
X X
$20x depreciation deduction attributable to A. For Example 47. No triggering event if consolidated ment described in §1.1503(d)–4(f)(2)(iii)(B) with
Country X tax purposes, however, F’s tax basis in A group remains in existence in connection with a re- respect to the Year 1 dual consolidated loss of DRC .
X
was not determined, in whole or in part, by reference verse acquisition. (i) Facts. S owns FB . FB in- If these requirements are satisfied, then pursuant to
X X
to the basis of A in the hands of DE1 . As a result, curs a dual consolidated loss of $100x in Year 1 and §1.1503(d)–4(i)(2) the domestic use agreement filed
X
the deduction composing the dual consolidated loss P makes a domestic use election with respect to such by the P consolidated group with respect to the Year
will not give rise to an item of deduction or loss in loss. At the end of Year 2, P merges into T, the com- 1 dual consolidated loss of DRC is terminated and
X
the form of tax basis for Country X purposes (for ex- mon parent of the T consolidated group, which in- has no further effect (if such requirements are not
ample, when F disposes of A). Therefore, P may be cludes U as a member. The shareholders of P imme- satisfied, the domestic use agreement would termi-
able to demonstrate pursuant to §1.1503(d)–4(e)(2) diately before the merger, as a result of owning stock nate pursuant to §1.1503(d)–4(i)(3).
that there can be no foreign use of the Year 1 dual in P, own 60% of the fair market value of T’s stock (B) Assume a triggering event occurs on De-
consolidated loss and, thus, may not be required to immediately after the merger. cember 31, Year 3, that requires recapture by the T
recapture the Year 1 dual consolidated loss. Pur- (ii) Result. The P group is treated as continuing in consolidated group of the dual consolidated loss that
suant to §1.1503(d)–4(i)(1), if such a demonstration existence under §1.1502–75(d)(3) with T and U be- DRC incurred in Year 1, as well as the payment of
X
is made, the domestic use agreement filed by the P ing added as members of the P group, and T taking an interest charge, as provided in §1.1503(d)–4(h).
consolidated group with respect to the Year 1 dual the place of P as the common parent. The merger of In that case, each member of the T consolidated
consolidated loss of DE1 is terminated pursuant to P into T does not constitute a triggering event with re- group, including DRC , is severally liable for the
X X
§1.1503(d)–4(i)(1) and has no further effect (absent a spect to the dual consolidated loss in Year 1 pursuant additional tax (and the interest charge) due upon
rebuttal, the domestic use agreement would terminate to §1.1503(d)–4(e)(1)(ii) because the P consolidated the recapture of the Year 1 dual consolidated loss
pursuant to §1.1503(d)–4(i)(3)). group, which owned FB , continues to exist. of DRC . The T consolidated group must prepare a
X X
Example 46. Termination of consolidated group Example 48. Triggering event exception—acqui- statement that computes the recapture tax amount as
not a triggering event if acquirer files a new domestic sition of assets by domestic owner. (i) Facts. P owns provided under §1.1503(d)–4(h)(3)(iii). Pursuant to
use agreement. (i) Facts. P owns DRC , a member of DE1 . In Year 1, DE1 incurs a loss of $100x and, §1.1503(d)–4(h)(3)(iv)(A), the recapture tax amount
X X X
the P consolidated group. The P consolidated group as a result, P’s interest in DE1 has a Year 1 dual is assessed as an income tax liability of the T con-
X
uses the calendar year as its taxable year. In Year 1, consolidated loss of $100x. P makes a domestic use solidated group and is considered as having been
DRC incurs a dual consolidated loss and P makes a election with respect to the Year 1 dual consolidated properly assessed as an income tax liability of the P
X
domestic use election with respect to such loss. No loss and such loss therefore is included in the compu- consolidated group. If the T consolidated group does
member of the P consolidated group incurs a dual tation of the P group’s consolidated taxable income. not pay in full the income tax liability attributable
consolidated loss in Year 2. On December 31, Year In Year 3, DE1 dissolves and surrenders its Coun- to the recapture tax amount, the unpaid balance of
X
2, T, the parent of the T consolidated group acquires try X corporate charter. Pursuant to its dissolution, such recapture tax amount may be collected from
all the stock of P, and all the members of the P group, DE1 distributes its assets and liabilities to P and the the P consolidated group in accordance with the
X
including DRC , become members of a consolidated shares of DE1 are cancelled. provisions of §1.1503(d)–4(h)(3)(iv)(B). Pursuant to
X X
group of which T is the common parent. (ii) Result. The disposition of the assets of DE1 §1.1503(d)–4(i)(3), the new domestic use agreement
X
(ii) Result. (A) Under §1.1503(d)–4(f)(2)(ii)(B), (and the disposition of P’s interest in DE1 ) as a re- filed by the T consolidated group is terminated and
X
the acquisition by T of the P consolidated group sult of the dissolution generally would be a trigger- has no further effect.
is not an event described in §1.1503(d)–4(e)(1) ing event under §1.1503(d)–4(e)(1). However, be- Example 50. Character and source of recapture
requiring the recapture of the Year 1 dual con- cause the assets of DE1 are acquired by P, its do- income. (i) Facts. (A) P owns DE1 . In Year 1, the
X X
solidated loss of DRC (and the payment of an mestic owner, as a result of the dissolution, the dis- items of income, gain, deduction, and loss that are
X
interest charge), provided that the T consolidated solution does not constitute a triggering event under attributable to P’s interest in DE1X for purposes of
group files a new domestic use agreement de- §1.1503(d)–4(f)(1). determining whether such interest has a dual consol-
scribed in §1.1503(d)–4(f)(2)(iii)(A). If a new Example 49. Subsequent elector rules. (i) Facts. idated loss are as follows:
domestic use agreement is filed, then pursuant to P owns DRCX, a member of the P consolidated group.
§1.1503(d)–4(i)(2), the domestic use agreement filed The P consolidated group uses the calendar year as its

Sales income $100x


Salary expense ($75x)
Interest expense ($50x)
Dual consolidated loss ($25x)

(B) P makes a domestic use election with respect solidated loss is included in the computation of P’s (C) Pursuant to §1.861–8, the $75x of salary ex-
to the Year 1 dual consolidated loss attributable to taxable income. pense incurred by DE1 is allocated and apportioned
X
P’s interest in DE1 and, thus, the $25x dual con- entirely to foreign source general limitation income.
X

June 20, 2005 1338 2005–25 I.R.B.


