Guidance Regarding the Transition Tax Under Section 965 and Related Provisions

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-104226-18]

RIN 1545-BO51

Guidance Regarding the Transition Tax Under Section 965 and Related Provisions

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

This document contains proposed regulations implementing section 965 of the Internal Revenue Code (“Code”) as amended by the Tax Cuts and Jobs Act, which was enacted on December 22, 2017. The proposed regulations would affect United States persons with direct or indirect ownership interests in certain foreign corporations.

DATES:

Written or electronic comments and requests for a public hearing must be received by October 9, 2018.

ADDRESSES:

Send submissions to: CC:PA:LPD:PR (REG-104226-18), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-104226-18), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC 20224, or sent electronically via the Federal eRulemaking Portal at

www.regulations.gov

(indicate IRS and REG-104226-18).

FOR FURTHER INFORMATION CONTACT:

Concerning the proposed regulations under §§ 1.962-1 and 1.962-2, 1.965-1 through 4, 1.965-7 through 9, and 1.986(c)-1, Leni C. Perkins at (202) 317-6934; concerning the proposed regulations under §§ 1.965-5 and 1.965-6, Karen J. Cate at (202) 317-6936; concerning submissions of comments and requests for a public hearing, Regina Johnson at (202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in this notice of proposed rulemaking have been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collections of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of information should be received by October 9, 2018.

Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the proper performance of the duties of the IRS, including whether the information will have practical utility;

The accuracy of the estimated burden associated with the proposed collection of information (including underlying assumptions and methodology);

How the quality, utility, and clarity of the information to be collected may be enhanced;

How the burden of complying with the proposed collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation, maintenance, and purchases of services to provide information.

The collections of information in these proposed regulations are in proposed §§ 1.965-2(d)(2)(ii)(B), 1.965-2(f)(2)(iii)(B), 1.965-3(b)(2), 1.965-3(c)(3), 1.965-4(b)(2)(i), 1.965-7(b)(2), 1.965-7(b)(3)(iii)(B), 1.965-7(c)(2), 1.965-7(c)(3)(iv)(B), 1.965-7(c)(3)(v)(D), 1.965-7(c)(6)(i), 1.965-7(d)(3), 1.965-7(e)(2), 1.965-7(f)(5), and 1.965-8(c). The information is required to be provided by taxpayers that make an election or rely on taxpayer-favorable rules. The information provided will be used by the IRS for tax compliance purposes.

Estimated total annual reporting burden:

500,000 hours.

Estimated average annual burden hours per respondent:

Five hours.

Estimated number of respondents:

100,000.

Estimated annual frequency of responses:

Once.

The number of respondents estimate is a rough estimate of the number of taxpayers completing the relevant parts of tax forms. The estimate of five hours per response is intended to capture the burden in gathering the required information for the election to determine the post-1986 earnings and profits and allocation of deficits and transfer agreements. In addition, the IRS intends that information collection requirements relating to the reporting and payment of tax under section 965 will be set forth in forms and instructions. For purposes of the Paperwork Reduction Act, the reporting burden associated with that collection of information will be reflected in the OMB Form 83-I, Paperwork Reduction Act Submission, associated with those forms.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection 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

I. In General

This document contains proposed amendments to 26 CFR part 1 under sections 962, 965, and 986 (the “proposed regulations”). As amended by section 14103 of the Tax Cuts and Jobs Act, Public Law 115-97 (2017) (the “Act”), section 965 applies in the case of the last taxable year of a deferred foreign income corporation (“DFIC”) that begins before January 1, 2018. The Department of the Treasury (“Treasury Department”) and the IRS have previously issued guidance announcing regulations intended to be issued under section 965.

See

Notice 2018-07, 2018-4 I.R.B. 317; Notice 2018-13, 2018-6 I.R.B. 341; and Notice 2018-26, 2018-16 I.R.B. 480 (collectively, the “notices”);

see also

Rev. Proc. 2018-17, 2018-9 I.R.B. 384. The proposed regulations contain the rules related to section 965 described in the notices, with certain modifications, as well as additional guidance related to section 965.

II. Section 965

A. Treatment of Accumulated Post-1986 Deferred Foreign Income as Subpart F Income

Section 965(a) provides that for the last taxable year of a DFIC (as defined in Part II.F of this Background section) that begins before January 1, 2018 (such year of the DFIC, the “inclusion year”), the subpart F income of the corporation (as otherwise determined for such taxable year under section 952) shall be increased by the greater of (i) the accumulated post-1986 deferred foreign income (as defined in Part II.F of this

Background section) of such corporation determined as of November 2, 2017, or (ii) the accumulated post-1986 deferred foreign income of such corporation determined as of December 31, 2017 (each such date, an “E&P measurement date”). The greater of those two amounts is the “section 965(a) earnings amount.”

B. Determination of United States Shareholder's Section 965(a) Inclusion

Section 965(b)(1) provides that, if a taxpayer is a United States shareholder with respect to at least one DFIC and at least one E&P deficit foreign corporation (as defined in Part II.C of this Background section), then the portion of the section 965(a) earnings amount which would otherwise be taken into account under section 951(a)(1) by a United States shareholder with respect to each DFIC is reduced by the amount of such United States shareholder's aggregate foreign E&P deficit (as defined in Part II.C of this Background section) that is allocated to such DFIC. The portion of the section 965(a) earnings amount that is taken into account under section 951(a)(1) by a United States shareholder, after the reduction described in the preceding sentence and, as applicable, the reduction described in Part II.D of this Background section, is referred to as the “section 965(a) inclusion amount.”

C. Allocation of Aggregate Foreign E&P Deficit and Definition of E&P Deficit Foreign Corporation

The aggregate foreign E&P deficit of any United States shareholder is allocated to each DFIC of the United States shareholder in an amount that bears the same proportion to such aggregate as (i) the United States shareholder's pro rata share of the section 965(a) earnings amount of the DFIC bears to (ii) the aggregate of the United States shareholder's pro rata shares of the section 965(a) earnings amounts of all DFICs of the United States shareholder. Section 965(b)(2). The term “aggregate foreign E&P deficit” means, with respect to any United States shareholder, the lesser of (A) the aggregate of the shareholder's pro rata shares of the specified E&P deficits of the E&P deficit foreign corporations of the shareholder or (B) the aggregate of the shareholder's pro rata shares of the section 965(a) earnings amounts of all DFICs of the shareholder. Section 965(b)(3)(A)(i).

The term “E&P deficit foreign corporation” means, with respect to any taxpayer, any specified foreign corporation (as defined in Part II.G of this Background section) with respect to which the taxpayer is a United States shareholder, if, as of November 2, 2017, (i) the specified foreign corporation had a deficit in post-1986 earnings and profits (as defined in Part II.F of this Background section), (ii) the corporation was a specified foreign corporation, and (iii) the taxpayer was a United States shareholder of the corporation. Section 965(b)(3)(B). The term “specified E&P deficit” means, with respect to an E&P deficit foreign corporation, the amount of the E&P deficit foreign corporation's deficit in post-1986 earnings and profits as of November 2, 2017.

See

section 965(b)(3)(C).

For purposes of applying section 959 in any taxable year beginning with the inclusion year, with respect to any United States shareholder of a DFIC, an amount equal to the reduction in the shareholder's pro rata share of the section 965(a) earnings amount of the DFIC by reason of the aggregate foreign E&P deficit allocated to such DFIC is treated as an amount which was included in the gross income of such United States shareholder under section 951(a). Section 965(b)(4)(A). With respect to any taxable year beginning with the inclusion year, a United States shareholder's pro rata share of the earnings and profits (“E&P”) of any E&P deficit foreign corporation is increased by the amount of the specified E&P deficit of the E&P deficit foreign corporation taken into account by the shareholder, and, for purposes of section 952, the increase is attributable to the same activity to which the deficit taken into account was attributable. Section 965(b)(4)(B).

D. Aggregate Unused E&P Deficit

Under section 965(b)(5), in the case of any affiliated group which includes at least one E&P net surplus shareholder and one E&P net deficit shareholder, the amount which would (but for section 965(b)(5)) be taken into account under section 951(a)(1) by reason of section 965(a) by each E&P net surplus shareholder is reduced (but not below zero) by such shareholder's applicable share of the affiliated group's aggregate unused E&P deficit.

The term “affiliated group” has the meaning provided in section 1504. The term “E&P net surplus shareholder” means any United States shareholder which would (but for section 965(b)(5)) take into account a section 965(a) inclusion amount greater than zero. Section 965(b)(5)(B). The term “E&P net deficit shareholder” means any United States shareholder if (i) the aggregate foreign E&P deficit with respect to such shareholder (as defined in section 965(b)(3)(A) without regard to clause (i)(II) thereof, which limits the aggregate foreign E&P deficit of a United States shareholder to the aggregate of the United States shareholder's pro rata share of the section 965(a) earnings amount of all DFICs of the United States shareholder) exceeds (ii) the amount that would (but for section 965(b)(5)) be taken into account by such shareholder under section 951(a)(1) by reason of section 965(a) (the excess, the “excess aggregate foreign E&P deficit”). Section 965(b)(5)(C). The term “applicable share” means, with respect to any E&P net surplus shareholder in any affiliated group, the amount which bears the same proportion to the group's aggregate unused E&P deficit as (i) the product of (A) the shareholder's group ownership percentage, multiplied by (B) the section 965(a) inclusion amount which would otherwise be taken into account by a United States shareholder, bears to (ii) the aggregate amount determined under clause (i) with respect to all E&P net surplus shareholders in the group. Section 965(b)(5)(E). The term “aggregate unused E&P deficit” means, with respect to any affiliated group, the lesser of (i) the sum of the excess aggregate foreign E&P deficits determined with respect to each E&P net deficit shareholder in such affiliated group, or (ii) with respect to all E&P net surplus shareholders in the group, the aggregate of the product of (A) the shareholder's group ownership percentage, multiplied by (B) the amount which would (but for section 965(b)(5)) be taken into account under section 951(a)(1) by reason of section 965(a) by the shareholder. Section 965(b)(5)(D).

E. Application of the Participation Exemption

Section 965(c)(1) provides that there shall be allowed as a deduction for the taxable year of a United States shareholder in which a section 965(a) inclusion amount is included in the gross income of the United States shareholder an amount equal to the sum of (i) the United States shareholder's 8 percent rate equivalent percentage (as defined in section 965(c)(2)(A)) of the excess (if any) of (A) the section 965(a) inclusion amount, over (B) the amount of such United States shareholder's aggregate foreign cash position, plus (ii) the United States shareholder's 15.5 percent rate equivalent percentage (as defined in section 965(c)(2)(B)) of so much of the United States shareholder's aggregate foreign cash position as does not exceed the section 965(a) inclusion amount. The amount of the deduction allowed under section 965(c) to a United States shareholder as described in the preceding sentence is referred to

as the “section 965(c) deduction amount.”

Section 965(c)(3)(A) provides that the term “aggregate foreign cash position” means, with respect to any United States shareholder, the greater of (i) the aggregate of the United States shareholder's pro rata share of the cash position of each specified foreign corporation of the United States shareholder determined as of the close of the last taxable year of the specified foreign corporation that begins before January 1, 2018, or (ii) one half of the sum of (A) the aggregate described in clause (i) determined as of the close of the last taxable year of each specified foreign corporation that ends before November 2, 2017, plus (B) the aggregate described in clause (i) determined as of the close of the taxable year of each specified foreign corporation which precedes the taxable year referred to in subclause (A). Each date referred to in the preceding sentence is referred to as a “cash measurement date.”

The cash position of any specified foreign corporation is the sum of (i) cash held by the corporation, (ii) the net accounts receivable of the corporation, and (iii) the fair market value of the following assets held by the corporation (each asset, a “cash-equivalent asset”): (A) Personal property which is of a type that is actively traded and for which there is an established financial market (“actively traded property”); (B) commercial paper, certificates of deposit, the securities of the Federal government and of any State or foreign government; (C) any foreign currency; (D) any obligation with a term of less than one year (“short-term obligation”); and (E) any asset which the Secretary identifies as being economically equivalent to any asset described in section 965(c)(3)(B). Section 965(c)(3)(B). Also, for purposes of section 965(c), the term “net accounts receivable” means, with respect to any specified foreign corporation, the excess (if any) of (i) the corporation's accounts receivable, over (ii) the corporation's accounts payable (determined consistent with the rules of section 461). Section 965(c)(3)(C).

Section 965(c)(3)(D) provides that net accounts receivable, actively traded property, and short-term obligations shall not be taken into account by a United States shareholder in determining its aggregate foreign cash position to the extent that the United States shareholder demonstrates to the satisfaction of the Secretary that the amount of the net accounts receivable, actively traded property, or short-term obligations is taken into account by the United States shareholder with respect to another specified foreign corporation.

Section 965(c)(3)(E) provides that an entity (other than a corporation) will be treated as a specified foreign corporation of a United States shareholder for purposes of determining the United States shareholder's aggregate foreign cash position if any interest in the entity is held by a specified foreign corporation of the United States shareholder (determined after application of the rule in this sentence) and the entity, if it were a foreign corporation, would be a specified foreign corporation of the United States shareholder.

Section 965(c)(3)(F) provides that if the Secretary determines that a principal purpose of any transaction was to reduce the aggregate foreign cash position taken into account under section 965(c), the transaction shall be disregarded for purposes of section 965(c).

F. Definition of DFIC and Accumulated Post-1986 Deferred Foreign Income

For purposes of section 965, a DFIC is, with respect to any United States shareholder, any specified foreign corporation of the United States shareholder that has accumulated post-1986 deferred foreign income greater than zero as of an E&P measurement date. Section 965(d)(1). The term “accumulated post-1986 deferred foreign income” means the post-1986 earnings and profits of the specified foreign corporation except to the extent such E&P (i) are attributable to income of the specified foreign corporation that is effectively connected with the conduct of a trade or business within the United States and subject to tax under chapter 1, or (ii) in the case of a controlled foreign corporation (“CFC”), if distributed, would be excluded from the gross income of a United States shareholder under section 959 (“previously taxed E&P”). Section 965(d)(2). Section 965(d)(3) provides that the term “post-1986 earnings and profits” means the E&P of the foreign corporation (computed in accordance with sections 964(a) and 986, and by taking into account only periods when the foreign corporation was a specified foreign corporation) accumulated in taxable years beginning after December 31, 1986, and determined (i) as of the E&P measurement date that is applicable with respect to such foreign corporation, and (ii) without diminution by reason of dividends distributed during the last taxable year of the foreign corporation that begins before January 1, 2018, other than dividends distributed to another specified foreign corporation.

G. Specified Foreign Corporations and United States Shareholders

Section 965(e)(1) provides that the term “specified foreign corporation” means (i) any CFC (regardless of whether there is a domestic corporate shareholder) and (ii) any foreign corporation with respect to which one or more domestic corporations is a United States shareholder (“10-percent corporation”). However, if a passive foreign investment company (as defined in section 1297) (“PFIC”) with respect to the shareholder is not a CFC, then such corporation is not a specified foreign corporation. Section 965(e)(3). An S corporation is treated as a partnership for purposes of sections 951 through 965.

See

section 1373(a). For purposes of sections 951 and 961, a 10-percent corporation is treated as a CFC solely for purposes of taking into account the subpart F income of such corporation under section 965(a) (and for purposes of determining a United States shareholder's pro rata share of any amount with respect to a specified foreign corporation under section 965(f)). Section 965(e)(2).

For taxable years of foreign corporations beginning before January 1, 2018, under section 951(b), a United States shareholder is a United States person (within the meaning of section 957(c)) that owns within the meaning of section 958(a), or is considered as owning by applying the rules of ownership of section 958(b), 10 percent or more of the total combined voting power of all classes of stock entitled to vote of the stock of a foreign corporation. Under section 957(c), a United States person generally has the meaning assigned to it by section 7701(a)(30), which includes a domestic partnership or domestic trust.

