Bulletin No. 1997–10

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March 10, 1997

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

EXEMPT ORGANIZATIONS

Rev. Rul. 97–10, page 31.

Federal rates; adjusted federal rates; adjusted federal long-term rate, and the long-term exempt rate.

For purposes of sections 1274, 1288, 382, and other

sections of the Code, tables set forth the rates for

March 1997.

Announcement 97–18, page 67.

A list is given of organizations now classified as private

foundations.

Rev. Rul. 97–11, page 5.

Election in respect of losses attributable to a disaster. This ruling lists the areas declared by the President

to qualify as major disaster areas under the Disaster

Relief and Emergency Assistance Act since the publication of Rev. Rul. 96–13.

T.D. 8708, page 14.

Final regulations under section 902 of the Code relate to

the computation of foreign taxes deemed paid.

REG–208172–91, page 59.

Proposed regulations under sections 108 and 1017 of

the Code provide ordering rules for the reduction of

bases of property that affect taxpayers who exclude

discharge of indebtedness from gross income. A public

hearing will be held on April 24, 1997.

Rev. Proc. 97–18, page 53.

This procedure provides guidance for any bank seeking

to change its accounting method for bad debts from the

section 585 reserve method to the section 166 specific

charge-off method in order to elect S corporation status

for the 1997 tax year.

Notice 97–20, page 52.

Accounting periods; small business corporations. Procedures are provided under which a taxpayer may

automatically change its annual accounting period in

order elect to be an S corporation effective for the

taxable year beginning January 1, 1997.

Finding Lists begin on page 71.

ADMINISTRATIVE

Rev. Proc. 97–19, page 55.

Timely filing or payment; private delivery services.

Criteria and application procedures are provided for

designation of private delivery services under section

7502(f) of the Code.

Notice 97–17, page 34.

The “differential earnings rate” under section 809 is

tentatively determined for 1996 together with the “recomputed differential earnings rate” for 1995.

Notice 97–18, page 35.

This notice provides guidance concerning the application

of sections 1491 through 1494 of the Code to certain

transfers of property by a U.S. person to a foreign

corporation, partnership, trust, or estate. Pursuant to

section 1902 of the Small Business Job Protection Act

of 1996, failure to report such a transfer made after

August 20, 1996, could result in a penalty equal to 35

percent of the value of the property transferred.

Notice 97–19, page 40.

This notice provides guidance under sections 877,

2107, 2501, and 6039F for expatriates who lose U.S.

citizenship or cease to be taxed as long-term residents

of the United States with a principal purpose to avoid

U.S. taxes. This notice also provides guidance on the

interaction of section 7701(b)(10) with section 877, as

amended by the Health Insurance Portability and Accountability Act of 1996.

(Continued on page 4)

HIGHLIGHTS

OF THIS ISSUE—Continued

ADMINISTRATIVE—Continued

its program to respond to requests for fact-of-filing

information from firms in the tax professional community

with respect to their employees and associates. The tax

professional community consists of all firms that prepare tax returns, offer tax advice, or provide tax services. This includes practitioners governed by Treasury

Department Circular 230.

Announcement 97–10, page 64.

Information on new reporting for medical savings accounts, long-term care accounts, and SIMPLE retirement

accounts is provided.

Announcement 97–19, page 68.

The Service will continue, through December 31, 1997,

Mission of the Service

The purpose of the Internal Revenue Service is to

collect the proper amount of tax revenue at the least

cost; serve the public by continually improving the

quality of our products and services; and perform in a

manner warranting the highest degree of public

confidence in our integrity, efficiency and fairness.

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying

and administering the law in a reasonable,

practical manner. Issues should only be raised by

examining of ficers when they have merit, never

arbitrarily or for trading purposes. At the same

time, the examining officer should never hesitate

to raise a meritorious issue. It is also important

that care be exercised not to raise an issue or to

ask a court to adopt a position inconsistent with

an established Service position.

The function of the Internal Revenue Service is to

administer the Internal Revenue Code. Tax policy

for raising revenue is determined by Congress.

With this in mind, it is the duty of the Service to

carry out that policy by correctly applying the laws

enacted by Congress; to determine the reasonable

meaning of various Code provisions in light of the

Congressional purpose in enacting them; and to

perform this work in a fair and impartial manner,

with neither a government nor a taxpayer point of view.

Administration should be both reasonable and

vigorous. It should be conducted with as little

delay as possible and with great cour tesy and

considerateness. It should never try to overreach,

and should be reasonable within the bounds of law

and sound administration. It should, however, be

vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax

devices and fraud.

At the heart of administration is interpretation of the

Code. It is the responsibility of each person in the

Service, charged with the duty of interpreting the

law, to try to find the true meaning of the statutory

provision and not to adopt a strained construction in

the belief that he or she is ‘‘protecting the revenue.’’

The revenue is properly protected only when we ascertain and apply the true meaning of the statute.

Introduction

The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for

announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conventions, legislation,

court decisions, and other items of general interest. It is

published weekly and may be obtained from the Superintendent of Documents on a subscription basis. Bulletin

contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold on a

single-copy basis.

court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are

cautioned against reaching the same conclusions in

other cases unless the facts and circumstances are

substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on

provisions of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all

substantive rulings necessary to promote a uniform

application of the tax laws, including all rulings that

supersede, revoke, modify, or amend any of those

previously published in the Bulletin. All published rulings

apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management

are not published; however, statements of internal

practices and procedures that affect the rights and

duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows:

Subpart A, Tax Conventions, and Subpart B, Legislation

and Related Committee Reports.

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 included in this part are Bank Secrecy

Act Administrative Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the

Treasury’s Office of the Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts

stated in the revenue ruling. In those based on positions

taken in rulings to taxpayers or technical advice to

Service field offices, identifying details 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.

With the exception of the Notice of Proposed Rulemaking and the disbarment and suspension list included in

this part, none of these announcements are consolidated in the Cumulative Bulletins.

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 relied on, used, or cited

as precedents by Service personnel in the disposition of

other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations,

The first Bulletin for each month includes an index for

the matters published during the preceding month.

These monthly indexes are cumulated on a quarterly and

semiannual basis, and are published in the first Bulletin

of the succeeding quarterly and semi-annual period,

respectively.

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, D.C. 20402.

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 42.—Low-Income Housing

Credit

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the

month of March 1997. See Rev. Rul. 97–10, page

31.

Section 165.—Losses

26 CFR 1.165–11: Election in respect of losses

attributable to a disaster.

Election in respect of losses attributable to a disaster. This ruling lists

the areas declared by the President to

qualify as major disaster areas under the

Disaster Relief and Emergency Assistance Act since the publication of Rev.

Rul. 96–13.

Rev. Rul. 97–11

Under § 165(i) of the Internal Revenue Code, if a taxpayer suffers a loss

attributable to a disaster occurring in an

area subsequently determined by the

President of the United States to warrant

assistance by the Federal Government

under the Disaster Relief and Emergency Assistance Act, 42 U.S.C.

§§ 5121–5204c (1988 & Supp. V 1993)

(the Act), the taxpayer may elect to

claim a deduction for that loss on the

taxpayer’s federal income tax return for

the taxable year immediately preceding

the taxable year in which the disaster

occurred.

Section 1.165–11(e) of the Income

Tax Regulations provides that the election to deduct a disaster loss for the

preceding year must be made by filing a

return, an amended return, or a claim

for refund on or before the later of (1)

the due date of the taxpayer’s income

tax return (determined without regard to

any extension of time to file the return)

for the taxable year in which the disaster actually occurred, or (2) the due date

of the taxpayer’s income tax return

(determined with regard to any extension of time to file the return) for the

taxable year immediately preceding the

taxable year in which the disaster actually occurred.

The provisions of § 165(i) apply only

to losses that are otherwise deductible

under § 165(a). An individual taxpayer

may deduct losses if they are incurred in

a trade or business, if they are incurred

in a transaction entered into for profit,

or if they are casualty losses under

§ 165(c)(3).

The President has determined that

during 1996 the areas listed below have

been adversely affected by disasters of

sufficient severity and magnitude to

warrant assistance by the Federal Government under the Act.

DRAFTING INFORMATION

The principal author of this revenue

ruling is Jonathan Strum of the Office

of Assistant Chief Counsel (Income Tax

and Accounting). For further information

regarding this revenue ruling, contact

Mr. Strum on (202) 622–4960 (not a

toll-free call).

Disaster Areas in 1996

Type of Disaster

Date of Disaster

Alabama

Counties of Blount, Colbert, Cullman, DeKalb, Etowah,

Jackson, Lauderdale, Lawrence, Limestone, Madison,

Marion, Marshall, Morgan, and Winston

Severe winter

storm, ice and

flooding

February 1-12, 1996

Severe storms,

flooding and tornadoes

March 5-6, 1996

Alaska

The City of Houston; and the Matanuska-Susitna Borough

Wildland fires

June 2-15, 1996

Arkansas

Counties of Crawford, Franklin, Madison, Marion, Sebastian,

and Washington

Severe storms and

tornadoes

April 21-22, 1996

Severe storms,

flooding, mud and

land slides

December 28, 1996

Blizzard of 1996

January 7-13, 1996

Delaware

Counties of Kent, New Castle, and Sussex

Blizzard of 1996

January 6-12, 1996

District of Columbia

Blizzard of 1996

January 6-12, 1996

Counties of Dallas, Macon, and Montgomery

California

Counties of Alameda, Alpine, Amador, Butte, Calaveras,

Colusa, Contra Costa, Del Norte, El Dorado, Fresno, Glenn,

Humboldt, Lake, Lassen, Madera, Marin, Mariposa,

Mendocino, Merced, Modoc, Mono, Monterey, Napa, Nevada, Placer, Plumas, Sacramento, San Benito, San Francisco,

San Joaquin, San Mateo, Santa Clara, Santa Cruz, Shasta,

Sierra, Siskiyou, Solano, Sonoma, Stanislaus, Sutter, Tehama,

Trinity, Tulare, Tuolumne, Yolo, and Yuba; and the City of

Morgan Hill

Connecticut

Counties of Fairfield, Hartford, Litchfield, Middlesex, New

Haven, New London, Tolland, and Windham

Disaster Areas in 1996

Type of Disaster

Date of Disaster

Storm surge,

heavy rains, flooding, and wind

damage due to

Tropical Storm

Josephine

October 7, 1996

Prolonged and

heavy rains, high

surf, flooding,

landslides,

mudslices and

severe storms

November 5-December 9, 1996

Idaho

Counties of Benewah, Bonner, Boundary, Clearwater, Idaho,

Kootenai, Latah, Lewis, Nez Perce, and Shoshone; and the

Nez Perce Indian Reservation

Severe storms and

flooding

February 6-23, 1996

Counties of Adams, Benewah, Bonner, Boundary, Boise,

Clearwater, Elmore, Gem, Idaho, Kootenai, Latah, Nez Perce,

Owyhee, Payette, Shoshone, Valley, and Washington

Severe storms,

flooding, mud and

land slides

November 16, 1996-January 3, 1997

Severe storms and

tornadoes

April 18-19, 1996

Counties of Adams, Brown, Cass, Champaign, Crawford,

Cumberland, Douglas, Effingham, Franklin, Gallatin,

Hamilton, Hancock, Jackson, Jasper, Lawrence, Madison,

Menard, Monroe, Perry, Richland, Saline, Sangamon,

Schuyler, St. Clair, Vermilion, Wabash, White, and Williamson

Severe storms and

flooding

April 28-May 17, 1996

Counties of Cook, Dekalb, DuPage, Grundy, Kane, Kendall,

LaSalle, Ogle, Stephenson, Will, and Winnebago

Severe storms and

flooding

July 17-August 7, 1996

Blizzard of 1996

January 6-12, 1996

Severe storms and

flooding

April 28-May 25, 1996

Severe storms and

flooding

May 8-28, 1996

Severe storms and

flooding

June 15-30, 1996

Florida

Counties of Baker, Citrus, Clay, Dixie, Duval, Hernando,

Hillsborough, Levy, Manatee, Nassau, Pasco, Pinellas,

Putnam, Sarasota, Taylor, and Volusia

Hawaii

Island of Oahu

Illinois

Counties of Champaign, Henry, Lake, Macon, and Marion

Indiana

Counties of Bartholomew, Blackford, Boone, Brown, Clark,

Clay, Clinton, Crawford, Daviess, Dearborn, Decatur, Delaware, Dubois, Fayette, Floyd, Franklin, Gibson, Greene,

Hamilton, Hancock, Harrison, Hendricks, Henry, Jackson,

Jay, Jefferson, Jennings, Johnson, Knox, Lawrence, Madison,

Marion, Monroe, Montgomery, Morgan, Ohio, Orange,

Owen, Parke, Perry, Pike, Posey, Putnam, Randolph, Rush,

Scott, Shelby, Spencer, Sullivan, Switzerland, Tipton, Union,

Vigo, Warrick, Washington, and Wayne.