Pursuant to §1.861–9T, $25x of the $50x interest ex- mestic use election with respect to DRC ’s Year 1
X
Notice of Proposed
pense attributable to DE1 is allocated and appor- dual consolidated loss. Therefore, the consolidated
X
tioned to domestic source income, $15x of such in- group is permitted to offset P’s $100x of income with
Rulemaking by
terest expense is allocated and apportioned to foreign DRC ’s $100x loss. In Year 2, DRC earns $30x,
X X
Cross-Reference to
source general limitation income, and the remaining which is completely offset by a $30x net operating Temporary Regulations;
$10x of such interest expense is allocated and appor- loss incurred by P in Year 2. In Year 3, DRCX earns
tioned to foreign source passive income. income of $25x, while P recognizes no income or Notice of Public Hearing;
(D) During Year 2, DE1 generates $5x of in-
X
loss. In addition, there is a triggering event at the end and Withdrawal of Previously
come, an amount which the $25x dual consolidated of Year 3.
loss generated by DE1 in Year 1 would have off- (ii) Result. (A) Under the presumptive rule Proposed Regulations
X
set if such loss had been subject to the separate of §1.1503(d)–4(h)(1)(i), DRC must recapture
X
return limitation year restrictions as provided under $100x. However, the $100x recapture amount Credit for Increasing Research
§1.1503(d)–3(c)(3). may be reduced by the amount by which the dual
(E) At the beginning of Year 3, DE1 consolidated loss would have offset other taxable Activities
X
undergoes a triggering event within the income if it had been subject to the limitation under
meaning of §1.1503(d)–4(e)(1). Pursuant to §1.1503(d)–3(c)(3), upon adequate documentation REG–134030–04 and
§1.1503(d)–4(h)(2)(i), P demonstrates, to the satis- of such offset under §1.1503(d)–4(h)(2)(i).
faction of the Commissioner, that the $5x generated (B) Although DRC earned $30x of income in
REG–133791–02
X
by DE1 in Year 2 qualifies to reduce the amount Year 2, there was no consolidated taxable income in
X AGENCY: Internal Revenue Service
that P must recapture as a result of the triggering such year. As a result, the $100x of recapture income
event. cannot be reduced by the $30x earned in Year 2, but (IRS), Treasury.
(ii) Result. P must recapture and report as income such amount can be carried forward to subsequent
$20x ($25x - $5x) of DE1 ’s Year 1 dual consoli-
X
taxable years and be used to the extent of consolidated ACTION: Notice of proposed rulemaking
dated loss, plus applicable interest, on its Year 3 tax taxable income generated in such years. In Year 3, by cross-reference to temporary regu-
return. Pursuant to §1.1503(d)–4(h)(5), the recapture DRC earns $25x of income and the P consolidated
X lations; notice of public hearing; and
income is treated as ordinary income whose source group has $25 of consolidated taxable income in such
and character (including section 904 separate limi- year. As a result, the $100x of recapture income can
withdrawal of previously proposed regu-
tation character) is determined by reference to the be reduced by the $25x. The $30x generated in Year 2 lations.
manner in which the recaptured items of expense cannot be used in Year 3 because there is insufficient
or loss taken into account in calculating the dual consolidated taxable income in such year. SUMMARY: In this issue of the Bulletin,
consolidated loss were allocated and apportioned. (C) Commencing in Year 4, the $75x recap- the IRS is issuing temporary regulations
Accordingly, P’s $20x of recapture income is char- ture amount ($100x - $25x) is reconstituted and (T.D. 9205) relating to the computation
acterized and sourced as follows: $4x of domestic treated as a loss incurred by DRCX in a separate
source income (($25x/$125x) x $20x); $14.4x of return limitation year, subject to the limitation under
and allocation of the credit for increasing
foreign source general limitation income (($75x + §1.1503(d)–2(b) (and therefore subject to the restric- research activities for members of a con-
$15x)/$125x) x $20x); and $1.6x of foreign source tions of §1.1503(d)–3(c)(3)). The carryover period trolled group of corporations, including
passive income (($10x/$125x) x $20x). Pursuant to of the loss, for purposes of section 172(b), will start consolidated groups, or a group of trades
§1.1503(d)–4(i)(3), the domestic use agreement filed from Year 1, when the dual consolidated loss was in- or businesses under common control. The
by the P consolidated group with respect to the Year curred. Pursuant to §1.1503(d)–4(i)(3), the domestic
1 dual consolidated of DE1 is terminated and has use agreement filed by the P consolidated group with
text of those regulations also serves as the
X
no further effect. respect to the Year 1 dual consolidated of DE1 is text of these proposed regulations. This
X
Example 51. Interest charge without recapture. terminated and has no further effect. document also provides notice of a public
(i) Facts. P owns DE1 . In Year 1, a dual consoli- hearing on these proposed regulations and
X
dated loss of $100x is attributable to P’s interest in §1.1503(d)–6 Effective date. withdraws the proposed regulations pub-
DE1 . P makes a domestic use election with respect
X
to the Year 1 dual consolidated loss and uses the loss
lished in the Federal Register on July 29,
Sections 1.1503(d)–1 through
to offset the P group’s consolidated taxable income. 2003 (68 FR 44499).
1.1503(d)–5 shall apply to dual consol-
DE1X earns income of $100x in Year 2. At the end of
Year 2, DE1 undergoes a triggering event within the
idated losses incurred in taxable years DATES: Written or electronic comments
X
meaning of §1.1503(d)–4(e)(1). P demonstrates, to beginning after the date that these regula- must be received by September 28, 2005.
the satisfaction of the Commissioner, that taking into tions are published as final regulations in Requests to speak and outlines of the top-
the limitation of §1.1503(d)–3(c)(3) (modified SRLY the Federal Register. ics to be discussed at the public hearing
limitation), the Year 1 $100x dual consolidated loss
Par. 4. In §1.6043–4T, paragraph scheduled for October 19, 2005, at 10 a.m.
would have been offset by the $100x Year 2 income.
(ii) Result. There is no recapture of the Year
(a)(1)(iii) is amended by removing the must be received by September 28, 2005.
1 dual consolidated loss attributable to P’s inter- language “§1.1503–2(c)(2)” and adding
est in DE1 because it is reduced to zero under “§1.1503(d)–1(b)(2)” in its place. ADDRESSES: Send submissions to:
§1.1503(d)–4(h)(2)(i). However, P is liable for one CC:PA:LPD:PR (REG–134030–04), room
year of interest charge under §1.1503(d)–4(h)(1)(ii), Mark E. Matthews, 5203, Internal Revenue Service, PO Box
even though P’s recapture amount is zero. Pursuant Deputy Commissioner for
to §1.1503(d)–4(i)(3), the domestic use agreement
7604, Ben Franklin Station, Washing-
Services and Enforcement. ton, DC 20044. Submissions may be
filed by the P consolidated group with respect to the
Year 1 dual consolidated of DE1X is terminated and (Filed by the Office of the Federal Register on May 19, 2005, hand delivered Monday through Friday
has no further effect. 9:47 a.m., and published in the issue of the Federal Register between the hours of 8 a.m. and 4 p.m.
Example 52. Reduced recapture and interest for May 24, 2005, 70 F.R. 29867)
to: CC:PA:LPD:PR (REG–134030–04),
charge, and reconstituted dual consolidated loss. (i)
Facts. P owns DRC , a member of the P consolidated
Courier’s Desk, Internal Revenue Ser-
X
group. In Year 1, DRC incurs a dual consolidated vice, 1111 Constitution Avenue, NW,
X
loss of $100x and P earns $100x. P makes a do- Washington, DC 20224. Alternatively,