But see

Notice 2010-41, 2010-22 I.R.B. 715 (announcing that the Treasury Department and the IRS intend to issue regulations treating certain domestic partnerships as foreign partnerships for purposes of identifying which United States shareholders are required to include amounts in gross income under section 951(a)). Special rules under section 957(c) and § 1.957-3 apply in determining when individuals residing in certain possessions or territories of the United States are considered United States persons for purposes of sections 951 and 965.

H. Determination of Pro Rata Share

Section 965(f)(1) provides that the determination of any United States shareholder's pro rata share of any

amount with respect to any specified foreign corporation shall be determined under rules similar to the rules of section 951(a)(2) by treating the amount in the same manner as subpart F income (and by treating the specified foreign corporation as a CFC).

I. Special Rules for Domestic Pass-Through Entities

Section 965(f)(2) provides that the portion that is included in the income of a United States shareholder under section 951(a)(1) by reason of section 965(a) that is equal to the section 965(c) deduction amount by reason of the inclusion is treated as income exempt from tax for purposes of sections 705(a)(1)(B) and 1367(a)(1)(A) but not treated as income exempt from tax for purposes of determining whether an adjustment is made to an accumulated adjustments account (“AAA”) of an S corporation under section 1368(e)(1)(A).

J. Foreign Tax Credit and Deduction

Section 965(g)(1) provides that no credit is allowed under section 901 for the applicable percentage of any taxes paid or accrued (or treated as paid or accrued) with respect to any amount for which a section 965(c) deduction is allowed.

The term “applicable percentage” means the amount (expressed as a percentage) equal to the sum of the following two amounts:

(i) 0.771 multiplied by the ratio of (A) the section 965(a) inclusion amount in excess of the United States shareholder's aggregate foreign cash position divided by (B) the section 965(a) inclusion amount, and

(ii) 0.557 multiplied by the ratio of (A) the amount of the section 965(a) inclusion amount equal to the United States shareholder's aggregate cash position, divided by (B) the section 965(a) inclusion amount.

Further, no deduction is allowed for any tax for which credit is not allowable under section 901 by reason of section 965(g)(1) (determined by treating the taxpayer as having elected the benefits of subpart A of part III of subchapter N).

With respect to the taxes treated as paid or accrued by a domestic corporation with respect to the section 965(a) inclusion amount, section 78 applies only to so much of such taxes as bears the same proportion to the amount of the taxes as (i) the excess of (A) the section 965(a) inclusion amount, over (B) the section 965(c) deduction amount with respect to such amount, bears to (ii) the section 965(a) inclusion amount.

K. Election Under Section 965(h) Concerning Payment of Net Tax Liability Under Section 965

Section 965(h)(1) provides that in the case of a United States shareholder of a DFIC, the United States shareholder may elect to pay the net tax liability under section 965 in eight installments. Section 965(h)(6) defines the net tax liability under section 965 with respect to any United States shareholder as the excess (if any) of (i) the taxpayer's net income tax for the taxable year in which an amount is included in the gross income of the United States shareholder under section 951(a)(1) by reason of section 965, over (ii) the taxpayer's net income tax for such taxable year determined (A) without regard to section 965, and (B) without regard to any income or deduction properly attributable to a dividend received by the United States shareholder from any DFIC. For this purpose, the term “net income tax” means the regular tax liability reduced by the credits allowed under subparts A, B, and D of part IV of subchapter A. Section 965(h)(6)(B).

Section 965(h)(2) provides that if a taxpayer makes an election under section 965(h), the first installment is due on the due date (without regard to extensions) for the return of tax for the inclusion year. Each successive installment is due on the due date (without regard to extensions) for the return of tax for the taxable year following the taxable year for which the previous installment payment was made.

Section 965(h)(3) provides that if there is an addition to tax for failure to timely pay an installment required under section 965(h), a liquidation or sale of substantially all the assets of the taxpayer (including in a title 11 or similar case), a cessation of business by the taxpayer, or any similar circumstance, the unpaid portion of the remaining installments will be due on the date of such event (or in the case of a title 11 or similar case, the day before the petition is filed). The preceding sentence does not apply in the case of the sale of substantially all the assets of a taxpayer to a buyer if the buyer enters into an agreement with the Secretary under which the buyer is liable for the remaining installments due under section 965(h) in the same manner as if the buyer were the taxpayer.

Section 965(h)(4) provides that if a taxpayer has made an election under section 965(h), and subsequently, a deficiency is assessed with respect to the taxpayer's net tax liability for purposes of section 965(h), then the amount of the deficiency will be prorated among the installments. The part of the deficiency prorated to any installment the date for payment of which has not arrived will be collected at the same time as, and as part of, such installment. The part of the deficiency prorated to any installment the date for payment of which has arrived must be paid upon notice and demand from the Secretary. However, the proration rule does not apply if the deficiency is due to negligence, intentional disregard of rules and regulations, or fraud with intent to evade tax.

L. Election Under Section 965(i) Concerning Payment of Net Tax Liability Under Section 965 by an S Corporation Shareholder and Related Reporting Requirements

Section 965(i)(1) provides that in the case of any S corporation that is a United States shareholder of a DFIC, each shareholder of the S corporation may elect to defer payment of the shareholder's net tax liability under section 965 with respect to the S corporation until the shareholder's taxable year which includes the triggering event with respect to such liability.

Under section 965(i)(1), any net tax liability, payment of which is deferred under section 965(i)(1), will be assessed on the return of tax as an addition to tax for the shareholder's taxable year which includes the triggering event with respect to such liability. As defined in section 965(i)(2), in the case of any shareholder's net tax liability under section 965 with respect to any S corporation, the triggering event with respect to such liability is whichever of the following occurs first: (i) The corporation ceases to be an S corporation (determined as of the first day of the first taxable year that the corporation is not an S corporation); (ii) a liquidation or sale of substantially all the assets of the S corporation (including in a title 11 or similar case), a cessation of business by the S corporation, the S corporation ceases to exist, or any similar circumstance; or (iii) a transfer of any share of stock in the S corporation by the taxpayer (including by reason of death, or otherwise). In the case of a transfer of less than all of the taxpayer's shares of stock in the S corporation, the transfer is only a triggering event with respect to the portion of the taxpayer's net tax liability under section 965 with respect to the S corporation as is properly allocable to the transferred stock. Section 965(i)(2)(B). Moreover, a transfer of stock in the S corporation is not a triggering event if the transferee enters into an agreement with the

Secretary under which the transferee is liable for the net tax liability under section 965 with respect to the stock in the same manner as if such transferee were the taxpayer. Section 965(i)(2)(C).

If a triggering event occurs, section 965(i)(4) permits a taxpayer to make an election under section 965(h) with respect to the liability to which the section 965(i) election applied by the due date for the return of tax for the taxable year in which the triggering event occurred, and the first installment under section 965(h) must also be paid by the due date (without regard to extensions) for the return for the taxable year of the triggering event. However, the election may only be made with the consent of the Secretary in the case of a triggering event that is a liquidation or sale of substantially all of the assets of the S corporation.

See

section 965(i)(4)(D).

Section 965(i)(3) defines a shareholder's net tax liability under section 965 with respect to any S corporation as the net tax liability under section 965 which would be determined under section 965(h)(6) if the only amounts taken into account by the shareholder under section 951(a)(1) by reason of section 965 were allocations from the S corporation.

Section 965(i)(5) provides that if any shareholder of an S corporation makes an election under section 965(i) to defer payment of its net tax liability under section 965 with respect to an S corporation, the S corporation is jointly and severally liable for the deferred payment and any penalty, addition to tax, or additional amount attributable thereto.

Section 965(i)(6) provides that any limitation on the time period for the collection of a liability deferred under section 965(i) is not treated as beginning before the date of the triggering event with respect to such liability.

Section 965(i)(7) requires any shareholder of an S corporation that makes an election under section 965(i) to report the amount of the shareholder's deferred net tax liability on the shareholder's return of tax for the taxable year for which the election is made and on the return of tax for each taxable year thereafter until the amount has been fully assessed. “Deferred net tax liability” means the amount of net tax liability under section 965 payment of which has been deferred under section 965(i) and which has not been assessed on a return of tax for any prior taxable year. Section 965(i)(7)(B). In the case of any failure to report any amount required to be reported pursuant to section 965(i)(7) with respect to any taxable year before the due date for the return of tax for the taxable year, there will be assessed on the return as an addition to tax 5 percent of such amount. Section 965(i)(7)(C).

M. Election Under Section 965(m) Concerning Inclusions of Amounts Under Section 965 and Related Provisions

Under section 965(m)(1)(B), a real estate investment trust (REIT) that is a United States shareholder of a DFIC may elect, in lieu of including any amount required to be taken into account under section 951(a)(1) by reason of section 965 in the taxable year in which it would otherwise be included in gross income (for purposes of the computation of REIT taxable income under section 857(b)), to include such amount in gross income in eight installments.

If this election is made, the REIT's aggregate section 965(c) deduction must be determined without regard to the election and allocated to each taxable year for which an installment is included in the same proportion as the amount of the installment included in gross income.

See

section 965(m)(2)(B)(i)(II). Furthermore, the REIT may not make a section 965(h) election for any taxable year for which an installment is included.

See

section 965(m)(2)(B)(i)(III). Under section 965(m)(2)(B)(ii), if there is a liquidation or sale of substantially all the assets of the REIT (including in a title 11 or similar case), a cessation of business by the trust, or any similar circumstance, then any amount not yet included in gross income will be included in gross income as of the day before the date of the event, and the unpaid portion of any tax liability with respect to the inclusion will be due on the date of the event (or in the case of a title 11 or similar case, the day before the petition is filed).

Section 965(m)(1)(A) provides that any amount required to be taken into account under section 951(a)(1) by reason of section 965 by a REIT that is a United States shareholder of a DFIC is not taken into account as gross income of the REIT for purposes of applying paragraphs (2) and (3) of section 856(c) to any taxable year for which the amount is taken into account under section 951(a)(1).

N. Election Under Section 965(n) Not To Apply Net Operating Loss Deduction

Under section 965(n)(1), a United States shareholder of a DFIC may make an election pursuant to which the amount described in section 965(n)(2) shall not be taken into account (i) in determining the amount of the shareholder's net operating loss (“NOL”) deduction under section 172 for the taxable year, or (ii) in determining the amount of taxable income for the taxable year which may be reduced by NOL carryovers or carrybacks to the taxable year under section 172. The amount described in section 965(n)(2) is the sum of (i) the amount required to be taken into account under section 951(a)(1) by reason of section 965 (determined after the application of section 965(c)), plus (ii) in the case of a domestic corporation which chooses to have the benefits of subpart A of part III of subchapter N for the taxable year, the taxes deemed to be paid by the corporation under subsections (a) and (b) of section 960 for the taxable year with respect to the amount described in section 965(n)(2)(A) which are treated as a dividend under section 78.

O. Recapture for Expatriated Entities

Section 965(l) provides that if a section 965(c) deduction is allowed to a United States shareholder and the shareholder first becomes an expatriated entity (as defined under section 7874(a)(2), except not including an entity if the surrogate foreign corporation with respect to it is treated as a domestic corporation under section 7874(b)) at any time during the 10-year period beginning on the date of the enactment of the Act (with respect to a surrogate foreign corporation (as defined under section 7874(a)(2)(B)) that first becomes a surrogate foreign corporation during such period), the tax imposed under chapter 1 will be increased for the first taxable year in which such taxpayer becomes an expatriated entity by an amount equal to 35 percent of the amount of the section 965(c) deduction, and no credits will be allowed against such increase in tax.

P. Regulations or Other Guidance

Section 965(o) provides that the Secretary shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of section 965, including regulations or other guidance to provide appropriate basis adjustments and regulations or other guidance to prevent the avoidance of the purposes of section 965, including through a reduction in E&P, changes in entity classification or accounting methods, or otherwise.

III. Other Provisions

A. Section 962

As amended by the Act, section 962 provides that an individual who is a United States shareholder may elect to

have the tax imposed under chapter 1 on amounts that are included in the individual's gross income under section 951(a) be an amount equal to the tax that would be imposed under section 11 if the amounts were received by a domestic corporation. In addition, if an election is made under section 962, the amounts included in the individual's gross income under section 951(a) are treated as if they were received by a domestic corporation for purposes of applying section 960 (relating to foreign tax credits).

See

§ 1.962-1(a). However, the taxable income determined for purposes of applying section 11 is not reduced by any deduction of the United States shareholder.

See

§ 1.962-1(b)(1)(i). An election under section 962 does not affect tax imposed under other chapters, including under chapter 2A.

B. Attribution Rules in Sections 958(b) and 318(a)

Section 958 provides rules for determining direct, indirect, and constructive stock ownership. Under section 958(a)(1), stock is considered owned by a person if it is owned directly or is owned indirectly through certain foreign entities under section 958(a)(2). Under section 958(b), section 318 applies, with certain modifications, to the extent that the effect is to treat any United States person as a United States shareholder within the meaning of section 951(b), to treat a person as a related person within the meaning of section 954(d)(3), to treat the stock of a domestic corporation as owned by a United States shareholder of a CFC for purposes of section 956(c)(2), or to treat a foreign corporation as a CFC under section 957.

Section 318 provides rules that attribute the ownership of stock to certain family members, between certain entities and their owners, and to holders of options to acquire stock. Section 318(a)(1) provides rules attributing stock ownership among members of a family. Section 318(a)(2) provides rules attributing stock ownership “upward” from partnerships, estates, trusts, and corporations to partners, beneficiaries, owners, and shareholders. In addition, section 318(a)(3) provides specific rules that attribute the ownership of stock “downward” from partners, beneficiaries, owners, and shareholders to partnerships, estates, trusts, and corporations. In particular, section 318(a)(3)(A) provides that stock owned, directly or indirectly, by or for a partner in a partnership or a beneficiary of an estate is considered as owned by the partnership or estate. This provision applies to all partners and beneficiaries without regard to the size of their interest in the partnership or estate. Section 318(a)(3)(B) similarly provides, subject to certain exceptions, that stock owned, directly or indirectly, by or for a beneficiary of a trust (or a person who is considered an owner of a trust) is considered owned by the trust. In comparison, section 318(a)(3)(C) provides that stock owned, directly or indirectly, by or for a shareholder in a corporation is considered owned by the corporation only if 50 percent or more in value of the stock in the corporation is owned, directly or indirectly, by such person.

Effective for the last taxable year of foreign corporations beginning before January 1, 2018, and each subsequent year of the foreign corporations, and for the taxable years of United States shareholders in which or with which such taxable years of the foreign corporations end, the Act repeals section 958(b)(4). As in effect before repeal, section 958(b)(4) provided that subparagraphs (A), (B), and (C) of section 318(a)(3) (providing for “downward” attribution) were not to be applied so as to consider a United States person as owning stock that is owned by a person who is not a United States person.

C. Miscellaneous Itemized Deductions

Under section 67(a), miscellaneous itemized deductions are allowed only to the extent that the aggregate of such deductions exceeds 2 percent of adjusted gross income. As amended by the Act, section 67(g) provides that for taxable years beginning after December 31, 2017, and before January 1, 2026, no miscellaneous itemized deductions are allowable under section 67(a). In addition, under section 56(b)(1)(A)(i), an individual subject to the alternative minimum tax in 2017 is not allowed a deduction for any miscellaneous itemized deduction. Under section 63(d), itemized deductions generally mean all allowable deductions except for the deductions allowable in arriving at adjusted gross income pursuant to section 62(a), the deduction provided by section 151, and the deduction provided in section 199A (added by the Act). Miscellaneous itemized deductions include all itemized deductions other than those listed in section 67(b), which does not reference the section 965(c) deduction.

D. Section 4940

An inclusion under section 951(a)(1), including a section 965(a) inclusion, generally is included in the calculation of gross investment income of a private foundation for purposes of determining the excise tax imposed under section 4940 (generally 2 percent of net investment income). Gross investment income under section 4940 does not include an inclusion under section 951(a)(1), including a section 965(a) inclusion, to the extent the amount is included in computing the unrelated business income tax imposed by section 511.