Counties of Brown, Crawford, Daviess, Dearborn, Dekalb,

Dubois, Franklin, Gibson, Harrison, Jefferson, Knox,

Lawrence, Martin, Montgomery, Ohio, Orange, Perry, Pike,

Posey, Putnam, Ripley, Steuben, Sullivan, Switzerland,

Union, Vanderburgh, Warrick, Washington, and Whitley.

Iowa

Counties of Adair, Adams, Des Moines, Henry, Iowa,

Johnson, Keokuk, Lee, Louisa, Madison, Mahaska,

Muscatine, Ringgold, Taylor, Union, and Washington.

Counties of Audubon, Boone, Cherokee, Crawford, Hamilton,

Hardin, Harrison, Ida, Monona, Plymouth, Pottawattamie,

Sac, Shelby, Story, and Woodbury.

Disaster Areas in 1996

Type of Disaster

Date of Disaster

Counties of Adair, Allen, Anderson, Ballard, Barren, Bath,

Bell, Boone, Bourbon, Boyd, Boyle, Bracken, Breathitt,

Breckinridge, Bullitt, Butler, Caldwell, Calloway, Campbell,

Carlisle, Carroll, Carter, Casey, Christian, Clark, Clay,

Clinton, Crittenden, Cumberland, Daviess, Edmonson, Elliott,

Estill, Fayette, Fleming, Floyd, Franklin, Fulton, Gallatin,

Garrard, Grant, Graves, Grayson, Green, Greenup, Hancock,

Hardin, Harlan, Harrison, Hart, Henderson, Henry, Hickman,

Hopkins, Jackson, Jefferson, Jessamine, Johnson, Kenton,

Knott, Knox, Larue, Laurel, Lawrence, Lee, Leslie, Letcher,

Lewis, Lincoln, Livingston, Logan, Lyon, McCracken, McCreary, McLean, Madison, Magoffin, Marion, Marshall,

Martin, Mason, Meade, Menifee, Mercer, Metcalfe, Monroe,

Montgomery, Morgan, Muhlenberg, Nelson, Nicholas, Ohio,

Oldham, Owen, Owsley, Pendleton, Perry, Pike, Powell,

Pulaski, Robertson, Rockcastle, Rowan, Russell, Scott,

Shelby, Simpson, Spencer, Taylor, Todd, Trigg, Trimble,

Union, Warren, Washington, Wayne, Webster, Whitley, Wolfe,

and Woodford

Blizzard of 1996

January 5-12, 1996

Counties of Bullitt, Owsley, Perry, and Spencer

Severe storms,

flooding and tornadoes

May 28, 1996

Severe storms, ice

jams and flooding

January 19-February 6, 1996

Counties of Androscroggin, Cumberland, Knox, Oxford, and

York

Severe storms,

mudslides, inland

and coastal flooding

April 16-17, 1996

Counties of Cumberland, Oxford, and York

Severe storms,

heavy rains, high

winds, and inland

and coastal flooding

October 20-26, 1996

Blizzard of 1996

January 6-12, 1996

Counties of Allegany, Carroll, Cecil, Frederick, Garrett, and

Washington

Flooding and severe storms

January 19-31, 1996

Counties of Allegany and Frederick

Severe storms and

flooding associated with Tropical

Storm Fran

September 6-9, 1996

Blizzard of 1996

January 7-13, 1996

Extreme weather

conditions and

flooding

October 20-25, 1996

Kentucky

Maine

Counties of Androscroggin, Franklin, Oxford, Penobscot,

Piscataquis, Somerset, and Waldo

Maryland

Counties of Allegany, Anne Arundel, Baltimore, Calvert,

Caroline, Carroll, Cecil, Charles, Dorchester, Frederick, Garrett, Harford, Howard, Kent, Montgomery, Prince Georges,

Queen Anne’s, Somerset, St. Mary’s, Talbot, Washington,

Wicomico and Worchester; and the Cities of Baltimore and

Ocean City.

Massachusetts

Counties of Barnstable, Berkshire, Bristol, Dukes, Essex,

Franklin, Hampden, Hampshire, Middlesex, Nantucket, Norfolk, Plymouth, Suffolk, and Worcester

Counties of Essex, Middlesex, Norfolk, Plymouth, and

Suffolk

Disaster Areas in 1996

Type of Disaster

Date of Disaster

Michigan

Counties of Bay, Lapeer, Midland, Saginaw, Sanilac, St.Clair,

and Tuscola

Severe storms and

flooding

June 21-July 1, 1996

Severe storms and

flooding

March 14-June 17, 1996

Severe ice storms

November 14-30, 1996

Severe storms,

flooding and ice

jams

February 4-29, 1996

Severe storms,

flooding, ice jams

and excessive soil

saturation

March 9-June 5, 1996

Tornado and severe storms

May 8-28, 1996

Severe storms,

flooding, mud and

land slides

December 20, 1996—January 17, 1997

Fall Northeaster

rainstorm

October 20-26, 1996

Blizzard of 1996

January 6-12, 1996

Severe storm and

flooding

October 18-23, 1996

Blizzard of 1996

January 6-12, 1996

Counties of Albany, Allegany, Broome, Cattaraugus, Cayuga,

Chemung, Chenango, Clinton, Columbia, Cortland, Delaware,

Dutchess, Essex, Franklin, Greene, Herkimer, Jefferson,

Lewis, Livingston, Madison, Montgomery, Onondaga,

Ontario, Orange, Otsego, Putnam, Rensselaer, Saratoga,

Schenectady, Schoharie, Schuyler, Steuben, St. Lawrence,

Sullivan, Tioga, Tompkins, Ulster, Warren, Washington, Wyoming, and Yates

Severe storms and

flooding

January 19-30, 1996

New York City; and the Counties of Nassau, Suffolk, and

Westchester

Severe storms and

flooding

October 19-20, 1996

Minnesota

Counties of Aitkin, Beltrami, Big Stone, Blue Earth, Chisago,

Clay, Clearwater, Dakota, Faribault, Freeborn, Kittson,

Koochiching, Lake of the Woods, Marshall, Nicollet, Norman, Pennington, Polk, Pope, Red Lake, Roseau, Steele,

Traverse, Wabasha, Waseca, and Washington

Counties of Cottonwood, Faribault, Freeborn, Jackson, Lincoln, Lyon, Murray, Nobles, Pipestone, Rock, Waseca, and

Yellow Medicine

Montana

Counties of Chouteau, Deer Lodge, Gallatin, Jefferson, Lewis

and Clark, Lincoln, Meagher, Mineral, Missoula, Park,

Powell, Ravalli, Sanders, and Silver Bow

Counties of Blain, Flathead, Hill, Liberty, Phillips, and Toole

Nebraska

Counties of Gage, Johnson, Nemaha, and Otoe

Nevada

Counties of Churchill, Douglas, Lyon, Mineral, Storey and

Washoe; and the City of Carson City; and the Walker River

Paiute tribal lands located in Churchill, Lyon, and Mineral

Counties

New Hampshire

Counties of Hillsborough, Merrimack, Rockingham, Strafford, and Sullivan

New Jersey

Counties of Atlantic, Bergen, Burlington, Camden, Cape

May, Cumberland, Essex, Gloucester, Hudson, Hunterdon,

Mercer, Middlesex, Monmouth, Morris, Ocean, Passaic, Salem, Somerset, Sussex, Union, and Warren

Counties of Hudson, Middlesex, Morris, Somerset, and

Union

New York

Counties of Albany, Bronx, Columbia, Delaware, Dutchess,

Greene, Kings, Nassau, New York, Orange, Putnam, Queens,

Rensselaer, Richmond, Rockland, Suffolk, Sullivan, Ulster,

and Westchester

Disaster Areas in 1996

Type of Disaster

Date of Disaster

Severe thunderstorms, high

winds, rain, and

flooding

November 8-15, 1996

Blizzard of 1996

January 6-12, 1996

Counties of Alexander, Burke, Caldwell, Caswell, Catawba,

Cherokee, Cleveland, Davidson, Davie, Forsyth, Gaston,

Gates, Guilford, Halifax, Haywood, Henderson, Hertford,

Iredell, Lincoln, Madison, McDowell, Montgomery,

Northampton, Polk, Randolph, Rockingham, Rutherford

Stokes, Surry, Warren, Watauga, Wilkes, Yadkin, and Yancey

Winter storm

February 2-9, 1996

Counties of Beaufort, Bladen, Brunswick, Cateret, Chowan,

Columbus, Craven, Duplin, Greene, Hyde, Jones, Lenoir,

New Hanover, Onslow, Pamlico, Pender, and Pitt

Severe storms,

high wind, and

flooding and related effects of

Hurricane Bertha

July 10-13, 1996

All Counties

Hurricane Fran

September 5-7, 1996

Counties of Alamance, Anson, Beaufort, Bertie, Bladen,

Brunswick, Buncombe, Caswell, Cateret, Chatham, Chowan,

Columbus, Craven, Cumberland, Davidson, Duplin, Durham,

Edgecombe, Franklin, Granville, Greene, Guilford, Halifax,

Harnett, Henderson, Hertford, Hoke, Hyde, Johnston, Jones,

Lee, Lenoir, Martin, Moore, Nash, New Hanover, Onslow,

Orange, Pamlico, Pender, Person, Pitt, Polk, Randolph,

Richmond, Robeson, Rockingham, Rutherford, Sampson,

Scotland, Stanley, Vance, Wake, Warren, Wayne, and Wilson

Hurricane Fran

September 5-October 21, 1996

North Dakota

Counties of Barnes, Benson, Burleigh, Cass, Cavalier,

Dickey, Eddy, Emmons, Foster, Grand Forks, Grant, Griggs,

Kidder, LaMoure, Logan, McHenry, McIntosh, McLean,

Morton, Nelson, Oliver, Pembina, Pierce, Ramsey, Ransom,

Richland, Sargent, Sheridan, Steele, Stutsman, Traill, Walsh,

and Wells

Severe storms,

flooding, ice jams,

and ground saturation due to high

water tables

March 12-June 21, 1996

Ohio

Counties of Adams, Belmont, Brown, Clermont, Columbiana,

Gallia, Hamilton, Jefferson, Lawrence, Meigs, Monroe,

Scioto, and Washington

Severe storms and

flooding

January 20-31, 1996

Flooding

May 2-June 24, 1996

Counties of Chemung, Clinton, Delaware, Essex, Franklin,

Fulton, Lewis, Montgomery, Schoharie, Schuyler, Steuben,

and Tompkins

North Carolina

Counties of Alamance, Alexander, Alleghany, Ashe, Avery,

Bertie, Buncombe, Burke, Cabarrus, Caldwell, Camden,

Caswell, Catawba, Chatham, Cherokee, Chowan, Cleveland,

Davidson, Davie, Durham, Edgecombe, Forsyth, Franklin,

Gaston, Gates, Graham, Granville, Guilford, Halifax, Harnett,

Haywood, Henderson, Hertford, High Point, Iredell, Jackson,

Johnston, Lee, Lincoln, Macon, Madison, McDowell,

Mecklenburg, Mitchell, Montgomery, Moore, Nash,

Northampton, Orange, Pasquotank, Person, Pitt, Polk,

Randolph, Rockingham, Rowan, Rutherford, Stanley, Stokes,

Surry, Swain, Transylvania, Union, Vance, Wake, Warren,

Watauga, Wilkes, Wilson, Yadkin, and Yancey; and the

Eastern Band of Cherokee Indians Reservation

Counties of Adams, Belmont, Brown, Butler, Clermont,

Gallia, Hamilton, Hocking, Jefferson, Lawrence, Meigs,

Monroe, Paulding, Scioto, Vinton, and Williams

Disaster Areas in 1996

Type of Disaster

Date of Disaster

High winds, severe storms and

flooding

February 4-21, 1996

Counties of Coos, Douglas, and Lane

Flooding, land and

mud slides, and

severe storms

November 17-December 11, 1996

Counties of Baker, Gilliam, Grant, Jackson, Josephine,

Klamath, Morrow, and Wheeler

Severe winter

storms, land and

mudslides and

flooding

December 25, 1996-January 6, 1997

Blizzard of 1996

January 6-12, 1996

Counties of Adams, Allegheny, Armstrong, Beaver, Bedford,

Berks, Blair, Bradford, Bucks, Butler, Cambria, Cameron,

Carbon, Centre, Chester, Clarion, Clearfield, Clinton, Columbia, Crawford, Cumberland, Dauphin, Delaware, Elk, Erie,

Fayette, Forest, Franklin, Fulton, Greene, Huntingdon, Indiana, Jefferson, Juniata, Lackawanna, Lancaster, Lawrence,

Lebanon, Lehigh, Luzerne, Lycoming, Mercer, McKean,

Mifflin, Monroe, Montgomery, Montour, Northampton,

Northumberland, Philadelphia, Perry, Pike, Potter, Schuylkill,

Snyder, Somerset, Sullivan, Susquehanna, Tioga, Union,

Venango, Warren, Washington, Wayne, Westmoreland, Wyoming, and York

Severe storms and

flooding

January 19-February 1, 1996

Counties of Adams, Beaver, Bedford, Bucks, and Franklin

Severe storms and

flooding

June 12-19, 1996

Counties of Armstrong, Blair, Cambria, Clarion, Clearfield,

Crawford, Greene, Indiana, Jefferson, and Venango

Severe storms,

flooding and tornadoes

July 19, 1996

Counties of Cumberland, Huntingdon, Juniata, Mifflin, Montgomery, and Perry

Flooding associated with Tropical

Depression Fran

September 6-8, 1996

County of Tioga

Severe thunderstorms, high

winds, rain and

flooding

November 8-15, 1996

Oregon

Counties of Benton, Clackamas, Clatsop, Columbia, Coos,

Deschutes, Douglas, Gilliam, Hood River, Jefferson,

Josephine, Lane, Lincoln, Linn, Marion, Morrow,

Multnomah, Polk, Sherman, Tillamook, Umatilla, Union,

Wallowa, Wasco, Washington, Wheeler, and Yamhill; and the

lands of the Coquille Indian Tribe, the Confederated Tribes

of Umatilla Indian Reservation, and the Warm Springs Indian

Reservation.

