Guidance Related to Section 951A (Global Intangible Low-Taxed Income) and Certain Guidance Related to Foreign Tax Credits

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9866]

RIN 1545-BO54; 1545-BO62

Guidance Related to Section 951A (Global Intangible Low-Taxed Income) and Certain Guidance Related to Foreign Tax Credits

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final and temporary regulations.

SUMMARY:

This document contains final regulations that provide guidance to determine the amount of global intangible low-taxed income included in the gross income of certain United States shareholders of foreign corporations, including United States shareholders that are members of a consolidated group. This document also contains final regulations relating to the determination of a United States shareholder's pro rata share of a controlled foreign corporation's subpart F income included in the shareholder's gross income, as well as certain reporting requirements relating to inclusions of subpart F income and global intangible low-taxed income. Finally, this document contains final regulations relating to certain foreign tax credit provisions applicable to persons that directly or indirectly own stock in foreign corporations.

DATES:

Effective date:

These regulations are effective on June 21, 2019.

Applicability dates:

For dates of applicability, see §§ 1.78-1(c), 1.861-12(k), 1.951-1(i), 1.951A-7, 1.1502-51(g), 1.6038-2(m), and 1.6038-5(e).

FOR FURTHER INFORMATION CONTACT:

Concerning the regulations §§ 1.951-1, 1.951A-0 through 1.951A-7, 1.6038-2, and 1.6038-5, Jorge M. Oben at (202) 317-6934; concerning the regulations §§ 1.951A-1(e) and 1.951A-3(g), Jennifer N. Keeney at (202) 317-5045; concerning the regulations §§ 1.1502-12, 1.1502-32, and 1.1502-51, Katherine H. Zhang at (202) 317-6848 or Kevin M. Jacobs at (202) 317-5332; concerning the regulations §§ 1.78-1, 1.861-12, 1.861-12T, and 1.965-7, Karen J. Cate at (202) 317-6936 (not toll free numbers).

SUPPLEMENTARY INFORMATION:

Background

Section 951A was added to the Internal Revenue Code (the “Code”)

1

by the Tax Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054, 2208 (2017) (the “Act”), which was enacted on December 22, 2017. On October 10, 2018, the Department of the Treasury (“Treasury Department”) and the IRS published proposed regulations (REG-104390-18) under sections 951, 951A, 1502, and 6038 in the

Federal Register

(83 FR 51072) (the “proposed regulations”). A public hearing on the proposed regulations was held on February 13, 2019. The Treasury Department and the IRS also received written comments with respect to the proposed regulations.

1

Except as otherwise stated, all section references in this preamble are to the Internal Revenue Code.

In addition, on December 7, 2018, the Treasury Department and the IRS published proposed regulations (REG-105600-18) relating to foreign tax credits in the

Federal Register

(83 FR 63200) (“foreign tax credit proposed regulations”). A public hearing on these regulations was scheduled for March 14, 2019, but it was not held because there were no requests to speak. However, the Treasury Department and the IRS received written comments with respect to the foreign tax credit proposed regulations. Certain rules in the foreign tax credit proposed regulations are being finalized in this Treasury decision to ensure that the applicability dates of these rules coincide with the applicability dates of the statutory provisions to which they relate. See section 7805(b)(2). The rules being finalized relate to §§ 1.78-1, 1.861-12(c)(2), and 1.965-7(e). See part XI of the Summary of Comments and Explanation of Revisions section.

Comments outside the scope of this rulemaking are generally not addressed but may be considered in connection with future guidance projects. In this regard, the Treasury Department and the IRS expect that future guidance will address issues concerning the allocation and apportionment of expenses in order to determine a taxpayer's foreign tax credit limitation under section 904. All written comments received in response to the proposed regulations and the foreign tax credit proposed regulations are available at

www.regulations.gov

or upon request. Terms used but not defined in this preamble have the meaning provided in these final regulations.

Summary of Comments and Explanation of Revisions

I. Overview

The final regulations retain the basic approach and structure of the proposed regulations and foreign tax credit proposed regulations, with certain revisions. This Summary of Comments and Explanation of Revisions section discusses those revisions as well as comments received in response to the solicitation of comments in the notices of proposed rulemaking accompanying those regulations.

II. Comments and Revisions to Proposed § 1.951-1—Amounts Included in Gross Income of United States Shareholders

A. Hypothetical Distribution of Allocable E&P

A United States shareholder (“U.S. shareholder”) who owns stock of a foreign corporation on the last day of the foreign corporation's taxable year on which the foreign corporation is a controlled foreign corporation (“CFC”) includes in gross income its “pro rata share” of the CFC's subpart F income (as defined in section 952) for the taxable year. See section 951(a)(1) and § 1.951-1(a). In general, a U.S. shareholder's pro rata share of subpart F income is determined based on its proportionate share of a hypothetical distribution of all the current earnings and profits (“E&P” and “current E&P”) of the CFC. See section 951(a)(2)(A) and § 1.951-1(b)(1)(i) and (e)(1). A U.S. shareholder's pro rata share of tested income (as defined in section 951A(c)(2)(A) and § 1.951A-2(b)(1)), tested loss (as defined in section 951A(c)(2)(B)(i) and § 1.951A-2(b)(2)), qualified business asset investment (“QBAI”) (as defined in section 951A(d)(1) and § 1.951A-3(b)), tested interest expense (as defined in § 1.951A-4(b)(1)), and tested interest income (as defined in § 1.951A-4(b)(2)) (each a “tested item”) generally are also determined based on a hypothetical distribution of current E&P, with certain modifications to account for the differences between each tested item and subpart F income. See section 951A(e)(1) and § 1.951A-1(d).

For purposes of the hypothetical distribution, the proposed regulations define “current E&P” for a taxable year as the greater of (i) the E&P of the corporation for the taxable year determined under section 964, or (ii) the sum of the subpart F income (as determined under section 952, as increased under section 951A(c)(2)(B)(ii) and proposed § 1.951A-6(d)) and the tested income of

the corporation for the taxable year. See proposed § 1.951-1(e)(1)(ii). One comment asserted that using the term “current earnings and profits” for this purpose is confusing because the definition differs significantly from the definition of “earnings and profits” provided in section 964(a), and therefore suggested using a different term for this purpose. In response to this comment, the final regulations replace the term “current earnings and profits” with “allocable earnings and profits” (“allocable E&P”).

B. Pro Rata Share Anti-Abuse Rule

The proposed regulations provide that any transaction or arrangement that is part of a plan a principal purpose of which is the avoidance of Federal income taxation, including, but not limited to, a transaction or arrangement to reduce a U.S. shareholder's pro rata share of the subpart F income of a CFC, which transaction or arrangement would otherwise avoid Federal income taxation, is disregarded in determining such U.S. shareholder's pro rata share of the subpart F income of the corporation (the “pro rata share anti-abuse rule”). See proposed § 1.951-1(e)(6). The pro rata share anti-abuse rule also applies in determining the pro rata share of each tested item of a CFC for purposes of determining a U.S. shareholder's global intangible low-taxed income (“GILTI”) inclusion amount under section 951A(a) and § 1.951A-1(b). See id.

Several comments suggested that the pro rata share anti-abuse rule is overbroad and could be interpreted to apply to nearly all transactions, arrangements, or tax elections that reduce the pro rata share amounts of a U.S. shareholder. In particular, comments noted that, under one interpretation of the rule, a U.S. shareholder that disposes of CFC stock could be required indefinitely to include its “pro rata share” of the CFC's subpart F income or tested items with respect to such stock. These comments recommended that the final regulations clarify the scope of the rule and, in particular, provide that the rule applies only to reallocate subpart F income and tested items of a CFC as of a hypothetical distribution date among persons that own, directly or indirectly, shares of the CFC on such date. According to these comments, the rule, as narrowed in this manner, could not apply to cause a U.S. person that disposes of stock of a CFC before a hypothetical distribution date to be treated as having a pro rata share of the CFC's subpart F income or tested items as of such date by reason of such stock.

The Treasury Department and the IRS agree that the scope of the pro rata share anti-abuse rule should be clarified. Accordingly, the final regulations clarify that the rule applies only to require appropriate adjustments to the allocation of allocable E&P that would be distributed in a hypothetical distribution with respect to any share outstanding as of the hypothetical distribution date. See § 1.951-1(e)(6). Thus, under the rule, if applicable, adjustments will be made solely to the allocation of allocable E&P in the hypothetical distribution between shareholders that own, directly or indirectly, stock of the CFC as of the relevant hypothetical distribution date. As clarified, the rule will not apply to adjust the allocable E&P allocated to a shareholder by reason of a transfer of CFC stock, except by reason of a change to the distribution rights with respect to stock in connection with such transfer (for example, an issuance of a new class of stock, including by recapitalization).

Other comments suggested that the final regulations limit the pro rata share anti-abuse rule to transactions or arrangements that lack economic substance or are artificial, or only to transactions or arrangements that result in non-economic allocations that shift subpart F income or tested items away from a U.S. shareholder. One comment suggested that the rule should apply only to enumerated transactions identified by the Treasury Department and the IRS as being abusive, and another comment suggested that the regulations should include examples illustrating transactions to which the pro rata share anti-abuse rule would or would not apply.

The Treasury Department and the IRS do not adopt these recommendations. Transactions that lack economic substance or are artificial would typically be disregarded under general tax principles, and non-economic allocations would generally be addressed through the facts and circumstances approach of § 1.951-1(e)(3) (as discussed in part II.C of this Summary of Comments and Explanation of Revisions section), such that limiting the pro rata share anti-abuse rule in the manner recommended could render it superfluous. Moreover, the concerns underlying the rule may arise in non-artificial transactions, or transactions with substance, that would be respected under general tax principles. In addition, attempting to specifically identify all the transactions covered by the rule or to specify such transactions by example would be impractical and inconsistent with one of the purposes underlying any anti-avoidance rule—that is, to deter the development and implementation of new transactions or arrangements intended to avoid the operative rule.

Another comment recommended an exception to the pro rata share anti-abuse rule for transactions entered into with unrelated parties and for transactions entered into with related parties located in the same country of tax residence as the relevant CFC. The comment also recommended a “small business” exception for U.S. shareholders with worldwide gross receipts under $25 million. The Treasury Department and the IRS have determined that the policy concerns underlying the rule can be implicated by transactions that involve unrelated parties, such as accommodation parties (for instance, a financial institution) that hold stock with certain distribution rights in order to reduce an unrelated U.S. shareholder's pro rata share of subpart F income or tested items. Further, these concerns can arise regardless of whether the parties involved are located in the same country of tax residence as the CFC. Finally, the Treasury Department and the IRS have concluded that the level of gross receipts of the shareholders is not relevant to, and therefore does not justify, an exception to the rule. Any administrative burden on small businesses would not stem from the rule itself but rather from engaging in a transaction a principal purpose of which is to avoid Federal income taxation. Accordingly, these recommendations are not adopted.

C. Facts and Circumstances Approach

Section 1.951-1(e)(3)(ii) of the existing regulations provides special rules applicable to CFCs with two or more classes of stock with discretionary distribution rights. Under these rules, the allocation of current E&P is primarily based on the relative fair market value of the stock with discretionary distribution rights. The preamble to the proposed regulations notes that this fair market value allocation method had been the basis of certain attempted avoidance structures. Accordingly, the proposed regulations adopt a facts and circumstances approach in allocating current E&P in a hypothetical distribution between multiple classes of stock, including stock with discretionary distribution rights. See proposed § 1.951-1(e)(3). The proposed regulations provide that, where appropriate, the relative fair market value of the stock may still be taken into account, but as one of several factors, none of which is dispositive. See id.

A comment asserted that the facts and circumstances approach set forth in the proposed regulations is a vague and subjective standard that would create uncertainty, while the fair market value approach in the existing regulations for stock with discretionary distribution rights is a long-standing and objective standard. The comment further noted that the preamble to the 2005 Treasury decision that adopts the fair market value approach specifically rejects the facts and circumstances approach, stating that “the interests of sound tax policy and administration are served by requiring the value-based allocation.” TD 9222, 70 FR 49864 (August 25, 2005). The comment recommended that the fair market value approach be retained in the final regulations, in lieu of the proposed facts and circumstances approach, for purposes of determining the pro rata share of subpart F income and tested items.

The Treasury Department and the IRS have determined, based on experience administering the fair market value approach, that a facts and circumstances approach, in which the fair market value of stock is relevant but not determinative, would be a more reliable method for determining a U.S. shareholder's pro rata share of subpart F income (and tested items) than the fair market value approach. While fair market value is easily determinable for publicly traded stock, determining the fair market value of privately-held stock is more difficult and typically requires a determination of the stock's rights to distributions of current and accumulated E&P and capital, as well as the voting rights with respect to such stock. In contrast, under section 951(a)(2) and § 1.951-1(b)(1), a shareholder's pro rata share of subpart F income is determined based solely on a hypothetical distribution of subpart F income for the taxable year. Furthermore, the amount of subpart F income treated as distributed in the hypothetical distribution is determined under § 1.951-1(e) based on a distribution of allocable E&P. Thus, the most relevant attribute of any share of CFC stock for purposes of the hypothetical distribution is its economic rights with respect to the allocable E&P of the CFC, which is generally determined by reference to its current E&P. Generally, a share's voting rights, rights to distributions of E&P accumulated before the current year, and rights to capital, all of which are also taken into account in determining fair market value, are not relevant to the hypothetical distribution of allocable E&P, and therefore a fair market value approach can distort the determination required under section 951(a)(2) and § 1.951-1(b)(1). A more flexible facts and circumstances approach that considers fair market value as a factor can also take into account other factors related to the expected distributions of allocable E&P with respect to such stock, without taking into account capital liquidation rights and other factors that are not relevant to the distribution of allocable E&P. Accordingly, the final regulations do not adopt this recommendation.

D. Modifications to Example 4

The proposed regulations provide that no amount of current E&P is distributed in the hypothetical distribution with respect to a particular class of stock to the extent that a distribution of such amount would constitute a redemption of stock (even if the redemption would be treated as a dividend under sections 301 and 302(d)), a distribution in liquidation, or a return of capital. See proposed § 1.951-1(e)(4)(i). The proposed regulations include an example to illustrate the application of this rule. See proposed § 1.951-1(e)(7)(v)

Example 4.

A comment asserted that proposed § 1.951-1(e)(4)(i) and the example illustrating the rule are confusing because, given the definition of current E&P in the proposed regulations, the hypothetical distribution would typically not give rise to a return of capital (other than through a redemption).

This rule is not intended to refer to the consequences of the hypothetical distribution itself (for example, the extent to which it could give rise to a return of capital), but rather is intended to provide that terms of the stock or related agreements and arrangements that could give rise to redemptions, liquidations, or returns of capital if actually exercised (or otherwise taken into account) are not taken into account for purposes of the hypothetical distribution. The final regulations and the related example are clarified to reflect this intent. See § 1.951-1(e)(4)(i) and § 1.951-1(e)(7)(v)

Example 4.