See

section 4940(c)(2). Section 4940(c)(3) allows as a deduction all the ordinary and necessary expenses paid or incurred for the production or collection of gross investment income or for the management, conservation, or maintenance of property held for the production of income.

E. Extensions of Time for Filing Income Tax Returns and Paying Tax for Certain Citizens and Residents Abroad

In relevant part, regulations under section 6081 provide an extension of time to the fifteenth day of the sixth month following the close of the taxable year for filing returns of income taxes and for paying any tax shown on the return for United States citizens or residents whose tax homes and abodes, in a real and substantial sense, are outside the United States and Puerto Rico, and United States citizens and residents in military or naval service on duty, including non-permanent or short term duty, outside the United States and Puerto Rico (“specified individuals”).

See

§ 1.6081-5(a)(5) and (6).

Explanation of Provisions

I. Overview of Proposed Regulations

Proposed § 1.965-1 provides general rules and definitions under section 965. Proposed § 1.965-2 provides rules relating to adjustments to E&P and basis to determine and account for the application of section 965 and a rule that limits the amount of gain recognized in connection with the application of section 961(b)(2). Proposed § 1.965-3 provides rules regarding the determination of section 965(c) deductions. Proposed § 1.965-4 sets forth rules that disregard certain transactions for purposes of section 965. Proposed §§ 1.965-5 and 1.965-6 provide rules with respect to foreign tax credits. Proposed § 1.965-7 provides rules regarding elections and payments. Proposed § 1.965-8 provides rules regarding affiliated groups, including consolidated groups. Proposed § 1.965-9 provides dates of applicability. Proposed §§ 1.962-1 and 1.962-2 provide rules relating to section 962 elections. Proposed § 1.986(c)-1 provides rules regarding the application of section 986(c) in connection with section 965.

II. Definitions and General Rules

Section 1.965-1 of the proposed regulations provides general rules and definitions under section 965, including general rules concerning section 965(a) inclusions, general rules concerning section 965(c) deductions, and rules concerning the treatment of certain specified foreign corporations as CFCs and certain controlled domestic partnerships as foreign partnerships.

A. General Rules

Proposed § 1.965-1 provides the general rules contained in section 965(a), (b), and (c). Proposed § 1.965-1(b)(1) provides that the subpart F income of a DFIC for its inclusion year is increased by the section 965(a) earnings amount. Proposed § 1.965-1(b)(2) provides that the pro rata share of the DFIC's section 965(a) earnings amount of a United States shareholder that owns, within the meaning of section 958(a), stock (the stock, “section 958(a) stock”, and the shareholder, a “section 958(a) U.S. shareholder”) is reduced by the DFIC's allocable share of the section 958(a) U.S. shareholder's aggregate foreign E&P deficit. If a section 958(a) U.S. shareholder is a member of a consolidated group, all section 958(a) U.S. shareholders that are members of a consolidated group are treated as a single section 958(a) U.S. shareholder for this purpose.

See

Part IX of this Explanation of Provisions section for a discussion of additional rules that apply with respect to a section 958(a) U.S. shareholder that is a member of an affiliated group of which not all members are part of a consolidated group. The amount determined after the reductions referenced in the preceding sentences is defined as the section 965(a) inclusion amount, which is the amount included by a section 958(a) U.S. shareholder of a DFIC for its taxable year in which or with which the DFIC's inclusion year ends (the “section 958(a) U.S. shareholder inclusion year”).

See

proposed § 1.965-1(b)(1);

see also

Part II.B of the Background section of this preamble. The proposed regulations also clarify that because an increase in subpart F income by reason of section 965(a) is generally determined after the subpart F income is otherwise determined under section 952 for the taxable year, neither the section 965(a) earnings amount nor the section 965(a) inclusion amount is subject to the rules or limitations in section 952 or otherwise limited by the accumulated E&P of the DFIC.

Id.

Proposed § 1.965-1(c) provides that a section 958(a) U.S. shareholder is generally allowed a deduction for a section 965(c) deduction amount for a section 958(a) U.S. shareholder inclusion year. The proposed regulations clarify that a section 958(a) U.S. shareholder's aggregate foreign cash position is applied against the aggregate section 965(a) inclusion amounts for a section 958(a) U.S. shareholder inclusion year.

See

proposed § 1.965-1(f)(1)-(4), (8), (42). In the case of a section 958(a) U.S. shareholder with more than one section 958(a) U.S. shareholder inclusion year, its aggregate foreign cash position is allocated to each year under proposed § 1.965-3(c)(2), and therefore the section 965(c) deduction amount is determined separately for each section 958(a) U.S. shareholder inclusion year.

Consistent with section 965(e)(2), proposed § 1.965-1(d) provides that a 10-percent corporation is treated as a CFC for purposes of sections 951 and 961, as well as for purposes of § 1.1411-10, so that those rules, applicable to CFCs, are also applicable to DFICs that are not CFCs.

Moreover, the proposed regulations provide that for purposes of identifying section 958(a) U.S. shareholders of specified foreign corporations and the section 958(a) stock of such specified foreign corporations owned by section 958(a) U.S. shareholders, a domestic partnership is treated as a foreign partnership if certain conditions are satisfied.

See

proposed § 1.965-1(e)(1). This is an expansion on the reference in section 2.13 of Notice 2018-26 to Notice 2010-41, which referred to CFCs, whereas the expanded rule includes specified foreign corporations generally.

B. Definitions

Section 1.965-1(f) of the proposed regulations sets forth definitions for terms that apply for all of the proposed regulations under section 965. Except as otherwise described in this Explanation of Provisions section, the definitions set forth in the proposed regulations that are also used in section 965 or one of the notices have the meaning described therein. This Part II.B of the Explanation of Provisions section also describes rules incorporated into certain defined terms that are not described elsewhere in this Explanation of Provisions section.

1. Specified Foreign Corporation

The proposed regulations provide that a specified foreign corporation means any CFC or 10-percent corporation, other than a foreign corporation that is a PFIC with respect to a shareholder and not a CFC.

See

proposed § 1.965-1(f)(45)(i) and (iii).

Section 3.01 of Notice 2018-26 noted that as a result of the application of the constructive ownership rule in section 318(a)(3)(A) (providing for “downward” attribution of stock from a partner to a partnership), it may be difficult to determine if a foreign corporation is a specified foreign corporation under certain circumstances. Consistent with that section of the notice, the definition of specified foreign corporation provides that, solely for purposes of determining whether a foreign corporation is a specified foreign corporation within the meaning of section 965(e)(1)(B), stock owned, directly or indirectly, by or for a partner (“tested partner”) will not be considered as being owned by a partnership under sections 958(b) and 318(a)(3)(A) if the tested partner owns less than five percent of the interests in the partnership's capital and profits.

See

proposed § 1.965-1(f)(45)(ii). For purposes of the preceding sentence, an interest in the partnership owned by another partner will be considered as being owned by the tested partner under the principles of sections 958(b) and 318, as modified pursuant to the preceding sentence, as if the interest in the partnership were stock.

2. Post-1986 Earnings and Profits

Section 3.02(b) of Notice 2018-07 indicated that the reduction of post-1986 earnings and profits of a specified foreign corporation to reflect dividends distributed during the corporation's inclusion year to another specified foreign corporation (the “dividend reduction rule”) is intended to address the potential double-counting of the E&P of the distributing specified foreign corporation in calculating the section 965(a) inclusion amounts of a United States shareholder with respect to the distributing specified foreign corporation and the distributee specified foreign corporation. It noted, however, that to the extent that a portion of a distribution reduces the post-1986 earnings and profits of a distributing specified foreign corporation (for example, by reason of a reduction pursuant to section 312(a)(3)) in an amount in excess of the increase in the post-1986 earnings and profits of the distributee specified foreign corporation, the reduction would not relieve double-counting and thus would be inconsistent with the purpose of the rule.

Accordingly, consistent with section 3.02(b) of Notice 2018-07, the definition of “post-1986 earnings and profits” clarifies, in proposed § 1.965-1(f)(29)(i)(B), that the amount by which the post-1986 earnings and profits of a

specified foreign corporation is reduced under section 965(d)(3)(B) as a result of a distribution made to a specified foreign corporation in the last taxable year of the foreign corporation that begins before January 1, 2018, may not exceed the amount by which the post-1986 earnings and profits of the distributee corporation is increased as a result of the distribution. Additionally, similar to section 3.03 of Notice 2018-26, in computing post-1986 earnings and profits on November 2, 2017, in certain cases, a reduction is allowed for a portion of foreign income taxes that accrue after November 2, 2017, and on or before December 31, 2017 (“applicable taxes”). In particular, post-1986 earnings and profits on November 2, 2017, are reduced by the portion of the applicable taxes that are attributable to the portion of the taxable income (as determined under foreign law) that accrues on or before November 2, 2017, and during the specified foreign corporation's U.S. taxable year that includes November 2, 2017.

See

proposed § 1.965-1(f)(29)(ii).

Moreover, consistent with the Conference Report accompanying the Act (the “Conference Report”) and section 3.03(b) of Notice 2018-13, proposed § 1.965-1(f)(29)(iii) provides that all deficits related to post-1986 earnings and profits, including hovering deficits, are taken into account for purposes of determining the post-1986 earnings and profits (including a deficit) of a specified foreign corporation.

See

H.R. Rep. No. 115-466, at 619 (2017) (Conf. Rep.). The fact that hovering deficits are taken into account for purposes of determining post-1986 earnings and profits, and ultimately the section 965(a) inclusion amount of a section 958(a) U.S. shareholder, does not mean that hovering deficits are taken into account for any other purpose. For example, this rule does not result in hovering deficits being taken into account for purposes of determining post-1986 undistributed earnings or pre-1987 accumulated profits in computing the taxes deemed paid for the foreign tax credit. The Treasury Department and the IRS request comments on whether additional rules are needed to address the treatment of hovering deficits that reduce post-1986 earnings and profits of a DFIC, for example when the hovering deficit creates a specified E&P deficit.

Comments noted that a specified foreign corporation that is not a CFC does not generally track E&P under U.S. tax principles and requested that taxpayers be allowed to use an alternative measurement method for determining its post-1986 earnings and profits and cash position, such as audited financial statements. This comment is not adopted in the proposed regulations. Generally, audited financial statements may serve as a starting point in the determination of a specified foreign corporation's E&P.

See

§ 1.964-1. The Treasury Department and the IRS appreciate that obtaining accurate information for U.S. federal income tax purposes may present administrative challenges, particularly in the case of United States shareholders that do not have a majority interest in a specified foreign corporation. However, this challenge is not unique to this context; there are numerous longstanding provisions in the Code where minority shareholders of foreign corporations must determine E&P consistent with section 312 where no alternative measurement method is provided. For example, United States persons who own stock in PFICs must, if they make an election to treat the PFIC as a qualified electing fund under section 1293, determine the E&P of the PFIC in accordance with principles of section 312.

See

section 1293(e)(3). Additionally, minority shareholders who are nonetheless United States shareholders of CFCs must know the E&P of the CFC in order to apply the rules under subpart F. Accordingly, the Treasury Department and the IRS have determined that it would not be appropriate for the proposed regulations to provide alternative methods for determining a corporation's E&P or cash position.

3. E&P Deficit Foreign Corporation

Consistent with section 3.01 of Notice 2018-13, under the proposed regulations, for purposes of determining the status of a specified foreign corporation as a DFIC or an E&P deficit foreign corporation, it must first be determined whether the specified foreign corporation is a DFIC. Proposed § 1.965-1(f)(17)(ii) provides that, if a specified foreign corporation meets the definition of a DFIC, it is classified solely as a DFIC and not also as an E&P deficit foreign corporation, even if the specified foreign corporation otherwise satisfies the requirements of section 965(b)(3)(B) and proposed § 1.965-1(f)(22). If a specified foreign corporation does not meet the definition of a DFIC, it then must be determined whether it is an E&P deficit foreign corporation. In some cases, a specified foreign corporation may be classified as neither a DFIC nor an E&P deficit foreign corporation, despite having post-1986 earnings and profits greater than zero or a deficit in accumulated post-1986 deferred foreign income.

See

proposed § 1.965-1(g),

Example 5.

Comments requested that previously taxed E&P should be disregarded in determining a specified E&P deficit of an E&P deficit foreign corporation. Section 965(b)(3)(B) provides that a specified foreign corporation is an E&P deficit foreign corporation if it has a deficit in post-1986 earnings and profits as of November 2, 2017. For purposes of section 965, the term post-1986 earnings and profits is defined in section 965(d)(3) and is computed in accordance with sections 964(a) and 986. Under section 964(a), earnings and profits are determined according to rules substantially similar to those applicable to domestic corporations.

Previously taxed E&P are a type of E&P.

See

section 959(c). No express exclusion of previously taxed E&P is provided in section 965(d)(3) for purposes of determining post-1986 earnings and profits. In contrast, the term accumulated post-1986 deferred foreign income, as defined in section 965(d)(2), explicitly excludes previously taxed E&P.

See

section 965(d)(2)(B) (citing section 959). Accordingly, the proposed regulations provide that previously taxed E&P is not excluded in determining the existence and amount of a specified E&P deficit, which is defined in reference to post-1986 earnings and profits and not in reference to accumulated post-1986 deferred foreign income. The Treasury Department and the IRS are considering other rules with respect to the definitions of post-1986 earnings and profits, accumulated post-1986 deferred foreign income, and specified E&P deficit in connection with the finalization of these proposed regulations.

See

section 965(o). The Treasury Department and the IRS welcome comments on this subject.

4. Accumulated Post-1986 Deferred Foreign Income

Consistent with section 3.02(c) of Notice 2018-07, proposed § 1.965-1(f)(7)(i)(C) provides that in the case of a CFC that has shareholders that are not United States shareholders on an E&P measurement date, the accumulated post-1986 deferred foreign income of the CFC on such E&P measurement date is reduced by amounts that would be described in section 965(d)(2)(B) if those shareholders were United States shareholders. In such cases, the principles of Revenue Ruling 82-16, 1982-1 C.B. 106, apply in order to determine the amounts by which accumulated post-1986 deferred foreign income is reduced.

Proposed § 1.965-1(f)(7)(ii) clarifies that, for purposes of determining the accumulated post-1986 deferred foreign income of a specified foreign corporation as of an E&P measurement date, the E&P of the specified foreign corporation that are described in section 959(c)(2) (or that would be described in section 959(c)(2) applying the principles of Revenue Ruling 82-16, 1982-1 C.B. 106) by reason of subpart F income are treated as described in section 965(d)(2)(B) and proposed § 1.965-1(f)(7)(i)(B) or (f)(7)(i)(C) only to the extent that such income is accrued by the specified foreign corporation as of such E&P measurement date. For rules regarding the interaction of sections 951, 956, 959, and 965 generally, see Part IV.A of this Explanation of Provisions section.

5. Cash Measurement Dates

Consistent with section 3.02 of Notice 2018-26, the definitions of the cash measurement dates, and of pro rata share, provide the following:

(i) The final cash measurement date of a specified foreign corporation is the close of the last taxable year of the specified foreign corporation that begins before January 1, 2018, and ends on or after November 2, 2017, if any;

(ii) The second cash measurement date of a specified foreign corporation is the close of the last taxable year of the specified foreign corporation that ends after November 1, 2016, and before November 2, 2017, if any;

(iii) The first cash measurement date of a specified foreign corporation is the close of the last taxable year of the specified foreign corporation that ends after November 1, 2015, and before November 2, 2016, if any; and

(iv) A United States shareholder takes into account its pro rata share of the cash position of a specified foreign corporation as of any cash measurement date of the specified foreign corporation on which the United States shareholder is a United States shareholder of the specified foreign corporation, regardless of whether the United States shareholder is a United States shareholder of the specified foreign corporation as of any other cash measurement date, including the final cash measurement date of the specified foreign corporation.