Pennsylvania

Counties of Adams, Allegheny, Armstrong, Bedford, Berks,

Blair, Bradford, Bucks, Cambria, Carbon, Centre, Chester,

Clearfield, Clinton, Columbia, Cumberland, Dauphin, Delaware, Fayette, Franklin, Fulton, Greene, Huntingdon, Indiana,

Juniata, Lackawanna, Lancaster, Lebanon, Lehigh, Luzerne,

Lycoming, Mifflin, Monroe, Montgomery, Montour,

Northampton, Northumberland, Perry, Philadelphia, Pike,

Schuylkill, Snyder, Somerset, Sullivan, Susquehanna, Union,

Washington, Wayne, Westmoreland, Wyoming, and York

Disaster Areas in 1996

Puerto Rico

Municipalities of Adjuntas, Aguada, Aguadilla, Aibonito,

Anasco, Arecibo, Arroyo, Augas Buenas, Barceloneta, Barranquitas, Bayamon, Cabo Rojo, Caguas, Camuy, Canovanas,

Carolina, Catano, Cayey, Ceiba, Ciales, Cidra, Coamo,

Comerio, Corozal, Dorado, Florida, Guanica, Guayama,

Guayanilla, Guaynabo, Gurabo, Hatillo, Humacao, Isabela,

Jayuya, Juana Diaz, Juncos, Lares, Las Marias, Las Piedras,

Loiza, Manati, Maricao, Maunabo, Mayaguez, Moca,

Morovis, Naguabo, Naranjito, Orocovis, Patillas, Penuelas,

Ponce, Quebradillas, Rincon, Rio Grande, Salinas, San

German, San Juan, San Lorenzo, San Sebastian, Santa Isabel,

Toa Alta, Toa Baja, Trujillo Alto, Utuado, Vega Alta, Vega

Baja, Villalbo, Yabucoa, and Yauco

Rhode Island

Counties of Bristol, Kent, Newport, Providence, and Washington

South Carolina

Counties of Dillon, Georgetown, Horry, Marion, and Williamsburg

U.S. Virgin Islands

Islands of St. Croix, St. John, and St. Thomas

Vermont

Counties of Addison, Bennington, Chittenden, Franklin,

Lamoille, Orange, Orleans, Rutland, Washington, Windham,

and Windsor

County of Windham

Virginia

Counties of Accomack, Albermarle, Alleghany, Amelia,

Amherst, Appomattox, Arlington, Augusta, Bath, Bedford,

Bland, Botetourt, Brunswick, Buchanan, Buckingham,

Campbell, Caroline, Carroll, Charlotte, Charles City, Chesterfield, Clarke, Craig, Culpeper, Cumberland, Dickenson,

Dinwiddie, Essex, Fauquier, Fairfax, Floyd, Fluvanna,

Franklin, Frederick, Giles, Gloucester, Goochland, Grayson,

Greene, Greensville, Halifax, Hanover, Henrico, Henry, Highland, Isle of Wight, James City, King George, King &

Queen, King William, Lancaster, Lee, Loudoun, Louisa,

Lunenburg, Madison, Mathews, Mecklenburg, Middlesex,

Montgomery, Nelson, New Kent, Northhampton,

Northumberland, Nottoway, Orange, Page, Patrick,

Pittsylvania, Powhatan, Prince George, Prince William,

Pulaski, Rappahannock, Richmond, Roanoke, Rockbridge,

Rockingham, Russell, Scott, Shenandoah, Smyth, Southhampton, Spotsylvania, Stafford, Surry, Sussex, Tazewell,

Warren, Washington, Westmoreland, Wise, Wythe, and York;

and Cities of Alexandria, Bedford, Bristol, Buena Vista,

Charlottesville, Chesapeake, Clifton Forge, Colonial Heights,

Covington, Danville, Emporia, Fairfax, Falls Church,

Franklin, Fredericksberg, Galax, Hampton, Harrisonburg,

Hopewell, Lexington, Lynchburg, Manassas, Manassas Park,

Type of Disaster

Date of Disaster

Hurricane

Hortense

September 9-11, 1996

Blizzard of 1996

January 7-13, 1996

Severe winds

and flooding

associated with

Hurricane Fran

September 4-October 15, 1996

Hurricane Bertha

July 8-9, 1996

Ice jams and

flooding

January 19-February 2, 1996

Extreme rainfall

and flooding

June 12-14, 1996

Blizzard of

1996

January 6-12, 1996

Disaster Areas in 1996

Type of Disaster

Date of Disaster

Martinsville, Newport News, Norfolk, Norton, Petersburg,

Portsmouth, Poquoson, Radford, Richmond, Roanoke, Salem,

South Boston Town, Staunton, Suffolk, Virginia Beach,

Waynesboro, Williamsburg, and Winchester

Blizzard of 1996

January 6-12, 1996

Counties of Alleghany, Augusta, Bath, Bland, Botetourt,

Clarke, Fauquier, Frederick, Giles, Grayson, Greene, Highland, Loudoun, Page, Pulaski, Rappahanock, Rockbridge,

Rockingham, Shenandoah, Warren, Washington, and Wythe;

and the Cities of Buena Vista, Clifton Forge, Covington,

Harrisonburg, and Waynesboro

Severe storm, high

winds, flooding,

and wind-driven

rain

January 19-February 1, 1996

All Counties

Hurricane Fran

September 5-7, 1996

Counties of Accomack, Albemarle, Alleghany, Amelia,

Amherst, Appomattox, Augusta, Bath, Bedford, Botetourt,

Brunswick, Buckingham, Campbell, Charles City, Charlotte,

Chesterfield, Clarke, Culpeper, Cumberland, Dinwiddie, Essex, Fluvanna, Giles, Gloucester, Goochland, Greene,

Greenville, Halifax, Hampton City, Henrico, Henry, Highland, Isle of Wight, James City, King & Queen, King

George, King William, Lancaster, Louisa, Lunenburg, Madison, Mathews, Mecklenburg, Middlesex, Montgomery,

Nelson, New Kent, Northampton, Northumberland, Nottoway,

Orange, Page, Pittsylvania, Powhattan, Prince Edward, Prince

George, Prince William, Rappahannock, Richmond, Roanoke,

Rockbridge, Rockingham, Shenandoah, Stafford, Surry, Warren, Westmoreland, and York; and the Cities of Bedford,

Buena Vista, Charlottesville, Danville, Emporia,

Fredericksburg, Hampton, Harrisonburg, Hopewell, Lexington, Lynchburg, Martinsville, Newport News, Poquoson,

Staunton, Suffolk, Waynesboro, and Williamsburg

Hurricane Fran

and severe storm

conditions including high winds,

tornadoes, winddriven rain, and

river and flash

flooding

September 5-23, 1996

High winds, severe storms and

flooding

January 26-February 23, 1996

Counties of Klickitat, Pend Oreille, and Spokane

Severe ice storms

November 19-December 4, 1996

Counties of Adams, Asotin, Benton, Chelan, Clallam, Clark,

Columbia, Cowlitz, Ferry, Garfield, Grant, Grays Harbor,

Island, Jefferson, King, Kitsap, Kittitas, Klickitat, Lewis,

Lincoln, Mason, Okanogan, Pacific, Pend Oreille, Pierce, San

Juan, Skagit, Skamania, Snohomish, Spokane, Stevens,

Thurston, Walla Walla, Whatcom, Whitman, and Yakima

Winter storms,

land and

mudslides and

flooding

December 26, 1996

Blizzard of 1996

January 6-12, 1996

Virginia—Continued

Washington

Counties of Adams, Asotin, Benton, Clark, Columbia,

Cowlitz, Garfield, Grays Harbor, King, Kitsap, Kittitas,

Klickitat, Lewis, Lincoln, Pierce, Skagit, Skamania, Snohomish, Spokane, Thurston, Wahkiakum, Walla Walla, Whitman,

and Yakima

West Virginia

Counties of Barbour, Berkeley, Boone, Braxton, Brooke,

Cabell, Calhoun, Clay, Doddridge, Fayette, Gilmer, Grant,

Greenbrier, Hampshire, Hancock, Hardy, Harrison, Jackson,

Jefferson, Kanawha, Lewis, Lincoln, Logan, Marion,

Marshall, Mason, McDowell, Mercer, Mineral, Mingo,

Monongalia, Monroe, Morgan, Nicholas, Ohio, Pendleton,

Pleasants, Pocahontas, Preston, Putnam, Raleigh, Randolph,

Ritchie, Roane, Summers, Taylor, Tucker, Tyler, Upshur,

Wayne, Webster, Wetzel, Wirt, Wood, and Wyoming

Disaster Areas in 1996

Type of Disaster

Date of Disaster

Counties of Berkeley, Brooke, Grant, Greenbriar, Hampshire,

Hancock, Hardy, Jefferson, Marshall, Mason, Mercer, Mineral, Monroe, Morgan, Nicholas, Ohio, Pendleton, Pleasants,

Pocahontas, Preston, Raleigh, Randolph, Summers, Tucker,

Tyler, Webster, Wetzel, and Wood

Flooding

January 19-February 2, 1996

Counties of Barbour, Boone, Harrison, Lincoln, Logan,

McDowell, Mercer, Mingo, Pendleton, Pocahontas, Raleigh,

Randolph, Tucker, Upshur, Wayne, Wetzel, and Wyoming

Flooding and

heavy winds

May 15-June 10, 1996

Counties of Barbour, Braxton, Clay, Gilmer, Monongalia,

Nicholas, Randolph, and Webster

Heavy rains, high

winds, flooding,

and slides

July 18-31, 1996

Counties of Berkeley, Grant, Hardy, Hampshire, Jefferson,

Mineral, Morgan, Pendleton, Randolph, and Tucker

Heavy rain, high

wind, flooding

and slides due to

Hurricane Fran

September 5-8, 1996

Tornadoes, severe

storms and flooding

July 17-22, 1996

West Virginia—Continued

Wisconsin

Counties of Fond du Lac and Green

Section 166.—Bad Debts

26 CFR 1.166–4: Bad debts.

How does a bank change its method of accounting for bad debts from the § 585 reserve method

to the § 166 specific charge-off method so that it

may elect S corporation status for the 1997 tax

year? See Rev. Proc. 97–18, page 53.

Section 280G.—Golden Parachute

Payments

Federal short-term, mid-term, and long-term

rates are set forth for the month of March 1997.

See Rev. Rul. 97–10, page 31.

Section 382.—Limitation on Net

Operating Loss Carryforwards and

Certain Built-In Losses Following

Ownership Change

The adjusted federal long-term rate is set forth

for the month of March 1997. See Rev. Rul.

97–10, page 31.

Section 412.—Minimum Funding

Standards

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the

month of March 1997. See Rev. Rul. 97–10, page

31.

Section 446.—General Rule for

Methods of Accounting

How does a bank change its method of accounting for bad debts from the § 585 reserve method

to the § 166 specific charge-off method so that it

may elect S corporation status for the 1997 tax

year? See Rev. Proc. 97–18, page 53.

Section 467.—Certain Payments

for the Use of Property or Services

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the

month of March 1997. See Rev. Rul. 97–10, page

31.

Section 468.—Special Rules for

Mining and Solid Waste

Reclamation and Closing Costs

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the

month of March 1997. See Rev. Rul. 97–10, page

31.

Section 481.—Adjustments

Required by Changes in Method of

Accounting

26 CFR 1.481–1: Adjustments in general.

How does a bank change its method of accounting for bad debts from the § 585 reserve method

to the § 166 specific charge-off method so that it

may elect S corporation status for the 1997 tax

year? See Rev. Proc. 97–18, page 53.