Similarly, the final regulations clarify that the facts and circumstances taken into account in determining the distribution rights of a class of stock do not include actual distributions (or any amount treated as a dividend) made during the taxable year that includes the hypothetical distribution date. See § 1.951-1(e)(3). Such distributions (or dividends) are not relevant in determining a class of stock's economic rights and interest in the allocable E&P (which are not reduced by actual distributions during the taxable year) as of the hypothetical distribution date.

E. Application of Section 951(a)(2)(B) to Subpart F Income and Tested Income in the Same Taxable Year

Under section 951(a)(2)(B), a U.S. shareholder's pro rata share of subpart F income with respect to stock for a taxable year (as determined under section 951(a)(2)(A)) is reduced by the amount of distributions received by any other person during the year as a dividend with respect to the stock, subject to a limitation based on the period of the taxable year in which the shareholder owned the stock within the meaning of section 958(a). Section 951A(e)(1) provides that the pro rata share of tested income, tested loss, and QBAI is determined under the rules of section 951(a)(2) in the same manner as such section applies to subpart F income. Accordingly, the proposed regulations provide that a U.S. shareholder's pro rata share of tested income is determined under section 951(a)(2) and § 1.951-1(b) and (e), generally substituting “tested income” for “subpart F income” each place it appears. See proposed § 1.951A-1(d)(2).

Because section 951(a)(2)(B) applies for purposes of determining the pro rata share of both subpart F income and tested income, the proposed regulations could be interpreted as permitting a dollar-for-dollar reduction under section 951(a)(2)(B) in both a U.S. shareholder's pro rata share of subpart F income and its pro rata share of tested income. The Treasury Department and the IRS have determined that this would be an inappropriate double benefit that is not contemplated under section 951(a)(2)(B) and section 951A(e)(1). Accordingly, the regulations under section 951(a)(2)(B) are revised to clarify that a dividend received during the taxable year by a person other than the U.S. shareholder reduces the U.S. shareholder's pro rata share of subpart F income and its pro rata share of tested income in the same proportion as its pro rata share of each amount bears to its aggregate pro rata share of both amounts. See § 1.951-1(b)(1)(ii).

The examples in § 1.951-1(b)(2) are modified solely to illustrate the application of the revised rule in § 1.951-1(b)(1) and to conform to the terminology in the final regulations. The Treasury Department and the IRS are studying the application of section 951(a)(2)(A) and (B) in certain cases that may lead to inappropriate results, for example, due to the concurrent application of the provisions. In addition, the Treasury Department and the IRS are studying the application of

section 951(a)(2)(B) with respect to dividends paid to foreign persons, dividends that give rise to a deduction under section 245A(a), and dividends paid on stock after the disposition of such stock by a U.S. shareholder. Comments are requested in this regard.

F. Revisions to Cumulative Preferred Stock Rule

The proposed regulations provide a special rule applicable to preferred shares with accrued but unpaid dividends that do not compound annually at or above the applicable Federal rate (“AFR”) under section 1274(d)(1) (“cumulative preferred stock rule”). See proposed § 1.951-1(e)(4)(ii). If the cumulative preferred stock rule applies with respect to stock, the current E&P allocable to the stock may not exceed the amount of dividends actually paid during the taxable year with respect to the stock plus the present value of the unpaid current dividends with respect to the stock determined by using the AFR that applies on the date the stock is issued for the term from such issue date to the mandatory redemption date and assuming the dividends will be paid at the mandatory redemption date. See id.

A comment stated that it is unclear whether the applicability of the cumulative preferred stock rule is determined based on the AFR as of the issuance date or, alternatively, the AFR for the current year. The comment suggested that, because the amount of the preferred dividend determined under the cumulative preferred stock rule is based on the AFR as of the issue date, for consistency, the applicability of the rule should be determined by reference to the AFR as of the issue date as well. The Treasury Department and the IRS agree with this comment, and the final regulations are revised accordingly. See § 1.951-1(e)(4)(ii).

The proposed regulations provide that the amount of any arrearage on cumulative preferred stock is determined taking into account the time value of money principles in the cumulative preferred stock rule. See proposed § 1.951-1(e)(4)(iii). A comment recommended that the rule be clarified to reference the calculation of the present value of the unpaid current dividends described in the cumulative preferred stock rule. The Treasury Department and the IRS agree with this comment, and the final regulations are revised accordingly. See § 1.951-1(e)(4)(iii).

The proposed regulations contain a special rule for purposes of sections 951 through 964 to treat a controlled domestic partnership as a foreign partnership to determine stock ownership in a CFC by a U.S. person for purposes of section 958(a) if certain conditions are met. See proposed § 1.951-1(h). A comment suggested that because the proposed regulations define a “controlled domestic partnership” by reference to a specific U.S. shareholder, the rule could be read to apply only with respect to that shareholder but not with respect to other partners of the controlled domestic partnership, for which the partnership would therefore still be treated as domestic. The comment requested that the final regulations clarify that the treatment as a foreign partnership is with respect to all partners of the partnership. The rule, if applicable, is intended to treat a domestic partnership as a foreign partnership with respect to all its partners. The final regulations revise the definition of controlled domestic partnership to clarify the scope of the rule. See § 1.951-1(h)(2); see also § 1.965-1(e)(2). A change is also made to § 1.951-1(h) to conform to the change in the final regulations to the treatment of domestic partnerships for purposes of section 951A. See part VII.C of this Summary of Comments and Explanation of Revisions section.

Finally, certain regulations have been revised to reflect the repeal of section 954(f) (regarding foreign base company shipping income) and section 955 (regarding foreign investments in less developed countries). See Public Law 108-357, 415(a)(2) (2004) and Public Law 115-97, 14212(a) (2017). The Treasury Department and the IRS intend to revise other regulations to reflect the repeal of these provisions in future guidance projects.

III. Comments and Revisions to Proposed § 1.951A-1—General Provisions

A. CFC Inclusion Date

The proposed regulations provide that, for purposes of determining the GILTI inclusion amount of a U.S. shareholder for a U.S. shareholder inclusion year, the U.S. shareholder takes into account its pro rata share of a tested item with respect to a CFC for the U.S. shareholder inclusion year that includes a CFC inclusion date with respect to the CFC. See proposed § 1.951A-1(d)(1). Under the proposed regulations, the term “U.S. shareholder inclusion year” means a taxable year of a U.S. shareholder that includes a CFC inclusion date of a CFC of the U.S. shareholder, the term “CFC inclusion date” means the last day of a CFC inclusion year on which a foreign corporation is a CFC, and the term “CFC inclusion year” means any taxable year of a foreign corporation beginning after December 31, 2017, at any time during which the corporation is a CFC. See proposed § 1.951A-1(e)(1), (2) and (4).

Several comments noted that, under certain circumstances, the requirement that a U.S. shareholder take into account its pro rata share of a CFC's tested items for a U.S. shareholder inclusion year that includes a CFC inclusion date could have the effect of requiring a U.S. shareholder to take into account its pro rata share of the CFC's tested items for a U.S. shareholder inclusion year that does not include the last day of the CFC inclusion year. This could happen, for instance, if a U.S. person with a taxable year ending December 31, 2019, sells a wholly-owned foreign corporation with a taxable year ending November 30, 2020, to a foreign person on December 1, 2019 and, as a result of the sale, the foreign corporation ceases to be a CFC; in that case, under the proposed regulations, the CFC inclusion date with respect to the foreign corporation would be December 1, 2019, whereas the CFC inclusion year of the foreign corporation would not end until November 30, 2020. The comments raised several concerns, in particular, that the U.S. person in this example would be unable to determine its pro rata share of any tested item of the foreign corporation as of December 31, 2019, since the foreign corporation's tested items could not be determined until November 30, 2020. The comments also noted that the proposed regulations' definition of CFC inclusion date was inconsistent with section 951A(e)(1), which provides that the pro rata share of certain amounts is taken into account in the taxable year of the U.S. shareholder in which or with which the taxable year of the CFC ends. The comments recommended that the relevant definitions be revised to accord with section 951A(e)(1).

The Treasury Department and the IRS agree with these comments. Accordingly, the final regulations provide that a U.S. shareholder takes into account its pro rata share of a tested item of a CFC in the U.S. shareholder inclusion year that includes the last day of the CFC inclusion year. See § 1.951A-1(d)(1). However, consistent with sections 951(a)(2) and 951A(e)(1), a U.S. shareholder's pro rata share of each tested item of a CFC is still determined based on the section 958(a) stock owned by the shareholder on the last day of the CFC's taxable year on which it is a CFC (the “hypothetical distribution date”). See §§ 1.951-1(e)(1)(i) and 1.951A-1(f)(3). The term “hypothetical distribution date” in the final regulations has the same meaning as the

term “CFC inclusion date” in the proposed regulations.

B. Pro Rata Share of Certain Tested Items

1. Pro Rata Share of QBAI

The proposed regulations provide that, in general, a U.S. shareholder's pro rata share of the QBAI of a tested income CFC is proportionate to the U.S. shareholder's pro rata share of the tested income of the tested income CFC for the CFC inclusion year. See proposed § 1.951A-1(d)(3)(i). However, the proposed regulations provide that, to the extent the amount of a tested income CFC's QBAI is greater than ten times its tested income for the year (that is, the point at which the shareholder's deemed tangible income return (“DTIR”) attributable to the QBAI would fully offset its pro rata share of the tested income CFC's tested income), the excess QBAI is allocated solely to common shares (and not to preferred shares) (the “excess QBAI rule”). See proposed § 1.951A-1(d)(3)(ii). The excess QBAI rule is intended to ensure that a shareholder cannot obtain an increase in its DTIR by reason of preferred stock that exceeds the increase in its aggregate pro rata share of tested income from the ownership of the stock. Without the excess QBAI rule, U.S. persons would be incentivized to acquire debt-like preferred stock of CFCs that have significant amounts of QBAI and minimal tested income in order to effectively exempt some or all of the U.S. person's pro rata shares of tested income from other CFCs from taxation under section 951A. The preamble to the proposed regulations requested comments on the approach in the proposed regulations, including the excess QBAI rule, for determining a U.S. shareholder's pro rata share of a CFC's QBAI.

The only comment received with respect to the QBAI allocation approach in the proposed regulations agreed that it was appropriate to limit the allocation of QBAI to a preferred shareholder, because the debt-like claim that a preferred shareholder has on a CFC should not entitle it to an amount of QBAI that could be used to effectively exempt tested income of the shareholder's other CFCs. The comment noted that, in cases where a CFC has minimal tested income and substantial QBAI, the approach in the proposed regulations could result in a common shareholder receiving a pro rata share of QBAI that is disproportionate to its pro rata share of tested income, but acknowledged that this effect would be reversed in future years when the CFC generates more tested income.

The Treasury Department and the IRS agree with the comment that the approach in the proposed regulations achieves the correct result over a multi-year period. Accordingly, the final regulations generally adopt the QBAI allocation rule of the proposed regulations, with certain modifications to the excess QBAI rule to better effectuate the purposes of the rule. Specifically, the final regulations provide that, in the case of a tested income CFC with tested income that is less than ten percent of its QBAI (the tested income CFC's “hypothetical tangible return”), a shareholder's pro rata share of QBAI is determined based on the shareholder's pro rata share of this hypothetical tangible return. See § 1.951A-1(d)(3)(ii)(A) and (C). A U.S. shareholder's pro rata share of the hypothetical tangible return is determined under the rules for determining the shareholder's pro rata share of tested income, for this purpose treating the hypothetical tangible return as tested income. See § 1.951A-1(d)(3)(ii)(B). In most cases, the excess QBAI rule in the final regulations will produce the same results as the excess QBAI rule in the proposed regulations. However, unlike the excess QBAI rule in the proposed regulations, the application of the excess QBAI rule in the final regulations is not limited to preferred stock.

2

Further, with respect to common stock, by untethering the allocation of excess QBAI from the allocation of tested income, and instead applying a hypothetical distribution model to the excess QBAI, the rule ensures that the reduction under section 951(a)(2)(B) and § 1.951A-1(b)(1)(ii) to a U.S. shareholder's pro rata share of tested income does not result in an excessive reduction to the U.S. shareholder's pro rata share of QBAI. See § 1.951A-1(d)(3)(iii)(C)

Example 3.

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When the excess QBAI rule in the final regulations applies to a CFC with preferred stock, the increase to the preferred shareholder's DTIR by reason of the preferred stock generally will be limited to an amount equal to its pro rata share of tested income, consistent with the purpose of the rule in the proposed regulations. This is the case because the formula for determining the preferred shareholder's pro rata share of QBAI (that is, multiplying the CFC's QBAI by the ratio that such shareholder's pro rata share of the hypothetical tangible return bears to the CFC's total hypothetical tangible return) will yield a product that equals 10 times that shareholder's pro rata share of tested income. For an illustration, see § 1.951A-1(d)(3)(iii)(B)

Example 2.

One comment recommended that the final regulations allocate QBAI to convertible preferred stock or participating preferred stock by bifurcating the stock into preferred stock (to the extent of the dividend and liquidation preference) and common stock (to the extent that the participation right is “in the money”), and then allocating QBAI to each component separately. This issue has been mooted because the determination of a U.S. shareholder's pro rata share of QBAI no longer depends on whether the stock owned by the shareholder is common or preferred. Accordingly, the final regulations do not adopt this recommendation.

Finally, for the avoidance of doubt, the final regulations clarify that the aggregate amount of any tested item (including QBAI) of a CFC for a CFC inclusion year allocated to the CFC's stock cannot exceed the amount of such tested item of the CFC for the CFC inclusion year. See § 1.951A-1(d)(1).

2. Pro Rata Share of Tested Loss

The proposed regulations provide that a CFC's tested loss is allocated based on a hypothetical distribution of an amount of current E&P equal to the amount of tested loss, except that, in general, tested loss is allocated only to common stock. See proposed § 1.951A-1(d)(4)(i)(C). The general rule that tested loss is allocated only to common stock is subject to two exceptions. First, the proposed regulations allocate tested loss to preferred shares to the extent the tested loss reduces the E&P accumulated since the issuance of those preferred shares to an amount below the amount necessary to satisfy any accrued but unpaid dividends with respect to such preferred shares. See proposed § 1.951A-1(d)(4)(ii). Second, when the common stock has no liquidation value, the proposed regulations allocate tested loss to classes of preferred stock with liquidation value in reverse order of priority. See proposed § 1.951A-1(d)(4)(iii). These two exceptions result in tested loss allocations corresponding to changes in the economic value of the CFC stock. The preamble to the proposed regulations requested comments on the proposed approach for determining a U.S. shareholder's pro rata share of a CFC's tested loss, including how (or whether) to allocate tested loss of a CFC when no class of CFC stock has positive liquidation value.