See

proposed § 1.965-1(f)(24), (31), (25), and (30)(iii), respectively. Section 3.02 of Notice 2018-26 also announced that for purposes of applying the rules contained therein, a 52-53-week taxable year is deemed to begin on the first day of the calendar month nearest to the first day of the 52-53-week taxable year and is deemed to end or close on the last day of the calendar month nearest to the last day of the 52-53-week taxable year, as the case may be.

See

§ 1.441-2(c). The Treasury Department and the IRS have determined that the rules contained in § 1.441-2(c), which relate to the application of effective dates, are not relevant in determining when a 52-53-week taxable year is considered to begin or end for purposes of the cash measurement dates; instead, the actual dates on which such a year begins and ends should be taken into account in determining cash measurement dates. Therefore, the proposed regulations do not contain the rule in section 3.02 of Notice 2018-26 referring to § 1.441-2(c).

Comments requested guidance on the measurement of cash when a section 381 transaction occurs during the last year of a specified foreign corporation that begins before January 1, 2018. The Treasury Department and the IRS have defined cash measurement date in the notices and largely adopted the definition in the proposed regulations. The Treasury Department and the IRS have determined that these rules provide appropriate guidance, and therefore additional rules are not necessary. See also Part V.A.2 of this Explanation of Provisions section, for a discussion of the rules for disregarding certain assets to prevent double-counting under section 965(c)(3)(D), and Part VI.A of this Explanation of Provisions section, for a discussion of the anti-avoidance rule in proposed § 1.965-4(b), which could apply, for example, to liquidations that reduce a section 958(a) U.S. shareholder's aggregate foreign cash position.

6. Cash Position & Derivative Financial Instruments

Consistent with section 3.01(c) of Notice 2018-07, the proposed regulations address the treatment of derivative financial instruments for purposes of measuring the cash position of a specified foreign corporation. Generally, the cash position of any specified foreign corporation includes, among other things, the fair market value of the cash-equivalent assets held by the corporation.

See

proposed § 1.965-1(f)(16)(i)(C). Consistent with section 3.01(c) of Notice 2018-07, the proposed regulations define the term cash-equivalent asset to include derivative financial instruments held by the specified foreign corporation that is not a bona fide hedging transaction.

See

proposed § 1.965-1(f)(13)(v). Derivative financial instruments include notional principal contracts, options contracts, forward contracts, futures contracts, short positions in securities and commodities, and any similar financial instruments.

See

proposed § 1.965-1(f)(18).

The proposed regulations provide that the value of each derivative financial instrument that must be taken into account in determining the cash position of a specified foreign corporation may be positive or negative, but that the aggregate amount taken into account for all derivative financial instruments (excluding bona fide hedging transactions) of a specified foreign corporation cannot be less than zero.

See

proposed § 1.965-1(f)(16)(iii).

Consistent with section 3.01(c) of Notice 2018-07, the proposed regulations also provide that if a derivative financial transaction is a bona fide hedging transaction that is used to hedge a cash-equivalent asset, the value of the cash-equivalent asset identified on the taxpayer's books and records as the asset being hedged must be adjusted by the fair market value of the bona fide hedging transaction that is used to hedge such cash-equivalent asset (such hedging transaction, a “cash-equivalent asset hedging transaction”).

See

proposed § 1.965-1(f)(16)(ii). The value of a cash-equivalent asset hedging transaction must be taken into account in determining the cash position of a specified foreign corporation whether the cash-equivalent asset hedging transaction has positive or negative value, but only to the extent that the cash-equivalent asset hedging transaction (or transactions) does not reduce the fair market value of the asset being hedged below zero.

Id.

A bona fide hedging transaction with respect to an asset that is not a cash-equivalent asset or with respect to a liability (as described in § 1.1221-2(b)(2)) is not included in a specified foreign corporation's cash position for purposes of section 965(c)(3)(B).

The proposed regulations define a bona fide hedging transaction as a hedging transaction that meets the requirements of a bona fide hedging transaction described in § 1.954-2(a)(4)(ii) and that is properly identified as such in accordance with the requirements of that subparagraph. Proposed § 1.965-1(f)(12). Consistent with the definition of a bona fide hedging transaction in § 1.954-2(a)(4)(ii), in the case of an asset hedging transaction, the risk being hedged may be with respect to ordinary property, section 1231 property, or a section 988 transaction. Because the identification requirements of § 1.954-2(a)(4)(ii) are generally relevant only to CFCs, whereas section 965 applies to all specified foreign corporations, the proposed regulations provide that the

identification requirements apply only with respect to CFCs.

Id.

7. Accounts Receivable and Accounts Payable

Consistent with section 3.04(a) of Notice 2018-13 as well as the clarification provided in section 3.06 of Notice 2018-26, the definitions of “accounts payable” and “accounts receivable” in proposed § 1.965-1(f)(5) and (6) provide that for purposes of determining net accounts receivable taken into account in determining the cash position of a specified foreign corporation, the term “accounts receivable” means receivables described in section 1221(a)(4), and the term “accounts payable” means payables arising from the purchase of property described in section 1221(a)(1) or 1221(a)(8) or the receipt of services from vendors or suppliers, and only receivables or payables with a term upon issuance that is less than one year are taken into account. In addition, receivables that are treated as accounts receivable within the meaning of section 965(c)(3)(C)(i) and proposed § 1.965-1(f)(6) are not also treated as short-term obligations.

See

proposed § 1.965-1(f)(43).

Comments requested modifications to the definition of accounts payable for purposes of determining a specified foreign corporation's cash position, including that accounts payable be defined to include payables related to the licensing of intellectual property, payables to employees in the ordinary course of business, and payables arising from property described in section 1221(a)(2). The term “accounts payable” is not defined in the statute, and the Treasury Department and the IRS have determined that the definition in the proposed regulations is consistent with the ordinary meaning of accounts payable. Therefore no change is made in the proposed regulations to the definition of accounts payable.

8. Short-Term Obligations

Consistent with section 3.04(b) of Notice 2018-13, proposed § 1.965-1(f)(43) provides that, for purposes of determining a specified foreign corporation's cash position, a loan that must be repaid on the demand of the lender (or that must be repaid within one year of such demand) is treated as a short-term obligation, regardless of the stated term of the instrument, and thus is included in the specified foreign corporation's cash position. In response to a comment, proposed § 1.965-1(f)(43) clarifies that an instrument's term upon issuance is used for purposes of determining whether an obligation is a short-term obligation.

A comment requested that taxpayers be able to prove, based on facts and circumstances, that a demand loan should not be treated as a short-term obligation. The Treasury Department and the IRS have determined that any facts-and-circumstances test would not be administrable, particularly to the extent that the test required a determination of a taxpayer's subjective intent with respect to the payment of the loan. Accordingly, this comment is not adopted.

9. Pro Rata Share

Consistent with section 3.03(a) of Notice 2018-13, the proposed regulations provide that, for purposes of determining a United States shareholder's pro rata share of the specified E&P deficit of an E&P deficit foreign corporation that has multiple classes of stock outstanding, the specified E&P deficit is allocated among the shareholders of the corporation's common stock and in proportion to the value of the common stock held by such shareholders.

See

proposed § 1.965-1(f)(30)(ii). Comments are requested regarding whether there are circumstances in which a specified E&P deficit should be allocated to shareholders of an E&P deficit foreign corporation's preferred stock and, if so, how to allocate as between shareholders of common stock and shareholders of preferred stock as well as among shareholders of preferred stock. The proposed regulations also clarify that, for purposes of determining a shareholder's pro rata share of a specified E&P deficit, the value of the common stock is determined as of the last day of the last taxable year of the E&P deficit foreign corporation that begins before January 1, 2018.

Id.

See Part II.B.5 of this Explanation of Provisions section for a discussion of the definition of pro rata share with respect to the cash position of a specified foreign corporation.

10. Domestic Pass-Through Entities

As explained in section 3.05(b) of Notice 2018-26, section 965 increases the amount included in the gross income of a United States shareholder under section 951(a)(1) only if the United States shareholder owns section 958(a) stock of one or more specified foreign corporations.

See

section 951(a)(2)(A). Accordingly, if a domestic pass-through entity is a United States shareholder of a DFIC and owns section 958(a) stock of the DFIC, the section 965(a) inclusion amount with respect to the section 958(a) stock and the section 965(c) deduction amount with respect to the section 965(a) inclusion amount are each determined at the level of the domestic pass-through entity.

See

section 951(a)(1). However, the domestic pass-through owners of the domestic pass-through entity are subject to federal income tax on their share of the aggregate section 965(a) inclusion amount with respect to section 958(a) stock owned by the domestic pass-through entity. Accordingly, in the case of a domestic pass-through entity that is a section 958(a) U.S. shareholder with respect to one or more DFICs, each domestic pass-through owner takes into account its share of the aggregate section 965(a) inclusion amount with respect to section 958(a) stock of one or more DFICs of the domestic pass-through entity and its share of the section 965(c) deduction amount with respect to such amount (each, a “domestic pass-through owner share”), regardless of whether such domestic pass-through owner is also a United States shareholder with respect to such DFIC, giving rise to a “section 965(a) inclusion” and a “section 965(c) deduction” to the domestic pass-through owner.

See

proposed § 1.965-1(f)(21), (37) and (41). For this purpose, a pass-through owner's share is determined under the provisions of subchapter K of the Code.

Proposed § 1.965-3(g) provides that an aggregate section 965(a) inclusion amount for a section 958(a) U.S. shareholder inclusion year and the related section 965(c) deduction amount must be allocated in the same proportion. For example, if a domestic pass-through owner is allocated 50 percent of an aggregate section 965(a) inclusion amount with respect to section 958(a) stock of a domestic pass-through entity, the domestic pass-through owner must be allocated 50 percent of the related section 965(c) deduction amount. If the domestic pass-through owner is also a section 958(a) U.S. shareholder with respect to the DFIC because it owns section 958(a) stock of the DFIC, the section 965(a) inclusion amount with respect to the section 958(a) stock of the domestic pass-through owner and the section 965(c) deduction amount with respect to such amount are determined separately from the domestic pass-through owner's share of the aggregate section 965(a) inclusion amount and section 965(c) deduction amount of the domestic pass-through entity.

Consistent with section 3.05(b) of Notice 2018-26, proposed § 1.965-1(f)(19) defines the term “domestic pass-through entity” to mean a pass-through entity that is a United States person (as defined in section 7701(a)(30)), and

proposed § 1.965-1(f)(28) defines the term “pass-through entity” to mean a partnership, S corporation, or any other person to the extent that the income or deductions of such person are included in the income of one or more direct or indirect owners or beneficiaries of the person. Accordingly, if, for example, a domestic trust owns section 958(a) stock of a single DFIC and is subject to federal income tax on a portion of its section 965(a) inclusion amount and its domestic pass-through owners are subject to tax on the remaining portion, the domestic trust is treated as a domestic pass-through entity with respect to such remaining portion. As defined, a pass-through entity does not include a REIT or a regulated investment company (“RIC”). The term “domestic pass-through owner” means a United States person that is a partner, shareholder, beneficiary, grantor, or owner, as the case may be, in a domestic pass-through entity, except that, in the case of tiered pass-through entities, the term does not include a partner, shareholder, beneficiary, grantor, or owner that is itself a domestic pass-through entity.

See

proposed § 1.965-1(f)(20). In the case of tiered pass-through entities, a reference to a domestic pass-through owner includes a United States person that is an indirect partner, shareholder, beneficiary, grantor, or owner through one or more other pass-through entities, and a reference to a domestic pass-through owner share of the aggregate section 965(a) inclusion amount and section 965(c) deduction amount of a domestic pass-through entity includes such domestic pass-through owner's share of the aggregate section 965(a) inclusion amount and section 965(c) deduction amount of a domestic pass-through entity owned indirectly by the domestic pass-through owner through one or more other pass-through entities.

See

proposed § 1.965-1(f)(20) and (21).

C. Foreign Currency Translation

Consistent with section 3.05(a) of Notice 2018-13, the proposed regulations provide that, for purposes of determining the section 965(a) earnings amount of a specified foreign corporation, the accumulated post-1986 deferred foreign income of the specified foreign corporation as of each of the E&P measurement dates must be compared in the functional currency of the specified foreign corporation.

See

proposed § 1.965-1(f)(36). If the functional currency of a specified foreign corporation changes between the two E&P measurement dates, the comparison must be made in the functional currency of the specified foreign corporation as of December 31, 2017, by translating the specified foreign corporation's E&P as of November 2, 2017, into the new functional currency using the spot rate on November 2, 2017.

Id.; see also

proposed § 1.965-4(c)(1) (disregarding any such change in functional currency for purposes of applying section 965 to a United States shareholder of the specified foreign corporation under certain circumstances).

Furthermore, the proposed regulations are consistent with section 3.05(b) of Notice 2018-13, which indicates that the spot rate on December 31, 2017, is to be used for translating the section 965(a) earnings amount of a DFIC into U.S. dollars for purposes of determining the section 965(a) inclusion amount of a United States shareholder with respect to the DFIC, as well as for purposes of translating other amounts necessary for the application of section 965(b), including (i) translating a section 965(a) earnings amount into U.S. dollars in computing amounts described in section 965(b)(2)(A) and (B), (ii) translating a specified E&P deficit into U.S. dollars in order to determine a United States shareholder's aggregate foreign E&P deficit under section 965(b)(3)(A), (iii) translating a section 965(a) inclusion amount with respect to a DFIC (if the amount was reduced by an aggregate foreign E&P deficit under section 965(b)(1)) back into the functional currency of the DFIC for purposes of determining the E&P of the DFIC described in section 959(c)(2), and (iv) translating the portion of the U.S. dollar-denominated aggregate foreign E&P deficit allocated to a DFIC under section 965(b)(2) into the functional currency of the DFIC for purposes of determining its E&P described in section 959(c)(2) by reason of section 965(b)(4)(A).

See

proposed §§ 1.965-1(b)(1), (f)(9) and (11), and 1.965-2(c) and (d). Proposed § 1.965-6(b) also provides that in applying section 902, the section 965(a) inclusion amount must be translated (if necessary) back into the DFIC's functional currency using the spot rate on December 31, 2017.

Section 3.05(c) of Notice 2018-13 describes regulations to ensure that the cash position of a specified foreign corporation with respect to any cash measurement date is expressed in U.S. dollars, so that the amount of a United States shareholder's aggregate foreign cash position is the greater of the aggregate amounts on each cash measurement date. In determining the cash position attributable to net accounts receivable, the amount of accounts receivable and accounts payable (in each case, if not otherwise denominated in U.S. dollars) must be translated into U.S. dollars at the spot rate on the relevant cash measurement date. The fair market value of assets described in section 965(c)(3)(B)(iii) must also be determined in U.S. dollars on the relevant cash measurement date. For example, in the case of foreign currency, the fair market value equals the currency amount translated at the spot rate on the relevant cash measurement date. Consistent with section 3.05(c) of Notice 2018-13, the proposed regulations provide that amounts taken into account in determining the cash position are translated (if necessary) using the spot rate on the relevant cash measurement date.

See

proposed § 1.965-1(f)(16)(iv).

III. Section 962 Elections

The proposed regulations provide rules consistent with section 5 of Notice 2018-26 related to elections under section 962. Proposed § 1.962-2(a) clarifies that an individual domestic pass-through owner that is a United States shareholder with respect to a DFIC may make an election under section 962 with respect to the individual's share of the section 965(a) inclusion amount of a domestic pass-through entity with respect to the DFIC, and an individual who is not a United States shareholder of a DFIC is not permitted to make an election under section 962 with respect to the individual's share of a section 965(a) inclusion amount of a domestic pass-through entity with respect to the DFIC.

See also

proposed § 1.962-1(b)(1)(i)(A)(

1

)(

ii

).