2005–25 I.R.B. 1339 June 20, 2005


taxpayers may submit electronic com- apply. Therefore, a Regulatory Flexibility Special Industries). However, other per-
ments directly to the IRS Internet site at Analysis is not required. Pursuant to sec- sonnel from the IRS and Treasury Depart-
www.irs.gov/regs or via the Federal eRule- tion 7805(f) of the Internal Revenue Code, ment participated in their development.
making Portal at www.regulations.gov this notice of proposed rulemaking will be
(IRS and REG–134030–04). The public submitted to the Chief Counsel for Advo- *****
hearing will be held in the Auditorium, cacy of the Small Business Administration
7th Floor, Internal Revenue Building, 1111 for comment on its impact on small busi- Withdrawal of Proposed Amendments
Constitution Avenue, NW, Washington, ness. to the Regulations
DC 20224.
Comments and Requests for a Public Accordingly, under the authority of
FOR FURTHER INFORMATION Hearing 26 U.S.C. 7805, the notice of proposed
CONTACT: Concerning these proposed rulemaking (REG–133791–02) published
regulations, Nicole R. Cimino at (202) Before these proposed regulations are in the Federal Register on July 29, 2003,
622–3120; concerning submissions of adopted as final regulations, consideration (68 FR 44499) is withdrawn.
comments, the hearing, and/or to be will be given to any written comments
placed on the building access list to at- (a signed original and eight (8) copies) Proposed Amendments to the
tend the hearing, Robin R. Jones at (202) or electronic comments that are submitted Regulations
622–7180 (not toll-free numbers). timely to the IRS. All comments will be
available for public inspection and copy- Accordingly, 26 CFR part 1 is proposed
SUPPLEMENTARY INFORMATION: ing. to be amended as follows:
A public hearing has been scheduled for
Background and Explanation of October 19, 2005, beginning at 10 a.m. in PART 1 — INCOME TAXES
Provisions the Auditorium, 7th Floor, of the Internal
Revenue Building, 1111 Constitution Av- Paragraph 1. The authority citation for
This document withdraws the notice of enue, NW, Washington, DC. Due to build- part 1 continues to read, in part, as follows:
proposed rulemaking (REG–133791–02, ing security procedures, visitors must enter Authority: 26 U.S.C. 7805 * * *
2003–2 C.B. 493) published on July 29, at the Constitution Avenue entrance. In ad- Section 1.41–6 also issued under 26
2003, and amends the Income Tax Reg- dition, all visitors must present photo iden- U.S.C. 41(f).* * *
ulations (26 CFR 1) relating to section tification to enter the building. Because Par. 2. In §1.41–0, the table of contents
41. The temporary regulations set forth of access restrictions, visitors will not be is amended as follows:
the rules relating to the computation and admitted beyond the immediate entrance
allocation of the credit for increasing area more than 30 minutes before the hear- §1.41–0 Table of contents.
research activities for members of a con- ing starts. For information about having
trolled group of corporations, including your name placed on the building access [The text of proposed §1.41–0 is the
consolidated groups, or a group of trades list to attend the hearing, see the “FOR same as the text of §1.41–0 published else-
or businesses under common control un- FURTHER INFORMATION CONTACT” where in this issue of the Bulletin].
der section 41(f) for taxable years ending section of this preamble. Par. 3. Section 1.41–6 is revised to read
on or after May 24, 2005. The text of The rules of 26 CFR 601.601(a)(3) ap- as follows:
those regulations also serves as the text of ply to the hearing. Persons who wish to
these proposed regulations. The preamble present oral comments at the hearing must §1.41–6 Aggregation of expenditures.
to the temporary regulations explains the submit written comments and an outline
amendments. of the topics to be discussed and the time [The text of proposed §1.41–6 is the
to be devoted to each topic (signed orig- same as the text of §1.41–6T published
Special Analyses inal and eight (8) copies) by September elsewhere in this issue of the Bulletin].
28, 2005. A period of 10 minutes will be Par. 4. Section 1.41–8 is revised to read
It has been determined that this notice as follows:
allotted to each person for making com-
of proposed rulemaking is not a significant
ments. An agenda showing the scheduling
regulatory action as defined in Executive §1.41–8 Special rules for taxable years
of the speakers will be prepared after the
Order 12866. Therefore, a regulatory as- ending on or after January 3, 2001.
deadline for receiving outlines has passed.
sessment is not required. It also has been
Copies of the agenda will be available free
determined that section 553(b) of the Ad- [The text of proposed §1.41–8 is the
of charge at the hearing.
ministrative Procedure Act (5 U.S.C. chap- same as the text of §1.41–8T published
ter 5) does not apply to these regulations Drafting Information elsewhere in this issue of the Bulletin].
and, because these regulations do not im-
pose on small entities a collection of infor- The principal author of these regula- Mark E. Matthews,
mation requirement, the Regulatory Flex- tions is Nicole R. Cimino, Office of the As- Deputy Commissioner for
ibility Act (5 U.S.C. chapter 6) does not sociate Chief Counsel (Passthroughs and Services and Enforcement.

June 20, 2005 1340 2005–25 I.R.B.