Comments were supportive of the approach taken in the proposed regulations to determine pro rata shares of tested loss because the approach avoids complexity, minimizes the potential for abusive allocations of tested loss, and is consistent with the economic reality that common stock generally bears the risk of loss before preferred stock. One comment that was

supportive of the approach in the proposed regulations suggested a possible alternative approach of allocating tested loss to preferred shares to the extent the preferred shares were allocated subpart F income. However, the comment noted that the approach of the proposed regulations is simpler and that the suggested approach would require additional rules to ensure that corresponding allocations of tested income were made in future periods to the preferred shares to reflect an actual payment of a dividend to the preferred shares. The Treasury Department and the IRS agree with the comment that the approach for allocating tested loss in the proposed regulations is simpler and that the suggested approach would require adjustments to the pro rata share rules for tested income as well, resulting in more complex tracking of previous year pro rata allocations for CFCs and their shareholders to determine current year allocations. Accordingly, the suggestion is not adopted.

One comment recommended that if no class of stock has liquidation value, the tested loss should be allocated first to any shareholders that hold guaranteed debt of the CFC, and then to the most senior class of common stock, unless another class of stock will in fact bear the economic loss. The Treasury Department and the IRS have determined, based on experience with pro rata share rules in the subpart F context, that the facts and circumstances approach provides a flexible and appropriate allocation of tested loss, including in cases where no class of stock has liquidation value. Therefore, this comment is not adopted.

IV. Comments and Revisions to Proposed § 1.951A-2—Tested Income and Tested Loss

A. Determination of Gross Income and Allowable Deductions

For purposes of determining tested income or tested loss, gross tested income is reduced by deductions (including taxes) properly allocable to the gross tested income (or which would be properly allocable to gross tested income if there were such gross income) under rules similar to the rules of section 954(b)(5). See section 951A(c)(2)(A)(ii). The proposed regulations provide that, for purposes of determining tested income and tested loss, the gross income and allowable deductions of a CFC for a CFC inclusion year are determined under the rules of § 1.952-2 for determining the subpart F income of a CFC. See proposed § 1.951A-2(c)(2). Section 1.952-2 provides rules for determining gross income and taxable income of a foreign corporation. For this purpose, and subject to certain exceptions, these rules generally treat foreign corporations as domestic corporations. See § 1.952-2(a)(1) and (b)(1).

The preamble to the proposed regulations requested comments on the application of § 1.952-2 for purposes of determining subpart F income, tested income, and tested loss, including whether other approaches for determining tested income and tested loss, or whether additional modifications to § 1.952-2 for purposes of calculating tested income and tested loss, would be appropriate. Several comments were received in response to this request. The comments generally supported applying § 1.952-2 for purposes of determining tested income. However, a number of comments requested modifications to, or clarifications regarding, the application of § 1.952-2. Some comments suggested that § 1.952-2 be revised for purposes of determining tested income and tested loss to allow the use of net operating loss carryforwards under section 172 and net capital losses subject to limits under section 1212. Another comment requested that the Treasury Department and the IRS provide a list of specific deductions allowed to a CFC that would be disallowed to a domestic corporation, such as under section 162(m) or 280G. The same comment requested clarification that carryforwards of a CFC's disallowed interest deduction under section 163(j)(2) are not subject to any limitation or restrictions. Several comments suggested that section 245A should apply to determine a CFC's subpart F income and tested income and tested loss under § 1.952-2. There is also a concern that § 1.952-2 could be interpreted so expansively as to entitle a CFC to a deduction expressly limited to domestic corporations, such as a deduction under section 250.

The Treasury Department and the IRS intend to address issues related to the application of § 1.952-2, taking into account these comments, in connection with a future guidance project. This guidance is expected to clarify that, in general, any provision that is expressly limited in its application to domestic corporations, such as section 250, does not apply to CFCs by reason of § 1.952-2. The Treasury Department and the IRS continue to study whether, and to what extent, section 245A should apply to dividends received by a CFC and welcome comments on this subject.

Section 1.952-2(b)(2) provides that the taxable income of a CFC engaged in the business of reinsuring or issuing insurance or annuity contracts and which, if it were a domestic corporation engaged in such business, would be taxable as a life insurance company to which subchapter L applies, is generally determined by treating such corporation as a domestic corporation taxable under subchapter L and by applying the principles of §§ 1.953-4 and 1.953-5 for determining taxable income. These regulations, which were promulgated in 1964, have not been updated to reflect current sections 953(a), 953(b)(3), and 954(i). A comment requested that the final regulations confirm that the rules of current sections 953 and 954(i) apply in determining the tested income or tested loss of a CFC described in § 1.952-2(b)(2). The Treasury Department and the IRS agree that the tested income or tested loss of a CFC described in § 1.952-2(b)(2) is calculated in the same manner as its insurance income under sections 953 and 954(i), and the rule is revised accordingly. See § 1.951A-2(c)(2)(i). However, no inference is intended that a CFC may determine reserve amounts based on foreign statement reserves in the absence of a ruling request. See section 954(i)(4)(B)(ii). In this regard, the Treasury Department and the IRS intend to address, in separate guidance, the use of foreign statement reserves for purposes of measuring qualified insurance income under section 954(i).

B. Gross Income Excluded by Reason of Section 954(b)(4)

Section 951A(c)(2)(A)(i)(III) provides that gross tested income does not include any item of gross income excluded from foreign base company income (as defined in section 954) (“FBCI”) or insurance income (as defined in section 953) “by reason of section 954(b)(4)” (the “GILTI high tax exclusion”). The proposed regulations clarify that the GILTI high tax exclusion applies only to items of gross income that are excluded from FBCI or insurance income solely by reason of an election under section 954(b)(4) and § 1.954-1(d)(5). See proposed § 1.951A-2(c)(1)(iii). Thus, this exclusion does not apply to any item of gross income excluded from FBCI or insurance income by reason of an exception other than section 954(b)(4), regardless of the effective rate of foreign tax to which such item is subject.

One comment noted that this clarification is consistent with the language of the GILTI high tax exclusion, which is limited by its terms to income subject to the high tax exception of section 954(b)(4). Several comments, however, requested that the final regulations expand the GILTI high tax exclusion to exclude additional

categories of high-taxed income. These comments asserted, based on the legislative history of the Act, that Congress intended that income of a CFC would be subject to tax under the GILTI regime only if it is subject to a low rate of foreign tax. Some of these comments suggested that the exclusion be expanded to apply to high-taxed income that would be FBCI or insurance income but for the application of one or more exceptions in section 954(c), (h), or (i). Others recommended that the final regulations apply the GILTI high tax exclusion to any item of gross income subject to a sufficiently high effective foreign tax rate, regardless of whether such income would be FBCI or insurance income but for an exception. Comments suggested that the Treasury Department and the IRS could exercise their authority under section 951A(f)(1)(B) to treat a GILTI inclusion as a subpart F inclusion that could potentially be excludible, on an elective basis, from FBCI (or insurance income) under section 954(b)(4).

Comments recommending an expansion of the GILTI high tax exclusion to any item of high-taxed income suggested various methods to determine the appropriate foreign tax rate for this purpose. One comment recommended the same threshold as used for the high tax exception for subpart F income under section 954(b)(4)—that is, a rate that is 90 percent of the maximum rate specified in section 11 (21 percent), or 18.9 percent. Another comment recommended a 13.125 percent rate, citing the conference report accompanying the Act that indicated that, in general, no residual U.S. tax would be owed on GILTI subject to a foreign tax rate greater than or equal to that rate. H.R. Rep. No. 115-466, at 627 (2017) (Conf. Rep.) (“Conference Report”).

Other comments suggested that even if the GILTI high tax exclusion is not expanded to take into account all high-taxed income, taxpayers should be permitted to elect to treat income that would otherwise be gross tested income as subpart F income in order to qualify for the exception under section 954(b)(4), for example, through a rebuttable presumption that all income (or alternatively, all high-taxed income) of a CFC is subpart F income. One comment asserted that such a rule would be consistent with taxpayers' historical ability to elect through the choice of transactional or operational structure to subject their CFC income to current taxation under subpart F. For example, the comment stated that a taxpayer could cause a CFC to make a loan to its U.S. shareholder, resulting in an inclusion under section 956, or could intentionally structure its operations in a manner that causes income to be characterized as FBCI. The comment also asserted that a rule that effectively permits a taxpayer to elect into subpart F income is consistent with the regulations under section 954, which permit an election to be made with respect to high-taxed income under section 954(b)(4) notwithstanding that that provision, similar to section 954(a) itself, is expressed as a mandatory rule. See § 1.954-1(d).

The final regulations do not adopt these comments. The Treasury Department and the IRS have declined to exercise regulatory authority under section 951A(f)(1)(B) because that authority relates to the treatment of a GILTI inclusion amount, rather than an item of gross tested income. A GILTI inclusion amount is determined based on a U.S. shareholder's pro rata share of all the tested items of one or more CFCs and, as a result, the determination of the extent to which foreign tax is imposed on any single item of net income for purposes of section 954(b)(4) cannot be made by reference to a GILTI inclusion amount. The final regulations also do not permit taxpayers to elect to treat income that would otherwise be gross tested income as subpart F income in order to qualify for the exception under section 954(b)(4). Unlike section 954(b)(4), nothing in section 954(a) or the legislative history suggests that taxpayers should be permitted to treat income that is not described in section 954(a), such as gross tested income, as FBCI through a rebuttable presumption or otherwise. In addition, this type of rebuttable presumption could give rise to significant administrability concerns. These concerns are discussed further in a notice of proposed rulemaking published in the same issue of the

Federal Register

addressing an election under section 954(b)(4) with respect to income that would otherwise qualify as tested income.

The Treasury Department and the IRS continue to believe that the GILTI high tax exclusion, as articulated in the proposed regulations, reflects a reasonable interpretation of section 951A(c)(2)(A)(i)(III) and section 954(b)(4), for the reasons stated in the notice of proposed rulemaking accompanying the proposed regulations. Accordingly, the final regulations retain the GILTI high tax exclusion without modification. See § 1.951A-2(c)(1)(iii). However, the Treasury Department and the IRS are studying, in light of the addition of section 951A by the Act, the appropriate circumstances under which taxpayers should be permitted to make an election under section 954(b)(4), with respect to income that would not be FBCI or insurance income, to exclude such income from gross tested income under the GILTI high tax exclusion using authority other than section 951A(f)(1)(B). In that regard, existing § 1.954-1(d)(1) does not provide the necessary framework for applying the exception under section 954(b)(4) to income that would be gross tested income, such as rules to determine the scope of an item of gross tested income to which the election applies and rules to determine the rate of foreign tax on such items. Therefore, the Treasury Department and the IRS are issuing a notice of proposed rulemaking published in the same issue of the

Federal Register

as these final regulations that will propose a framework under which taxpayers would be permitted to make an election under section 954(b)(4) with respect to income that would otherwise be gross tested income in order to exclude that income from gross tested income by reason of the GILTI high tax exclusion. However, until the regulations described in the separate notice of proposed rulemaking are effective, a taxpayer may not exclude any item of income from gross tested income under section 951A(c)(2)(A)(i)(III) unless the income would be FBCI or insurance income but for the application of section 954(b)(4) and § 1.954-1(d).

C. Gross Income Taken Into Account in Determining Subpart F Income

1. In General

Section 951A(c)(2)(A)(i)(II) provides that gross tested income is determined without regard to any gross income taken into account in determining the subpart F income of the corporation (the “subpart F exclusion”). Section 952(a) defines “subpart F income” as the sum of certain categories of income, including FBCI and insurance income.

Other than with respect to the coordination between the subpart F exclusion and section 952(c) (discussed in part IV.C.2 of this Summary of Comments and Explanation of Revisions section), the proposed regulations do not provide guidance on income that is “taken into account in determining the subpart F income” of a CFC within the meaning of the subpart F exclusion. In this regard, the final regulations provide rules for determining gross income included in FBCI and insurance company for purposes of the subpart F exclusion, including by reason of the application of the de minimis and full inclusion rules in section 954(b). See

§ 1.951A-2(c)(4)(ii)(A), (B), and § 1.951A-2(c)(4)(iii)(C); see also part IV.C.3 of this Summary of Comments and Explanation of Revisions section. The final regulations also clarify the circumstances in which the subpart F exclusion applies to less common items included in subpart F income under section 952(a)(3) through (5) (subpart F income resulting from participation in or cooperation with certain international boycotts, payments of illegal bribes, kickbacks, or other payments, or income derived from any country during which section 901(j) applies to that country). See § 1.951A-2(c)(4)(ii)(C) through (E).

2. Coordination With Section 952(c)

a. In General

The amount of subpart F income for a taxable year is subject to the E&P limitation and recapture provisions in section 952(c). Section 952(c)(1)(A) provides that a CFC's subpart F income for any taxable year cannot exceed its E&P for that year. See also § 1.952-1(c)(1). However, section 952(c)(2) provides that, to the extent subpart F income is reduced by reason of the E&P limitation in any taxable year, any excess of the E&P of the corporation for any subsequent taxable year over the subpart F income for that year is recharacterized as subpart F income. See also § 1.952-1(f)(1). An amount recaptured under section 952(c)(2) is treated as subpart F income in the same separate category (as defined in § 1.904-5(a)) as the subpart F income that was subject to the E&P limitation in a prior taxable year. See § 1.952-1(f)(2)(ii).

The Code does not provide a rule that explicitly coordinates the subpart F exclusion with section 952(c), which commenters identified as a source of confusion and potential inconsistency. In order to resolve this ambiguity, the proposed regulations set forth such a coordination rule by providing that the gross tested income and allowable deductions properly allocable to gross tested income are determined without regard to the application of section 952(c) (the “section 952(c) coordination rule”). See proposed § 1.951A-2(c)(4)(i). Thus, income that would be subpart F income but for the application of the E&P limitation in section 952(c)(1)(A) is excluded from gross tested income by reason of the subpart F exclusion. In addition, income that gives rise to E&P that results in subpart F recapture under section 952(c)(2) is not excluded from gross tested income by reason of the subpart F exclusion. In effect, the section 952(c) coordination rule treats an item of gross income as “taken into account” in determining subpart F income to the extent, and only to the extent, that the item would be included in subpart F income absent the application of section 952(c).

The proposed regulations include an example that illustrates this rule. See proposed § 1.951A-2(c)(4)(ii)(A). In the example, in Year 1, FS, a CFC wholly owned by a U.S. shareholder, has $100x of foreign base company sales income, a $100x loss in foreign oil and gas extraction income, and no E&P. In Year 2, FS has gross income of $100x that is not otherwise excluded from the definition of gross tested income in proposed § 1.951A-2(c)(1)(i) through (v), and no allowable deductions, and $100x of E&P. The example concludes that in Year 1 FS has no subpart F income because of the E&P limitation in section 952(c)(1)(A) and no gross tested income because gross tested income is determined without regard to section 952(c). In Year 2, the example concludes that, because FS's E&P ($100x) exceed its Year 2 subpart F income ($0), the subpart F income of Year 1 is recaptured in Year 2 under section 952(c)(2), and FS also has $100x of gross tested income in Year 2 because gross tested income is determined without regard to section 952(c).