In addition, notwithstanding the rule in current § 1.962-1(b)(1)(i) providing that a deduction of a United States shareholder does not reduce the amount included in gross income under section 951(a) for purposes of computing the amount of tax that would be imposed under section 11, the Treasury Department and the IRS have determined that in the case of a taxpayer making an election under section 962, the section 965(c) deduction (which is generally available to United States shareholders of DFICs, including individuals) should be allowed with respect to the tax imposed under section 11 rather than under section 1.

See

H.R. Rep. No. 115-466, at 620 (2017) (Conf. Rep.). Thus, under proposed § 1.962-1(b)(1)(i)(B), “taxable income” as used in section 11 is reduced by a taxpayer's section 965(c) deduction with respect to a section 965(a) inclusion to which the section 962 election applies. However, the proposed regulations clarify that, subject to future guidance, “taxable

income” as used in section 11 is not reduced by any other amounts, including any other deductions.

To clarify that a section 965(c) deduction taken into account in determining “taxable income” as used in section 11 cannot then be deducted again at the individual level, the proposed regulations provide that any section 965(c) deduction allowed in determining “taxable income” as used in section 11 for purposes of computing the tax due as a result of a section 962 election is not also allowed for purposes of determining an individual's actual taxable income.

See

proposed § 1.965-3(e)(1).

IV. Adjustments to E&P and Basis

Proposed § 1.965-2 contains rules related to adjustments to E&P and basis to determine and account for the application of section 965(a) and (b) and proposed § 1.965-1(b) and a rule that limits the amount of gain recognized in connection with the application of section 961(b)(2).

A. Determination of and Adjustments to E&P in the Last Taxable Year of a Specified Foreign Corporation That Begins Before January 1, 2018, for Purposes of Applying Sections 959 and 965

Consistent with section 3.02(d) of Notice 2018-07, the proposed regulations clarify the interaction between the rules under sections 959 and 965 in the last taxable year of a specified foreign corporation that begins before January 1, 2018, and the taxable year of a section 958(a) U.S. shareholder of the specified foreign corporation in which or with which such year ends. Proposed § 1.965-2(b) provides the following rules relating to adjustments to E&P for determining a section 958(a) U.S. shareholder's inclusion under section 951(a)(1), including by reason of section 965(a) and proposed § 1.965-1(b), and the treatment of distributions under section 959: First, the subpart F income of the specified foreign corporation is determined without regard to section 965(a), and a section 958(a) U.S. shareholder's inclusion under section 951(a)(1)(A) by reason of such amount is taken into account.

Second, the treatment of a distribution from the specified foreign corporation to another specified foreign corporation that is made before January 1, 2018, is determined under section 959.

Third, each of the post-1986 earnings and profits (including a deficit) of the specified foreign corporation, the accumulated post-1986 deferred foreign income of the specified foreign corporation, the section 965(a) earnings amount of the specified foreign corporation, and the section 965(a) inclusion amount of the section 958(a) U.S. shareholder with respect to the specified foreign corporation, if any, is determined, and the E&P (including a deficit) of the specified foreign corporation are adjusted as provided in proposed § 1.965-2(c) and (d) (as discussed in Part IV.B of this Explanation of Provisions section). For a rule disregarding subpart F income earned after an E&P measurement date for purposes of calculating accumulated post-1986 deferred foreign income as of the E&P measurement date, see Part II.B.4 of this Explanation of Provisions section and proposed § 1.965-2(j),

Example 2

and

Example 3.

Fourth, the treatment of all distributions from the specified foreign corporation other than those described in step 2 is determined under section 959.

Fifth, an amount is determined under section 956 with respect to the specified foreign corporation and the section 958(a) U.S. shareholder, and the shareholder's inclusion under section 951(a)(1)(B) is taken into account.

B. Adjustments to E&P by Reason of Section 965(a) and (b)

1. Adjustments to E&P by Reason of Section 965(a)

Proposed § 1.965-2(c) provides that if a section 958(a) U.S. shareholder has a section 965(a) inclusion with respect to a DFIC, the DFIC will have previously taxed E&P with respect to the section 958(a) U.S. shareholder in an amount equal to the section 965(a) inclusion amount (referred to as “section 965(a) previously taxed earnings and profits”). Because section 965(a) previously taxed earnings and profits must be tracked in functional currency whereas the section 965(a) inclusion amount is in U.S. dollars, as noted in Part II.C of this Explanation of Provisions section, the proposed regulations provide that the section 965(a) inclusion amount must be translated (if necessary) into the functional currency of the DFIC using the spot rate on December 31, 2017, in determining the amount of the section 965(a) previously taxed earnings and profits.

Under proposed § 1.965-2(c), the E&P of a DFIC described in section 959(c)(3) are reduced by an amount equal to the section 965(a) previously taxed earnings and profits of the corporation. In certain cases, the section 965(a) inclusion amount with respect to the DFIC, and therefore the section 965(a) previously taxed earnings and profits of the DFIC with respect to a section 958(a) U.S. shareholder, may exceed the E&P described in section 959(c)(3) of the DFIC. For example, this will be the case when a DFIC incurs a loss after the E&P measurement date on which it determines its section 965(a) earnings amount and before the end of its inclusion year. In such a case, under the proposed regulations, a deficit in E&P described in section 959(c)(3) will be created or increased.

2. Adjustments to E&P by Reason of Section 965(b)

Proposed § 1.965-2(d) provides rules relating to E&P of DFICs and E&P deficit foreign corporations by reason of a reduction under section 965(b)(1) and proposed § 1.965-1(b)(2) (reduction by the DFIC's allocable share of a section 958(a) U.S. shareholder's aggregate foreign E&P deficit) or section 965(b)(5) and proposed § 1.965-8(b) (reduction by the DFIC's allocable share of a section 958(a) U.S. shareholder's applicable share of an affiliated group's aggregate unused E&P deficit) (collectively, the “reduction rules”).

i. Adjustments to E&P of DFICs

Under proposed § 1.965-2(d)(1), if a section 958(a) U.S. shareholder's pro rata share of the section 965(a) earnings amount of a DFIC is reduced under the reduction rules, the DFIC will have previously taxed E&P (referred to as “section 965(b) previously taxed earnings and profits”) with respect to the section 958(a) U.S. shareholder in an amount equal to the amount of the reduction, if any, translated (if necessary) into the functional currency of the DFIC using the spot rate on December 31, 2017. For purposes of applying section 959, section 965(b) previously taxed earnings and profits are treated as E&P that are included in the gross income of the section 958(a) U.S. shareholder under section 951(a)(1)(A). Furthermore, the E&P (including a deficit) described in section 959(c)(3) of the DFIC are reduced (or, in the case of a deficit, increased) by an amount equal to the section 965(b) previously taxed earnings and profits.

ii. Adjustments to E&P of E&P Deficit Foreign Corporations

Under proposed § 1.965-2(d)(2)(i)(A), the E&P described in section 959(c)(3) of an E&P deficit foreign corporation are increased by an amount equal to the portion of a section 958(a) U.S. shareholder's pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under the reduction rules, translated (if necessary) into the functional currency

of the E&P deficit foreign corporation using the spot rate on December 31, 2017. The proposed regulations clarify that the E&P increased by reason of this provision are not treated as E&P of the taxable year described in section 316(a)(2). See also proposed § 1.965-6(c)(3) for a rule on the timing of this adjustment for purposes of determining a deemed paid credit allowed under sections 902 and 960 with respect to the E&P deficit foreign corporation (which is discussed in Part VII.C.1 of this Explanation of Provisions section).

In addition, proposed § 1.965-2(d)(2)(i)(B) provides that, for purposes of section 952, a section 958(a) U.S. shareholder's pro rata share of the E&P of an E&P deficit foreign corporation is increased by an amount equal to the portion of the section 958(a) U.S. shareholder's pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under the reduction rules, translated (if necessary) into the functional currency of the E&P deficit foreign corporation using the spot rate on December 31, 2017, and such increase is attributable to the same activity to which the deficit so taken into account was attributable.

Proposed § 1.965-2(d)(2)(ii) provides rules for determining the portion of a section 958(a) U.S. shareholder's pro rata share of a specified E&P deficit of an E&P deficit foreign corporation taken into account under the reduction rules. Proposed § 1.965-2(d)(2)(ii)(A) details the circumstances in which all of a pro rata share of a specified E&P deficit will be taken into account. Proposed § 1.965-2(d)(2)(ii)(B) provides that if the rule in the preceding sentence does not apply, a section 958(a) U.S. shareholder must designate the portion taken into account.

C. Adjustments to Basis by Reason of Section 965(a) and (b)

1. Adjustments to Basis by Reason of Section 965(a)

Proposed § 1.965-2(e) provides that, under section 961(a), a section 958(a) U.S. shareholder's basis in section 958(a) stock of a DFIC, or property by reason of which the section 958(a) U.S. shareholder is considered under section 958(a)(2) as owning section 958(a) stock of a DFIC (“applicable property”), is increased by the section 958(a) U.S. shareholder's section 965(a) inclusion amount with respect to the DFIC. However, rules relating to basis adjustments in the case of a section 962 election are reserved. Comments are requested as to the appropriate amount of a basis adjustment with respect to a DFIC with respect to which a section 962 election is effective.

2. Adjustments to Basis by Reason of Section 965(b)

Proposed § 1.965-2(f)(1) clarifies that, in general, no adjustments to basis of stock or property are made under section 961 (or any other provision of the Code) to take into account the reduction to a section 958(a) U.S. shareholder's pro rata share of the section 965(a) earnings amount of a DFIC under the reduction rules. However, section 965(o) provides authority to write regulations concerning basis adjustments in contemplation of the fact that “basis adjustments (increases or decreases) may be necessary with respect to both the stock of the DFIC and the E&P deficit foreign corporation.” H.R. Rep. No. 115-466, at 620 (2017) (Conf. Rep.). The Conference Report stated:

For example, with respect to the stock of the deferred foreign income corporation, the Secretary may determine that a basis increase is appropriate in the taxable year of the section 951A [sic] inclusion or, alternatively, the Secretary may modify the application of section 961(b)(1) with respect to such stock. Moreover, with respect to the stock of the E&P deficit [foreign] corporation, the Secretary may require a reduction in basis for the taxable year in which the U.S. shareholder's pro rata share of the earnings of the E&P deficit [foreign] corporation are increased.

Id.

at 620-21.

The Treasury Department and the IRS have determined that an increase to the basis of stock of DFICs is appropriate only if there is a corollary reduction to the basis of the stock of E&P deficit foreign corporations. However, the Treasury Department and the IRS recognize that such reduction, which could in certain cases give rise to gain, could be overly burdensome for taxpayers. Accordingly, proposed § 1.965-2(f)(2) allows taxpayers to elect to make the relevant basis adjustments, in which case such adjustments must be consistently made with respect to all section 958(a) stock of specified foreign corporations owned by a section 958(a) U.S. shareholder and related persons. The relevant basis adjustments are (i) an increase in the section 958(a) U.S. shareholder's basis in the section 958(a) stock of a DFIC or applicable property with respect to a DFIC by an amount equal to the section 965(b) previously taxed earnings and profits of the DFIC with respect to the section 958(a) U.S. shareholder, and (ii) a reduction in the section 958(a) U.S. shareholder's basis in the section 958(a) stock of an E&P deficit foreign corporation or applicable property with respect to an E&P deficit foreign corporation by an amount equal to the portion of the section 958(a) U.S. shareholder's pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under the reduction rules. However, as noted in Part IV.C.1 of this Explanation of Provisions section, rules relating to basis adjustments in the case of a section 962 election are reserved. An election under § 1.965-2(f)(2) is generally made by attaching a statement, signed under penalties of perjury, to the section 958(a) U.S. shareholder's return for the first taxable year that includes the last day of the last taxable year of a DFIC or E&P deficit foreign corporation of the shareholder that begins before January 1, 2018, including the shareholder's name and taxpayer identification number and a statement that the shareholder and all related persons make the election.

See

proposed § 1.965-2(f)(2)(iii)(B).

D. Gain-Reduction Rule

Consistent with section 3.03 of Notice 2018-07, and with the modification described in section 4 of Notice 2018-13, proposed § 1.965-2(g)(1) provides a gain-reduction rule pursuant to which, if a section 958(a) U.S. shareholder receives distributions through a chain of ownership described under section 958(a) from a DFIC during the inclusion year that are attributable to section 965(a) previously taxed earnings and profits, the amount of gain that would otherwise be recognized under section 961(b)(2) by the section 958(a) U.S. shareholder with respect to the section 958(a) stock of the DFIC, or applicable property with respect to the DFIC, is reduced (but not below zero) by an amount equal to the section 965(a) previously taxed earnings and profits of the DFIC with respect to the section 958(a) U.S. shareholder.

If a taxpayer makes the election described in proposed § 1.965-2(f)(2), the gain-reduction rule will also apply to distributions attributable to section 965(b) previously taxed earnings and profits, and the amount of gain that would otherwise be recognized by the section 958(a) U.S. shareholder is also reduced by the amount of the section 965(b) previously taxed earnings and profits of the DFIC with respect to the section 958(a) U.S. shareholder.

In order to ensure that the amount of gain in the section 958(a) stock or applicable property that would have been recognized under section 961(b)(2) remains reflected in the section 958(a) stock or applicable property, proposed § 1.965-2(g)(2) provides that the basis in the section 958(a) stock or applicable

property must be reduced by the amount that would have been recognized as gain.

E. Rules of Application for Basis Adjustments

The proposed regulations provide certain rules of application common to all basis adjustments described in proposed § 1.965-2(e), (f)(2), and (g)(2) (“specified basis adjustments”).

See

proposed § 1.965-2(h). The rules address the timing and allocation among shares of the specified basis adjustments.

See

proposed § 1.965-2(h)(1) and (4). They also require netting of the specified basis adjustments and gain recognition to the extent that a net downward adjustment would exceed basis.

See

proposed § 1.965-2(h)(2) and (3). In addition, they make clear that the specified basis adjustments are limited to adjustments to property held by a section 958(a) U.S. shareholder, except in circumstances involving foreign pass-through entities.

See

proposed § 1.965-2(h)(5).

V. Section 965(c) Deductions

Proposed § 1.965-3 provides rules regarding section 965(c) deductions and section 965(c) deduction amounts.

A. Determination of Aggregate Foreign Cash Position

1. Disregard of Certain Obligations Between Related Specified Foreign Corporations

Consistent with section 3.01(b) and (c) of Notice 2018-07, the proposed regulations provide that, for purposes of determining the aggregate foreign cash position of a section 958(a) U.S. shareholder, accounts receivable, accounts payable, short-term obligations, and derivative financial instruments between related specified foreign corporations are disregarded, if applicable, on the corresponding cash measurement dates of the specified foreign corporations to the extent of the smallest of the section 958(a) U.S. shareholder's ownership percentages of section 958(a) stock of the specified foreign corporations owned by the section 958(a) U.S. shareholder on the corresponding cash measurement dates.

See

proposed § 1.965-3(b)(1).

2. Disregard of Certain Assets To Prevent Double Counting

Section 3.05(a) of Notice 2018-26 announced the intent to issue forms, publications, regulations, or other guidance specifying the documentation that a United States shareholder must maintain or provide, and the time and manner for providing any such documentation, in order to make the required demonstration to the Secretary to rely on section 965(c)(3)(D) in excluding net accounts receivable, actively traded property, and short-term obligations in determining its aggregate foreign cash position. To disregard assets under this rule, the proposed regulations provide that a section 958(a) U.S. shareholder must attach a statement to its timely filed return (taking into account extensions, if any) containing a description of the asset that would be taken into account with respect to both specified foreign corporations; a statement of the amount by which its pro rata share of the cash position of one specified foreign corporation is reduced; a detailed explanation of why there would otherwise be double-counting, including the computation of the amount taken into account with respect to the other specified foreign corporation; and an explanation of why the rule described in Part V.A.1 of this Explanation of Provisions section does not apply to disregard such amounts.

See

proposed § 1.965-3(b)(2).