(Filed by the Office of the Federal Register on May 20, 2005, FOR FURTHER INFORMATION ternal Revenue Service and to provide the
8:45 a.m., and published in the issue of the Federal Register
for May 24, 2005, 70 F.R. 29662)
CONTACT: Concerning the proposed information to the donor of the qualified
regulations, Donnell M. Rini-Swyers, intellectual property. Section 1.6050L–2
(202) 622–4910; concerning submissions provides guidance for the filing of in-
of comments, the hearing, and/or to be formation returns by donees relating to
Notice of Proposed placed on the building access list to attend qualified intellectual property contribu-
Rulemaking by the hearing, Guy Traynor, (202) 622–7180 tions. These collections of information are
Cross-Reference to (not toll-free numbers). required to obtain a tax benefit. The likely
Temporary Regulations respondents are tax-exempt organizations.
SUPPLEMENTARY INFORMATION: Estimated total annual reporting and/or
recordkeeping burden: 200 hours. Esti-
Information Returns by Paperwork Reduction Act mated average annual burden per respon-
Donees Relating to Qualified dent and/or recordkeeper is two hours.
Intellectual Property The collection of information contained
Estimated number respondents and/or
in this notice of proposed rulemaking has
Contributions been submitted to the Office of Manage-
recordkeepers: 100.
An agency may not conduct or sponsor,
ment and Budget for review in accordance
REG–158138–04 with the Paperwork Reduction Act of 1995
and a person is not required to respond to, a
collection of information unless it displays
(44 U.S.C. 3507(d)). Comments on the
AGENCY: Internal Revenue Service a valid control number assigned by the Of-
collection of information should be sent
(IRS), Treasury. fice of Management and Budget.
to the Office of Management and Bud-
Books or records relating to a collection
ACTION: Notice of proposed rulemaking get, Attn: Desk Officer for the Depart-
of information must be retained as long
by cross-reference to temporary regula- ment of the Treasury, Office of Informa-
as their contents may become material in
tions. tion and Regulatory Affairs, Washington,
the administration of any internal revenue
DC 20503, with copies to the Internal Rev-
law. Generally, tax returns and return in-
SUMMARY: This document contains pro- enue Service, Attn: IRS Reports Clearance
formation are confidential, as required by
posed regulations that provide guidance Officer, SE:W:CAR:MP:T:T:SP, Washing-
26 U.S.C. 6103.
for the filing of information returns by ton, DC 20224. Comments on the collec-
donees relating to qualified intellectual tion of information should be received by Background
property contributions. The text of the July 22, 2005. Comments are specifically
temporary regulations (T.D. 9206) pub- requested concerning: Temporary regulations in this issue of
lished in this issue of the Bulletin also Whether the proposed collection of in- the Bulletin amend the Income Tax Regu-
serves as the text of these proposed reg- formation is necessary for the proper per- lations (26 CFR part 1) relating to section
ulations. The regulations affect donees formance of the functions of the IRS, in- 6050L. The temporary regulations provide
receiving qualified intellectual property cluding whether the information will have guidance for filing information returns by
contributions after June 3, 2004. practical utility; donees relating to qualified intellectual
The accuracy of the estimated burden property contributions.
DATES: Written or electronic comments associated with the proposed collection of This document contains proposed In-
and requests for a public hearing must be information (see below); come Tax Regulations under the Amer-
received by August 22, 2005. How the quality, utility, and clarity of ican Jobs Creation Act of 2004 (Public
the information to be collected may be en- Law 108–357, 118 Stat. 1418) (the Act).
ADDRESSES: Send submissions to: hanced; They are necessary to implement section
CC:PA:LPD:PR (REG–158138–04), room How the burden of complying with the 882 of that Act, which directs that regula-
5203, Internal Revenue Service, POB proposed collection of information may be tions be issued regarding information re-
7604, Ben Franklin Station, Washing- minimized, including through the appli- turns by donees relating to qualified intel-
ton, DC 20044. Submissions may be cation of automated collection techniques lectual property contributions made after
hand delivered Monday through Friday or other forms of information technology; June 3, 2004.
between the hours of 8 a.m. and 4 p.m. and The Act provides rules that enable tax-
to: CC:PA:LPD:PR (REG–158138–04), Estimates of capital or start-up costs payers who donate qualified intellectual
Courier’s Desk, Internal Revenue Service, and costs of operation, maintenance, and property to receive additional charitable
1111 Constitution Avenue, NW, Wash- purchase of services to provide informa- contribution deductions if and when their
ington, DC, or sent electronically, via the tion. donated property produces net income for
IRS Internet site at www.irs.gov/regs, The collections of information in this the donee (qualified donee income), under
or via the Federal eRulemaking Por- proposed regulation are in 1.6050L–2. specified conditions. Section 170(m)(2),
tal at www.regulations.gov (IRS- Section 6050L(b) requires certain donees (8), (9). Under the Act, a taxpayer who
REG–158138–04). A public hearing may of qualified intellectual property to annu- contributes a “patent, copyright (other
be scheduled if requested by any person ally report certain information regarding than a copyright described in section
who timely submits comments. the qualified intellectual property to the In- 1221(a)(3) or 1231(b)(1)(C)), trademark,