One comment agreed that the section 952(c) coordination rule was an appropriate interpretation of the statute, noting that the rule preserves the ability for section 952(c)(2) to recapture subpart F income generated in prior years, while preventing recapture under section 952(c)(2) from permanently exempting gross tested income generated in subsequent years. However, several comments suggested that the section 952(c) coordination rule be withdrawn. These comments asserted that the section 952(c) coordination rule can lead to double taxation because the rule can result in the taxation of an aggregate amount of CFC income in excess of the net economic CFC income over a multi-year period. Some comments further suggested that the section 952(c) coordination rule is contrary to the language of the subpart F exclusion, on the grounds that any income of a CFC that generates E&P that are recharacterized as subpart F income by reason of the E&P recapture rule is “taken into account in determining the subpart F income” of the CFC and should therefore be excluded from gross tested income under the subpart F exclusion. Other comments recommended that the section 952(c) coordination rule be retained as it pertains to the E&P limitation rule under section 952(c)(1)(A), but be modified to exclude from its scope the E&P recapture rule of section 952(c)(2). Under that approach, both the subpart F income subject to E&P limitation in a prior year and gross income in a subsequent year that generates E&P giving rise to recapture of subpart F income would be excluded from gross tested income.

The Treasury Department and the IRS have determined that the section 952(c) coordination rule is consistent with the relevant statutory provisions and results in the appropriate amount of income that is subject to tax under sections 951 and 951A. Gross income that would be subpart F income during the current year but for the application section 952(c)(1)(A) is literally “taken into account” in determining subpart F income in that it potentially gives rise to future subpart F income by reason of section 952(c)(2). Furthermore, gross tested income is not subject to an E&P limitation analogous to the E&P limitation on subpart F income under section 952(c)(1)(A). In this regard, the determination of tested income under the GILTI regime is based on a taxable income concept, similar to the determination of income earned directly by a U.S. taxpayer, whereas the subpart F regime is rooted in a distributable dividend model, and thus predicated on the existence of E&P. Therefore, for example, a CFC may have $100x of gross tested income but no E&P in a taxable year (due, for instance, to a loss in foreign oil and gas extraction income), and the U.S. shareholder of the CFC (assuming no QBAI or other CFCs) will nonetheless have a $100x GILTI inclusion amount for the taxable year. This is the result under section 951A notwithstanding that the CFC in this case has no net economic income and no E&P for the year. If the same CFC for the same taxable year also has $100x of foreign base company sales income and $100x of E&P related to such income, in addition to the $100x GILTI inclusion amount, the CFC's U.S. shareholder would have a $100x subpart F inclusion. Under these facts, the U.S. shareholder is taxed on an aggregate amount of taxable income of the CFC ($200x) that exceeds the CFC's net economic income and E&P ($100x). In this example, the U.S. shareholder is not subject to tax twice with respect to a single item of income, but rather is subject to tax once with respect to each of two items—the CFC's subpart F income of $100x and the CFC's gross tested income of $100x. The section 952(c) coordination rule merely ensures that the same result obtains whether all items of income and loss arise in a single year (as in this example) or arise

in different taxable years (as in the example in proposed § 1.951A-2(c)(4)(ii)(A)).

The Treasury Department and the IRS have also determined that it is not appropriate to exclude the E&P recapture rule from the scope of the section 952(c) coordination rule. Because section 951A contains no analog to the E&P limitation in section 952(c)(1)(A), it also contains no analog to the E&P recapture rule in section 952(c)(2). Without a GILTI recapture rule, the approach recommended by comments would effectively allow prior year losses in categories of income excluded from gross tested income (for example, subpart F income or foreign oil and gas extraction income) to permanently exempt gross tested income in subsequent years. For instance, if, in a taxable year, a CFC has $100x of foreign base company sales income, a $100x loss in foreign base company services income, and thus no subpart F income by reason of the E&P limitation of section 952(c)(1)(A), any gross tested income earned by the CFC in a subsequent year would recapture the foreign base company sales income from the previous year, and thus such gross income would never be subject to section 951A.

In excluding certain categories of income from gross tested income (namely, subpart F income, foreign oil and gas extraction income, and effectively connected income), Congress not only ensured that such income would not be subject to the GILTI regime, but also that losses with respect to such income would not be permitted to reduce income subject to the GILTI regime. Likewise, section 951A(c)(2)(B)(ii) provides that a loss in a category of income subject to the GILTI regime (that is, tested loss) cannot reduce the income subject to the subpart F regime by reason of the E&P limitation rule of section 952(c)(1)(A). See also § 1.951A-6(b) and part VIII.A of this Summary of Comments and Explanation of Revisions section. It is apparent, based on the purpose and structure of section 951A, that Congress intended for the GILTI and subpart F regimes to act as parallel, independent systems of taxation with respect to prescribed categories of CFC income, and losses with respect to one regime (or subject to neither regime) should not be permitted to permanently exempt the income subject to another regime. Therefore, an interpretation of section 952(c) that permits losses related to GILTI-exempt categories of income to reduce gross tested income would be contrary to the purpose and structure of section 951A.

A comment recommended, as an alternative to taking into account section 952(c)(2) recapture in determining gross tested income, that the recapture rules of section 952(c)(2) be modified so that E&P derived from gross tested income does not trigger recapture under section 952(c)(2). Although such amount would not be recaptured as subpart F income, the comment recommended that, in order to avoid double taxation of the same earnings, any recapture account should nonetheless be reduced by the amount treated as gross tested income. The Treasury Department and the IRS have determined that this recommendation is inconsistent with the language and purpose of section 952(c)(2). Section 952(c)(2) requires recapture in any taxable year in which E&P exceed subpart F income, and the recommendation would not result in recapture in these circumstances. Further, the purpose of section 952(c)(2) is to postpone the inclusion of subpart F income to a subsequent taxable year in which the CFC has sufficient E&P. The recommendation, by reducing a recapture account without recapture of subpart F income, would result in the permanent exemption of subpart F income. Finally, as illustrated in this part IV.C of the Summary of Comments and Explanation of Revisions section, the simultaneous recapture of subpart F income and the inclusion of gross tested income does not amount to double taxation of a single item of income, but rather the single taxation of each of two items of income. Accordingly, this recommendation is not adopted.

A comment recommended as another alternative that the section 952(c)(2) coordination rule not be applied with respect to recapture accounts that existed before the Act. The comment asserted that it would be inappropriate for income that triggers recapture under section 952(c)(2) based on pre-Act recapture account balances to also be treated as gross tested income because section 951A did not exist before 2018 and therefore no tested losses could have reduced subpart F income. The final regulations do not adopt this recommendation. Nothing in the statute or legislative history suggests that pre-Act recapture account balances should be treated differently than post-Act account balances. Further, there appears to be no stronger policy rationale for permitting losses that arose before the Act to permanently exempt gross tested income from taxation than for permitting GILTI-exempt losses that arise after the Act to do the same.

While the comments with respect to the section 952(c) coordination rule generally pertained to the application of the E&P limitation in section 952(c)(1)(A), the same issues as discussed in respect to section 952(c)(1)(A) arise with respect to application of the qualified deficit rule in section 952(c)(1)(B) and the chain deficit rule in section 952(c)(1)(C). Accordingly, the final regulations revise the section 952(c) coordination rule to apply also to disregard the effect of a qualified deficit or a chain deficit in determining gross tested income. See § 1.951A-2(c)(4)(ii).

One comment requested clarification that income subject to the high tax exception of section 954(b)(4) is not included in gross tested income even if such income would also be excluded from subpart F income by reason of section 952(c)(1)(A). The comment provided an example in which a CFC has $100x of foreign base company services income, a $100x loss in another category of subpart F income, no E&P, and thus no subpart F income by reason of the E&P limitation of section 952(c)(1)(A). According to the comment, if the election under section 954(b)(4) is made with respect to the foreign base company services income, one interpretation of the proposed regulations is that the $100x of foreign base company services income is not excluded from gross tested income by either the subpart F exclusion under section 951A(c)(2)(A)(i)(II) (because such income is not included in subpart F by reason of the high tax exception of section 954(b)(4)) or the GILTI high tax exclusion under section 951A(c)(2)(A)(i)(III) (because such income is not excluded from subpart F income “solely” by reason of the high tax exception of section 954(b)(4)). The Treasury Department and the IRS have determined that such clarification is unnecessary because an election under section 954(b)(4) cannot be made with respect to a net item eliminated by reason of section 952(c)(1)(A). Section 1.954-1(d)(4)(ii) provides that the net item of income to which the high tax exception of section 954(b)(4) applies is the subpart F income of a CFC determined after taking into account the earnings and profits limitation of section 952(c)(1)(A). Therefore, the net item of income that can be excluded under the high tax exception is determined after the application of section 952(c)(1)(A). Indeed, in the example presented by the comment, because the subpart F income of the CFC after application of the E&P limitation is zero, there is no net item of income for which an election under section 954(b)(4) and § 1.954-1(d)(5) can

be made. Accordingly, the $100x of foreign base company services income is excluded from gross tested income solely by reason of the subpart F exclusion under section 951A(c)(2)(A)(i)(II).

b. Coordination With Qualified Deficit Rule in Section 952(c)(1)(B)

The qualified deficit rule in section 952(c)(1)(B) reduces a U.S. shareholder's subpart F inclusion attributable to a qualified activity (defined in section 952(c)(1)(B)(iii)) to the extent of that shareholder's pro rata share of any qualified deficit (defined in section 952(c)(1)(B)(ii)). A comment suggested that a tested loss could, in some cases, also give rise to a qualified deficit that could reduce subpart F income in a subsequent taxable year. The comment asserted that this could occur, for example, if certain deductions and losses that make up a qualified deficit are also properly allocable to gross tested income. Accordingly, the comment recommended that the final regulations deny a U.S. shareholder the ability to both reduce its net CFC tested income and increase a qualified deficit by reason of the same economic loss.

The Treasury Department and the IRS agree that the same deduction or loss should not result in a double benefit under section 951A and the qualified deficit rule, but have not identified a situation in which a single deduction or loss can both reduce tested income (or increase tested loss) and also give rise to or increase a qualified deficit. A deduction or loss that is properly allocable to gross tested income cannot also be attributable to a qualified activity that gives rise to subpart F income, and the same deduction cannot be taken into account more than once under sections 954(b)(5) and 951A(c)(2)(A)(ii). Nevertheless, for the avoidance of doubt, the final regulations provide that deductions that are allocated and apportioned to gross tested income are not attributable to a qualified activity and thus do not also increase or give rise to a qualified deficit. See § 1.951A-2(c)(3).

c. Coordination With Section 952(c)(1)(B)(vii)

Section 952(c)(1)(B)(vii)(I) contains an election to apply section 953(a) without regard to the same country exception in section 953(a)(1)(A). Comments requested that the section 952(c) coordination rule be modified to clarify that gross tested income is determined after giving effect to the election in section 952(c)(1)(B)(vii)(I). The rule in proposed § 1.951A-2(c)(4) was not intended to address the election in section 952(c)(1)(B)(vii)(I). Accordingly, the final regulations modify the section 952(c) coordination rule to apply only with respect to the E&P limitation rules of section 952(c)(1) (including the qualified deficit and chain deficit rules) and the E&P recapture rule of section 952(c)(2).

3. Coordination With De Minimis Rule, Full Inclusion Rule, and High Tax Exception

Section 954(a) provides that FBCI for a taxable year is equal to the sum of foreign personal holding company income (as determined under section 954(c)) (“FPHCI”), foreign base company sales income (as determined under section 954(d)) and foreign base company services income (as determined under section 954(e)). However, section 954(b)(3)(A) provides that if the sum of FBCI (determined without regard to allocable deductions) (“gross FBCI”) and gross insurance income for the taxable year is less than the lesser of five percent of gross income or $1,000,000, then no part of the gross income for the taxable year is treated as FBCI or insurance income (the “de minimis rule”). Conversely, section 954(b)(3)(B) provides that if the sum of gross FBCI and gross insurance income for the taxable year exceeds 70 percent of gross income, the entire gross income for the taxable year is treated as gross FBCI or gross insurance income, as appropriate (the “full inclusion rule”).

One comment requested that the de minimis and full inclusion rules be taken into account for purposes of determining “gross income taken into account” in determining subpart F income within the meaning of the subpart F exclusion. The comment asserted that such a rule would prevent double taxation because full inclusion subpart F income would be taxed solely under section 951 (and not section 951A), whereas de minimis subpart F income would be taxed solely under section 951A (and not section 951).

The Treasury Department and the IRS agree with this comment. Accordingly, subject to the application of the section 952(c) coordination rule, discussed in part IV.C.2 of this Summary of Comments and Explanation of Revisions section, the final regulations provide that the subpart F exclusion applies to gross income included in FBCI (adjusted net FBCI as defined in § 1.954-1(a)(5)) or insurance income (adjusted net insurance income as defined in § 1.954-1(a)(6)). See § 1.951A-2(c)(4)(i). Thus, for purposes of the subpart F exclusion, gross income taken into account in determining subpart F income does not include any item of gross income excluded from FBCI or insurance income under the de minimis rule or the high tax exception of section 954(b)(4), but generally does include any item of gross income included in FBCI or insurance income under the full inclusion rule. In addition, for purposes of the subpart F exclusion, gross income taken into account in determining subpart F income does not include gross income that qualifies for an exception to a category of FBCI described in section 954(a), including amounts excepted from the definition of FPHCI, such as rents and royalties derived from an active business under section 954(c)(2)(A) and § 1.954-2(b)(5) and (6) or active financing income under section 954(h).

Section 1.954-1(d)(6) provides that an item of gross income that is included in FBCI or insurance income under the full inclusion rule (“full inclusion FBCI”) is excluded from subpart F income if more than 90 percent of the gross FBCI and gross insurance income for the taxable year (determined without regard to the full inclusion rule) is attributable to net amounts excluded from subpart F income under the high tax exception of section 954(b)(4). The Treasury Department and the IRS have determined that it would be inappropriate for an item of gross income that would be included in gross tested income but for the full inclusion rule to be excluded from both gross tested income (by reason of the subpart F exclusion) and subpart F income (by reason of § 1.954-1(d)(6)). Accordingly, the final regulations provide that full inclusion FBCI excluded from subpart F income by reason of § 1.954-1(d)(6) is not excluded from gross tested income by reason of the subpart F exclusion. See § 1.951A-2(c)(4)(iii)(C). The final regulations further clarify that income excluded from subpart F income under § 1.954-1(d)(6) is also not excluded from gross tested income by reason of the GILTI high tax exclusion (discussed in part IV.B of this Summary of Comments and Explanation of Revisions section). See id. Accordingly, income excluded from subpart F income by reason of § 1.954-1(d)(6) is included in gross tested income.