B. Determination of Aggregate Foreign Cash Position for Section 958(a) U.S. Shareholder Inclusion Year

Consistent with section 3.05(a) of Notice 2018-07, the proposed regulations provide that in the case of a section 958(a) U.S. shareholder that has a section 965(a) inclusion amount in more than one taxable year, the amount of the aggregate foreign cash position taken into account in the first taxable year will equal the lesser of the section 958(a) U.S. shareholder's aggregate foreign cash position or the aggregate 965(a) inclusion amount taken into account by the section 958(a) U.S. shareholder in that taxable year. Furthermore, the amount of the section 958(a) U.S. shareholder's aggregate foreign cash position taken into account in any succeeding taxable year will be the lesser of the excess, if any, of its aggregate foreign cash position over the amount of its aggregate foreign cash position taken into account in preceding taxable years, or the aggregate section 965(a) inclusion amount taken into account by the section 958(a) U.S. shareholder in such succeeding taxable year.

See

proposed § 1.965-3(c)(2).

In addition, also consistent with section 3.05(a) of Notice 2018-07, the proposed regulations provide that, for purposes of determining the aggregate foreign cash position of a section 958(a) U.S. shareholder for a taxable year in which it takes into account a section 965(a) inclusion amount, a section 958(a) U.S. shareholder can assume that its pro rata share of the cash position of any specified foreign corporation whose last taxable year beginning before January 1, 2018, ends after the date the return for such taxable year of the section 958(a) U.S. shareholder is timely filed (taking into account extensions, if any) will be zero as of the cash measurement date with which the year of the specified foreign corporation ends. If a section 958(a) U.S. shareholder's pro rata share of the cash position of a specified foreign corporation was treated as zero pursuant to the preceding sentence for a section 958(a) U.S. shareholder inclusion year (an “estimated section 958(a) U.S. shareholder inclusion year”), the final cash measurement date amount in fact exceeds the average of the first and second cash measurement date amounts with respect to the section 958(a) shareholder, and the shareholder's aggregate section 965(a) inclusion amount in fact exceeds the final cash measurement date amount, interest and penalties will not be imposed if the section 958(a) U.S. shareholder makes appropriate adjustments by amending the return for the estimated section 958(a) U.S. shareholder inclusion year to reflect the correct aggregate foreign cash position by the due date (taking into account extensions, if any) for the return for the year after the estimated section 958(a) U.S. shareholder inclusion year.

See

proposed § 1.965-3(c)(3).

C. Recapture of Section 965(c) Deductions for Expatriated Entities

Proposed § 1.965-3(d) harmonizes the rule provided in section 965(l) requiring the recapture of a section 965(c) deduction by an expatriated entity with the expanded scope of availability of section 965(c) deductions (that is, to a domestic pass-through owner that is not itself a United States shareholder) by requiring recapture of all section 965(c) deductions taken into account by an expatriated entity without regard to whether the expatriated entity was itself a United States shareholder.

D. Treatment of Section 965(c) Deductions Under Certain Code Provisions

Consistent with section 3.06 of Notice 2018-26, proposed § 1.965-3(f)(1) provides that a section 965(c) deduction will not be treated as an itemized deduction for any purpose of the Code (including, as described in Notice 2018-26, for purposes of sections 56 and 67).

The Treasury Department and the IRS are aware that the rules of subchapter K and subchapter S may prevent a partner or S corporation shareholder from taking into account its domestic pass-

through owner share of a section 965(c) deduction amount in certain circumstances if allocated by a partnership or S corporation separately from the corresponding section 965(a) inclusion amount, particularly to the extent that a partnership or S corporation makes distributions to one or more partners or shareholders (as the case may be) during the year of its section 965(a) inclusion.

See, e.g.,

section 1366(d). Accordingly, proposed § 1.965-3(f)(2)(i) provides that in the case of a domestic partnership or S corporation, the aggregate amount of its section 965(a) inclusions net of the aggregate amount of its section 965(c) deductions is treated as a separately stated item of net income solely for purposes of calculating basis under section 705(a) and § 1.705-1(a) and section 1367(a)(1) and § 1.1367-1(f). Furthermore, the proposed regulations incorporate the rules concerning basis and AAA adjustments contained in section 965(f)(2) and provide an example illustrating the application of the rules described in this paragraph.

See

proposed § 1.965-3(f)(2)(i)(B), (ii), and (iii).

The proposed regulations clarify whether a United States person that must pay tax under section 1411 on a section 965(a) inclusion is entitled to take into account a section 965(c) deduction for purposes of determining the amount of such tax. Section 965(c) deductions are intended to reduce the rate of income tax to which section 965(a) inclusions are subject.

See

H.R. Rep. No. 115-466, at 620 (2017) (Conf. Rep.). The Treasury Department and the IRS have determined that the section 965(c) deduction was not intended to reduce the rate of tax imposed by non-income tax provisions outside of chapter 1. Accordingly, proposed § 1.965-3(f)(3) provides that for purposes of section 1411 and § 1.1411-4(f)(6), a section 965(c) deduction is not treated as a deduction properly allocable to a corresponding section 965(a) inclusion. Consistent with the rule for section 1411, proposed § 1.965-3(f)(4) provides that a section 965(c) deduction is not treated as an ordinary and necessary expense paid or incurred for the production or collection of gross investment income for purposes of section 4940(c)(3)(A).

VI. Disregard of Certain Transactions

Proposed § 1.965-4 provides rules that disregard certain transactions for purposes of applying section 965. In particular, proposed § 1.965-4 provides rules that disregard (i) transactions undertaken with a principal purpose of reducing the section 965 tax liability of a United States shareholder, (ii) certain changes in method of accounting and entity classification elections, and (iii) certain transactions occurring between E&P measurement dates.

A. Anti-Avoidance Rules

The proposed regulations provide rules, consistent with section 3.04 of Notice 2018-26, to prevent the avoidance of section 965, including an anti-avoidance rule disregarding certain transactions and rules disregarding certain changes in accounting methods and entity classification elections.

See

proposed § 1.965-4(b) through (e). The application of the anti-avoidance rule is based on whether there is a “change in the amount of a section 965 element” rather than a change in the section 965 tax liability, as described in the notice.

See

proposed § 1.965-4(b)(1). For this purpose, generally there is a change in the amount of a section 965 element if there is a reduction of a section 958(a) inclusion amount or aggregate foreign cash position or an increase in deemed paid foreign income taxes as a result of a section 965(a) inclusion.

See

proposed § 1.965-4(d) and (e)(1).

Comments requested that the anti-avoidance rule not apply to the extent a reduction in tax liability by reason of section 965 is offset by an equal amount of tax increase pursuant to a different Code provision. This comment is not adopted. The Conference Report reflects an intent for the Treasury Department and the IRS to address all strategies for avoiding a section 965(a) inclusion, without regard to the effect on overall tax liability.

See

H.R. Rep. No. 115-466, at 619 (2017) (Conf. Rep.). Furthermore, it would be difficult for the IRS to determine whether a particular increase in tax liability for non-section 965 reasons is related to the reduction in the taxpayer's section 965(a) inclusion. Finally, the anti-avoidance rule generally does not apply without a principal purpose of changing the amount of a section 965 element. Depending on the facts and circumstances, transactions that do not reduce overall tax liability may not meet the principal purpose test described in proposed § 1.965-4(b)(1).

Comments also requested a de minimis exception for the anti-avoidance rule. This comment is not adopted. The Treasury Department and the IRS have determined that any reduction in tax imposed by reason of section 965 through tax avoidance strategies occurring after November 2, 2017, is inconsistent with congressional intent and should not be respected.

Comments to Notice 2018-26 requested that the rule disregarding changes to methods of accounting not apply when the change is from an impermissible to a permissible method, and that a principal purpose test should apply. These comments are not adopted. Proposed § 1.965-4(c)(1) does not affect a taxpayer's ability to change its method of accounting, including to change to a permissible method. Instead, the rule disregarding an accounting method change is relevant only for the limited purpose of determining the amount of a taxpayer's section 965 elements.

The choice of a November 2, 2017, measurement date reflects an intent to impose a transition tax on a snapshot of earnings as of a date that coincides with the introduction of the Act in Congress, and reflects a general policy of disregarding taxpayer actions occurring after November 2, 2017, that reduce the taxpayer's liability imposed by reason of section 965, even if such future actions are otherwise respected under the Code. Such actions can include changes in accounting methods, whether to methods that are permissible or impermissible and regardless of the principal purpose for such change. A rule disregarding such changes is also consistent with the Conference Report, which reflects a clear intent for the Treasury Department and the IRS to exercise their authority under section 965(o) to disregard accounting method changes that reduce a taxpayer's tax liability under section 965.

See

H.R. Rep. No. 115-466, at 619 (2017) (Conf. Rep.).

B. Disregard of Certain Transactions Occurring Between E&P Measurement Dates

In section 3.02(a) of Notice 2018-07, the Treasury Department and the IRS announced the intent to issue regulations to address the possibility of double-counting or double non-counting in the computation of post-1986 earnings and profits arising from amounts paid or incurred (including certain dividends) between related specified foreign corporations of a United States shareholder that occur between E&P measurement dates and that would otherwise reduce the post-1986 earnings and profits as of December 31, 2017, of the specified foreign corporation that paid or incurred such amounts. The notice contained examples illustrating fact patterns involving double-counting or double non-counting to be addressed by the future regulations. The proposed regulations provide, consistent with section 3.02(a) of Notice 2018-07, that amounts paid or incurred between related specified foreign corporations of a section 958(a) U.S. shareholder

between E&P measurement dates that would otherwise reduce the post-1986 earnings and profits as of December 31, 2017, of the specified foreign corporation that paid or incurred such amounts are disregarded for purposes of determining the post-1986 earnings and profits of both of the specified foreign corporations as of the E&P measurement date on December 31, 2017.

See

proposed § 1.965-4(f).

A number of comments requested that these rules be expanded to cover other transactions that could lead to double counting and double non-counting in the computation of post-1986 earnings and profits of a specified foreign corporation, including: (i) Deductible payments by a specified foreign corporation to a United States shareholder or to a partnership owned by the United States shareholder; and (ii) distributions by specified foreign corporations to a United States shareholder. The recommendations in these comments are not adopted. The Treasury Department and the IRS have determined that the concerns regarding issues of double counting and double non-counting in the computation of post-1986 earnings and profits of a specified foreign corporation relate to transactions occurring between specified foreign corporations rather than between a specified foreign corporation and a United States shareholder.

See

H.R. Rep. No. 115-466, at 619 (2017) (Conf. Rep.). Payments by a specified foreign corporation to a United States shareholder only affect the post-1986 earnings and profits of a single specified foreign corporation, and thus do not result in double counting in determining a United States shareholder's section 965(a) inclusion amount. Additionally, payments by a specified foreign corporation to a United States shareholder can have attendant U.S. tax effects that do not occur with respect to payments between specified foreign corporations and that would need to be considered if such payments were disregarded. For example, a distribution from a specified foreign corporation to its United States shareholder may permit the United States shareholder to take into account foreign tax credits under section 902 and avoid the limitation under section 965(g)(1) that would apply if the underlying foreign taxes had been deemed paid with respect to the United States shareholder's section 965(a) inclusion amount.

VII. Foreign Tax Credits

A. In General

Section 14301 of the Act repealed section 902 effective for taxable years of foreign corporations beginning after December 31, 2017, and taxable years of United States shareholders in which or with which such taxable years of foreign corporations end. The proposed regulations include, in addition to rules under the foreign tax credit specific rules of section 965, rules coordinating the provisions of section 965 with the foreign tax credit provisions as in effect before their repeal or amendment by the Act.

B. Allowance of a Credit or Deduction for Foreign Income Taxes

1. Scope

Section 965(g)(1) provides that no credit is allowed under section 901 for the applicable percentage of any taxes paid or accrued (or treated as paid or accrued) with respect to any amount for which a section 965(c) deduction amount is allowed. The Conference Report does not elaborate on the meaning of “taxes paid or accrued” or “taxes treated as paid or accrued.” Comments requested clarification of the meaning of these terms and the scope of section 965(g). Under the proposed regulations, “taxes paid or accrued” refers to foreign income taxes paid or accrued directly by the taxpayer under section 901, and “taxes treated as paid or accrued” includes foreign income taxes deemed paid by the taxpayer under section 960, foreign income taxes allocated to an entity under § 1.901-2(f)(4), and a distributive share of taxes paid by a partnership.

2. Applicable Percentage

The proposed regulations clarify that the term “applicable percentage” is determined with respect to a section 958(a) U.S. shareholder and a section 958(a) U.S. shareholder inclusion year. As a result, if a section 958(a) U.S. shareholder has more than one section 958(a) U.S. shareholder inclusion year, the shareholder might have more than one applicable percentage as a result of differing aggregate foreign cash positions for those different section 958(a) U.S. shareholder inclusion years.

See

proposed § 1.965-5(d)(1). In addition, if a person is a domestic pass-through owner with respect to more than one domestic pass-through entity, each of which is a section 958(a) U.S. shareholder, the person might have a different applicable percentage with respect to each of those domestic pass-through entities because of differing aggregate foreign cash positions of those entities, as well as a different applicable percentage with respect to the person's section 958(a) stock, if any.

See

proposed § 1.965-5(d)(2). Therefore, the amount of foreign tax credits disallowed under section 965(g) and proposed § 1.965-5(b) and (c) could differ depending on the section 958(a) U.S. shareholder inclusion year and section 958(a) U.S. shareholder to which the foreign income taxes relate.

3. Foreign Income Taxes Paid or Accrued Directly by Taxpayer

For purposes of section 965(g)(1), foreign income taxes paid or accrued directly by a taxpayer include foreign income taxes imposed on the taxpayer on a distribution of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits. Section 965(g)(3) provides that no deduction is allowed for any tax for which a credit is not allowable under section 901 by reason of section 965(g)(1). The proposed regulations provide that neither a deduction (including under section 164) nor a credit under section 901 is allowed for the applicable percentage of any foreign income taxes paid or accrued with respect to any amount for which a section 965(c) deduction is allowed for a section 958(a) U.S. shareholder inclusion year. The proposed regulations also provide that neither a deduction nor a credit under section 901 is allowed for the applicable percentage of any foreign income taxes attributable to a distribution of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits.

See

proposed § 1.965-5(b).

Accordingly, no deduction or credit is allowed for the applicable percentage of any withholding taxes imposed on a United States shareholder by the jurisdiction of residence of the distributing foreign corporation with respect to a distribution of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits. Similarly, no deduction or credit is allowed for the applicable percentage of net basis taxes imposed on a United States citizen by the citizen's jurisdiction of residence upon receipt of a distribution of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits.

4. Foreign Income Taxes Treated as Paid or Accrued by Taxpayer

i. Section 960(a)(1)

For taxable years of foreign corporations beginning before January 1, 2018, and taxable years of United States shareholders in which or with which such taxable years of foreign corporations end, section 960(a)(1) provides that, if there is included under section 951(a) in the gross income of a domestic corporation any amount attributable to E&P of a foreign corporation which is a member of a qualified group (as defined in section 902(b)) with respect to the domestic corporation, then, except to the extent provided in regulations, section 902 shall be applied as if the amount so included were a dividend paid by such foreign corporation (determined by applying section 902(c) in accordance with section 904(d)(3)(B)). The proposed regulations provide that a credit under section 901 is not allowed for the applicable percentage of any foreign income taxes treated as paid or accrued under section 960(a)(1) (for taxable years of foreign corporations beginning before January 1, 2018, and to taxable years of United States persons in which or with which such taxable years of foreign corporations end) with respect to any amount for which a section 965(c) deduction is allowed for a section 958(a) U.S. shareholder inclusion year.

ii. Section 960(a)(3)

For a taxable year of a foreign corporation beginning before January 1, 2018, section 960(a)(3) provides that any portion of a distribution from such a foreign corporation received by a domestic corporation which is excluded from gross income under section 959(a) is treated by the domestic corporation as a dividend, solely for purposes of taking into account under section 902 any foreign taxes, on or with respect to the accumulated profits of such foreign corporation from which such distribution is made, which were not deemed paid by the domestic corporation for any prior taxable year.