26 CFR 1.446–1: General rule for methods of

accounting.

Section 483.—Interest on Certain

Deferred Payments

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the

month of March 1997. See Rev. Rul. 97–10, page

31.

Section 585.—Reserves for Bad

Debts

26 CFR 1.585–1: Reserve for losses on loans of

banks.

How does a bank change its method of accounting for bad debts from the § 585 reserve method

to the § 166 specific charge-off method so that it

may elect S corporation status for the 1997 tax

year? See Rev. Proc. 97–18, page 53.

Section 807.—Rules for Certain

Reserves

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the

month of March 1997. See Rev. Rul. 97–10, page

31.

Section 846.—Discounted Unpaid

Losses Defined

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the

month of March 1997. See Rev. Rul. 97–10, page

31.

Section 877.—Expatriation To

Avoid Tax

What are the tax consequences under sections

877, 2107, 2501, and 6039F for individuals who

lose U.S. citizenship or cease to be taxed as

long-term residents of the United States with a

principal purpose to avoid U.S. taxes? See Notice

97–19, page 40.

Section 902.—Deemed Paid Credit

Where Domestic Corporation Owns

10 Percent or More of Voting Stock

of Foreign Corporation

26 CFR 1.902.1: Credit for domestic corporate

shareholder of a foreign corporation for foreign

income taxes paid by the foreign corporation.

T.D. 8708

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

Computation of Foreign Taxes

Deemed Paid Under Section 902

Pursuant to a Pooling Mechanism

for Undistributed Earnings and

Foreign Taxes

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final income tax regulations relating to

the computation of foreign taxes deemed

paid under section 902. Changes to the

applicable law were made by the Tax

Reform Act of 1986 and by the Technical and Miscellaneous Revenue Act of

1988 (TAMRA). These regulations provide guidance needed to comply with

these changes and affect foreign corporations and their United States corporate

shareholders.

DATES: These regulations are effective

January 7, 1997.

Applicability: For the specific dates

of applicability of these regulations, see

§§ 1.902–1(g) and 1.902–3(l).

FOR FURTHER INFORMATION

CONTACT: Caren S. Shein (202) 622–

3850 (not a toll free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has been

reviewed and approved by the Office of

Management and Budget in accordance

with the Paperwork Reduction Act (44

U.S.C. 3507) under control number

1545– 1458. Responses to these collections of information are required by the

IRS to implement the section 902 pooling regime enacted in the Tax Reform

Act of 1986.

An agency may not conduct or sponsor, and a person is not required to

respond to, a collection of information

unless the collection of information displays a valid control number.

The burden for the collection of information is reflected in the burden for

Form 1118.

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing this burden should be sent to

the Internal Revenue Service, Attention: IRS Reports Clearance Officer

T:FP, Washington, DC 20224, and to the

Office of Management and Budget,

Attention: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington,

DC 20503.

Books or records relating to the collections of information must be retained

as long as their contents may become

material in the administration of any

internal revenue law. Generally, tax returns and tax return information are

confidential, as required by 26 U.S.C.

6103.

Background

Section 902 (26 CFR part 1) was

amended by section 1202(a) of the Tax

Reform Act of 1986 (Public Law 99–

514, 100 Stat. 1085), and section

1012(b) of the Technical and Miscellaneous Revenue Act of 1988 (TAMRA)

(Public Law 100– 647, 102 Stat. 3242).

On January 6, 1995, the IRS published a

notice of proposed rulemaking in the

Federal Register (60 FR 2049 [INTL–

933–86 (1995–1 C.B. 959)]). The proposed regulations provide guidance

needed to comply with section 902 as

amended in 1986 and 1988. No public

hearing was requested or held, but numerous written comments were received.

The proposed regulations, with certain

changes made in response to comments,

are adopted in this Treasury decision as

final regulations. The principal changes

to the regulations, as well as the major

comments and suggestions, are discussed below.

Explanation of Provisions

Section 1.902–1

In the preamble to the proposed regulations, the IRS requested comments on

whether the holding of Revenue Ruling

71–141 (1971–1 C.B. 211) should be

expanded to allow taxes paid by a

foreign corporation to be considered

deemed paid by domestic corporations

that are partners in domestic limited

partnerships or foreign partnerships,

shareholders in limited liability companies, beneficiaries of domestic or foreign

trusts and estates, or interest holders in

other pass-through entities. The revenue

ruling held that two 50-percent domestic

corporate general partners of a domestic

general partnership that owned 40 percent of a foreign corporation were entitled to compute an amount of foreign

taxes deemed paid under section 902

with respect to dividends they received

from the foreign corporation through the

partnership.

The IRS received numerous comments in response to the request in the

preamble. The commenters uniformly

argue that the aggregate theory of partnerships should apply to allow domestic

corporate partners to compute an

amount of foreign taxes deemed paid

with respect to dividends paid to any

partnership by a foreign corporation,

provided that the partner owns at least

10 percent of the voting stock of the

foreign corporation through the partnership.

The final regulations do not resolve

under what circumstances a domestic

corporate partner may compute an

amount of foreign taxes deemed paid

with respect to dividends received from

a foreign corporation by a partnership or

other pass-through entity. That issue will

be the subject of a future proposed

regulations project. However, in recognition of the holding in Revenue Ruling

71–141 (1971–1 C.B. 211) that a general partner of a domestic general partnership may compute an amount of

foreign taxes deemed paid with respect

to a dividend distribution from a foreign

corporation to the partnership, § 1.902–

1(a)(1) is amended to define a domestic

shareholder as a domestic corporation

that ‘‘owns’’ the requisite voting stock

in a foreign corporation rather than one

that ‘‘owns directly’’ the voting stock.

The IRS is still considering under what

other circumstances the revenue ruling

should apply.

Section 1.902–1(a)(8) is amended to

clarify under what circumstances the

pool of post-1986 foreign income taxes

must be reduced to account for distributions made in prior post-1986 taxable

years. The regulations require a reduction in the taxes pool for taxes attribut-

able to earnings distributed to shareholders ineligible for the deemed paid credit

(for example, a foreign shareholder, a

U.S. individual shareholder, or a domestic corporate shareholder that owns less

than 10 percent of the foreign corporation’s voting stock) and to shareholders

that are eligible for the credit but that

choose to deduct foreign taxes under

section 164(a) in the year of the distribution rather than claim a credit.

The IRS understands that some taxpayers have taken the position, contrary

to the position taken in § 1.902–1(a)(8)

of the proposed regulations, that although post-1986 undistributed earnings

must be reduced to account for all

distributions out of current or accumulated earnings and profits, post-1986

foreign income taxes should be reduced

only to account for taxes attributable to

distributions with respect to which a

shareholder both is eligible to claim a

credit for foreign taxes deemed paid

under section 902(a) and in fact elects

to credit foreign taxes for the taxable

year under section 901(a). These taxpayers argue that only in those circumstances are foreign taxes ‘‘deemed paid’’

and thus required to be removed from

the taxes pool under a literal reading of

sections 902(a) and 902(c)(2)(B).

The IRS has not changed its position

as reflected in § 1.902–1(a)(8)(i) of the

proposed regulations that the foreign

taxes pool must be reduced to account

for foreign taxes attributable to all distributions and deemed distributions or

inclusions to all shareholders. However,

the text of the final regulations has been

amended to clarify the rule. The requirement that the foreign taxes pool must be

reduced proportionately as the earnings

pool is reduced is consistent with the

legislative history of the Tax Reform

Act of 1986 (Public Law 99–514). The

House Report states that under the pooling regime, ‘‘[a] dividend or subpart F

inclusion is considered to bring with it a

pro rata share of the accumulated foreign taxes paid by the subsidiary.’’ H.R.

Rep. No. 426, 99th Cong., 1st Sess. 357

(1985). In addition, removing taxes attributable to distributions to ineligible

shareholders and eligible shareholders

that choose to deduct foreign taxes is

supported by the general matching principles of section 902, which presume

that a dividend distribution will carry

with it a ratable share of the foreign

corporation’s taxes. If taxes paid with

respect to distributed earnings remained

in the pool, eligible shareholders eventually could receive credits for more than

their ratable share of the foreign corporation’s taxes, a result at odds with the

statutory scheme.

Section 1.902–1(a)(8)(i) is amended

to correct an oversight in the proposed

regulation. In the case of a distribution

out of current earnings and profits that

is treated as a ‘‘nimble’’ dividend under

section 316(a)(2) when there is a deficit

in accumulated earnings and profits,

post-1986 foreign income taxes are not

reduced. This rule is not inconsistent

with the general rule of paragraph

(a)(8)(i) that the foreign taxes pool must

be reduced to account for taxes attributable to all distributions and deemed

distributions out of post-1986 undistributed earnings. Rather, it reflects the fact

that under section 902 and these regulations, no taxes are deemed paid with

respect to a nimble dividend under section 316(a)(2) because the post-1986

undistributed earnings pool is zero or

less than zero.

Section 1.902–1(a)(9), defining post1986 undistributed earnings, is amended

to clarify that the earnings pool is

reduced only to account for distributions

or deemed distributions that reduce

earnings and profits and inclusions that

result in previously-taxed amounts described in sections 959(c)(1) and (c)(2)

or 1293(c). Thus, for example, in the

case of a controlled foreign corporation

owned 60 percent by a domestic corporate shareholder and 40 percent by a

foreign shareholder, the earnings and

taxes pools are reduced only to account

for 60 percent of the foreign corporation’s subpart F income.

The rules precluding special allocations of earnings and taxes in § 1.902–

1(a)(9)(iv) and (10)(ii) of the proposed

regulations have been retained in the

final regulations. These regulations are

intended to reverse the result in Vulcan

v. Commissioner, 96 T.C. 410 (1991),

aff’d per curiam, 959 F.2d 973 (11th

Cir. 1992), nonacq. 1995–1 C.B. 1, for

post-1986 taxable years. Several commenters argued that the Vulcan decision

was correct and should be applied to

both pre-1987 and post-1986 taxable

years, and the regulations should be

revised to reflect the decision. For the

reasons stated in the preamble to the

proposed regulations, the IRS declines

to do so.

Commenters also argued that the rule

precluding special allocations of earnings and taxes is inconsistent with

§ 1.904–6(a)(2). Section 1.904–6(a)(2)

is an anti-abuse rule designed to prevent

the use of accommodation parties to

improve a United States taxpayer’s foreign tax credit position. The rule states

that if a taxpayer receives or accrues a

dividend from a noncontrolled section

902 corporation and the Commissioner

establishes the existence of an express

or implied agreement that the dividend

is paid out of the foreign corporation’s

passive or high withholding tax interest

earnings, then only taxes imposed on

passive or high withholding tax interest

earnings will be considered related to

the dividend. The IRS may invoke this

rule to prevent a shareholder from sheltering investment income from tax by

investing it through a noncontrolled section 902 corporation that distributes only

the investment earnings to the shareholder, which then treats the distribution

as a dividend sheltered by taxes paid on

the corporation’s high-taxed active business income. The IRS believes that this

narrowly defined anti-abuse rule is an

appropriate exception to the general rule

of § 1.902–1(a)(9)(iv) and (a)(10)(ii)

barring special allocations of earnings

and taxes.

Section 1.902–1(a)(11) has been

amended to clarify that the definition of

a dividend in section 316(a) applies for

purposes of section 902, and that the

section 902 definition of a dividend also

includes deemed dividends under sections 551 and 1248. Deemed inclusions

under sections 951(a) and 1293 are not

dividends for purposes of section 902.

However, sections 960(a)(1) and 1293(f)

provide that deemed paid taxes with

respect to inclusions under sections

951(a) and 1293 are determined under

section 902 in the same manner as if a

dividend was paid.

Paragraph (a)(11) also has been

amended to add a cross-reference to

section 1291 and § 1.1291–5 of the

proposed regulations, which provide

special rules for computing foreign taxes

deemed paid with respect to distributions from section 1291 funds. These

distributions are treated as dividends

solely for foreign tax credit purposes,

but the general section 902 computational rules do not apply.

A commenter correctly pointed out

that the regulation’s inclusion of deemed

distributions under section 551 as dividends for purposes of section 902 is

contrary to the holding in Revenue

Ruling 74–59 (1974–1 C.B. 183) that an

amount includible in gross income under

section 551 is not considered a dividend

received for purposes of the allowance

of a foreign tax credit under section

902. The holding of the revenue ruling

is based on language in the 1937 legislative history of the foreign personal

holding company provisions. The Report

of the Joint Committee on Tax Evasion

and Avoidance of the Congress of the

United States, H.R. Doc. No. 337, 75th

Cong., 1st Sess. 18 (1937), recommended that shareholders of foreign personal holding companies not be allowed

a credit for foreign income taxes paid

by the foreign corporation with respect

to amounts deemed distributed. The Report goes on to state that the committee

recommended against allowing a credit

because ‘‘it is not administratively feasible, although it might seem equitable

under the circumstances.’’