D. Effect of Basis Adjustments Under Section 961(c)

Section 961(c) provides that, under regulations prescribed by the Secretary, if a U.S. shareholder is treated under section 958(a)(2) as owning stock of a CFC which is owned by another CFC, then adjustments similar to those provided under section 961(a) and (b) are made to the basis in such stock, and the basis in stock of any other CFC by

reason of which the U.S. shareholder is considered under section 958(a)(2) as owning the stock. The provision further provides, however, that these adjustments are made only for the purposes of determining the amount included under section 951 in the gross income of such U.S. shareholder (or any successor U.S. shareholder). There are no regulations in effect under section 961(c).

Comments have questioned whether basis adjustments under section 961(c) should be taken into account for purposes of determining gross tested income of a CFC upon the CFC's disposition of stock of another CFC. One comment noted that, while section 951A(f)(1)(A) treats a GILTI inclusion in the same manner as a subpart F inclusion for purposes of basis adjustments under section 961, the resulting basis under section 961(c) only applies for purposes of determining amounts included in gross income under section 951. The comment recommended nonetheless that regulations provide that section 961(c) basis adjustments apply both for purposes of determining subpart F income and gross tested income to prevent certain items of income from being inappropriately taxed twice; the comment further noted, however, that unintentional non-taxation should also be avoided.

The interaction of basis adjustments under section 961(c) and section 951A will be further considered in connection with a guidance project addressing previously taxed E&P (“PTEP”) under sections 959 and 961.

See

Notice 2019-1, 2019-2 I.R.B. 275, section 3 (announcing an intention to address PTEP in forthcoming proposed regulations). The Treasury Department and the IRS are sensitive to the concern expressed in the comment but are also aware that taking into account section 961(c) basis adjustments for purposes of determining gross tested income could inappropriately reduce the amount of stock gain subject to tax. This may occur because, as was the case before the Act, section 961(c) adjustments are not taken into account for purposes of determining E&P, and thus a disposition of lower-tier CFC stock may generate E&P for the upper-tier CFC to the extent of the amount of the gain in the stock determined without regard to section 961(c). If the resulting E&P give rise to a dividend (including by reason of a disposition under section 1248) to a corporate U.S. shareholder, the dividend may result in an offsetting dividends received deduction. See sections 245A(a) and 1248(j). If section 245A(a) applies to the dividend, the taxable portion of any unrealized appreciation in the upper-tier CFC stock, to the extent attributable to unrealized appreciation in assets of the upper-tier CFC, would effectively be reduced in an amount equal to the dividend, either because of a dividend distribution that reduces the value in the upper-tier CFC stock without a corresponding basis reduction (section 961(d) applies only to the extent loss would otherwise be recognized) or by reason of a disposition to the extent the gain is recharacterized under section 1248(j) as a dividend for purposes of applying section 245A. Comments are requested on this issue, including the extent to which adjustments should be made to minimize the potential for the same item of income being subject to tax more than once and to minimize the inappropriate reduction of gain in CFC stock held by corporate U.S. shareholders.

E. Deduction or Loss Attributable to Disqualified Basis

1. In General

The proposed regulations include a rule that generally disallows, for purposes of calculating tested income or tested loss, any deduction or loss attributable to disqualified basis in depreciable or amortizable property (including, for example, intangible property) resulting from a disqualified transfer of the property. See proposed § 1.951A-2(c)(5). The relevant terms for purposes of applying the rule in proposed § 1.951A-2(c)(5) are defined by reference to certain provisions and terms in proposed § 1.951A-3(h)(2) (disregarding disqualified basis for purposes of determining QBAI), with certain modifications. See proposed § 1.951A-2(c)(5)(iii). In general, the term “disqualified basis” is defined as the excess of a property's adjusted basis immediately after a disqualified transfer, over the sum of the property's adjusted basis immediately before the disqualified transfer and the amount of gain recognized by the transferor in the disqualified transfer that is subject to tax as subpart F income or effectively connected income. See proposed § 1.951A-3(h)(2)(ii)(A) and (B). The term “disqualified transfer” is defined as a transfer of property by a transferor CFC during the transferor CFC's disqualified period to a related person in which gain was recognized, in whole or in part. See proposed § 1.951A-3(h)(2)(ii)(C). Finally, the term “disqualified period” is defined with respect to a transferor CFC as the period that begins on January 1, 2018, and ends as of the close of the transferor CFC's last taxable year that is not a CFC inclusion year. See proposed § 1.951A-3(h)(2)(ii)(D). Income generated by fiscal-year CFCs during the disqualified period is subject to neither the transition tax under section 965 nor the tax on GILTI under section 951A.

In response to comments, the Treasury Department and the IRS have revised these rules in a manner consistent with the purpose of the rule in the proposed regulations, as discussed in this part IV.E of the Summary of Comments and Explanation of Revisions section. Certain comments and revisions related to the determination of disqualified basis for purposes of both proposed §§ 1.951A-2(c)(5) and 1.951A-3(h)(2) are discussed in part IV.E.3 and 4 of this Summary of Comments and Explanation of Revisions section. For a discussion of additional comments and revisions related to the determination of disqualified basis for purposes of both proposed §§ 1.951A-2(c)(5) and 1.951A-3(h)(2), see part V.G of this Summary of Comments and Explanation of Revisions section.

2. Authority

Several comments recommended that the rule in proposed § 1.951A-2(c)(5) be withdrawn or substantially narrowed and re-proposed. Some of these comments recommended that the rule be revised to apply only to “non-economic” transactions or transactions engaged in with a tax-avoidance purpose, or that avoidance-type transactions be addressed through existing statutory or judicial doctrines. One comment recommended that the rule continue to be limited to transfers between related persons because third-party sales are fundamentally different from the “non-economic transactions” described in the legislative history. However, one comment opposed any additional limitations or weakening of the anti-abuse rules in the proposed regulations.

Several comments questioned the Treasury Department and the IRS's authority for issuing the rule. Many of these comments asserted that section 951A(d)(4), which provides authority to issue regulations that are “appropriate to prevent the avoidance of the purposes of this subsection,” does not authorize the Treasury Department and the IRS to promulgate rules that apply for any purpose other than for purposes of determining QBAI under section 951A(d). Also, two comments stated that the disallowance of deductions under proposed § 1.951A-2(c)(5) is contrary to, and therefore not authorized by, section 951A(c)(2)(A)(ii), which requires that the deductions of the CFC

be allocated to gross tested income under rules similar to the rules of section 954(b)(5) for purposes of calculating tested income or tested loss.

In response to these comments, the Treasury Department and the IRS have revised the proposed rule in a manner that better reflects the source of its authority. Section 7805(a) provides that “the Secretary shall prescribe all needful rules and regulations for the enforcement of this title, including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.” Section 951A(c)(2)(A) defines “tested income” by reference to certain items of gross income, reduced by “the deductions (including taxes) properly allocable to such gross income under rules similar to the rules of section 954(b)(5) (or to which such deductions would be allocable if there were such gross income).” Section 954(b)(5) provides that FPHCI, foreign base company sales income, and foreign base company services income are reduced, “under regulations prescribed by the Secretary,” by deductions “properly allocable” to such income. Similarly, section 882(c)(1)(A) provides that, for purposes of determining a foreign corporation's income which is effectively connected with the conduct of a trade or business within the United States (“effectively connected income”), “proper apportionment and allocation” of deductions of the foreign corporation “shall be determined as provided in regulations prescribed by the Secretary.” The rule, as revised in the final regulations, provides guidance for determining whether certain deductions or losses are “properly allocable” to gross tested income, subpart F income, or effectively connected income within the meaning of section 951A(c)(2)(A), section 954(b)(5), or section 882(c)(1)(A), respectively. See, for example,

Redlark

v.

Commissioner,

141 F.3d 936, 940-41 (9th Cir. 1998) and

Miller

v.

United States,

65 F.3d 687, 690 (8th Cir. 1995) (determining that the term “properly allocable” in section 163(e) is ambiguous and therefore there is an implicit legislative delegation of authority to the Commissioner to define the term).

The legislative history to the Act indicates that section 965 was intended as a transition measure to the new territorial tax system in which section 951A applies, and that Congress intended that all earnings of a CFC would be potentially subject to tax under either section 965 or section 951A. Conference Report, at 613 (“The [transition tax applies in] the last taxable year of a deferred foreign income corporation that begins before January 1, 2018, which is that foreign corporation's last taxable year before the transition to the new corporate tax regime elsewhere in the bill goes into effect.”). Because the final date for measuring the E&P of a CFC for purposes of section 965 is December 31, 2017 (the “final E&P measurement date”), and the effective date of section 951A is the first taxable year of a CFC beginning after December 31, 2017, all the earnings of a calendar year CFC are potentially subject to taxation under either section 965 or section 951A. However, a fiscal year CFC (for example, a CFC with a taxable year ending November 30) may have a gap between its final E&P measurement date under section 965 (December 31, 2017) and the date on which section 951A first applies with respect to its income (December 1, 2018, for a CFC with a taxable year ending November 30). Congress was aware that taxpayers could take advantage of this period to create “cost-free” basis in assets that could be used to reduce their U.S. tax liability in subsequent years, and expected the Treasury Department and the IRS to issue regulations to prevent this result. See Conference Report, at 645 (“The conferees intend that non-economic transactions intended to affect tax attributes of CFCs and their U.S. shareholders (including amounts of tested income and tested loss, tested foreign income taxes, net deemed tangible income return, and QBAI) to minimize tax under this provision be disregarded. For example, the conferees expect the Secretary to prescribe regulations to address transactions that occur after the measurement date of post-1986 earnings and profits under amended section 965, but before the first taxable year for which new section 951A applies, if such transactions are undertaken to increase a CFC's QBAI.”).

Consistent with the statute and the legislative history, the Treasury Department and the IRS have determined that a deduction or loss attributable to basis (disqualified basis) created by reason of a transfer from a CFC to a related CFC (a disqualified transfer) during the period between the final E&P measurement date and the effective date of section 951A (the disqualified period), to the extent no taxpayer included an amount in gross income by reason of such disqualified transfer, should not be permitted to reduce a taxpayer's U.S. income tax liability in subsequent years. Accordingly, the final regulations treat any deduction or loss attributable to disqualified basis as not “properly allocable” to gross tested income, subpart F income, or effectively connected income of the CFC (“residual CFC gross income”). See § 1.951A-2(c)(5)(i).

While the rules that allocate and apportion expenses generally depend on the factual relationship between the item of expense and the associated gross income, the relevant statutory language in sections 882(c)(1)(A), 951A(c)(2)(A)(ii), and 954(b)(5) does not constrain the Secretary from taking into account other considerations in determining whether it is “proper” for a certain item of expense to be allocated to, and therefore reduce, a particular item of gross income. Indeed, the Treasury Department and the IRS are not required to issue rules that mechanically allocate an item of expense to gross income to which such expense factually relates if taxable income would be distorted by reason of such allocation. In this regard, the Treasury Department and the IRS have determined that the rule in § 1.951A-2(c)(5) is necessary to ensure that transactions during the disqualified period, the income or earnings from which are not subject to tax, are not permitted to improperly reduce or eliminate a taxpayer's income that would be subject to tax after the disqualified period. This rule creates symmetry between the category of income generated by reason of a transfer during the disqualified period and the category of income to which any deduction or loss attributable to the resulting basis is allocated. That is, a disqualified transfer, by definition, generates residual CFC gross income (income that is not subpart F income, tested income, or effectively connected income), and the rule in § 1.951A-2(c)(5) allocates the deduction or loss attributable to the disqualified basis to the same category of income. In the case of a depreciable or amortizable asset with disqualified basis that is held until the end of its useful life, the aggregate amount of deduction or loss attributable to the disqualified basis allocated to residual CFC gross income under the rule will equal the amount of residual CFC gross income generated in the disqualified transfer.

The rule in proposed § 1.951A-2(c)(5) provides that any deduction or loss attributable to disqualified basis is disregarded for purposes of determining tested income or tested loss. In contrast, the rule in the final regulations allocates and apportions any such deduction or loss to gross income other than gross tested income, subpart F income, or effectively connected income. With respect to the determination of tested

income or tested loss, whether an item of deduction or loss is disregarded (under the proposed regulations) or allocated to income other than gross tested income (under the final regulations) does not provide a different result. In either case, the deduction or loss is not permitted to reduce tested income or increase tested loss. However, by allocating an item of deduction or loss to residual CFC gross income, the rule in the final regulations ensures that any deduction or loss attributable to disqualified basis is also not taken into account for purposes of determining the CFC's subpart F income or effectively connected income. The broadening of the rule to allocate any deduction or loss attributable to disqualified basis away from subpart F income and effectively connected income is intended to ensure that taxpayers cannot simply circumvent the rule by converting their gross tested income into either subpart F income or effectively connected income, and thus be permitted to use the deduction or loss attributable to the disqualified basis against such income. The preamble to the proposed regulations evidenced an intention that taxpayers not be permitted to claim tax benefits with respect to cost-free disqualified basis, and the rule in the final regulations effectuates this intent by closing an obvious loophole. Furthermore, the rule ensures that the words “properly allocable” are interpreted consistently across provisions—sections 882(c)(1)(A), 951A(c)(2)(A)(ii), and 954(b)(5)—with respect to any deduction or loss attributable to disqualified basis.

The rule in proposed § 1.951A-2(c)(5) applies only to deductions or losses attributable to disqualified basis in “specified property,” which is defined as property that is of a type with respect to which a deduction is allowable under section 167 or 197. See proposed § 1.951A-2(c)(5)(ii). The Treasury Department and the IRS have concluded, however, that the rule should not be limited to specified property because deductions or losses attributable to disqualified basis in other property may also be used to inappropriately reduce a taxpayer's U.S. income tax liability. On the other hand, the Treasury Department and the IRS have concluded that it would be unduly burdensome to require CFCs to determine the disqualified basis in each item of inventory and that it is reasonable to expect that most inventory acquired during the disqualified period will be sold at a gain such that the disqualified basis in an item of inventory would rarely be relevant. Accordingly, the rule in the final regulations applies to deductions or losses attributable to disqualified basis in any property, other than property described in section 1221(a)(1), regardless of whether the property is of a type with respect to which a deduction is allowable under section 167 or 197. See §§ 1.951A-2(c)(5)(iii)(A) and 1.951A-3(h)(2)(ii).