2005–25 I.R.B. 1341 June 20, 2005


trade name, trade secret, know-how, soft- beginning after the expiration of the le- original and 8 copies) or electronic com-
ware (other than software described in sec- gal life of such qualified intellectual prop- ments that are submitted timely to the IRS.
tion 197(e)(3)(A)(i)), or similar property, erty. Additionally, section 6050L(b) re- The IRS and Treasury Department request
or applications or registrations of such quires a return only for specified taxable comments on the clarity of the proposed
property,” to a donee described in section years of the donee, which years are de- rules and how they can be made easier to
170(c) (other than to a private foundation fined in section 6050L(b)(2)(B) as any tax- understand. All comments will be avail-
referred to in section 170(e)(1)(B)(ii)) may able year any portion of which is part of able for public inspection and copying.
be allowed an initial charitable contribu- the 10-year period beginning on the date A public hearing will be scheduled if
tion deduction limited to the lesser of the of contribution of the qualified intellectual requested in writing by any person that
taxpayer’s basis or the fair market value property. Therefore, the donee is not re- timely submits written comments. If a
of the qualified intellectual property. In quired to make a return for taxable years public hearing is scheduled, notice of the
addition, the taxpayer may be permitted to beginning more than 10 years after the date date, time, and place for the public hearing
deduct certain additional amounts in the of the qualified intellectual property con- will be published in the Federal Register.
year of contribution or in subsequent tax- tribution.
able years based on a specified percentage Under these regulations, the donee Drafting Information
of the qualified donee income received generally is required to file an informa-
The principal author of these regula-
by the donee with respect to the qualified tion return (with a copy of such return
tions is Donnell M. Rini-Swyers, Office of
intellectual property. to the donor) on or before the last day of
Assistant Chief Counsel (Procedure & Ad-
Section 882(c)(1) of the Act amended the first full month following the close
ministration).
section 6050L to require donees to make of the donee’s taxable year. See section
an annual information return that reports 7701(a)(23) for the definition of taxable *****
the qualified donee income for the taxable year. Transition rules are provided to take
Proposed Amendments to the
year and other specified information relat- into account these filing requirements be-
Regulations
ing to qualified intellectual property con- fore a form is prescribed by the Internal
tributions. The IRS expects to issue a new Revenue Service and for donees’ taxable Accordingly, 26 CFR part 1 is proposed
Form 8899 on which donees will report years ending prior to or on the date of to be amended as follows:
qualified donee income. issuance of these regulations.
Under section 170(m)(8)(B), a donor PART 1—INCOME TAXES
must notify the donee of the donor’s in- Special Analyses
tent to treat a charitable contribution as Paragraph 1. The authority citation for
It has been determined that this notice part 1 continues to read, in part, as follows:
a qualified intellectual property contribu-
of proposed rulemaking is not a significant Authority: 26 U.S.C. 7805 * * *
tion under sections 170(m) and 6050L. For
regulatory action as defined in Executive Par. 2. Section 1.6050L–2 is added to
rules relating to donor notification, see sec-
Order 12866. Therefore, a regulatory as- read as follows:
tion 170(m)(8)(B) and Notice 2005–41,
sessment is not required. It is hereby cer-
2005–23 I.R.B. 1203, issued thereunder.
tified that these regulations will not have §1.6050L–2 Information returns by
Unless timely notice is provided, the donor
a significant economic impact on a sub- donees relating to qualified intellectual
has not made a qualified intellectual prop-
stantial number of small entities. This cer- property contributions.
erty contribution, and the donee has no re-
tification is based upon the fact that few,
porting obligation under section 6050L or [The text of §1.6050L–2 is the same as
if any, small entities will be required to
these regulations. the text of §1.6050L–2T published else-
file under these regulations. Therefore, a
The donee is not required to make an where in this issue of the Bulletin].
Regulatory Flexibility Analysis under the
information return if the qualified intellec-
Regulatory Flexibility Act (5 U.S.C. chap-
tual property produced no net income for Mark E. Matthews,
ter 6) is not required. Pursuant to section
the donee’s taxable year. Under section Deputy Commissioner for
7805(f) of the Internal Revenue Code, this
170(m)(5) and (m)(6), income received or Services and Enforcement.
notice of proposed rulemaking will be sub-
accrued during the donee’s taxable year
mitted to the Chief Counsel for Advocacy (Filed by the Office of the Federal Register on May 20, 2005,
is not treated as allocated to qualified in- 8:45 a.m., and published in the issue of the Federal Register
of the Small Business Administration for
tellectual property if such income is re- for May 23, 2005, 70 F.R. 29460)
comment on its impact on small business.
ceived or accrued after the 10-year period
beginning on the date of the contribution Comments and Requests for a Public
or after the expiration of the legal life of Hearing
the qualified intellectual property. Thus,
the donee is not required to make a re- Before these proposed regulations are
turn with regard to a qualified intellec- adopted as final regulations, considera-
tual property contribution for taxable years tion will be given to any written (a signed

June 20, 2005 1342 2005–25 I.R.B.


Definition of Terms
Revenue rulings and revenue procedures and B, the prior ruling is modified because of a prior ruling, a combination of terms
(hereinafter referred to as “rulings”) that it corrects a published position. (Compare is used. For example, modified and su-
have an effect on previous rulings use the with amplified and clarified, above). perseded describes a situation where the
following defined terms to describe the ef- Obsoleted describes a previously pub- substance of a previously published ruling
fect: lished ruling that is not considered deter- is being changed in part and is continued
Amplified describes a situation where minative with respect to future transac- without change in part and it is desired to
no change is being made in a prior pub- tions. This term is most commonly used in restate the valid portion of the previously
lished position, but the prior position is be- a ruling that lists previously published rul- published ruling in a new ruling that is self
ing extended to apply to a variation of the ings that are obsoleted because of changes contained. In this case, the previously pub-
fact situation set forth therein. Thus, if in laws or regulations. A ruling may also lished ruling is first modified and then, as
an earlier ruling held that a principle ap- be obsoleted because the substance has modified, is superseded.
plied to A, and the new ruling holds that the been included in regulations subsequently Supplemented is used in situations in
same principle also applies to B, the earlier adopted. which a list, such as a list of the names of
ruling is amplified. (Compare with modi- Revoked describes situations where the countries, is published in a ruling and that
fied, below). position in the previously published ruling list is expanded by adding further names in
Clarified is used in those instances is not correct and the correct position is subsequent rulings. After the original rul-
where the language in a prior ruling is be- being stated in a new ruling. ing has been supplemented several times, a
ing made clear because the language has Superseded describes a situation where new ruling may be published that includes
caused, or may cause, some confusion. the new ruling does nothing more than re- the list in the original ruling and the ad-
It is not used where a position in a prior state the substance and situation of a previ- ditions, and supersedes all prior rulings in
ruling is being changed. ously published ruling (or rulings). Thus, the series.
Distinguished describes a situation the term is used to republish under the Suspended is used in rare situations
where a ruling mentions a previously pub- 1986 Code and regulations the same po- to show that the previous published rul-
lished ruling and points out an essential sition published under the 1939 Code and ings will not be applied pending some
difference between them. regulations. The term is also used when future action such as the issuance of new
Modified is used where the substance it is desired to republish in a single rul- or amended regulations, the outcome of
of a previously published position is being ing a series of situations, names, etc., that cases in litigation, or the outcome of a
changed. Thus, if a prior ruling held that a were previously published over a period of Service study.
principle applied to A but not to B, and the time in separate rulings. If the new rul-
new ruling holds that it applies to both A ing does more than restate the substance

Abbreviations
The following abbreviations in current use ER—Employer. PRS—Partnership.
and formerly used will appear in material ERISA—Employee Retirement Income Security Act. PTE—Prohibited Transaction Exemption.
EX—Executor. Pub. L.—Public Law.
published in the Bulletin.
F—Fiduciary. REIT—Real Estate Investment Trust.
FC—Foreign Country. Rev. Proc.—Revenue Procedure.
A—Individual.
FICA—Federal Insurance Contributions Act. Rev. Rul.—Revenue Ruling.
Acq.—Acquiescence.
B—Individual. FISC—Foreign International Sales Company. S—Subsidiary.
FPH—Foreign Personal Holding Company. S.P.R.—Statement of Procedural Rules.
BE—Beneficiary.
F.R.—Federal Register. Stat.—Statutes at Large.
BK—Bank.
B.T.A.—Board of Tax Appeals. FUTA—Federal Unemployment Tax Act. T—Target Corporation.
FX—Foreign corporation. T.C.—Tax Court.
C—Individual.
G.C.M.—Chief Counsel’s Memorandum. T.D. —Treasury Decision.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations. GE—Grantee. TFE—Transferee.
GP—General Partner. TFR—Transferor.
CI—City.
GR—Grantor. T.I.R.—Technical Information Release.
COOP—Cooperative.
Ct.D.—Court Decision. IC—Insurance Company. TP—Taxpayer.
I.R.B.—Internal Revenue Bulletin. TR—Trust.
CY—County.
LE—Lessee. TT—Trustee.
D—Decedent.
DC—Dummy Corporation. LP—Limited Partner. U.S.C.—United States Code.
LR—Lessor. X—Corporation.
DE—Donee.
M—Minor. Y—Corporation.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation. Nonacq.—Nonacquiescence. Z —Corporation.
O—Organization.
DR—Donor.
P—Parent Corporation.
E—Estate.
EE—Employee. PHC—Personal Holding Company.
PO—Possession of the U.S.
E.O.—Executive Order.
PR—Partner.