Section 551(b) provides that amounts

required to be included in the gross

income of a U.S. shareholder under

section 551(a) are treated as dividends,

and under current law it is administratively feasible to allow deemed paid

taxes to be computed with respect to

deemed dividends. In addition, the Code

now includes other anti-deferral regimes,

e.g., the subpart F and passive foreign

investment company provisions, the application of which may overlap with the

foreign personal holding company rules.

Shareholders are permitted to compute

deemed paid taxes with respect to subpart F and passive foreign investment

company inclusions.

The IRS, therefore, has concluded the

revenue ruling is not supported by current law. A shareholder of a foreign

personal holding company should be

entitled to compute deemed paid taxes

with respect to amounts required to be

included in gross income as dividends

under section 551(a). Revenue Ruling

74–59 (1974–1 C.B. 183) is hereby

revoked effective as of the date these

regulations are published in the Federal

A commenter argued that the rule in

§ 1.902–1(b)(4), providing that no taxes

are deemed paid with respect to dividends out of current earnings and profits

when the foreign corporation has no

post-1986 undistributed earnings and no

accumulated earnings and profits (socalled ‘‘nimble’’ dividends) conflicts

with the general purpose of the foreign

tax credit to prevent double taxation.

The rule is retained in the final regulations for two reasons. First, the legislative history of the Tax Reform Act of

1986 (Public Law 99–514) clearly indicates that Congress was aware of the

issue and agreed with the position stated

in the regulation. See S. Rep. No. 313,

99th Cong., 2d Sess. 321 (1986). Sec-

ond, because no taxes can be deemed

paid under the computational rules of

section 902 when post-1986 undistributed earnings are zero or less than zero,

no taxes are removed from the post1986 foreign income taxes pool. Thus,

all of the foreign corporation’s taxes

remain in its post-1986 foreign income

taxes pool and are available to be

credited if the corporation pays another

dividend in a later year in which the

post-1986 undistributed earnings pool is

positive.

Section 1.902–1(c)(8) of the proposed

regulations reserved on the application

of section 902 in section 304 exchanges.

Commenters suggested that the regulations should address this area by incorporating the holdings in Revenue Ruling

91–5 (1991–1 C.B. 114), and Revenue

Ruling 92–86 (1992–1 C.B. 199). In

addition, the commenters argued that the

regulations should state that a deemed

paid credit is available in a section 304

exchange involving a foreign parent corporation. The IRS is still studying the

area and the regulations thus continue to

reserve on the application of section 902

in a section 304 exchange.

Section 1.902–1(c)(9) of the proposed

regulations is reserved in these final

regulations. The proposed regulation

provided a cross-reference to regulations

under section 905(c) with respect to

adjustments to post-1986 undistributed

earnings and taxes that result from a

section 482 allocation of income. There

currently are no regulations under section 905(c) addressing section 482 allocations and the IRS, therefore, has reserved this paragraph pending issuance

of final regulations under section 905(c).

Section 1.902–1(d)(3)(ii) through (iv)

of the proposed regulations is not included in the final regulations. Paragraph (d)(3) set out rules and examples

exercising a grant of regulatory authority under the last sentence of section

904(d)(2)(E)(i) to limit beyond the statute the circumstances under which a

dividend paid to a new U.S. shareholder

by a controlled foreign corporation out

of earnings accumulated while it was a

controlled foreign corporation will be

treated

dividends

from

noncontrolled section 902 corporation.

Identical rules were proposed in 1992

under section 904(d). See § 1.904–

4(g)(3)(ii) through (iv) of the proposed

regulations. The rules address the character of a dividend distribution under

section 904(d) and are more appropriately placed in the regulations under that

section. After considering the comments

received, the rule will be finalized as

part of the section 904 regulations.

Section 1.902–2

A commenter suggested that the deficit carryback rules in § 1.902–2(a)(1)

should be amended to provide that a

deficit in post-1986 undistributed earnings will not be carried back to pre1987 years on a return of capital or

capital gain distribution. The rule states

that a deficit will be carried back when

‘‘* * * a corporation makes a distribution to shareholders that is a dividend or

would be a dividend if there were

current or accumulated earnings and

profits, * * * .’’ The commenter suggests that the rule in the proposed

regulation can result in ‘‘locked-in’’

taxes when earnings attributable to one

or more pre-1987 years are eliminated

by the deficit carryback. If the deficit

stays in the post-1986 pool there is a

chance it can be absorbed by future

earnings, leaving the pre-1987 earnings

and taxes intact. In support of its position, the commenter argues that section

902 establishes rules that minimize

double taxation by allowing a taxpayer

to compute a deemed paid credit on a

taxable dividend. The legislative history

indicates that the pooling provisions of

section 902 are to apply solely for

purposes of computing the deemed paid

credit. Because a return of capital or

capital gain distribution is not a taxable

dividend and no section 902 credit is

allowable, the commenter argues that

the pooling rules (including the deficit

carryback rules) should not apply.

The IRS declines to adopt the commenter’s suggestion. When an amount is

distributed in a post-1986 taxable year

and there is a deficit in post-1986

undistributed earnings, the deficit must

be carried back and reduce earnings and

profits in pre-1987 years to determine

whether any earnings remain to support

treatment of the distribution as a dividend. To the extent there are earnings

remaining in one or more pre-1987

years after a deficit is carried back, the

distribution is a dividend. Any remaining amount is a return of capital and

capital gain. It would be incongruous to

adopt a rule providing a different result

if a single dollar of pre-1987 accumulated profits remains in a pre-1987 year

after a post-1986 deficit is carried back

than if the deficit carryback eliminated

all pre-1987 accumulated profits and the

entire distribution were treated as a

return of capital.

Another commenter argued that the

interplay among § 1.902–2(b)(1) (pre1987 accumulated deficit carries over to

become the opening balance of post1986 undistributed earnings pool) and

§ 1.902–1(b)(4) (no taxes deemed paid

if a dividend is a nimble dividend) of

the proposed regulations, and section

960 (incorporating the section 902 rules

with respect to deemed inclusions under

subpart F) results in a denial of deemed

paid taxes to a U.S. shareholder if a

controlled foreign corporation has both a

pre-1987 accumulated deficit and post1986 earnings and profits that are entirely subpart F income. The commenter

suggests that regulations be issued under

section 960 to provide, solely for purposes of that section, that accumulated

deficits in pre-1987 accumulated profits

will not carry over into the post-1986

pool.

The IRS cannot adopt the rule the

commenter suggests. Congress amended

sections 902 and 960 in 1986 specifically to eliminate different earnings and

profits and deemed paid taxes computations for purposes of sections 902 and

960. Further, in the situation the commenter posits, the credits are deferred

but not permanently disallowed. If the

controlled foreign corporation earns

enough post-1986 income to eliminate

the accumulated deficit, any distribution

or deemed distribution will carry with it

a ratable share of post-1986 foreign

income taxes.

A commenter argued that § 1.902–

2(b)(2) and (3), Example 1, are incorrect

because they imply that annual deficits

in pre-1987 accumulated profits were

required to be carried back under pre1987 section 902 regardless of how

foreign income taxes were determined.

The commenter argues that pre-1987

section 902 requires a ‘‘correlation’’ between accumulated profits as determined

under U.S. law and the foreign law

method by which foreign taxes were

determined.

The IRS disagrees with the comment

and the proposed regulation has not

been amended. The regulation reflects

the IRS’ longstanding position that in

the case of a deficit in accumulated

profits of a foreign corporation for a

particular pre-1987 year, the deficit first

reduces prior years’ accumulated profits

on a LIFO basis to the extent thereof,

and then the remaining deficit reduces

accumulated profits in subsequent years.

That rule applies regardless of whether

foreign law permits or requires the carryback or carryforward of losses. See

Revenue Ruling 74–550 (1974–2 C.B.

209) and Revenue Ruling 87–72

(1987–2 C.B. 170).

§ 1.902–0 Outline of regulations provisions for section 902.

Effect on Other Documents

This section lists the provisions under

section 902.

The following revenue ruling is revoked as of January 7, 1997.

Revenue Ruling 74–59, 1974–1 C.B.

183.

§ 1.902–1 Credit for domestic corporate shareholder of a foreign corporation for foreign income taxes paid by the

foreign corporation.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.

Therefore, a regulatory assessment is not

required. It also has been determined

that section 553(b) of the Administrative

Procedure Act (5 U.S.C. chapter 5) does

not apply to these regulations, and because the notice of proposed rulemaking

preceding the regulations was issued

prior to March 29, 1996, the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does

not apply. Pursuant to section 7805(f) of

the Internal Revenue Code, the notice of

proposed rulemaking preceding these

regulations was submitted to the Small

Business Administration for comment on

its impact on small business.

Drafting Information

The principal author of these final

regulations is Caren Silver Shein of the

Office of Associate Chief Counsel (International), within the Office of Chief

Counsel, IRS. However, other personnel

from the IRS and Treasury Department

participated in their development.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR parts 1 and 602

are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding entries

in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.902–1 also issued under 26

U.S.C. 902(c)(7).

Section 1.902–2 also issued under 26

U.S.C. 902(c)(7). * * *

Par. 2. Sections 1.902–1 and 1.902–2

are redesignated §§ 1.902–3 and

1.902–4, respectively.

Par. 3. Sections 1.902–0, 1.902–1 and

1.902–2 are added to read as follows:

(a) Definitions and special effective

date.

(1) Domestic shareholder.

(2) First-tier corporation.

(3) Second-tier corporation.

(4) Third-tier corporation.

(5) Example.

(6) Upper- and lower-tier corporations.

(7) Foreign income taxes.

(8) Post-1986 foreign income taxes.

(i) In general.

(ii) Distributions out of earnings and

profits accumulated by a lower-tier corporation in its taxable years beginning

before January 1, 1987, and included in

the gross income of an upper-tier corporation in its taxable year beginning after

December 31, 1986.

(iii) Foreign income taxes paid or

accrued with respect to high withholding

tax interest.

(9) Post-1986 undistributed earnings.

(i) In general.

(ii) Distributions out of earnings and

profits accumulated by a lower-tier corporation in its taxable years beginning

before January 1, 1987, and included in

the gross income of an upper-tier corporation in its taxable year beginning after

December 31, 1986.

(iii) Reduction for foreign income

taxes paid or accrued.

(iv) Special allocations.

(10) Pre-1987 accumulated profits.

(i) Definition.

(ii) Computation of pre-1987 accumulated profits.

(iii) Foreign income taxes attributable

to pre-1987 accumulated profits.

(11) Dividend.

(12) Dividend received.

(13) Special effective date.

(i) Rule.

(ii) Example.

(b) Computation of foreign income

taxes deemed paid by a domestic shareholder, first-tier corporation, and secondtier corporation.

(1) General rule.

(2) Allocation rule for dividends attributable to post-1986 undistributed

earnings and pre-1987 accumulated

profits.

(i) Portion of dividend out of post1986 undistributed earnings.

(ii) Portion of dividend out of pre1987 accumulated profits.

(3) Dividends paid out of pre-1987

accumulated profits.

(4) Deficits in accumulated earnings

and profits.

(5) Examples.

(1) Separate computations required

for dividends from each first-tier and

lower-tier corporation.

(i) Rule.

(ii) Example.

(2) Section 78 gross-up.

(i) Foreign income taxes deemed paid

by a domestic shareholder.

(ii) Foreign income taxes deemed

paid by an upper-tier corporation.

(iii) Example.

(3) Creditable foreign income taxes.

(4) Foreign mineral income.

(5) Foreign taxes paid or accrued in

connection with the purchase or sale of

certain oil and gas.

(6) Foreign oil and gas extraction

income.

(7) United States shareholders of controlled foreign corporations.

(8) Credit for foreign taxes deemed

paid in a section 304 transaction.

(9) Effect of section 482 adjustments

on post-1986 foreign income taxes and

post-1986 undistributed earnings.

(d) Dividends from controlled foreign

corporations.

(1) General rule.

(2) Look-through.

(i) Dividends.

(ii) Coordination with section 960.

(3) Dividends distributed out of earnings accumulated before a controlled

foreign corporation became a controlled

foreign corporation.

(i) General rule.

(ii) Dividend distributions out of

earnings and profits for a year during

which a shareholder that is currently a

more-than-90-percent United States

shareholder of a controlled foreign corporation was not a United States shareholder of the controlled foreign corporation.

(e) Information to be furnished.

(f) Examples.

(g) Effective date.

§ 1.902–2 Treatment of deficits in post1986 undistributed earnings and pre1987 accumulated profits of a first-,

second-, or third-tier corporation for

purposes of computing an amount of

foreign taxes deemed paid § 1.902–1.

(a) Carryback of deficits in post-1986

undistributed earnings of a first-,

second-, or third-tier corporation to preeffective date taxable years.

(1) Rule.

(2) Examples.

(b) Carryforward of deficits in pre1987 accumulated profits of a first-,

second-, or third-tier corporation to post1986 undistributed earnings for purposes

of section 902.