One comment asserted that the use of the phrase “non-economic transactions” in the Conference Report means that the authority to draft anti-abuse rules pursuant to sections 7805 and 951A(d)(4) is limited to non-economic transactions, which necessitates a facts and circumstances test. The rule in § 1.951A-2(c)(5) is not premised upon facts and circumstances, such as a taxpayer's intent; rather, the rule is based on an interpretation of the term “properly allocable” in the context of a deduction or loss attributable to disqualified basis. Moreover, the rule applies only to a narrow subset of transactions—that is, transfers by fiscal year CFCs to related parties that occur between the final E&P measurement date under section 965 and the effective date of section 951A—and only has the effect of allocating a deduction or loss attributable to the cost-free basis created in such transaction to residual CFC gross income. The Treasury Department and the IRS have concluded that these narrowly circumscribed transactions will in almost all cases be motivated by tax avoidance rather than business exigencies, and that the allocation and apportionment of deduction or loss to residual CFC gross income is an appropriately tailored measure to address these transactions.

Based on the foregoing, the Treasury Department and the IRS have concluded that the rule in § 1.951A-2(c)(5), with the modifications discussed in this part IV.E of the Summary of Comments and Explanation of Revisions section, represents an appropriate exercise of its authority under sections 951A and 7805.

3. Effect of Disqualified Basis for Purposes of Determining Income or Gain

Some comments noted that the rule in proposed § 1.951A-2(c)(5) addresses only deductions or losses attributable to disqualified basis and does not address the effect of disqualified basis in determining a CFC's income or gain upon the disposition of property. For example, assume USP, a domestic corporation, wholly owns CFC1, which holds property with a fair market value of $100x and an adjusted basis of $80x, $70x of which is disqualified basis. CFC1 sells the property to an unrelated party in exchange for $100x of cash and, without regard to proposed § 1.951A-2(c)(5), recognizes $20x of gain. The comments asked whether, under the rule, the disqualified basis of $70x in the property is disregarded such that the sale results in $90x (rather than $20x) of gross tested income to CFC1.

The Treasury Department and the IRS have determined that the rule in § 1.951A-2(c)(5) should apply only for purposes of determining whether a deduction or loss is properly allocable to gross tested income, subpart F income, or effectively connected income. Thus, disqualified basis is not disregarded for purposes of determining income or gain recognized on the disposition of the property. However, because many taxpayers capitalize depreciation or amortization expense to other property, including inventory, and recover those costs through cost of goods sold or depreciation of the other property, the final regulations also provide that any depreciation, amortization, or cost recovery allowances attributable to disqualified basis is not properly allocable to property produced or acquired for resale under section 263, 263A, or 471. See § 1.951A-2(c)(5)(i). This rule ensures that depreciation or amortization expenses attributable to disqualified basis are not permitted to indirectly reduce taxable income through the depreciation expense of other property or from the disposition of inventory.

As discussed in part V.G of this Summary of Comments and Explanation of Revisions section, disqualified basis is generally reduced or eliminated to the extent that such basis reduces taxable income. Therefore, a sale of property with disqualified basis generally results in the elimination of the disqualified basis, because the basis is taken into account in determining the CFC's taxable income. As a result, absent a special provision, a CFC could “cleanse” the disqualified basis in property by selling the property to a related person after the disqualified period; the related person would have no disqualified basis in the property, and the selling CFC would recognize income only to the extent the amount realized exceeded its adjusted basis in the property (for this purpose, including its disqualified basis). To address this obvious loophole, the final regulations provide that, except to the extent that any loss recognized on the transfer of such property is treated as attributable to disqualified basis under § 1.951A-2(c)(5), or the basis is reduced or eliminated in a nonrecognition transaction within the meaning of

section 7701(a)(45), a transfer of property with disqualified basis in the hands of a CFC to a related person does not reduce the disqualified basis in the hands of the transferee. See § 1.951A-3(h)(2)(ii)(B)(

1

)(

ii

). Thus, for example, if a CFC sells property with an adjusted basis of $80x and disqualified basis of $70x to a related person for $100x in a fully taxable exchange, the selling CFC would recognize $20x of gross income on the sale, which income may be included in gross tested income, and the disqualified basis in the property immediately after the transfer would remain $70x in the hands of the related person.

4. Concurrent Application of the Rule With Other Provisions

One comment asserted that if the Treasury Department and the IRS retain the rule in proposed § 1.951A-2(c)(5), then the disqualified transfer should be disregarded for all U.S. tax purposes, including for purposes of determining the gain or loss recognized by the transferor CFC by reason of the transfer and the tax attributes of the transferor CFC created by reason of the transfer. The comment expressed concern with potentially adverse consequences to the transferor CFC from the concurrent application of the rule and certain other provisions, such as incremental subpart F income generated by reason of the transfer, additional E&P that could dilute foreign tax credits with respect to a subpart F inclusion, and immediate U.S. taxation on any effectively connected income under section 882 from the transfer.

As discussed in part IV.E.2 of this Summary of Comments and Explanation of Revisions section, the rule in § 1.951A-2(c)(5) is intended to provide guidance on determining whether deductions of a CFC attributable to disqualified basis are properly allocable to gross tested income, subpart F income, and effectively connected income. The rule is not intended to disregard the transfer that created the disqualified basis in its entirety. Moreover, the Treasury Department and the IRS have determined that disregarding the transfer for all U.S. tax purposes is not appropriate because the property has in fact been transferred. In addition, disqualified basis in property does not include basis resulting from “qualified gain,” which is gain from the transfer included by the transferor CFC as effectively connected income or by a U.S. shareholder as its pro rata share of subpart F income. See § 1.951A-3(h)(2)(ii)(C)(

3

). Thus, the rule in § 1.951A-2(c)(5) does not apply to basis created in connection with amounts that are taxed under sections 882 and 951. Accordingly, this recommendation is not adopted.

Section 901(m) disallows certain foreign tax credits on foreign income not taken into account for U.S. tax purposes as a result of a “covered asset acquisition,” which includes an acquisition of assets for U.S. tax purposes that is treated as the acquisition of stock of a corporation (or is disregarded) for foreign tax purposes and an acquisition of an interest in a partnership which has an election in effect under section 754. See section 901(m)(2)(B) and (C). One comment noted that a disqualified transfer subject to the rule in proposed § 1.951A-2(c)(5) could also constitute a covered asset acquisition under section 901(m), such as the sale of an interest in a disregarded entity during the disqualified period. In such a case, according to the comment, a deduction or loss that is not taken into account for purposes of determining tested income or tested loss under the rule may nevertheless be taken into account for purposes of section 901(m) such that foreign tax credits under section 960 might be disallowed. The comment asserted that the concurrent application of the rule and section 901(m) could be unduly punitive to taxpayers that engaged in disqualified transfers that were also covered asset acquisitions and therefore recommended that a deduction or loss attributable to disqualified basis also be disregarded for purposes of section 901(m).

Disqualified basis could give rise to policy concerns under section 901(m) even when a deduction attributable to the disqualified basis is not taken into account in determining tested income or tested loss (or subpart F income or effectively connected income). For example, a deduction or loss attributable to the disqualified basis can reduce E&P for a taxable year, with the result that subpart F income for the taxable year may be limited under section 952(c)(1)(A). Indeed, proposed § 1.901(m)-5(b)(1) provides that basis differences must be taken into account under section 901(m) regardless of whether the deduction is deferred or disallowed for U.S. income tax purposes.

Based on the foregoing, the Treasury Department and the IRS have determined that it is not appropriate to disregard disqualified basis for purposes of section 901(m). However, in response to this comment, the final regulations permit taxpayers to make an election pursuant to which the adjusted basis in each property with disqualified basis held by a CFC or a partnership is reduced by the amount of the disqualified basis and the disqualified basis is eliminated. See § 1.951A-3(h)(2)(ii)(B)(

3

). This reduction in adjusted basis is for all purposes of the Code, including section 901(m). Thus, if an election is made, a disqualified transfer of property that is also a covered asset acquisition of a relevant foreign asset will result in neither disqualified basis in the property within the meaning of § 1.951A-3(h)(2)(ii) nor a basis difference with respect to the relevant foreign asset within the meaning of section 901(m)(3)(C). As a result, in the case of an election, the rule in § 1.951A-2(c)(5) and section 901(m) will not apply concurrently with respect to a disqualified transfer that is also a covered asset acquisition.

F. Other Comments and Revisions

1. Tested Loss Carryforward

In determining a U.S. shareholder's net CFC tested income for a taxable year, the U.S. shareholder's aggregate pro rata share of tested losses for the taxable year reduces the shareholder's aggregate pro rata share of tested income for the taxable year. See section 951A(c)(1). Comments recommended that the final regulations include a provision allowing a U.S. shareholder's aggregate pro rata share of tested losses in excess of the shareholder's aggregate pro rata share of tested income for the taxable year to be carried forward to offset the shareholder's net CFC tested income in subsequent years.

A GILTI inclusion amount is an annual calculation, and nothing in the statute or legislative history suggests that unused items, such as a U.S. shareholder's aggregate pro rata share of tested losses in excess of the shareholder's aggregate pro rata share of tested income for the taxable year, can or should be carried to another taxable year. Accordingly, this recommendation is not adopted.

2. Deemed Payments Under Section 367(d)

In general, section 367(d) provides that if a U.S. person transfers intangible property to a foreign corporation in an exchange described in section 351 or 361, the person is treated as having sold the property in exchange for payments contingent upon the productivity, use, or disposition of such property. The regulations under section 367(d) provide that the deemed payment may be treated as an expense (whether or not that amount is actually paid) of the transferee foreign corporation that is properly allocated and apportioned to gross income subject to subpart F under

the provisions of §§ 1.954-1(c) and 1.861-8. See § 1.367(d)-1T(c)(2)(ii) and (e)(2)(ii).

In response to comments, the final regulations clarify that a deemed payment under section 367(d) is treated as an allowable deduction for purposes of determining tested income and tested loss. See § 1.951A-2(c)(2)(ii). Accordingly, consistent with the regulations under section 367(d), such deemed payments may be allocated and apportioned to gross tested income to the extent provided under § 1.951A-2(c)(3).

3. Compute Tested Income in the Same Manner as E&P

A comment requested that the final regulations provide that tested income and tested loss be determined under the principles of section 964, which provides rules for the calculation of E&P of foreign corporations. Another comment requested that the final regulations permit small CFCs to make an annual election to treat their tested income or tested loss for a CFC inclusion year to be equal to their E&P for such CFC inclusion year. Section 951A(c)(2) is clear that tested income or tested loss for a CFC inclusion year is computed by subtracting properly allocable deductions from gross tested income, and there is nothing in the statute or legislative history that indicates that tested income or tested loss should be limited by, or otherwise determined by reference to, E&P for such year. Accordingly, these recommendations are not adopted.

4. Effect of Losses in Other Categories of Income

The proposed regulations provide that allowable deductions are allocated and apportioned to gross tested income under the principles of section 954(b)(5) and § 1.954-1(c), by treating gross tested income within a single category (as defined in § 1.904-5(a)) as a single item of gross income, in addition to the items in § 1.954-1(c)(1)(iii). See proposed § 1.951A-2(c)(3). The final regulations clarify that losses in other categories of income (such as FBCI) cannot reduce gross tested income, and that tested losses cannot reduce other categories of income. See § 1.951A-2(c)(3).

V. Comments and Revisions to Proposed § 1.951A-3—Qualified Business Asset Investment

A. Inability of Tested Loss CFCs To Have QBAI

A U.S. shareholder's GILTI inclusion amount is equal to the excess of its net CFC tested income over its net DTIR for the taxable year. See section 951A(b)(1) and § 1.951A-1(c)(1). A U.S. shareholder's net DTIR is equal to 10 percent of its aggregate pro rata share of the QBAI of its CFCs. See section 951A(b)(2) and § 1.951A-1(c)(3). A CFC's QBAI is equal to its aggregate average adjusted basis in specified tangible property. See section 951A(1) and proposed § 1.951A-3(b). Specified tangible property is defined as tangible property used in the production of tested income. See section 951A(d)(2)(A) and proposed § 1.951A-3(c)(1). Consistent with the statute and the Conference Report, the proposed regulations clarify that tangible property of a tested loss CFC is not used in the production of tested income within the meaning of section 951A(d)(2)(A). See Conference Report, at 642, fn. 1536. In this regard, the proposed regulations provide that tangible property of a tested loss CFC is not specified tangible property and thus a tested loss CFC's QBAI is zero (the “tested loss QBAI exclusion”). See proposed § 1.951A-3(b), (c)(1), and (g)(1).

Comments recommended that the final regulations eliminate the tested loss QBAI exclusion, such that a tested loss CFC could have specified tangible property and therefore QBAI. One of the comments noted that the version of section 951A in the House bill defined specified tangible property as any tangible property to the extent such property is used in the production of tested income or tested loss. See H.R. 1, 115th Cong. § 4301(a) (2017). The comment posited that the text of the statute is ambiguous, the tested loss QBAI exclusion is otherwise inconsistent with section 951A, and the exclusion is not compelled by the statute. The comment also asserted that this rule may be easily avoided by combining a tested loss CFC with a tested income CFC (including through an election under § 301.7701-3 to change the classification of either entity for U.S. tax purposes) because there is no corollary to the tested loss QBAI exclusion for partnerships or disregarded entities.

The Treasury Department and the IRS reject this recommendation. The Senate amendment to the House bill struck the reference to “tested loss” in the definition of specified tangible property, and the Conference Report explains that the term “used in the production of tested income” means that “[s]pecified tangible property does not include property used in the production of a tested loss, so that a CFC that has a tested loss in a taxable year does not have QBAI for the taxable year.” See Conference Report, at 642, fn.1536. Thus, the statute, taking into account the footnote in the Conference Report, unambiguously provides that tested loss CFCs cannot have QBAI. Accordingly, the final regulations retain the tested loss QBAI exclusion. But cf. part VI.D of this Summary of Comments and Explanation of Revisions section regarding a reduction to tested interest expense of a CFC for a “tested loss QBAI amount,” a new component in computing specified interest expense.

One comment requested that, if the tested loss QBAI exclusion is retained, proposed § 1.951A-3(b) and (c) should be revised to clarify that the exclusion applies only for a CFC inclusion year with respect to which a CFC is a tested loss CFC. The final regulations do not revise these provisions because it is sufficiently clear that the tested loss QBAI exclusion rule applies only with respect to a CFC inclusion year of a CFC for which it is a tested loss CFC and that a CFC is a tested loss CFC only for a CFC inclusion year in which the CFC does not have tested income. See § 1.951A-2(b)(2).

B. Determination of Depreciable Property

Section 951A(d)(1)(B) provides that specified tangible property is taken into account in determining QBAI only if the property is of a type with respect to which a depreciation deduction is allowable under section 167. Similarly, the proposed regulations define “specified tangible property” as tangible property used in the production of tested income, and define “tangible property” as property for which the depreciation deduction provided by section 167(a) is eligible to be determined under section 168 (even if the CFC has elected not to apply section 168). See proposed § 1.951A-3(c)(1) and (2).

A comment recommended that, for purposes of determining QBAI, the final regulations take into account the entire adjusted basis in precious metals and other similar tangible property that are used in the production of tested income, even if only a portion of the adjusted basis in such property is depreciable in calculating regular taxable income. The comment suggested that if property is depreciable in part, then the entire asset is “of a type” with respect to which a deduction is allowable under section 167 within the meaning of section 951A(d)(1)(B).