2005–25 I.R.B. i June 20, 2005


Numerical Finding List1 Notices— Continued: Proposed Regulations— Continued:
2005-5, 2005-3 I.R.B. 337 REG-168892-03, 2005-25 I.R.B. 1293
Bulletins 2005–1 through 2005–25 2005-6, 2005-5 I.R.B. 448 REG-102144-04, 2005-25 I.R.B. 1297
Announcements: 2005-7, 2005-3 I.R.B. 340 REG-122847-04, 2005-13 I.R.B. 804
2005-8, 2005-4 I.R.B. 368 REG-127740-04, 2005-24 I.R.B. 1254
2005-1, 2005-1 I.R.B. 257 2005-9, 2005-4 I.R.B. 369 REG-130370-04, 2005-8 I.R.B. 608
2005-2, 2005-2 I.R.B. 319 2005-10, 2005-6 I.R.B. 474 REG-130671-04, 2005-10 I.R.B. 694
2005-3, 2005-2 I.R.B. 270 2005-11, 2005-7 I.R.B. 493 REG-131128-04, 2005-11 I.R.B. 733
2005-4, 2005-2 I.R.B. 319 2005-12, 2005-7 I.R.B. 494 REG-134030-04, 2005-25 I.R.B. 1339
2005-5, 2005-3 I.R.B. 353 2005-13, 2005-9 I.R.B. 630 REG-139683-04, 2005-4 I.R.B. 371
2005-6, 2005-4 I.R.B. 377 2005-14, 2005-7 I.R.B. 498 REG-147195-04, 2005-15 I.R.B. 888
2005-7, 2005-4 I.R.B. 377 2005-15, 2005-7 I.R.B. 527 REG-148521-04, 2005-18 I.R.B. 995
2005-8, 2005-4 I.R.B. 380 2005-16, 2005-8 I.R.B. 605 REG-152354-04, 2005-13 I.R.B. 805
2005-9, 2005-4 I.R.B. 380 2005-17, 2005-8 I.R.B. 606 REG-152914-04, 2005-9 I.R.B. 650
2005-10, 2005-5 I.R.B. 450 2005-18, 2005-9 I.R.B. 634 REG-152945-04, 2005-6 I.R.B. 484
2005-11, 2005-5 I.R.B. 451 2005-19, 2005-9 I.R.B. 634 REG-154000-04, 2005-19 I.R.B. 1009
2005-12, 2005-7 I.R.B. 555 2005-20, 2005-9 I.R.B. 635 REG-158138-04, 2005-25 I.R.B. 1341
2005-13, 2005-8 I.R.B. 627 2005-21, 2005-11 I.R.B. 727 REG-159824-04, 2005-4 I.R.B. 372
2005-14, 2005-9 I.R.B. 653 2005-22, 2005-12 I.R.B. 756 REG-162813-04, 2005-19 I.R.B. 1010
2005-15, 2005-9 I.R.B. 654 2005-23, 2005-11 I.R.B. 732
Revenue Procedures:
2005-16, 2005-10 I.R.B. 702 2005-24, 2005-12 I.R.B. 757
2005-17, 2005-10 I.R.B. 673 2005-25, 2005-14 I.R.B. 827 2005-1, 2005-1 I.R.B. 1
2005-18, 2005-9 I.R.B. 660 2005-26, 2005-12 I.R.B. 758 2005-2, 2005-1 I.R.B. 86
2005-19, 2005-11 I.R.B. 744 2005-27, 2005-13 I.R.B. 795 2005-3, 2005-1 I.R.B. 118
2005-20, 2005-12 I.R.B. 772 2005-28, 2005-13 I.R.B. 796 2005-4, 2005-1 I.R.B. 128
2005-21, 2005-12 I.R.B. 776 2005-29, 2005-13 I.R.B. 796 2005-5, 2005-1 I.R.B. 170
2005-22, 2005-14 I.R.B. 826 2005-30, 2005-14 I.R.B. 827 2005-6, 2005-1 I.R.B. 200
2005-23, 2005-14 I.R.B. 845 2005-31, 2005-14 I.R.B. 830 2005-7, 2005-1 I.R.B. 240
2005-24, 2005-15 I.R.B. 889 2005-32, 2005-16 I.R.B. 895 2005-8, 2005-1 I.R.B. 243
2005-25, 2005-15 I.R.B. 891 2005-33, 2005-17 I.R.B. 960 2005-9, 2005-2 I.R.B. 303
2005-26, 2005-17 I.R.B. 969 2005-34, 2005-17 I.R.B. 960 2005-10, 2005-3 I.R.B. 341
2005-27, 2005-16 I.R.B. 918 2005-35, 2005-21 I.R.B. 1087 2005-11, 2005-2 I.R.B. 307
2005-28, 2005-17 I.R.B. 969 2005-36, 2005-19 I.R.B. 1007 2005-12, 2005-2 I.R.B. 311
2005-29, 2005-17 I.R.B. 969 2005-37, 2005-20 I.R.B. 1049 2005-13, 2005-12 I.R.B. 759
2005-30, 2005-18 I.R.B. 988 2005-38, 2005-22 I.R.B. 1100 2005-14, 2005-7 I.R.B. 528
2005-31, 2005-18 I.R.B. 996 2005-39, 2005-21 I.R.B. 1087 2005-15, 2005-9 I.R.B. 638
2005-32, 2005-19 I.R.B. 1012 2005-40, 2005-21 I.R.B. 1088 2005-16, 2005-10 I.R.B. 674
2005-33, 2005-19 I.R.B. 1013 2005-41, 2005-23 I.R.B. 1203 2005-17, 2005-13 I.R.B. 797
2005-34, 2005-19 I.R.B. 1014 2005-42, 2005-23 I.R.B. 1204 2005-18, 2005-13 I.R.B. 798
2005-35, 2005-21 I.R.B. 1095 2005-43, 2005-24 I.R.B. 1221 2005-19, 2005-14 I.R.B. 832
2005-36, 2005-21 I.R.B. 1095 2005-44, 2005-25 I.R.B. 1287 2005-20, 2005-18 I.R.B. 990
2005-37, 2005-21 I.R.B. 1096 2005-45, 2005-24 I.R.B. 1228 2005-21, 2005-16 I.R.B. 899
2005-38, 2005-21 I.R.B. 1097 2005-22, 2005-15 I.R.B. 886
Proposed Regulations:
2005-39, 2005-22 I.R.B. 1151 2005-23, 2005-18 I.R.B. 991
2005-40, 2005-22 I.R.B. 1152 REG-108524-00, 2005-23 I.R.B. 1209 2005-24, 2005-16 I.R.B. 909
2005-41, 2005-23 I.R.B. 1212 REG-117969-00, 2005-7 I.R.B. 533 2005-25, 2005-17 I.R.B. 962
2005-42, 2005-24 I.R.B. 1257 REG-125443-01, 2005-16 I.R.B. 912 2005-26, 2005-17 I.R.B. 965
Court Decisions: REG-125628-01, 2005-7 I.R.B. 536 2005-27, 2005-20 I.R.B. 1050
REG-100420-03, 2005-24 I.R.B. 1236 2005-28, 2005-21 I.R.B. 1093
2080, 2005-15 I.R.B. 850 REG-105346-03, 2005-24 I.R.B. 1244 2005-29, 2005-22 I.R.B. 1118