(1) General rule.

(2) Effect of pre-effective date deficit.

(3) Examples.

§ 1.902–3 Credit for domestic corporate shareholder of a foreign corporation for foreign income taxes paid with

respect to accumulated profits of taxable

years of the foreign corporation beginning before January 1, 1987.

(a) Definitions.

(1) Domestic shareholder.

(2) First-tier corporation.

(3) Second-tier corporation.

(4) Third-tier corporation.

(5) Foreign income taxes.

(6) Dividend.

(7) Dividend received.

(b) Domestic shareholder owning

stock in a first-tier corporation.

(1) In general.

(2) Amount of foreign taxes deemed

paid by a domestic shareholder.

stock in a second-tier corporation.

(1) In general.

(2) Amount of foreign taxes deemed

paid by a first-tier corporation.

(d) Second-tier corporation owning

stock in a third-tier corporation.

(1) In general.

(2) Amount of foreign taxes deemed

paid by a second-tier corporation.

(e) Determination of accumulated

profits of a foreign corporation.

(f) Taxes paid on or with respect to

accumulated profits of a foreign corporation.

(g) Determination of earnings and

profits of a foreign corporation.

(1) Taxable year to which section 963

does not apply.

(2) Taxable year to which section 963

applies.

(3) Time and manner of making

choice.

(4) Determination by district director.

(h) Source of income from first-tier

corporation and country to which tax is

deemed paid.

(1) Source of income.

(2) Country to which taxes deemed

paid.

(i) United Kingdom income taxes

paid with respect to royalties.

(j) Information to be furnished.

(k) Illustrations.

(l) Effective date.

§ 1.902–4 Rules for distributions attributable to accumulated profits for taxable

years in which a first-tier corporation

was a less developed country corporation.

(a) In general.

(b) Combined distributions.

from second- or third-tier corporations.

(d) Illustrations.

§ 1.902–1 Credit for domestic corporate shareholder of a foreign corporation for foreign income taxes paid by the

foreign corporation.

(a) Definitions and special effective

date. For purposes of section 902, this

section, and § 1.902–2, the definitions

provided in paragraphs (a)(1) through

(12) of this section and the special

effective date of paragraph (a)(13) of

this section apply.

(1) Domestic shareholder. In the case

of dividends received by a domestic

corporation from a foreign corporation

after December 31, 1986, the term domestic shareholder means a domestic

corporation, other than an S corporation

as defined in section 1361(a), that owns

at least 10 percent of the voting stock of

the foreign corporation at the time the

domestic corporation receives a dividend

from that foreign corporation.

(2) First-tier corporation. In the case

of dividends received by a domestic

shareholder from a foreign corporation

in a taxable year beginning after December 31, 1986, the term first-tier

corporation means a foreign corporation,

at least 10 percent of the voting stock of

which is owned by a domestic shareholder at the time the domestic shareholder receives a dividend from that

foreign corporation. The term first-tier

corporation also includes a DISC or

former DISC, but only with respect to

dividends from the DISC or former

DISC that are treated under sections

861(a)(2)(D) and 862(a)(2) as income

from sources without the United States.

(3) Second-tier corporation. In the

case of dividends paid to a first-tier

corporation by a foreign corporation in a

taxable year beginning after December

31, 1986, the foreign corporation is a

second-tier corporation if, at the time a

first-tier corporation receives a dividend

from that foreign corporation, the firsttier corporation owns at least 10 percent

of the foreign corporation’s voting stock

and the product of the following equals

at least 5 percent—

(i) The percentage of voting stock

owned by the domestic shareholder in

the first-tier corporation; multiplied by

(ii) The percentage of voting stock

owned by the first-tier corporation in the

second-tier corporation.

(4) Third-tier corporation. In the case

of dividends paid to a second-tier corporation by a foreign corporation in a

taxable year beginning after December

31, 1986, a foreign corporation is a

third-tier corporation if, at the time a

second-tier corporation receives a dividend from that foreign corporation, the

second-tier corporation owns at least 10

percent of the foreign corporation’s voting stock and the product of the following equals at least 5 percent—

(i) The percentage of voting stock

owned by the domestic shareholder in

the first-tier corporation; multiplied by

(ii) The percentage of voting stock

owned by the first-tier corporation in the

second-tier corporation; multiplied by

(iii) The percentage of voting stock

owned by the second-tier corporation in

the third-tier corporation.

(5) Example. The following example

illustrates the ownership requirements of

paragraphs (a)(1) through (4) of this

section:

Example. (i) Domestic corporation M owns 30

percent of the voting stock of foreign corporation

A on January 1, 1991, and for all periods thereafter. Corporation A owns 40 percent of the voting

stock of foreign corporation B on January 1, 1991,

and continues to own that stock until June 1,

1991, when Corporation A sells its stock in

Corporation B. Both Corporation A and Corporation B use the calendar year as the taxable year.

Corporation B pays a dividend out of its post-1986

undistributed earnings to Corporation A, which

Corporation A receives on February 16, 1991.

Corporation A pays a dividend out of its post-1986

undistributed earnings to Corporation M, which

Corporation M receives on January 20, 1992.

Corporation M uses a fiscal year ending on June

30 as the taxable year.

(ii) On February 16, 1991, when Corporation B

pays a dividend to Corporation A, Corporation M

satisfies the 10-percent stock ownership requirement of paragraphs (a)(1) and (2) of this section

with respect to Corporation A. Therefore, Corporation A is a first-tier corporation within the meaning of paragraph (a)(2) of this section and Corporation M is a domestic shareholder of Corporation

A within the meaning of paragraph (a)(1) of this

section. Also on February 16, 1991, Corporation B

is a second-tier corporation within the meaning of

paragraph (a)(3) of this section because Corporation A owns at least 10 percent of its voting stock,

and the percentage of voting stock owned by

Corporation M in Corporation A on February 16,

1991 (30 percent) multiplied by the percentage of

voting stock owned by Corporation A in Corporation B on February 16, 1991 (40 percent) equals

12 percent. Corporation A shall be deemed to have

paid foreign income taxes of Corporation B with

respect to the dividend received from Corporation

B on February 16, 1991.

(iii) On January 20, 1992, Corporation M satisfies the 10-percent stock ownership requirement of

paragraphs (a)(1) and (2) of this section with

respect to Corporation A. Therefore, Corporation A

is a first-tier corporation within the meaning of

paragraph (a)(2) of this section and Corporation M

is a domestic shareholder within the meaning of

paragraph (a)(1) of this section. Accordingly, for

its taxable year ending on June 30, 1992, Corporation M is deemed to have paid a portion of the

post-1986 foreign income taxes paid, accrued, or

deemed to be paid, by Corporation A. Those taxes

will include taxes paid by Corporation B that were

deemed paid by Corporation A with respect to the

dividend paid by Corporation B to Corporation A

on February 16, 1991, even though Corporation B

is no longer a second-tier corporation with respect

to Corporations A and M on January 20, 1992, and

has not been a second-tier corporation with respect

to Corporations A and M at any time during the

taxable years of Corporations A and M that

include January 20, 1992.

(6) Upper- and lower-tier corporations. In the case of a third-tier corporation, the term upper-tier corporation

means a first- or second-tier corporation.

In the case of a second-tier corporation,

the term upper-tier corporation means a

first-tier corporation. In the case of a

first-tier corporation, the term lower-tier

corporation means a second- or third-tier

corporation. In the case of a second-tier

corporation, the term lower-tier corporation means a third-tier corporation.

(7) Foreign income taxes. The term

foreign income taxes means income, war

profits, and excess profits taxes as defined in § 1.901–2(a), and taxes included in the term income, war profits,

and excess profits taxes by reason of

section 903, that are imposed by a

foreign country or a possession of the

United States, including any such taxes

deemed paid by a foreign corporation

under this section. Foreign income, war

profits, and excess profits taxes shall not

include amounts excluded from the definition of those taxes pursuant to section

901 and the regulations under that section. See also paragraphs (c)(4) and (5)

of this section (concerning foreign taxes

paid with respect to foreign mineral

income and in connection with the purchase or sale of oil and gas).

(8) Post-1986 foreign income taxes—

(i) In general. Except as provided in

paragraphs (a)(10) and (13) of this section, the term post-1986 foreign income

taxes of a foreign corporation means the

sum of the foreign income taxes paid,

accrued, or deemed paid in the taxable

year of the foreign corporation in which

it distributes a dividend plus the foreign

income taxes paid, accrued, or deemed

paid in the foreign corporation’s prior

taxable years beginning after December

31, 1986, to the extent the foreign taxes

were not paid or deemed paid by the

foreign corporation on or with respect to

earnings that in prior taxable years were

distributed to, or otherwise included

(e.g., under sections 304, 367(b), 551,

951(a), 1248 or 1293) in the income of,

a foreign or domestic shareholder. Except as provided in paragraph (b)(4) of

this section, foreign taxes paid or

deemed paid by the foreign corporation

on or with respect to earnings that were

distributed or otherwise removed from

post-1986 undistributed earnings in prior

post-1986 taxable years shall be removed from post-1986 foreign income

taxes regardless of whether the shareholder is eligible to compute an amount

of foreign taxes deemed paid under

section 902, and regardless of whether

the shareholder in fact chose to credit

foreign income taxes under section 901

for the year of the distribution or inclusion. Thus, if an amount is distributed

or deemed distributed by a foreign corporation to a United States person that

is not a domestic shareholder within the

meaning of paragraph (a)(1) of this

section (e.g., an individual or a corporation that owns less than 10% of the

foreign corporation’s voting stock), or to

a foreign person that does not meet the

definition of a first- or second-tier corporation under paragraph (a)(2) or (3) of

this section, then although no foreign

income taxes shall be deemed paid

under section 902, foreign income taxes

attributable to the distribution or deemed

distribution that would have been

deemed paid had the shareholder met

the ownership requirements of paragraphs (a)(1) through (4) of this section

shall be removed from post-1986 foreign income taxes. Further, if a domestic

shareholder chooses to deduct foreign

taxes paid or accrued for the taxable

year of the distribution or inclusion, it

shall nonetheless be deemed to have

paid a proportionate share of the foreign

corporation’s post-1986 foreign income

taxes under section 902(a), and the

foreign taxes deemed paid must be

removed from post-1986 foreign income

taxes. In the case of a foreign corporation the foreign income taxes of which

are determined based on an accounting

period of less than one year, the term

year means that accounting period. See

sections 441(b)(3) and 443.

(ii) Distributions out of earnings and

profits accumulated by a lower-tier corporation in its taxable years beginning

before January 1, 1987, and included in

the gross income of an upper-tier corporation in its taxable year beginning after

December 31, 1986. Post-1986 foreign

income taxes shall include foreign income taxes that are deemed paid by an

upper-tier corporation with respect to

distributions from a lower-tier corporation out of non-previously taxed pre1987 accumulated profits, as defined in

paragraph (a)(10) of this section, that

are received by an upper-tier corporation

in any taxable year of the upper-tier

corporation beginning after December

31, 1986, provided the upper-tier corporation’s earnings and profits in that year

are included in its post-1986 undistributed earnings under paragraph (a)(9) of

this section. Foreign income taxes

deemed paid with respect to a distribution of pre-1987 accumulated profits

shall be translated from the functional

currency of the lower-tier corporation

into dollars at the spot exchange rate in

effect on the date of the distribution. To

determine the character of the earnings

and profits and associated taxes for

foreign tax credit limitation purposes,

see section 904 and § 1.904–7(a).

(iii) Foreign income taxes paid or

accrued with respect to high withholding

tax interest. Post-1986 foreign income

taxes shall not include foreign income

taxes paid or accrued by a noncontrolled

section 902 corporation (as defined in

section 904(d)(2)(E)(i)) with respect to

high withholding tax interest (as defined

in section 904(d)(2)(B)) to the extent the

foreign tax rate imposed on such interest

exceeds 5 percent. See section

904(d)(2)(E)(ii) and § 1.904–4(g)(2)(iii).

The reduction in foreign income taxes

paid or accrued by the amount of tax in

excess of 5 percent imposed on high

withholding tax interest income must be

computed in functional currency before

foreign income taxes are translated into

U.S. dollars and included in post-1986

foreign income taxes.