Accordingly, the proposed regulations provide that the credit allowed under section 960(a)(3) is only with respect to foreign income taxes imposed on an upper-tier foreign corporation on distributions of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits from a lower-tier foreign corporation.

See

proposed § 1.965-5(c)(1)(ii). Furthermore, section 960(a)(3) does not allow a credit for foreign income taxes attributable to the portion of a section 965(a) earnings amount that was reduced pursuant to section 965(b) since such taxes were not imposed on a distribution of previously taxed E&P. Instead, because section 965(b) previously taxed earnings and profits are treated as having been included in a United States shareholder's income under section 951(a), foreign income taxes that would have been deemed paid with respect to section 965(b) previously taxed earnings and profits under section 960(a)(1) had such amounts actually been included in income are treated as having been deemed paid, with the result that no credit is allowed under section 960(a)(3) or any other provision of the Code for such taxes.

Id.

The proposed regulations also provide that the disallowance under section 965(g) applies to foreign taxes deemed paid under section 960(a)(3) with respect to distributions of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits with respect to a section 958(a) U.S. shareholder inclusion year. For example, if a lower-tier foreign corporation distributes section 965(a) previously taxed earnings and profits to an upper-tier foreign corporation, and the upper-tier foreign corporation pays a foreign withholding tax with respect to the distribution of the section 965(a) previously taxed earnings and profits, such withholding tax would be creditable under section 960(a)(3) upon a distribution by the upper-tier foreign corporation to an eligible domestic corporation. However, the domestic corporation cannot claim a credit for the applicable percentage of such withholding tax.

See

proposed § 1.965-5(c)(ii).

The Act replaces section 960(a)(3) with section 960(b). The proposed regulations only address distributions out of section 965(a) previously taxed earnings and profits and section 965(b) previously taxed earnings and profits in years before the effective date of section 960(b) in the Act. The Treasury Department and the IRS anticipate that future regulations will provide similar rules in connection with new section 960(b).

iii. Disallowance of Deduction

The proposed regulations clarify that no deduction, including under section 164, is allowed for the applicable percentage of any foreign income taxes treated as paid or accrued with respect to any amount for which a section 965(c) deduction is allowed.

See

proposed § 1.965-5(c)(2).

C. Computation of Foreign Income Taxes Deemed Paid

1. General Rule and Exception

Comments requested clarification regarding the determination of deemed paid taxes under section 960 in connection with section 965. One comment also requested specific changes to the application of sections 902 and 960 that would permit a taxpayer to reduce the post-1986 undistributed earnings of a DFIC by the amount of any deficit from an E&P deficit foreign corporation that reduced the section 965(a) earnings amount of the DFIC. In general, the proposed regulations confirm that sections 902 and 960 apply in the same manner for section 965(a) inclusions as for other inclusions under section 951(a)(1)(A), and therefore a DFIC's post-1986 undistributed earnings is not reduced by specified E&P deficits from an E&P deficit foreign corporation.

A comment noted that in determining the indirect credit with respect to a section 965(a) inclusion, the numerator of the section 902 fraction (as defined in proposed § 1.965-6(c)(1)) may be greater than the denominator given that the section 965(a) inclusion is determined on one of two measurement dates. For example, if the amount of the accumulated post-1986 deferred foreign income of a DFIC is greater on November 2, 2017, than such amount is on December 31, 2017, the section 965(a) earnings amount of the DFIC will be based on E&P as of the November 2, 2017 date. However, the denominator of the section 902 fraction, post-1986 undistributed earnings, is determined as of the close of the taxable year of the foreign corporation and without diminution by reason of earnings distributed or otherwise included in income during the year. Section 902(c)(1). Where the post-1986 undistributed earnings as of the close of the DFIC's U.S. taxable year is positive, but less than the section 965(a) earnings amount, this could result in a section 902 fraction greater than one.

The section 902 fraction cannot exceed one.

See H.H. Robertson Co.

v.

Commissioner of Internal Revenue,

59 T.C. 53 (1972),

aff'd

500 F.2d 1399 (3d Cir. 1974). For the avoidance of doubt, the proposed regulations clarify that when the denominator of the section 902 fraction is positive but less than the numerator of such fraction, the section 902 fraction is one.

See

proposed § 1.965-6(c)(2).

Comments also requested that taxpayers be deemed to pay taxes when the denominator of the section 902 fraction is zero or less than zero, either

by treating the DFIC as having post-1986 undistributed earnings equal to the DFIC's post-1986 foreign income taxes, or by determining the DFIC's post-1986 undistributed earnings as of the measurement date used to determine its section 965(a) earnings amount. This comment is not adopted. The Treasury Department and the IRS have determined that the Act was not intended to alter the application of sections 902 and 960 with respect to section 965. Thus, the proposed regulations confirm that when the denominator of the section 902 fraction is zero or less than zero, no taxes are deemed paid with respect to the section 965(a) inclusion.

See

proposed § 1.965-6(c)(2);

cf.

§ 1.902-1(b)(4) (providing that no foreign income taxes are deemed paid in the case of a distribution out of current E&P that is treated as a “nimble” dividend under section 316(a)(2) when there is a deficit in accumulated E&P).

Section 965(b)(4)(B), which provides that a United States shareholder's pro rata share of the E&P of any E&P deficit foreign corporation is increased by the amount of the specified E&P deficit of such corporation taken into account by such shareholder by reason of allocation of such deficit to a DFIC, does not indicate whether that increase applies for purposes of determining the post-1986 undistributed earnings in the last taxable year of an E&P deficit foreign corporation that begins before January 1, 2018. The Treasury Department and the IRS have determined that section 965(b)(4)(B) should not apply for purposes of section 902 in that year. Therefore, the proposed regulations provide that post-1986 undistributed earnings of an E&P deficit foreign corporation are increased by reason of section 965(b)(4)(B) or proposed § 1.965-2(d)(2)(i) as of the first day of the foreign corporation's first taxable year following the E&P deficit foreign corporation's last taxable year that begins before January 1, 2018.

Comments also recommended that, to the extent that a hovering deficit is treated as reducing the post-1986 earnings and profits of a DFIC, those taxes should be added to the DFIC's post-1986 foreign income taxes in the inclusion year with respect to the DFIC. The Treasury Department and the IRS have determined that the existing rules adequately address this issue and decline to adopt this comment. The proposed regulations do not provide special rules for foreign income taxes that are related to hovering deficits; as a result, the rules in § 1.367(b)-7 continue to apply with respect to such foreign income taxes.

2. Taxes Deemed Paid in the Case of Certain Lower-Tier Corporations

A credit is allowable under section 960(a)(1) for taxes paid or accrued by a foreign corporation only if it is a member of a qualified group (as defined in section 902(b)) with respect to the domestic corporation. Section 902(b)(2) states that the term “qualified group” does not include any foreign corporation below the third tier in the chain unless the foreign corporation is a CFC and the domestic corporation is a United States shareholder with respect to it. Comments requested clarification as to whether a 10-percent corporation treated as a CFC under section 965(e)(2) for purposes of sections 951 and 961 is treated as a CFC for purposes of section 902(b).

Section 965(e)(2) applies to treat a 10-percent corporation as a CFC solely for purposes of taking into account the subpart F income of such corporation under section 965(a) and for purposes of determining the United States shareholder's pro rata share of the section 965(a) inclusion amount. The proposed regulations also treat a 10-percent corporation as a CFC for other limited purposes.

See

Part I.A of this Explanation of Provisions. However, section 965 does not modify the computation of foreign income taxes deemed paid under sections 902 and 960, or for purposes of any other Code section. Therefore, the proposed regulations clarify that a United States shareholder is not entitled to an indirect credit with respect to a 10-percent corporation that is below the third tier in a chain of foreign corporations of the United States shareholder.

See

proposed § 1.965-1(d).

D. Allocation and Apportionment of Expenses

The generally applicable rules of sections 861 through 865 and the regulations thereunder for allocating and apportioning deductions to separate categories of income described in section 904(d)(1) and § 1.904-4(m) apply for purposes of determining the foreign tax credits allowed by reason of a section 965(a) inclusion. For purposes of allocating and apportioning any deductible expense, any tax-exempt asset (and any income from such asset) is not taken into account.

See

section 864(e)(3). A similar rule applies in the case of the portion of any dividend (other than a qualifying dividend as defined in section 243(b)) equal to the deduction allowable under section 243 or 245(a) with respect to such dividend and in the case of a like portion of any stock the dividends on which would be so deductible and would not be qualifying dividends (as so defined). The proposed regulations confirm that the allowance of a deduction under section 965(c) with respect to the section 965(a) inclusion does not result in any portion of the section 965(a) inclusion being treated as exempt income. In addition, the assets to which the section 965(a) inclusion relates are not treated as exempt assets under section 864(e)(3) or § 1.861-8T(d).

The proposed regulations also confirm that section 965(a) previously taxed earnings and profits and 965(b) previously taxed earnings and profits, like all previously taxed E&P, do not give rise to exempt treatment under section 864(e)(3).

See

proposed § 1.965-6(d).

Under section 864(e)(4), for purposes of allocating and apportioning expenses on the basis of assets, the adjusted basis in stock of any nonaffiliated 10-percent owned corporation is increased by the E&P accumulated during the period the taxpayer held the stock, or reduced (but not below zero) by deficits in E&P of the corporation attributable to the stock for such period. The purpose for this adjustment is to better approximate the value of such stock.

See

Joint Committee on Tax'n, General Explanation of the Tax Reform Act of 1986 (Pub. L. 99-514) (May 4, 1987), JCS-10-87, at p.87 (adjustment to E&P “takes account of some changes in value attributable to taxpayer's equity interests in such corporations”).

In order to avoid double counting of previously taxed E&P and the basis adjustments under section 961, section 864(e)(4)(D) provides that proper adjustments must be made to the E&P of a corporation to account for previously taxed E&P and reflected in the adjusted basis of the stock.

See

Joint Committee on Tax'n, General Explanation of the Tax Reform Act of 1986 (Pub. L. 99-514) (May 4, 1987), JCS-10-87, at p.91. Section 1.861-12T(c)(2)(i)(B) provides that a taxpayer's basis in stock of a CFC shall not include any amount included in basis under section 961. At the same time, all E&P (including previously taxed E&P) generally increase the taxpayer's adjusted basis in stock of a CFC.

As a result of the enactment of section 965, the Treasury Department and the IRS recognize that the application of section 965(b)(4)(A) and (B) may warrant the issuance of special rules for the determination of adjusted basis. Furthermore, a different rule may be needed if a taxpayer has made an election under proposed § 1.965-2(f)(2) to adjust its basis to reflect the use of a specified E&P deficit. The Treasury

Department and the IRS request comments on what rules may be appropriate, including whether the rules under § 1.861-12(c)(2) should be modified.

E. Application of Section 904

The proposed regulations do not address the assignment of a section 965(a) inclusion and the related taxes to a separate category of income. The Treasury Department and the IRS have determined that the application of section 904 is clear with respect to section 951(a) inclusions regardless of whether the DFIC is a CFC or a 10-percent corporation. Furthermore, the Treasury Department and the IRS have determined that no clarification is necessary with respect to § 1.904-6 for purposes of relating the creditable portion of the foreign income taxes with respect to a section 965(a) inclusion to a separate category of income. For example, withholding tax imposed on a distribution of section 965(a) previously taxed earnings and profits and section 965(b) previously taxed earnings and profits will be related to the separate category of income to which the original section 965(a) inclusion was assigned.

See

§ 1.904-6(b)(2) and (c),

Example 7.

The Treasury Department and the IRS request comments on whether more guidance is necessary with respect to the assignment of the section 965(a) inclusion and the related taxes to a separate category or categories of income.

In addition, comments are requested on whether additional rules are needed for determining the amount of the increase in the section 904 limitation with respect to distributions of section 965(a) previously taxed earnings and profits and section 965(b) previously taxed earnings and profits, taking into account the section 965(c) deduction and the disallowed foreign taxes under section 965(g).

See

section 960(b) (effective with respect to taxable years of foreign corporations beginning before January 1, 2018, and to taxable years of United States shareholders with or within which such taxable years of those foreign corporations end) and section 960(c) for later years.

VIII. Election, Payment, and Other Special Rules

A. In General

Section 965 provides certain elections that taxpayers can make with respect to the application of section 965.

See

Parts II.K through N of the Background section of this preamble. As discussed in Part II.B.10 of this Explanation of Provisions section and in section 3.05(b) of Notice 2018-26, if the United States shareholder of a DFIC is a domestic pass-through entity and owns section 958(a) stock of the DFIC, then each domestic pass-through owner of the domestic pass-through entity will take into account its share of the section 965(a) inclusion amount with respect to the section 958(a) stock of the DFIC of the domestic pass-through entity and the section 965(c) deduction amount with respect to such amount, regardless of whether the domestic pass-through owner is itself also a United States shareholder with respect to the DFIC. The elections described in Parts II.K through N of the Background section of this preamble under sections 965(h) (the “section 965(h) election”), 965(m) (the “section 965(m) election”), and 965(n) (the “section 965(n) election”) are available to a United States shareholder of a DFIC under the terms of section 965. However, because a domestic pass-through owner will take into account its share of a section 965(a) inclusion amount (and the related section 965(c) deduction amount) whether or not it is itself a United States shareholder, the proposed regulations provide, consistent with section 3.05(b) of Notice 2018-26, that a domestic pass-through owner may make the section 965(h) election, the section 965(m) election, and the section 965(n) election.

B. Net Tax Liability Under Section 965

The proposed regulations define a new term, “total net tax liability under section 965,” which reflects the definition of net tax liability under section 965 in section 965(h)(6) with respect to a person as if the person were a United States shareholder of all DFICs with respect to which it has section 965(a) inclusions, consistent with section 3.05(c) of Notice 2018-26.

See

proposed § 1.965-7(g)(10). However, the proposed regulations provide that the dividends excluded pursuant to the second prong of the computation (the “without” prong) include dividends received directly or through a chain of ownership described in section 958(a).

See

proposed § 1.965-7(g)(10)(i)(B)(

2

).

For purposes of determining a person's total net tax liability under section 965, the proposed regulations also clarify the computation of the foreign tax credit for purposes of the amount described in section 965(h)(6)(A)(ii)(II) and proposed § 1.965-7(g)(10)(i)(B) (the net income tax liability determined without regard to section 965 and dividends from DFICs). Specifically, the proposed regulations provide that the foreign tax credits disregarded in determining net income tax determined under section 965(h)(6)(A)(ii)(II) and proposed § 1.965-7(g)(10)(i)(B) includes the credits for foreign income taxes deemed paid with respect to section 965(a) inclusions or foreign income taxes deemed paid with respect to a dividend, including a distribution that would have been treated as a dividend in the absence of section 965, as well as the credits for foreign income taxes imposed on distributions of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits made in the taxable year in which the person includes a section 965(a) inclusion in income.

C. Section 965(h) Election

The proposed regulations provide that the section 965(h) election may be made by any person with a section 965(h) net tax liability (which includes a section 958(a) U.S. shareholder or a domestic pass-through owner in a domestic pass-through entity that is a section 958(a) U.S. shareholder, but not a domestic pass-through entity itself). Under the proposed regulations, the section 965(h) election may be revoked only by paying the full amount of the unpaid section 965(h) net tax liability.

See

proposed § 1.965-7(b)(1). The proposed regulations also provide that a section 965(h) election is made with respect to the section 965(h) net tax liability of a person, which is the person's total net tax liability under section 965 reduced by the aggregate amount of the person's section 965(i) net tax liabilities, if any, with respect to which elections under section 965(i) are effective.

See

proposed § 1.965-7(g)(4).