Notices: REG-129709-03, 2005-3 I.R.B. 351 2005-30, 2005-22 I.R.B. 1148


REG-148701-03, 2005-13 I.R.B. 802 2005-32, 2005-23 I.R.B. 1206
2005-1, 2005-2 I.R.B. 274 REG-148867-03, 2005-9 I.R.B. 646 2005-33, 2005-24 I.R.B. 1231
2005-2, 2005-3 I.R.B. 337 REG-159243-03, 2005-20 I.R.B. 1075 2005-34, 2005-24 I.R.B. 1233
2005-3, 2005-5 I.R.B. 447 REG-160315-03, 2005-14 I.R.B. 833
2005-4, 2005-2 I.R.B. 289 REG-163314-03, 2005-14 I.R.B. 835

1A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2004–27 through 2004–52 is in Internal Revenue Bulletin
2004–52, dated December 27, 2004.

June 20, 2005 ii 2005–25 I.R.B.


Revenue Rulings: Treasury Decisions— Continued:
9178, 2005-11 I.R.B. 708
2005-1, 2005-2 I.R.B. 258
9179, 2005-11 I.R.B. 707
2005-2, 2005-2 I.R.B. 259
9180, 2005-11 I.R.B. 714
2005-3, 2005-3 I.R.B. 334
9181, 2005-11 I.R.B. 717
2005-4, 2005-4 I.R.B. 366
9182, 2005-11 I.R.B. 713
2005-5, 2005-5 I.R.B. 445
9183, 2005-12 I.R.B. 754
2005-6, 2005-6 I.R.B. 471
9184, 2005-12 I.R.B. 753
2005-7, 2005-6 I.R.B. 464
9185, 2005-12 I.R.B. 749
2005-8, 2005-6 I.R.B. 466
9186, 2005-13 I.R.B. 790
2005-9, 2005-6 I.R.B. 470
9187, 2005-13 I.R.B. 778
2005-10, 2005-7 I.R.B. 492
9188, 2005-15 I.R.B. 883
2005-11, 2005-14 I.R.B. 816
9189, 2005-13 I.R.B. 788
2005-12, 2005-9 I.R.B. 628
9190, 2005-15 I.R.B. 855
2005-13, 2005-10 I.R.B. 664
9191, 2005-15 I.R.B. 854
2005-14, 2005-12 I.R.B. 749
9192, 2005-15 I.R.B. 866
2005-15, 2005-11 I.R.B. 720
9193, 2005-15 I.R.B. 862
2005-16, 2005-13 I.R.B. 777
9194, 2005-20 I.R.B. 1016
2005-17, 2005-14 I.R.B. 823
9195, 2005-17 I.R.B. 958
2005-18, 2005-14 I.R.B. 817
9196, 2005-19 I.R.B. 1000
2005-19, 2005-14 I.R.B. 819
9197, 2005-18 I.R.B. 985
2005-20, 2005-14 I.R.B. 821
9198, 2005-18 I.R.B. 972
2005-21, 2005-14 I.R.B. 822
9199, 2005-19 I.R.B. 1003
2005-22, 2005-13 I.R.B. 787
9200, 2005-23 I.R.B. 1158
2005-23, 2005-15 I.R.B. 864
9201, 2005-23 I.R.B. 1153
2005-24, 2005-16 I.R.B. 892
9202, 2005-24 I.R.B. 1213
2005-25, 2005-18 I.R.B. 971
9203, 2005-25 I.R.B. 1285
2005-26, 2005-17 I.R.B. 957
9204, 2005-25 I.R.B. 1279
2005-27, 2005-19 I.R.B. 998
9205, 2005-25 I.R.B. 1267
2005-28, 2005-19 I.R.B. 997
9206, 2005-25 I.R.B. 1283
2005-29, 2005-21 I.R.B. 1080
2005-30, 2005-20 I.R.B. 1015
2005-31, 2005-21 I.R.B. 1084
2005-32, 2005-23 I.R.B. 1156
2005-33, 2005-23 I.R.B. 1155
2005-34, 2005-22 I.R.B. 1098
2005-35, 2005-24 I.R.B. 1214

Tax Conventions:

2005-3, 2005-2 I.R.B. 270


2005-17, 2005-10 I.R.B. 673
2005-22, 2005-14 I.R.B. 826
2005-30, 2005-18 I.R.B. 988

Treasury Decisions:

9164, 2005-3 I.R.B. 320


9165, 2005-4 I.R.B. 357
9166, 2005-8 I.R.B. 558
9167, 2005-2 I.R.B. 261
9168, 2005-4 I.R.B. 354
9169, 2005-5 I.R.B. 381
9170, 2005-4 I.R.B. 363
9171, 2005-6 I.R.B. 452
9172, 2005-6 I.R.B. 468
9173, 2005-8 I.R.B. 557
9174, 2005-9 I.R.B. 629
9175, 2005-10 I.R.B. 665
9176, 2005-10 I.R.B. 661
9177, 2005-10 I.R.B. 671