(9) Post-1986 undistributed earnings—(i) In general. Except as provided

in paragraphs (a)(10) and (13) of this

section, the term post-1986 undistributed

earnings means the amount of the earnings and profits of a foreign corporation

(computed in accordance with sections

964(a) and 986) accumulated in taxable

years of the foreign corporation beginning after December 31, 1986, deter-

mined as of the close of the taxable year

of the foreign corporation in which it

distributes a dividend. Post-1986 undistributed earnings shall not be reduced by

reason of any earnings distributed or

otherwise included in income, for example under section 304, 367(b), 551,

951(a), 1248 or 1293, during the taxable

year. Post-1986 undistributed earnings

shall be reduced to account for distributions or deemed distributions that reduced earnings and profits and inclusions that resulted in previously-taxed

amounts described in section 959(c)(1)

and (2) or section 1293(c) in prior

taxable years beginning after December

31, 1986. Thus, post-1986 undistributed

earnings shall not be reduced to the

extent of the ratable share of a controlled foreign corporation’s subpart F

income, as defined in section 952, attributable to a shareholder that is not a

United States shareholder within the

meaning of section 951(b) or section

953(c)(1)(A), because that amount has

not been included in a shareholder’s

gross income. Post-1986 undistributed

earnings shall be reduced as provided

herein regardless of whether any shareholder is deemed to have paid any

foreign taxes, and regardless of whether

any domestic shareholder chose to claim

a foreign tax credit under section 901(a)

for the year of the distribution. For rules

on carrybacks and carryforwards of deficits and their effect on post-1986 undistributed earnings, see § 1.902–2. In the

case of a foreign corporation the foreign

income taxes of which are computed

based on an accounting period of less

than one year, the term year means that

accounting period. See sections

441(b)(3) and 443.

(ii) Distributions out of earnings and

profits accumulated by a lower-tier corporation in its taxable years beginning

before January 1, 1987, and included in

the gross income of an upper-tier corporation in its taxable year beginning after

December 31, 1986. Distributions by a

lower-tier corporation out of nonpreviously taxed pre-1987 accumulated

profits, as defined in paragraph (a)(10)

of this section, that are received by an

upper-tier corporation in any taxable

year of the upper-tier corporation beginning after December 31, 1986, shall be

treated as post-1986 undistributed earnings of the upper-tier corporation, provided the upper-tier corporation’s earnings and profits for that year are

included in its post-1986 undistributed

earnings under paragraph (a)(9)(i) of

this section. To determine the character

of the earnings and profits and associated taxes for foreign tax credit limitation purposes, see section 904 and

§ 1.904–7(a).

(iii) Reduction for foreign income

taxes paid or accrued. In computing

post-1986 undistributed earnings, earnings and profits shall be reduced by

foreign income taxes paid or accrued

regardless of whether the taxes are creditable. Thus, earnings and profits shall

be reduced by foreign income taxes paid

with respect to high withholding tax

interest even though a portion of the

taxes is not creditable pursuant to section 904(d)(2)(E)(ii) and is not included

in post-1986 foreign income taxes under

paragraph (a)(8)(iii) of this section.

Earnings and profits of an upper-tier

corporation, however, shall not be reduced by foreign income taxes paid by a

lower-tier corporation and deemed to

have been paid by the upper-tier corporation.

(iv) Special allocations. The term

post-1986 undistributed earnings means

the total amount of the earnings of the

corporation determined at the corporate

level. Special allocations of earnings and

taxes to particular shareholders, whether

required or permitted by foreign law or

a shareholder agreement, shall be disregarded. If, however, the Commissioner

establishes that there is an agreement to

pay dividends only out of earnings in

the separate categories for passive or

high withholding tax interest income,

then only taxes imposed on passive or

high withholding tax interest earnings

shall be treated as related to the dividend. See § 1.904–6(a)(2).

(10) Pre-1987 accumulated profits—

(i) Definition. The term pre-1987 accumulated profits means the amount of the

earnings and profits of a foreign corporation computed in accordance with section 902 and attributable to its taxable

years beginning before January 1, 1987.

If the special effective date of paragraph

(a)(13) of this section applies, pre-1987

accumulated profits also includes any

earnings and profits (computed in accordance with sections 964(a) and 986)

attributable to the foreign corporation’s

taxable years beginning after December

31, 1986, but before the first day of the

first taxable year of the foreign corporation in which the ownership requirements of section 902(c)(3)(B) and paragraphs (a)(1) through (4) of this section

are met with respect to that corporation.

(ii) Computation of pre-1987 accumulated profits. Pre-1987 accumulated

profits must be computed under United

States principles governing the computation of earnings and profits. Pre-1987

accumulated profits are determined at

the corporate level. Special allocations

of accumulated profits and taxes to

particular shareholders with respect to

distributions of pre-1987 accumulated

profits in taxable years beginning after

December 31, 1986, whether required or

permitted by foreign law or a shareholder agreement, shall be disregarded.

Pre-1987 accumulated profits of a particular year shall be reduced by amounts

distributed from those accumulated profits or otherwise included in income from

those accumulated profits, for example

under sections 304, 367(b), 551, 951(a),

1248 or 1293. If a deficit in post-1986

undistributed earnings is carried back to

offset pre-1987 accumulated profits, pre1987 accumulated profits of a particular

taxable year shall be reduced by the

amount of the deficit carried back to

that year. See § 1.902–2. The amount of

a distribution out of pre-1987 accumulated profits, and the amount of foreign

income taxes deemed paid under section

902, shall be determined and translated

into United States dollars by applying

the law as in effect prior to the effective

date of the Tax Reform Act of 1986.

See §§ 1.902–3, 1.902–4 and 1.964–1.

(iii) Foreign income taxes attributable to pre-1987 accumulated profits.

The term pre-1987 foreign income taxes

means any foreign income taxes paid,

accrued, or deemed paid by a foreign

corporation on or with respect to its

pre-1987 accumulated profits. Pre-1987

foreign income taxes of a particular year

shall be reduced by the amount of taxes

paid or deemed paid by the foreign

corporation on or with respect to

amounts distributed or otherwise included in income from pre-1987 accumulated profits of that year. Thus, pre1987 foreign income taxes shall be

reduced by the amount of taxes deemed

paid by a domestic shareholder (regardless of whether the shareholder chose to

credit foreign income taxes under section 901 for the year of the distribution

or inclusion) or a first-tier or second-tier

corporation, and by the amount of taxes

that would have been deemed paid had

any other shareholder been eligible to

compute an amount of foreign taxes

deemed paid under section 902. Foreign

income taxes deemed paid with respect

to a distribution of pre-1987 accumulated profits shall be translated from the

functional currency of the distributing

corporation into United States dollars at

the spot exchange rate in effect on the

date of the distribution.

(11) Dividend. For purposes of section 902, the definition of the term

dividend in section 316 and the regulations under that section applies. Thus,

for example, distributions and deemed

distributions under sections 302, 304,

305(b) and 367(b) that are treated as

dividends within the meaning of section

301(c)(1) also are dividends for purposes of section 902. In addition, the

term dividend includes deemed dividends under sections 551 and 1248, but

not deemed inclusions under sections

951(a) and 1293. For rules concerning

excess distributions from section 1291

funds that are treated as dividends solely

for foreign tax credit purposes, (see

Regulation Project INTL–656–87 published in 1992–1 C.B. 1124; see

§ 601.601(d)(2)(ii)(b) of this chapter).

(12) Dividend received. A dividend

shall be considered received for purposes of section 902 when the cash or

other property is unqualifiedly made

subject to the demands of the

distributee. See § 1.301–1(b). A dividend also is considered received for

purposes of section 902 when it is

deemed received under section 304,

367(b), 551, or 1248.

(13) Special effective date—(i) Rule.

If the first day on which the ownership

requirements of section 902(c)(3)(B) and

paragraphs (a)(1) through (4) of this

section are met with respect to a foreign

corporation, without regard to whether a

dividend is distributed, is in a taxable

year of the foreign corporation beginning after December 31, 1986, then—

(A) The post-1986 undistributed earnings and post-1986 foreign income taxes

of the foreign corporation shall be determined by taking into account only taxable years beginning on and after the

first day of the first taxable year of the

foreign corporation in which the ownership requirements are met, including

subsequent taxable years in which the

ownership requirements of section

902(c)(3)(B) and paragraphs (a)(1)

through (4) of this section are not met;

and

(B) Earnings and profits accumulated

prior to the first day of the first taxable

year of the foreign corporation in which

the ownership requirements of section

902(c)(3)(B) and paragraphs (a)(1)

through (4) of this section are met shall

be considered pre-1987 accumulated

profits.

(ii) Example. The following example

illustrates the special effective date rules

of this paragraph (a)(13):

Example. As of December 31, 1991, and since

its incorporation, foreign corporation A has owned

100 percent of the stock of foreign corporation B.

Corporation B is not a controlled foreign corporation. Corporation B uses the calendar year as its

taxable year, and its functional currency is the u.

Assume 1u equals $1 at all relevant times. On

April 1, 1992, Corporation B pays a 200u dividend to Corporation A and the ownership requirements of section 902(c)(3)(B) and paragraphs

(a)(1) through (4) of this section are not met at

that time. On July 1, 1992, domestic corporation

M purchases 10 percent of the Corporation B

stock from Corporation A and, for the first time,

Corporation B meets the ownership requirements

of section 902(c)(3)(B) and paragraph (a)(2) of

this section. Corporation M uses the calendar year

as its taxable year. Corporation B does not

distribute any dividends to Corporation M during

1992. For its taxable year ending December 31,

1992, Corporation B has 500u of earnings and

profits (after foreign taxes but before taking into

account the 200u distribution to Corporation A)

and pays 100u of foreign income taxes that is

equal to $100. Pursuant to paragraph (a)(13)(i) of

this section, Corporation B’s post-1986 undistributed earnings and post-1986 foreign income taxes

will include earnings and profits and foreign

income taxes attributable to Corporation B’s entire

1992 taxable year and all taxable years thereafter.

Thus, the April 1, 1992, dividend to Corporation A

will reduce post-1986 undistributed earnings to

300u (500u – 200u) under paragraph (a)(9)(i) of

this section. The foreign income taxes attributable

to the amount distributed as a dividend to Corporation A will not be creditable because Corporation

A is not a domestic shareholder. Post-1986 foreign

income taxes, however, will be reduced by the

amount of foreign taxes attributable to the dividend. Thus, as of the beginning of 1993, Corporation B has $60 ($100 – [$100 x 40% (200u/

500u)]) of post-1986 foreign income taxes. See

paragraphs (a)(8)(i) and (b)(1) of this section.

(b) Computation of foreign income

taxes deemed paid by a domestic shareholder, first-tier corporation, and

second-tier corporation—(1) General

rule. If a foreign corporation pays a

dividend in any taxable year out of post1986 undistributed earnings to a shareholder that is a domestic shareholder or

an upper-tier corporation at the time it

receives the dividend, the recipient shall

be deemed to have paid the same proportion of any post-1986 foreign income

taxes paid, accrued or deemed paid by

the distributing corporation on or with

respect to post-1986 undistributed earnings which the amount of the dividend

out of post-1986 undistributed earnings

(determined without regard to the

gross-up under section 78) bears to the

amount of the distributing corporation’s

post-1986 undistributed earnings. An

upper-tier corporation shall not be entitled to compute an amount of foreign

taxes deemed paid on a dividend from a

lower-tier corporation, however, unless

the ownership requirements of paragraphs (a)(1) through (4) of this section

are met at each tier at the time the

upper-tier corporation receives the dividend. Foreign income taxes deemed paid

by a domestic shareholder or an uppertier corporation must be computed under

the following formula:

Foreign income taxes

deemed paid

by domestic

shareholder

(or upper-tier

corporation)

Post-1986

foreign income taxes

of first-tier

corporation

(or lowertier corporation)

Dividend

paid to domestic shareholder (or

upper-tier

corporation)

by first-tier

corporation

(or lowerx tier) corporation)

Post-1986

undistributed

earnings of

first-tier corporation (or

lower-tier

corporation)

(2) Allocation rule for dividends attributable to post-1986 undistributed

earnings and pre-1987 accumulated

profits—(i) Portion of dividend out of

post-1986 undistributed earnings. Dividends will be deemed to be paid first

out of post-1986 undistributed earnings

to the extent thereof. If dividends exceed post-1986 undistributed earnings

and dividends are paid to more than one

shareholder, then the dividend to each

shareholder shall be deemed to be paid

pro rata out of post-1986 undistributed

earnings, computed as follows:

Portion of

Dividend to

a SharePost-1986

holder AttribUndistrib=

utable to

uted EarnPost-1986

ings

Undistributed

Earnings

Dividend to

Shareholder

Total Divix

dends Paid

To all Shareholders

(ii) Portion of dividend out of pre1987 accumulated profits. After the portion of the dividend attributable to post1986

undistributed

earnings

determined under paragraph (b)(2)(i) of

this section, the remainder of the dividend received by a shareholder is attributable to pre-1987 accumulated profits

to the extent thereof. That part of the

dividend attributable to pre-1987 accumulated profits will be treated as paid

first from the most recently accumulated

earnings and profits. See § 1.902–3. If

dividends paid out of pre-1987 accumulated profits are attributable to more

than one pre-1987 taxable year and are

paid to more than one shareholder, then

the dividend to each shareholder attributable to earnings and profits accumu-

lated in a particular pre-1987 taxable

year shall be deemed to be paid pro rata

out of accumulated profits of that taxable year, computed as follows:

Portion of

Dividend to

a Shareholder Attributable to

Accumu=

lated Profits

of a Particular Pre1987 Taxable Year

Divident

Paid Out

of Pre1987 Accumulated

Profits

with Respect to

the Particular Pre1987 Taxable Year

Dividend to

Shareholder

Total Dividends Paid

to all Shareholders

(3) Dividends paid out of pre-1987

accumulated profits. If dividends are

paid by a first-tier corporation or a

lower-tier corporation out of pre-1987

accumulated profits, the domestic shareholder or upper-tier corporation that receives the dividends shall be deemed to

have paid foreign income taxes to the

extent provided under section 902 and

the regulations thereunder as in effect

prior to the effective date of the Tax

Reform Act of 1986. See paragraphs

(a)(10) and (13) of this section and

§§ 1.902–3 and 1.902–4.