1. Underpayment of an Installment

As noted in Part II.K of the Background section of this preamble, section 965(h)(3) provides that an addition to tax for failure to timely pay an installment required under section 965(h) is an acceleration event with respect to the unpaid portion of the remaining installments. Section 965(h)(4) provides that if a taxpayer has made an election under section 965(h), and subsequently a deficiency is assessed with respect to the taxpayer's net tax liability for purposes of section 965(h), then the amount of the deficiency will be prorated among the installments.

Comments requested clarification regarding whether the underpayment of an installment (including payment of the first installment that reflects a section 965(h) net tax liability lower than what is calculated on a tax return filed by the extended due date) would constitute an acceleration event under section 965(h)(3) or would result in the

proration under section 965(h)(4) of the difference between the section 965(h) net tax liability initially calculated and the subsequently determined section 965(h) net tax liability. The proposed regulations provide that if a person is assessed a deficiency with respect to the person's section 965(h) net tax liability, or the person timely files a return increasing the amount of its section 965(h) net tax liability above the amount taken into account in the payment of the first installment, or the person files an amended return increasing the amount of its section 965(h) net tax liability, the deficiency or additional amount will be prorated among the installments under section 965(h)(4). This proration rule does not apply if the deficiency or additional liability is due to negligence, intentional disregard of rules and regulations, or fraud with intent to evade tax, in which case, the proposed regulations clarify that the deficiency is payable on notice and demand.

See

proposed § 1.965-7(b)(1)(ii)(C).

A comment also requested guidance regarding whether an underpayment of the first installment would prevent a taxpayer from making an election under section 965(h). The proposed regulations provide that if a taxpayer makes a section 965(h) election and does not pay the correct amount for the first installment, and if the rule in the preceding paragraph applies to prorate the additional liability, the remaining installment payments due pursuant to the section 965(h) election will not be accelerated, and the taxpayer's section 965(h) election will not be affected.

See

proposed § 1.965-7(b)(1)(ii).

2. Acceleration Events

The proposed regulations provide that if a taxpayer makes a section 965(h) election, and subsequently an acceleration event described in section 965(h)(3) and proposed § 1.965-7(b)(3)(ii) occurs, the unpaid portion of all remaining installments of the taxpayer's section 965(h) net tax liability generally will be accelerated and due on the date of the event.

Proposed § 1.965-7(b)(3)(ii) lists the events treated as acceleration events for this purpose. As noted in Section II.K of the Background section of this preamble, acceleration events include an addition to tax for failure to timely pay an installment required under section 965(h), a liquidation or sale of substantially all the assets of the taxpayer (including in a title 11 or similar case), a cessation of business by the taxpayer, or any similar circumstance. The proposed regulations identify circumstances similar to those referenced in section 965(h)(3). Proposed § 1.965-7(b)(3)(ii)(B) provides that, in addition to a liquidation or sale of substantially all of the assets of a taxpayer, any exchange or other disposition of substantially all of the assets of a taxpayer constitutes an acceleration event. In addition, proposed § 1.965-7(b)(3)(ii)(D) provides that any event that results in a person no longer being a United States person (including, for example, a resident alien becoming a nonresident alien) is an acceleration event. Proposed § 1.965-7(b)(3)(ii)(E) provides that a person that was not a member of any consolidated group becoming a member of a consolidated group is treated as an acceleration event with respect to the person. Proposed § 1.965-7(b)(3)(ii)(F) provides that when a consolidated group ceases to exist, or otherwise no longer files a consolidated return, that constitutes an acceleration event.

A comment requested guidance specifying that the liquidation of a member of a consolidated group, other than the consolidated parent, would not constitute an acceleration event for purposes of section 965(h)(3). Because proposed § 1.965-8(e)(1) provides that all of the members of a consolidated group are treated as a single person for purposes of the section 965(h) election, a liquidation of one member of the group would not constitute an acceleration event for purposes of section 965(h)(3) and proposed § 1.965-7(b).

The proposed regulations provide an exception (the “eligible section 965(h) transferee exception”) pursuant to which the acceleration provisions of section 965(h)(3) and proposed § 1.965-7(b)(3)(ii) do not apply (such that the unpaid portion of all remaining installments will not be due as of the date specified therein) to a person with respect to which an acceleration event occurs if the requirements described in proposed § 1.965-7(b)(3)(iii)(A)(

1

) (describing the acceleration events eligible for this exception) and (

2

) (setting forth the terms of a required transfer agreement) are satisfied.

Generally, acceleration events eligible for this exception include (i) liquidations, sales, exchanges, or other dispositions of substantially all of the assets of a person (with the exception of, in the case of an individual, by reason of death, and with special rules applying in the case of a consolidated group), (ii) a corporation that was not a member of any consolidated group becoming a member of a consolidated group, and (iii) a consolidated group ceasing to exist by reason of acquisition and immediately joining another consolidated group. In each case, the exception applies only to the extent that the person with respect to which an acceleration event occurs (an “eligible section 965(h) transferor”) and an eligible section 965(h) transferee (generally, a United states person that is not a domestic pass-through entity and that satisfies certain requirements set forth in the proposed regulations) enter into a transfer agreement described in proposed § 1.965-7(b)(3)(iii)(B).

Generally, a transfer agreement must include various acknowledgments, representations, and information, including an agreement by the eligible section 965(h) transferee to assume the liability of the eligible section 965(h) transferor for any unpaid installment payments of the eligible section 965(h) transferor under section 965(h); an agreement that the eligible section 965(h) transferee agrees to comply with all of the conditions and requirements of section 965(h) and proposed § 1.965-7(b), as well as any other applicable requirements in the section 965 regulations; a representation that the eligible section 965(h) transferee is able to make the remaining payments required under section 965(h) and proposed § 1.965-7(b) with respect to the section 965(h) net tax liability being assumed; and, if the eligible section 965(h) transferor continues to exist immediately after the acceleration event, an acknowledgement that the eligible section 965(h) transferor and any successor to the eligible section 965(h) transferor will remain jointly and severally liable for any unpaid installment payments of the eligible section 965(h) transferor under section 965(h), including, if applicable, under § 1.1502-6.

See

proposed § 1.965-7(b)(3)(iii)(B)(

4

). The proposed regulations also provide procedural rules regarding the completion and submission of a transfer agreement, as well as rules relating to the Commissioner's review of such agreements.

See generally

proposed § 1.965-7(b)(3)(iii)(B) and (C).

3. Election Mechanics

Section 965(h)(5) provides that a section 965(h) election must be made no later than the due date (taking into account extensions, if any) for the return for the taxable year in which the taxpayer has the section 965(a) inclusions to which the section 965(h) net tax liability is attributable and must be made in the manner prescribed by the Secretary. A comment requested that taxpayers with section 965(a) inclusions be treated as having made a section 965(h) election by default. The Treasury Department and the IRS decline to adopt this comment because the statute

provides for an affirmative election, and the proposed regulations provide an extended period in which to make it. Under proposed § 1.965-7(b)(2)(ii), a section 965(h) election must be made no later than the due date taking into account extensions, if any, or any additional time that would have been granted if the person had made an extension request, without regard to whether an extension request was made. The election is made by attaching a statement, signed under penalties of perjury, to the taxpayer's return for the relevant taxable year including the taxpayer's name, taxpayer identification number, total net tax liability under section 965, section 965(h) net tax liability, section 965(i) net tax liability with respect to which a section 965(i) election is effective (if applicable), and anticipated amounts of each installment. Proposed § 1.965-7(b)(2)(iii).

4. Application to Non-Chapter 1 Taxes

Comments requested that the Treasury Department and the IRS provide that tax imposed under section 1411 on section 965(a) inclusions be payable in installments under section 965(h). However, because the definition of net income tax in section 965(h)(6)(B) refers to credits allowed under subparts A, B, and D of part IV of subchapter A of chapter 1 of subtitle A of the Code, the Treasury Department and the IRS have determined that section 965(h) applies only with respect to tax imposed under subchapter A of chapter 1 of subtitle A of the Code. Accordingly, elections may not be made under section 965(h) to pay tax imposed under other subchapters or chapters (such as, for example, the taxes imposed under sections 1411 and 4940) in eight installments.

See also

sections 55(a)(2) and 26(b)(2) (excluding the minimum tax under section 55 from the definition of regular tax).

D. Section 965(i) Election

As discussed in Part II.L of the Background section of this preamble, section 965(i) provides that a shareholder of an S corporation that is itself a United States shareholder of a DFIC may elect to defer payment of its net tax liability under section 965 with respect to such S corporation until the shareholder's taxable year which includes a triggering event with respect to such liability. The proposed regulations provide guidance regarding how an S corporation shareholder can make a section 965(i) election and, consistent with section 3.05(b) of Notice 2018-26, provide that any shareholder of an S corporation that is a United States shareholder of a DFIC, whether it owns section 958(a) stock of such DFIC or not, may make the election. However, if the S corporation is not a United States shareholder with respect to a DFIC, the shareholders of that S corporation may not make a section 965(i) election for their shares of the section 965(a) inclusion or section 965(c) deduction with respect to that DFIC.

See

proposed § 1.965-7(c) and (g)(6).

Furthermore, the proposed regulations implement the statutory reporting requirements in section 965(i)(7) until the section 965(i) net tax liability is fully assessed.

See

proposed § 1.965-7(c)(6).

1. Election Mechanics

The proposed regulations provide procedural rules regarding how an S corporation shareholder can make the section 965(i) election. A section 965(i) election must be made no later than the due date (taking into account extensions, if any) for the S corporation shareholder's return for the taxable year that includes the last day of the taxable year of the S corporation in which the S corporation has a section 965(a) inclusion to which the shareholder's section 965(i) net tax liability is attributable by attaching a statement, signed under penalties of perjury, to its return for that year. The statement must include the shareholder's name, taxpayer identification number, the name and taxpayer identification number of the S corporation with respect to which the election is made, the amount described in § 1.965-7(g)(10)(i)(A) as modified by § 1.965-1(f)-7(g)(6) for purposes of determining the section 965(i) net tax liability with respect to the S corporation, the amount described in § 1.965-7(g)(10)(i)(B), and the section 965(i) net tax liability with respect to the S corporation.

See

proposed § 1.965-7(c)(2)(ii) and (iii).

2. Triggering Events

The proposed regulations also provide rules concerning triggering events described in section 965(i)(2). An event will not be treated as a triggering event (such that a shareholder's section 965(i) net tax liability with respect to an S corporation will not be assessed as an addition to tax for the shareholder's taxable year that includes the triggering event) if the triggering event is the transfer of any share of stock of the S corporation by the shareholder (including by reason of death or otherwise), and the shareholder (an “eligible section 965(i) transferor”) and an eligible section 965(i) transferee (a United States person that is not a domestic pass-through entity) enter into a transfer agreement.

See generally

proposed § 1.965-7(c)(3)(iv);

see also

§ 1.965-7(c)(4)(iv)(B)(

4

) (setting forth the required terms of a transfer agreement).

3. Consent for Section 965(h) Election in the Event of a Triggering Event

The proposed regulations also provide rules for an S corporation shareholder to obtain the consent of the Secretary to make a section 965(h) election in the event of a triggering event that is a liquidation, sale, exchange, or other disposition of substantially all of the assets of the S corporation (including in a title 11 or similar case), a cessation of business by the S corporation, or the S corporation ceasing to exist.

See

proposed § 1.965-7(c)(3)(v)(D). To obtain consent, the shareholder intending to make the section 965(h) election must file the agreement described in proposed § 1.965-7(c)(3)(v)(D)(

4

) and must provide, with its timely-filed return for the taxable year during which the triggering event occurs (taking into account extensions, if any), the election statement for the section 965(h) election.

See

proposed § 1.965-7(c)(3)(v)(D)(

2

). For the required terms of the agreement, see generally proposed § 1.965-7(c)(3)(v)(D).

A comment requested guidance specifying that if an S corporation shareholder makes a section 965(i) election, the S corporation's income inclusion is not deferred, and the S corporation's AAA should be increased by the gross amount (and not the net amount after the application of the section 965(c) deduction). Because, by its terms, a section 965(i) election affects only the timing of assessment and payment of an S corporation shareholder's section 965(a) net tax liability and not the timing or amount of the section 965(a) inclusion of either the S corporation or the S corporation shareholder, the Treasury Department and the IRS have determined that it is not necessary that the proposed regulations provide this additional guidance. See Part V.D of this Explanation of Provisions section for a discussion of the consequences of section 965(a) inclusions and section 965(c) deductions for the AAA of an S corporation.

E. Section 965(m) Election

The proposed regulations provide procedural rules regarding how a REIT can make the section 965(m) election. A REIT makes a section 965(m) election by attaching a statement, signed under penalties of perjury, to its return for the taxable year in which it would

otherwise be required to include REIT section 965 amounts (as defined in proposed § 1.965-7(g)(2)) in gross income. The statement must include the REIT's name, taxpayer identification number, REIT section 965 amounts, and anticipated amounts of each portion of the REIT section 965 amounts to be included in each year. Proposed § 1.965-7(d)(3)(ii) and (iii). With respect to a REIT that has made the section 965(m) election, adjustments described in proposed § 1.965-2 to the E&P of any specified foreign corporations held by the REIT, and the basis of stock of a specified foreign corporation and other applicable property held by a REIT, are made as of the close of each year in which an installment is included in the gross income of the REIT. A comment requested that RICs also be allowed to make a similar election to include any amount required to be taken into account under section 951(a)(1) by reason of section 965 in eight installments. This comment is not adopted because the statute provides the election solely for REITs.

For the reasons discussed in Part VIII.A of this Explanation of Provisions section, the proposed regulations also provide that no section 965(a) inclusions of a REIT are taken into account as gross income for purposes of section 856(c)(2) and (3), regardless of whether the REIT is a United States shareholder with respect to the DFIC with respect to which it has a section 965(a) inclusion. See section 965(m)(1)(A) and proposed § 1.965-7(d)(6).

F. Section 965(n) Election

As discussed in Part II.N of the Background section of this preamble, section 965(n) provides that a United States shareholder of a DFIC may elect to exclude the amount described in section 965(n)(2) from the determination of the amount of the NOL deduction under section 172 of such shareholder for such taxable year or the amount of taxable income for such taxable year which may be reduced by NOL carryovers or carrybacks to such taxable year under section 172. The proposed regulations provide procedural rules regarding how a taxpayer may make the section 965(n) election, clarify the effect of the election, and provide that the election is irrevocable.

1. Scope of Election

As discussed in section 3.05(d) of Notice 2018-26, comments have requested clarification regarding the scope of the section 965(n) election as a result of the use of the term “deduction” in section 965(n)(1)(A). An NOL “deduction” for a taxable year generally refers to the amount of an NOL carried to such taxable year from a prior or subsequent year rather than the NOL arising from such year.

Compare

section 172(a) and (c). However, interpreting “deduction” in section 965(n)(1)(A) to refer to carryovers or carrybacks to the taxable year (and not the NOL for the taxable year) would cause that paragraph to be duplicative of section 965(n)(1)(B), which already provides that amounts described in section 965(n)(2) are disregarded for purposes of applying NOL carryovers or carrybacks to such taxable year under section 172. The Treasury Department and the IRS have determined that section 965(n)(1)(A) was intended to apply to a different set of losses than those to which section 965(n)(1)(B) applies. A comment also requested clarification regarding whether taxpayers could make the section 965(n) election for only a portion of their NOLs. The Treasury Department and the IRS have determined that the election was intended to apply to the NOL amount in its entirety. Accordingly, the proposed regulations provide that if a section 965(n) election is made for a taxable year, the election applies to NOLs for the taxable year for which the election is made as well as the NOL carryovers or carrybacks to such taxable year, each in their entirety.

See

proposed § 1.965-7(e)(1)(iii).

A comment also requested clarification regarding whether consolidated groups could make the section 965(n) election. The proposed regulations clarify that the section 965(n) election also applies to all components of the consolidated NOL deduction (as defined in § 1.1502-21(a)).

Id.

2. Election Mechanics

A person makes a section 965(n) election by attaching a statement, signed under penalties of perjury, to its return for the taxable year (taking into acc

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