2005–25 I.R.B. iii June 20, 2005


Finding List of Current Actions on Notices— Continued: Revenue Procedures— Continued:
Previously Published Items1 2005-17 2004-2
Clarified and modified by Superseded by
Bulletins 2005–1 through 2005–25
Notice 2005-22, 2005-12 I.R.B. 756 Rev. Proc. 2005-2, 2005-1 I.R.B. 86
Announcements:
Proposed Regulations: 2004-3
2001-77 Superseded by
REG-133791-02 Rev. Proc. 2005-3, 2005-1 I.R.B. 118
Modified by
Withdrawn by
Rev. Proc. 2005-16, 2005-10 I.R.B. 674 2004-4
REG-134030-04, 2005-25 I.R.B. 1339
2005-19 Superseded by
REG-149519-03 Rev. Proc. 2005-4, 2005-1 I.R.B. 128
Supplemented by
Corrected by
Ann. 2005-39, 2005-22 I.R.B. 1151 2004-5
Ann. 2005-11, 2005-5 I.R.B. 451
Notices: Superseded by
REG-163314-03 Rev. Proc. 2005-5, 2005-1 I.R.B. 170
88-30 Corrected by
2004-6
Obsoleted by Ann. 2005-32, 2005-19 I.R.B. 1012
Superseded by
Notice 2005-4, 2005-2 I.R.B. 289 REG-114726-04 Rev. Proc. 2005-6, 2005-1 I.R.B. 200
88-132 Corrected by
2004-7
Obsoleted by Ann. 2005-10, 2005-5 I.R.B. 450
Superseded by
Notice 2005-4, 2005-2 I.R.B. 289 REG-152945-04 Rev. Proc. 2005-7, 2005-1 I.R.B. 240
89-29 Corrected by
2004-8
Obsoleted by Ann. 2005-34, 2005-19 I.R.B. 1014
Superseded by
Notice 2005-4, 2005-2 I.R.B. 289 Revenue Procedures: Rev. Proc. 2005-8, 2005-1 I.R.B. 243
89-38
84-58 2004-13
Obsoleted by
Superseded by Superseded by
Notice 2005-4, 2005-2 I.R.B. 289
Rev. Proc. 2005-18, 2005-13 I.R.B. 798 Rev. Proc. 2005-27, 2005-20 I.R.B. 1050
97-19
84-78 2004-16
Obsoleted in part by
Superseded by Modified and superseded by
Notice 2005-36, 2005-19 I.R.B. 1007
Rev. Proc. 2005-34, 2005-24 I.R.B. 1233 Rev. Proc. 2005-25, 2005-17 I.R.B. 962
98-34
94-68 2004-18
Obsoleted in part by
Modified and superseded by Obsoleted in part by
Notice 2005-36, 2005-19 I.R.B. 1007
Rev. Proc. 2005-32, 2005-23 I.R.B. 1206 Rev. Proc. 2005-15, 2005-9 I.R.B. 638
2002-45
98-16 2004-24
Amplified by
Modified and superseded by Obsoleted by
Rev. Rul. 2005-24, 2005-16 I.R.B. 892
Rev. Proc. 2005-11, 2005-2 I.R.B. 307 Rev. Proc. 2005-22, 2005-15 I.R.B. 886
2004-22
2000-20 2004-35
Modified and superseded by
Modified and superseded by Corrected by
Notice 2005-30, 2005-14 I.R.B. 827
Rev. Proc. 2005-16, 2005-10 I.R.B. 674 Ann. 2005-4, 2005-2 I.R.B. 319
2004-38
2001-22 2004-60
Obsoleted by
Superseded by Superseded by
T.D. 9186, 2005-13 I.R.B. 790
Rev. Proc. 2005-12, 2005-2 I.R.B. 311 Rev. Proc. 2005-10, 2005-3 I.R.B. 341
2004-80
2002-9 2005-6
Clarified and modified by
Modified and amplified by Modified by
Notice 2005-22, 2005-12 I.R.B. 756
Rev. Proc. 2005-9, 2005-2 I.R.B. 303 Rev. Proc. 2005-16, 2005-10 I.R.B. 674
Updated by
Notice 2005-17, 2005-8 I.R.B. 606 2003-32 2005-8
Amplified and superseded by Modified by
2005-4
Rev. Proc. 2005-20, 2005-18 I.R.B. 990 Rev. Proc. 2005-16, 2005-10 I.R.B. 674
Modified by
Notice 2005-24, 2005-12 I.R.B. 757 2004-1 2005-9
Superseded by Modified by
2005-10
Rev. Proc. 2005-1, 2005-1 I.R.B. 1 Rev. Proc. 2005-17, 2005-13 I.R.B. 797
Modified by
Notice 2005-38, 2005-22 I.R.B. 1100

1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2004–27 through 2004–52 is in Internal Revenue Bulletin 2004–52, dated December 27,
2004.

June 20, 2005 iv 2005–25 I.R.B.


Revenue Rulings: Treasury Decisions— Continued:
9170
69-516
Corrected by
Obsoleted by
Ann. 2005-13, 2005-8 I.R.B. 627
T.D. 9182, 2005-11 I.R.B. 713
Ann. 2005-35, 2005-21 I.R.B. 1095
76-96
9187
Suspended in part by
Corrected by
Rev. Rul. 2005-28, 2005-19 I.R.B. 997
Ann. 2005-25, 2005-15 I.R.B. 891
77-415
9196
Obsoleted by
Corrected by
T.D. 9182, 2005-11 I.R.B. 713
Ann. 2005-40, 2005-22 I.R.B. 1152
77-479
9198
Obsoleted by
Corrected by
T.D. 9182, 2005-11 I.R.B. 713
Ann. 2005-41, 2005-23 I.R.B. 1212
79-335
Modified and superseded by
Rev. Rul. 2005-30, 2005-20 I.R.B. 1015

82-34
Obsoleted by
T.D. 9182, 2005-11 I.R.B. 713

92-19
Supplemented in part by
Rev. Rul. 2005-29, 2005-21 I.R.B. 1080

92-63
Modified and superseded by
Rev. Rul. 2005-3, 2005-3 I.R.B. 334

95-63
Modified and superseded by
Rev. Rul. 2005-3, 2005-3 I.R.B. 334

2004-43
Revoked by
Rev. Rul. 2005-10, 2005-7 I.R.B. 492

2004-103
Superseded by
Rev. Rul. 2005-3, 2005-3 I.R.B. 334

Treasury Decisions:

8408
Corrected by
Ann. 2005-28, 2005-17 I.R.B. 969

9130
Corrected by
Ann. 2005-29, 2005-17 I.R.B. 969

9165
Revised by
T.D. 9201, 2005-23 I.R.B. 1153
Corrected by
Ann. 2005-31, 2005-18 I.R.B. 996

9166
Corrected by
Ann. 2005-33, 2005-19 I.R.B. 1013

2005–25 I.R.B. v *U.S. Government Printing Office: 2005—314–048/20010 June 20, 2005