In defining QBAI, section 951A(d) distinguishes between depreciable tangible property and non-depreciable tangible property, such as land. Section 951A(d) defines QBAI as specified tangible property “of a type” for which

a deduction is allowable under section 167. The proposed and final regulations interpret the phrase “of a type” consistent with the interpretation of the phrase “of a character” with respect to section 168. See Rev. Rul. 2015-11, 2015-21 I.R.B. 975. See § 1.951A-3(c)(2) (defining tangible property as property for which the depreciation deduction provided by section 167(a) is eligible to be determined under section 168 (with certain exclusions)). The Treasury Department and the IRS determined that for consistency, the same standard for determining whether property is depreciable should apply for determining whether property qualifies as QBAI.

In

Newark Morning Ledger Co.

v.

United States,

507 U.S. 546 (1993), the Supreme Court provided that “[w]hether or not . . . a tangible asset, is depreciable for Federal income tax purposes depends upon the determination that the asset is actually exhausting, and that such exhaustion is susceptible of measurement.”

Newark Morning Ledger Co.

v.

United States

at 566. Although unrecoverable commodities used in a business are depreciable, recoverable commodities used in a business are not depreciable because they do not suffer from exhaustion, wear and tear, or obsolescence over a determinable useful life.

O'Shaughnessy

v.

Commissioner,

332 F.3d 1125 (8th Cir. 2003);

Arkla, Inc.

v.

United States,

765 F.2d 487 (5th Cir. 1985). The recoverable quantity of a commodity used in the business suffers no change in its physical characteristics or value as a result of its use in the business. The comment seemed to imply that precious metals were a single unit of property that was partially depreciable and partially non-depreciable, rather than quantities of metal in separate categories of property, one of which is depreciable.

The Treasury Department and the IRS have determined that it would not be appropriate for purposes of determining a CFC's QBAI to take into account the CFC's entire adjusted basis in an asset that is only partially depreciable. Taking into account basis that is not subject to a depreciation allowance would overstate a CFC's QBAI. For example, in the case of precious metals that are partially depreciable, such as platinum used in a catalyst, a portion of the metal may be subject to exhaustion, wear and tear, or obsolescence during its useful life. The remainder of the metal is recoverable for reuse or sale. When initially purchased, the value and tax basis of the recoverable portion generally should reflect the forward price of such metal. The value and tax basis of the depreciable portion of the metal generally should reflect the net present value of the expected returns generated by the metal. QBAI is a proxy for the base upon which non-extraordinary, tangible returns should be calculated. See S. Comm. on the Budget, Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. Print No. 115-20, at 371 (2017) (“Senate Explanation”) (The provision approximates . . . tangible income . . . as a 10-percent return on . . . the adjusted basis in tangible depreciable property.”). Therefore, only the depreciable portion of the precious metal, which is associated with the tangible returns, should be taken into account in this measurement. Given that liquid commodity markets exist for these precious metals, taxpayers could sell the future rights to the recoverable portion of the asset (thereby reducing their economic outlay and exposure with respect to the property). Cf.

Guardian Industries

v.

Commissioner,

97 T.C. 308 (1991) (taxpayer regularly sold silver waste from photographic development process to refiners). Thus, the depreciable portion of the asset represents the taxpayer's economic investment in generating tangible returns. Accordingly, the comment is not adopted.

The comment also requested that in calculating the adjusted basis in precious metals for QBAI purposes, the final regulations provide that class lives applied to precious metals for purposes of the alternative depreciation system (“ADS”) are the same class lives determined under the principles of Rev. Rul. 2015-11, rather than the ADS class lives of the equipment to which the precious metals attach. This recommendation is not adopted because Rev. Rul. 2015-11 does not establish principles for determining class lives of the precious metals discussed therein, but rather addresses whether certain precious metals are depreciable under the facts and circumstances described in the ruling.

One comment requested that all expenditures paid or incurred with respect to the acquisition, exploration, and development of a mine or other natural deposit should be taken into account in determining QBAI. The comment stated that such exploration and development costs for mining operations are “of a type” for which depreciation is allowed, even though the costs are recovered through depletion rather than depreciation. The comment also recommended that the adjusted basis in a mine or other natural deposit included as QBAI should be determined using cost depletion, rather than percentage depletion.

Section 951A(d)(1)(B) limits property taken into account in determining QBAI to tangible property of a type with respect to which a deduction is allowable under section 167. Congress did not extend the definition of QBAI to property of a type with respect to which a deduction is allowed under section 611 (the allowance of deduction for depletion). Although the comment focused on the similarities between cost depletion and depreciation, there are also similarities between cost depletion of mineral properties and the acquisition cost of inventory. The inventory cost of a severed mineral includes the cost depletion attributable to the severed mineral. See section 263A and § 1.263A-1(e)(3)(ii)(J). In essence, the acquisition cost of the mineral property recovered through cost depletion is the inventory cost of the severed mineral, and QBAI does not include inventory. Accordingly, the recommendation is not adopted.

The proposed regulations define “tangible property” as property for which the depreciation deduction provided by section 167(a) is eligible to be determined under section 168 without regard to section 168(f)(1), (2), or (5) and the date placed in service. See proposed § 1.951A-3(c)(2). Section 168(k) increases the depreciation deduction allowed under section 167(a) with respect to qualified property, which includes tangible and certain intangible property. The final regulations revise the definition of tangible property in § 1.951A-3(c)(2) to exclude certain intangible property to which section 168(k) applies, namely, computer software, qualified film or television productions, and qualified live theatrical productions described in section 168(k)(2)(A).

C. Determination of Basis Under Alternative Depreciation System

For purposes of determining QBAI, the adjusted basis in specified tangible property is determined by using ADS under section 168(g), and by allocating the depreciation deduction with respect to such property for the CFC inclusion year ratably to each day during the period in the taxable year to which such depreciation relates. See section 951A(d)(3)

3

and § 1.951A-3(e)(1). ADS

applies to determine the adjusted basis in property for purposes of determining QBAI regardless of whether the property was placed in service before the enactment of section 951A, or whether the basis in the property is determined under another depreciation method for other purposes of the Code. See section 951A(d)(3) and § 1.951A-3(e)(2). In addition, for purposes of determining income and E&P, a CFC is generally required to use ADS for depreciable property used predominantly outside the United States. See section 168(g) and §§ 1.952-2(c)(2)(ii) and (iv) and 1.964-1(a)(2). However, a CFC may instead use for this purpose a depreciation method used for its books of account regularly maintained for accounting to shareholders or a method conforming to United States generally accepted accounting principles (a “non-ADS depreciation method”) if the differences between ADS and the non-ADS depreciation method are immaterial. See §§ 1.952-2(c)(2)(ii) and (iv) and 1.964-1(a)(2).

3

As enacted, section 951A(d) contains two paragraphs designated as paragraph (3). The section 951A(d)(3) discussed in this part V.C of the Summary of Comments and Explanation of Revisions section relates to the determination of the adjusted basis in property for purposes of calculating QBAI.

A comment recommended that ADS not be required under section 951A(d) for specified tangible property placed in service before the enactment of section 951A. This comment asserted that section 951A(d)(3) does not compel the conclusion that ADS must be used for assets placed in service before the enactment of section 951A, and cited compliance concerns as a justification for not requiring the use of ADS with respect to such assets. Another comment recommended that the final regulations permit taxpayers to elect to compute the adjusted basis in all specified tangible property of a CFC—not just specified tangible property placed in service before the enactment of section 951A—under the method that the CFC uses to compute its tested income and tested loss, even if such method is not ADS.

Section 951A(d)(3) is clear that the adjusted basis in specified tangible property is determined using ADS under section 168(g), and therefore the final regulations do not adopt the recommendation to permit taxpayers an election to compute the adjusted basis in all specified tangible property under the CFC's non-ADS depreciation method. However, recognizing the potential burden of re-determining the basis under ADS of all specified tangible property held by a CFC placed in service before the enactment of section 951A, and given that a non-ADS depreciation method is permissible only when there are immaterial differences between ADS and such other method, the Treasury Department and the IRS have determined that a transition rule is warranted for CFCs that are not required to use ADS for purposes of computing income and E&P. Accordingly, the final regulations provide that a CFC that is not required to use ADS for purposes of computing income and E&P may elect, for purposes of calculating QBAI, to use its non-ADS depreciation method to determine the adjusted basis in specified tangible property placed in service before the first taxable year beginning after December 22, 2017, subject to a special rule related to salvage value. See § 1.951A-3(e)(3)(ii). The election also applies to the determination of a CFC's partner adjusted basis under § 1.951A-3(g)(3) in partnership specified tangible property placed in service before the CFC's first taxable year beginning after December 22, 2017. See id. This transition rule does not apply for purposes of determining the foreign-derived intangible income (“FDII”) of a domestic corporation. Cf. section 250(b)(2)(B) (in calculating deemed tangible income return for purposes of FDII, QBAI is generally determined under section 951A(d)).

A comment requested that the final regulations confirm that the use of ADS in determining the basis in specified tangible property, whether placed in service before or after the enactment of section 951A, for purposes of determining QBAI is not a change in method of accounting or, if it is a change in method, that global approval under section 446(e) be given for such a change. Another comment recommended that a CFC switching to ADS for property placed in service before the enactment of section 951A should not be required to file Form 3115 to request an accounting method change for depreciation, and that the cumulative adjustment should be taken into account for the adjusted basis in the specified tangible property as of the CFC's first day of the first year to which section 951A applies.

The determination of the adjusted basis in property under section 951A(d) is not a method of accounting subject to the consent requirement of section 446(e). As a result, a CFC does not need the Commissioner's consent to use ADS for purposes of determining its adjusted basis in specified tangible property in determining its QBAI. A CFC that uses ADS for purposes of determining QBAI should determine the correct basis in the property under ADS as of the CFC's first day of the first taxable year to which section 951A applies and apply section 951A(d)(3) accordingly. The final regulations also clarify that the adjusted basis in property is determined based on the cost capitalization methods of accounting used by the CFC for purposes of determining its tested income and tested loss. See § 1.951A-3(e)(1).

A change to ADS from another depreciation method for purposes of computing tested income or tested loss is a change in method of accounting subject to section 446(e). The Treasury Department and the IRS expect that many CFCs that are not already using ADS for purposes of computing income and E&P will change their method of accounting for depreciation to the straight-line method, the applicable recovery period, or the applicable convention under ADS to comply with § 1.952-2(c)(2)(iv) and § 1.964-1(c)(1)(iii)(c) and that most of such changes are already eligible for automatic consent under Rev. Proc. 2015-13, 2015-5 I.R.B. 419. The Treasury Department and the IRS intend to publish another revenue procedure further expanding the availability of automatic consent for depreciation changes and updating the terms and conditions in sections 7.07 and 7.09 of Rev. Proc. 2015-13 (related to the source, separate limitation classification, and character of section 481(a) adjustments) to take into account section 951A. After the change in accounting method, the basis in specified tangible property will be the correct basis for purposes of determining income, E&P, and QBAI.

The final regulations clarify the interaction between the daily proration of depreciation rule in section 951A(d)(3) and the applicable convention under ADS. Under section 951A(d)(3), the adjusted basis in property is determined by allocating the depreciation deduction with respect to property to each day during the period in the taxable year to which the depreciation relates. The half-year convention, mid-month convention, and mid-quarter convention in section 168(d) treat property as placed in service (or disposed of) for purposes of section 168 at the midpoint of the taxable year, month, or quarter, as applicable, irrespective of when the property was placed in service (or disposed of) during the taxable year. The final regulations clarify that the period in the CFC inclusion year to which such depreciation relates is determined without regard to the applicable convention under section 168(d). See § 1.951A-3(e)(1). Accordingly, in the year property is placed in service, the depreciation deduction allowed for the taxable year is prorated from the day the property is actually placed in service, and, in the year property is disposed of, the

depreciation deduction allowed for the taxable year is prorated to the date of disposition. Allocating depreciation to each day during the period in which the property is used irrespective of the applicable convention ensures that the average of the aggregate adjusted basis as of the close of each quarter is properly adjusted to reflect the depreciation allowed for the taxable year.

The Treasury Department and the IRS continue to study issues related to the determination of QBAI for purposes of section 951A. In particular, the Treasury Department and the IRS are aware that a CFC that is a partner in a foreign partnership may have difficulty determining the basis in partnership property under ADS, particularly when the partnership is not controlled by U.S. persons. Comments are requested on methodologies for determining the basis in partnership property owned by a foreign partnership that is not controlled directly or indirectly by U.S. persons.

D. Dual Use Property

Section 951A(d)(2)(B) provides that if property is used both in the production of tested income and income that is not tested income, the property is specified tangible property in the same proportion that the gross income described in section 951A(c)(1)(A) produced with respect to such property bears to the total gross income produced with respect to such property. The proposed regulations provide that if tangible property is used in both the production of gross tested income and other income, the portion of the adjusted basis in the property treated as adjusted basis in specified tangible property is determined by multiplying the average of the adjusted basis in the property by the dual use ratio. See proposed § 1.951A-3(d)(1). If the property produces directly identifiable income for a CFC inclusion year, the dual use ratio is the ratio of the gross tested income produced by the property to the total amount of gross income produced by the property. See proposed § 1.951A-3(d)(2)(i). In all other cases, the dual use ratio is the ratio of the gross tested income of the tested income CFC to the total amount of gross income of the tested income CFC. See proposed § 1.951A-3(d)(2)(ii).

Under the proposed regulations, the dual use ratio requires a determination of whether and how much gross income is “directly identifiable” with particular specified tangible property. The Treasury Department and the IRS recognize that application of the directly identifiable standard could result in substantial uncertainty and controversy. In addition, the Treasury Department and the IRS have determined that the rules under section 861 for allocating a depreciation or amortization deduction attributable to property owned by a CFC to categories of income of the CFC represent a reliable and well-understood proxy for determining the type of income produced by the property, even in circumstances where there is no income that is “directly identifiable” with the property. Accordingly, the final regulations provide that the dual use ratio, with respect to tangible property for a CFC inclusion year, is the ratio calculated as the sum of the amount of the depreciation deduction with respect to the property for the CFC inclusion year that is allocated and apportioned to gross tested income for the CFC inclusion year under § 1.951A-2(c)(3) and the depreciation with respect to the property capitalized to inventory or other property held for sale, the gross income or loss from the sale of which is taken into account in determining tested income for the CFC inclusion year, divided by the sum of the total amount of the depreciation deduction with respect to the property for the CFC inclusion year and the total amount of depreciation with respect to the property capitalized to inventory or other property held for sale, the gross income or loss from the sale of which is taken into account for the CFC inclusion year. See § 1.951A-3(d)(3). The dual use ratio also applies with respect to partnership specified tangible property, except, for this purpose, determined by reference to a tested income CFC's distributive share of the amounts described in the preceding sentence. See § 1.951A-3(g)(3)(iii) and part V.E of this Summary of Comments and Explanation of Revisions section.