(4) Deficits in accumulated earnings

and profits. No foreign income taxes

shall be deemed paid with respect to a

distribution from a foreign corporation

out of current earnings and profits that

is treated as a dividend under section

316(a)(2), and post-1986 foreign income

taxes shall not be reduced, if as of the

end of the taxable year in which the

dividend is paid or accrued, the corporation has zero or a deficit in post-1986

undistributed earnings and the sum of

current plus accumulated earnings and

profits is zero or less than zero. The

dividend shall reduce post-1986 undistributed earnings and accumulated earnings and profits.

(5) Examples. The following examples illustrate the rules of this paragraph (b):

Example 1. Domestic corporation M owns 100

percent of foreign corporation A. Both Corporation

M and Corporation A use the calendar year as the

taxable year, and Corporation A uses the u as its

functional currency. Assume that 1u equals $1 at

all relevant times. All of Corporation A’s pre-1987

accumulated profits and post-1986 undistributed

earnings are non-subpart F general limitation earnings and profits under section 904(d)(1)(I). As of

December 31, 1992, Corporation A has 100u of

post-1986 undistributed earnings and $40 of post1986 foreign income taxes. For its 1986 taxable

year, Corporation A has accumulated profits of

200u (net of foreign taxes) and paid 60u of

foreign income taxes on those earnings. In 1992,

Corporation A distributes 150u to Corporation M.

Corporation A has 100u of post-1986 undistributed

earnings and the dividend, therefore, is treated as

paid out of post-1986 undistributed earnings to the

extent of 100u. The first 100u distribution is from

post-1986 undistributed earnings, and, because the

distribution exhausts those earnings, Corporation

M is deemed to have paid the entire amount of

post-1986 foreign income taxes of Corporation A

($40). The remaining 50u dividend is treated as a

dividend out of 1986 accumulated profits under

paragraph (b)(2) of this section. Corporation M is

deemed to have paid $15 (60u x 50u/200u,

translated at the appropriate exchange rates) of

Corporation A’s foreign income taxes for 1986. As

of January 1, 1993, Corporation A’s post-1986

undistributed earnings and post-1986 foreign income taxes are 0. Corporation A has 150u of

accumulated profits and 45u of foreign income

taxes remaining in 1986.

Example 2. Domestic corporation M (incorporated on January 1, 1987) owns 100 percent of

foreign corporation A (incorporated on January 1,

1987). Both Corporation M and Corporation A use

the calendar year as the taxable year, and Corporation A uses the u as its functional currency.

Assume that 1u equals $1 at all relevant times.

Corporation A has no pre-1987 accumulated profits. All of Corporation A’s post-1986 undistributed

earnings are non-subpart F general limitation earnings and profits under section 904(d)(1)(I). On

January 1, 1992, Corporation A has a deficit in

accumulated earnings and profits and a deficit in

post-1986 undistributed earnings of (200u). No

foreign taxes have been paid with respect to

post-1986 undistributed earnings. During 1992,

Corporation A earns 100u (net of foreign taxes),

pays $40 of foreign taxes on those earnings and

distributes 50u to Corporation M. As of the end of

1992, Corporation A has a deficit of (100u)

((200u) post-1986 undistributed earnings + 100u

current earnings and profits) in post-1986 undistributed earnings. Corporation A, however, has

current earnings and profits of 100u. Therefore,

the 50u distribution is treated as a dividend in its

entirety under section 316(a)(2). Under paragraph

(b)(4) of this section, Corporation M is not

deemed to have paid any of the foreign taxes paid

by Corporation A because post-1986 undistributed

earnings and the sum of current plus accumulated

earnings and profits are (100u). The dividend

reduces both post-1986 undistributed earnings and

accumulated earnings and profits. Therefore, as of

January 1, 1993, Corporation A’s post-1986 undistributed earnings are (150u) and its accumulated

earnings and profits are (150u). Corporation A’s

post-1986 foreign income taxes at the start of

1993 are $40.

each first-tier and lower-tier corporation—(i) Rule. If in a taxable year

dividends are received by a domestic

shareholder or an upper-tier corporation

from two or more first-tier corporations

or two or more lower-tier corporations,

the foreign income taxes deemed paid

by the domestic shareholder or the

upper-tier corporation under sections

902(a) and (b) and paragraph (b) of this

section shall be computed separately

with respect to the dividends received

from each first-tier corporation or lowertier corporation. If a domestic shareholder receives dividend distributions

from one or more first-tier corporations

and in the same taxable year the first-

tier corporation receives dividends from

one or more lower-tier corporations,

then the amount of foreign income taxes

deemed paid shall be computed by starting with the lowest-tier corporation and

working upward.

(ii) Example. The following example

illustrates the application of this paragraph (c)(1):

Example. P, a domestic corporation, owns 40

percent of the voting stock of foreign corporation

S. S owns 30 percent of the voting stock of

foreign corporation T, and 30 percent of the voting

stock of foreign corporation U. Neither S, T, nor

U is a controlled foreign corporation. P, S, T and

U all use the calendar year as their taxable year.

In 1993, T and U both pay dividends to S and S

pays a dividend to P. To compute foreign taxes

deemed paid, paragraph (c)(1) of this section

requires P to start with the lowest tier corporations

and to compute foreign taxes deemed paid separately for dividends from each first-tier and lowertier corporation. Thus, S first will compute foreign

taxes deemed paid separately on its dividends

from T and U. The deemed paid taxes will be

added to S’s post-1986 foreign income taxes, and

the dividends will be added to S’s post-1986

undistributed earnings. Next, P will compute foreign taxes deemed paid with respect to the

dividend from S. This computation will take into

account the taxes paid by T and U and deemed

paid by S.

(2) Section 78 gross-up—(i) Foreign

income taxes deemed paid by a domestic

shareholder. Except as provided in section 960(b) and the regulations under

that section (relating to amounts excluded from gross income under section

959(b)), any foreign income taxes

deemed paid by a domestic shareholder

in any taxable year under section 902(a)

and paragraph (b) of this section shall

be included in the gross income of the

domestic shareholder for the year as a

dividend under section 78. Amounts included in gross income under section 78

shall, for purposes of section 904, be

deemed to be derived from sources

within the United States to the extent

the earnings and profits on which the

taxes were paid are treated under section

904(g) as United States source earnings

and profits. Section 1.904–5(m)(6).

Amounts included in gross income under section 78 shall be treated for

purposes of section 904 as income in a

separate category to the extent that the

foreign income taxes were allocated and

apportioned to income in that separate

category. See section 904(d)(3)(G) and

§ 1.904–6(b)(3).

(ii) Foreign income taxes deemed

paid by an upper-tier corporation. Foreign income taxes deemed paid by an

upper-tier corporation on a distribution

from a lower-tier corporation are not

included in the earnings and profits of

the upper-tier corporation. For purposes

of section 904, foreign income taxes

shall be allocated and apportioned to

income in a separate category to the

extent those taxes were allocated to the

earnings and profits of the lower-tier

corporation in that separate category.

See section 904(d)(3)(G) and § 1.904–

6(b)(3). To the extent that section 904(g)

treats the earnings of the lower-tier

corporation on which those foreign income taxes were paid as United States

source earnings and profits, the foreign

income taxes deemed paid by the uppertier corporation on the distribution from

the lower-tier corporation shall be

treated as attributable to United States

source earnings and profits. See section

904(g) and § 1.904–5(m)(6).

(iii) Example. The following example

illustrates the rules of this paragraph

(c)(2):

Example. P, a domestic corporation, owns 100

percent of the voting stock of controlled foreign

corporation S. Corporations P and S use the

calendar year as their taxable year, and S uses the

u as its functional currency. Assume that 1u equals

$1 at all relevant times. As of January 1, 1992, S

has -0- post-1986 undistributed earnings and -0post-1986 foreign income taxes. In 1992, S earns

150u of non-subpart F general limitation income

net of foreign taxes and pays 60u of foreign

income taxes. As of the end of 1992, but before

dividend payments, S has 150u of post-1986

undistributed earnings and $60 of post-1986 foreign income taxes. Assume that 50u of S’s

earnings for 1992 are from United States sources.

S pays P a dividend of 75u which P receives in

1992. Under § 1.904–5(m)(4), one-third of the

dividend, or 25u (75u x 50u/150u), is United

States source income to P. P computes foreign

taxes deemed paid on the dividend under paragraph (b)(1) of this section of $30 ($60 x

50%[75u/150u]) and includes that amount in gross

income under section 78 as a dividend. Because

25u of the 75u dividend is United States source

income to P, $10 ($30 x 33.33%[25u/75u]) of the

section 78 dividend will be treated as United

States source income to P under this paragraph

(c)(2).

(3) Creditable foreign income taxes.

The amount of creditable foreign income taxes under section 901 shall

include, subject to the limitations and

conditions of sections 902 and 904,

foreign income taxes actually paid and

deemed paid by a domestic shareholder

that receives a dividend from a first-tier

corporation. Foreign income taxes

deemed paid by a domestic shareholder

under paragraph (b) of this section shall

be deemed paid by the domestic shareholder only for purposes of computing

the foreign tax credit allowed under

section 901.

(4) Foreign mineral income. Certain

foreign income, war profits and excess

profits taxes paid or accrued with re-

spect to foreign mineral income will not

be considered foreign income taxes for

purposes of section 902. See section

901(e) and § 1.901–3.

(5) Foreign taxes paid or accrued in

connection with the purchase or sale of

certain oil and gas. Certain income, war

profits, or excess profits taxes paid or

accrued to a foreign country in connection with the purchase and sale of oil or

gas extracted in that country will not be

considered foreign income taxes for purposes of section 902. See section 901(f).

(6) Foreign oil and gas extraction

income. For rules relating to reduction

of the amount of foreign income taxes

deemed paid with respect to foreign oil

and gas extraction income, see section

907(a) and the regulations under that

section.

(7) United States shareholders of

controlled foreign corporations. See

paragraph (d) of this section and sections 960 and 962 and the regulations

under those sections for special rules

relating to the application of section 902

in computing foreign income taxes

deemed paid by United States shareholders of controlled foreign corporations.

(8) Credit for foreign taxes deemed

paid in a section 304 transaction. [Reserved].

(9) Effect of section 482 adjustments

on post-1986 foreign income taxes and

post-1986 undistributed earnings. [Reserved].

(d) Dividends from controlled foreign

corporations— (1) General rule. Except

as provided in paragraph (d)(3) of this

section, if a dividend is received by a

domestic shareholder that is a United

States shareholder (as defined in section

951(b) or section 953(c)(1)(A)) from a

first-tier corporation that is a controlled

foreign corporation (as defined in section 957(a) or section 953(c)(1)(B)), or

by an upper-tier corporation from a

lower-tier corporation if the corporations

are related look-through entities within

the meaning of § 1.904–5(i), the following rule applies. If a dividend is paid

out of post-1986 undistributed earnings

or pre-1987 accumulated profits of the

upper- or lower-tier controlled foreign

corporation attributable to more than

one separate category under section

904(d), the amount of foreign income

taxes deemed paid by the domestic

shareholder or the upper-tier corporation

under section 902 and paragraph (b) of

this section shall be computed separately

with respect to the post-1986 undistributed earnings or pre-1987 accumulated

profits in each separate category out of

which the dividend is paid. See

§ 1.904–5(c)(4) and paragraph (d)(2) of

this section. The separately computed

deemed paid taxes shall be added to

other taxes paid by the U.S. shareholder

or upper-tier corporation with respect to

income in the appropriate separate category.

(2) Look-through—(i) Dividends. Except as otherwise provided in paragraph

(d)(3) of this section, any dividend distribution out of post-1986 undistributed

earnings of a look-through entity to a

related look-through entity shall be

deemed to be paid pro rata out of each

separate category of income. See

§§ 1.904–5(c)(4) and 1.904–7. The portion of the foreign income taxes attributable to a particular separate category

that shall be deemed paid by the domestic shareholder or upper-tier corporation

must be computed under the following

formula:

Post-1986

Foreign taxes

foreign indeemed paid

come taxes

by domestic

of first-tier

shareholder

or lower-tier

or upper-tier

corporation

= allocated

with respect

and apporto a separate

tioned to a

category unseparate

der section