A comment recommended that the final regulations clarify, through additional examples, that the method for determining the dual use ratio with respect to specified tangible property does not change if (i) the dual use property becomes or ceases to be specified tangible property during the year, or (ii) the dual use property gives rise to increasing or decreasing gross tested income across quarters in a taxable year. The Treasury Department and the IRS have determined that additional examples are unnecessary. As the comment suggests, the dual use ratio is not determined on the basis of the type and amount of gross income produced by the property as of any particular quarter close, but rather is determined based on the type and the amount of gross income produced by the property for the entire taxable year. In this regard, there is no ambiguity in the language in the regulations, and therefore no need for additional clarification.

The rules in § 1.951A-3 do not apply in determining QBAI for purposes of computing the deduction of a domestic corporation under section 250 for its FDII. See proposed § 1.250(b)-2 (REG-104464-18, 84 FR 8188 (March 6, 2019)) for the QBAI rules related to the FDII deduction. However, it is anticipated that, except as indicated in part V.D of this Summary of Comments and Explanation of Revisions section with respect to the election to use a non-ADS depreciation method for assets placed in service before the enactment of section 951A, revisions similar to the revisions to proposed § 1.951A-3 discussed in parts V.B through E of this Summary of Comments and Explanation of Revisions section will be made to proposed § 1.250(b)-2.

E. Partnership QBAI

Section 951A(d)(3)

4

provides that, for purposes of calculating QBAI, if a CFC holds an interest in a partnership at the close of the CFC's taxable year, the CFC takes into account its distributive share of the aggregate of the partnership's adjusted basis in depreciable tangible property used in its trade or business that is used in the production of tested income (determined with respect to the CFC's distributive share of income with respect to such property). For this purpose, a CFC's distributive share of the adjusted basis in any property is the CFC's distributive share of income with respect to such property. See section 951A(d)(3) (flush language).

4

As enacted, section 951A(d) contains two paragraphs designated as paragraph (3). The section 951A(d)(3) discussed in this part V.E of the Summary of Comments and Explanation of Revisions section relates to tangible property held by a partnership taken into account in calculating the QBAI of a CFC partner.

The proposed regulations implement the rule in section 951A(d)(3) by providing that, if a tested income CFC holds an interest in one or more partnerships as of the close of a CFC inclusion year, the QBAI of the tested income CFC for the CFC inclusion year is increased by the sum of the tested income CFC's partnership QBAI with respect to each partnership for the CFC inclusion year. See proposed § 1.951A-3(g)(1). A tested income CFC's partnership QBAI with respect to a partnership is the sum of the tested income CFC's share of the partnership's adjusted basis in partnership specified tangible property as of the close of a partnership taxable year that ends with

or within a CFC inclusion year. See proposed § 1.951A-3(g)(2)(i). A tested income CFC's share of the partnership's adjusted basis in partnership specified tangible property is determined by multiplying the partnership's adjusted basis in the property by the tested income CFC's partnership QBAI ratio with respect to the property. See id. Similar to the rule for dual use property, under the proposed regulations, the tested income CFC's partnership QBAI ratio with respect to partnership specified tangible property depends on whether the property produces directly identifiable income. In the case of partnership specified tangible property that produces directly identifiable income for a partnership taxable year, a tested income CFC's partnership QBAI ratio with respect to the property is the tested income CFC's distributive share of the gross income produced by the property for the partnership taxable year that is included in the gross tested income of the tested income CFC for the CFC inclusion year to the total gross income produced by the property for the partnership taxable year. See proposed § 1.951A-3(g)(2)(ii)(A). In the case of partnership specified tangible property that does not produce directly identifiable income for a partnership taxable year, a tested income CFC's partnership QBAI ratio with respect to the property is the tested income CFC's distributive share of the gross income of the partnership for the partnership taxable year that is included in the gross tested income of the tested income CFC for the CFC inclusion year to the total amount of gross income of the partnership for the partnership taxable year. See proposed § 1.951A-3(g)(2)(ii)(B).

The partnership QBAI ratio in the proposed regulations is effectively an amalgamation of two ratios—a ratio that describes the portion of the partnership specified tangible property that is used in the production of gross tested income (that is, the dual use ratio) and a ratio that describes a tested income CFC's proportionate interest in all the income produced by the property. The final regulations disaggregate the partnership QBAI ratio into these two ratios—the dual use ratio (as defined in § 1.951A-3(d)(3)) and a new proportionate share ratio (as defined in § 1.951A-3(g)(4)(ii)). Accordingly, the final regulations provide that a tested income CFC's “partner adjusted basis” with respect to partnership specified tangible property—that is, the adjusted basis in partnership specified tangible property taken into account in determining the tested income CFC's partnership QBAI—is generally, in the case of partnership specified tangible property used in the production of only gross tested income (“sole use partnership property”), the tested income CFC's proportionate share of the partnership's adjusted basis in the property for the partnership taxable year. See § 1.951A-3(g)(3)(ii). A tested income CFC's partner adjusted basis with respect to partnership specified tangible property used in the production of gross tested income and gross income that is not gross tested income (“dual use partnership property”) is generally the tested income CFC's proportionate share of the partnership's adjusted basis in the property for the partnership taxable year, multiplied by the tested income CFC's dual use ratio with respect to the property (determined by reference to the tested income CFC's distributive share of amounts described in § 1.951A-3(d)(3)). See § 1.951A-3(g)(3)(iii). In either case, a tested income CFC's proportionate share of the partnership's adjusted basis in partnership specified tangible property is the partnership's adjusted basis in the property for the partnership taxable year multiplied by the tested income CFC's proportionate share ratio with respect to the property for the partnership taxable year.

As discussed in part V.D of this Summary of Comments and Explanation of Revisions section, a rule that determines adjusted basis in specified tangible property taken into account in determining QBAI by reference to the “directly identifiable income” attributable to such property would lead to substantial uncertainty and controversy, whereas the rules under section 861 for allocating and apportioning depreciation attributable to property owned by a CFC to categories of income represent a longstanding proxy for determining the types of income produced by the property. For this reason, the final regulations determine the dual use ratio by reference to the amount of depreciation deductions allocated to gross tested income under § 1.951A-2(c)(3). Similarly, the Treasury Department and the IRS have determined that calculating partnership QBAI by reference to the “directly identifiable income” produced by partnership specified tangible property would lead to substantial uncertainty and controversy, and that a partner's share of a depreciation deduction with respect to partnership specified tangible property is a reliable proxy for determining a CFC's distributive share of income with respect to such property. Accordingly, the final regulations determine the proportionate share ratio with respect to partnership specified tangible property also by reference to the depreciation with respect to the property, rather than the directly identifiable income attributable to the property or the gross income of the partner. See § 1.951A-3(g)(4)(ii).

A comment requested clarification that the partnership QBAI ratio in the proposed regulations, which references the amount of “gross income” produced by the property, is determined by reference to “gross taxable income,” rather than gross section 704(b) income. The comment also recommended that if the partnership QBAI ratio is determined by reference to a partnership's gross taxable income, that section 704(c) allocations (including items of income under the remedial method) be taken into account in determining the CFC's distributive share of the gross income produced by the property for the partnership taxable year. The specific comment regarding the calculation of gross income produced by property has been mooted by the change to determining the dual use and proportionate share ratios by reference to the depreciation with respect to the property. However, the comment remains relevant to the calculation of the depreciation with respect to property for purposes of determining the dual use ratio and proportionate share ratio.

For purposes of the proportionate share ratio, the final regulations do not adopt this recommendation. Section 704(b) income represents a partner's economic interest in the partnership and therefore more closely aligns with the economic production of income from partnership property that QBAI is intended to measure. Accordingly, the final regulations clarify that the proportionate share ratio is determined by reference to the amount of depreciation with respect to property (and a tested income CFC's distributive share of such amount) determined under section 704(b). See § 1.951A-3(g)(4)(i). Therefore, items determined under section 704(c) are not taken into account for purposes of determining a tested income CFC's partner adjusted basis in partnership specified tangible property held by a partnership and thus the tested income CFC's partnership QBAI with respect to the partnership. However, because the dual use ratio is determined by reference to the allocation and apportionment of depreciation deductions to gross tested income of a tested income CFC, and thus is based on a taxable income concept, items determined under section 704(c) are taken into account for

purposes of determining the dual use ratio.

The proposed regulations provide that partnership QBAI is the sum of the tested income CFC's share of the partnership's adjusted basis in partnership specified tangible property. See proposed § 1.951A-3(g)(2)(i). A comment recommended that the final regulations clarify that the adjusted basis in partnership specified tangible property includes any basis adjustment under section 743(b). In response to this comment, the final regulations clarify that an adjustment under section 743(b) to the adjusted basis in partnership specified tangible property with respect to a tested income CFC is taken into account in determining the tested income CFC's partner adjusted basis in the partnership specified tangible property. See § 1.951A-3(g)(3) and (7). In addition, to ensure that the adjusted basis in property other than tangible property is not inappropriately shifted to tangible property for purposes of determining QBAI, the final regulations provide that basis adjustments to partnership specified tangible property under section 734(b) are taken into account only if they are basis adjustments under section 734(b)(1)(B) or 734(b)(2)(B) attributable to distributions of tangible property or basis adjustments under section 734(b)(1)(A) or 734(b)(2)(A) by reason of gain or loss recognized by a distributee partner under section 731(a). See § 1.951A-3(g)(6).

A comment also requested that the final regulations clarify that a CFC's QBAI is increased not only for partnership specified tangible property owned by partnerships in which the CFC is a direct partner, but also for lower-tier partnerships in which the CFC indirectly owns an interest through one or more upper-tier partnerships. The final regulations make this clarification. See § 1.951A-3(g)(1).

Finally, a comment suggested that, under section 951A(d)(3) and the proposed regulations, a disposition of a partnership interest by a tested income CFC could result in the CFC including its distributive share of partnership income in its gross tested income, but not taking into account any of the partnership's basis in partnership specified tangible property for purposes of calculating the CFC's QBAI. Under section 951A(d)(3) and proposed § 1.951A-3(g)(1), if a CFC holds an interest in a partnership at the close of the taxable year of the CFC, the CFC takes into account its share of a partnership's adjusted basis in certain tangible property for QBAI purposes. However, neither section 951A(d)(3) nor the proposed regulations have a rule that would allow a tested income CFC to increase its QBAI for its share of partnership QBAI if the tested income CFC owned the partnership interest for part of the year but not at the close of the CFC taxable year. However, a partner that disposes of its entire partnership interest before the close of the CFC taxable year could have a distributive share of partnership income if the partnership taxable year closes before the close of the CFC taxable year, including by reason of the disposition itself. See section 706(c)(2)(A) (taxable year of partnership closes with respect to partner whose entire interest terminates, including by reason of a disposition).

The Treasury Department and the IRS agree that a partner that has a distributive share of income from a partnership should also be permitted partnership QBAI with respect to the partnership. Therefore, the final regulations are revised to provide that a partner need only hold an interest in a partnership during the CFC inclusion year to have partnership QBAI with respect to the partnership. See § 1.951A-3(g)(1). The final regulations also provide that section 706(d) applies to determine a tested income CFC's partner adjusted basis in partnership specified tangible property owned by a partnership if there is a change in the tested income CFC's interest in the partnership during the CFC inclusion year. See § 1.951A-3(g)(3)(i).

F. Disregard of Basis in Specified Tangible Property Held Temporarily

Section 951A(d)(4) authorizes the issuance of regulations or other guidance that the Secretary determines are appropriate to prevent the avoidance of the purposes of section 951A(d), including regulations or other guidance which provide for the treatment of property that is transferred, or held, temporarily. The proposed regulations provide that if a tested income CFC (“acquiring CFC”) acquires specified tangible property with a principal purpose of reducing the GILTI inclusion amount of a U.S. shareholder for any U.S. shareholder inclusion year, and the tested income CFC holds the property temporarily but over at least the close of one quarter, the specified tangible property is disregarded in determining the acquiring CFC's average adjusted basis in specified tangible property for purposes of determining the acquiring CFC's QBAI for any CFC inclusion year during which the tested income CFC held the property (the “temporary ownership rule”). See proposed § 1.951A-3(h)(1). If an acquisition of specified tangible property would, but for the temporary ownership rule, reduce the GILTI inclusion amount of a U.S. shareholder, then the property is “per se” treated as temporarily held and acquired with a principal purpose of reducing the GILTI inclusion amount of a U.S. shareholder if the tested income CFC holds the property for less than a 12-month period that includes at least the close of one quarter during its taxable year (the “12-month per se rule”). See id. Therefore, the specified tangible property is disregarded under the proposed regulations for purposes of determining QBAI.

Although some comments supported the temporary ownership rule and, in particular, stated that the principal purpose standard was a reasonable interpretation of section 951A(d)(4), many comments asserted that it was overbroad. Comments expressed particular concern with the scope of the 12-month per se rule, noting for example that it could (i) apply to transactions not motivated by tax avoidance such as ordinary course transactions, (ii) require burdensome asset-level tracking of CFC property, and (iii) lead to uncertain return filing positions or financial accounting volatility if property acquired by a CFC has not yet been held for 12 months when a U.S. shareholder files its return or publishes a financial statement.

Comments suggested various ways to minimize the scope of the temporary ownership rule, including (i) eliminating the 12-month per se rule; (ii) converting the 12-month per se rule into a rebuttable presumption; (iii) providing an exception for property transferred among related CFCs owned by a U.S. shareholder when there is no decrease in that shareholder's GILTI inclusion amount (for this purpose, treating a consolidated group as a single entity); (iv) providing that, for purposes of applying the 12-month per se rule, a CFC's holding period in property received in a nonrecognition transaction include a tacked holding period under section 1223(2); (v) providing de minimis or ordinary course transaction exceptions; (vi) excepting acquisitions of property that result in effectively connected income or subpart F income to the transferor; (vii) tailoring the rule's application depending on whether property is acquired from or transferred to unrelated parties; and (viii) establishing a period of ownership that will not be considered temporary.

In response to the comments, the Treasury Department and the IRS have determined that it is appropriate to narrow the scope of the temporary ownership rule, and that the following

changes strike the appropriate balance between mitigating the compliance burden and identifying transactions that have the potential to avoid the purposes of section 951A(d). First, the final regulations make certain technical changes that are intended to refine and clarify the application of the temporary ownership rule. For example, the rule applies, in part, based on a principal purpose of increasing the DTIR of a U.S. shareholder (“applicable U.S. shareholder”) and, for this purpose, certain related U.S. persons are treated as a single applicable U.S. shareholder. See § 1.951A-3(h)(1)(i) and (vi). Further, in response to comments, the final regulations clarify that property held temporarily over a quarter close is subject to the temporary ownership rule only if the holding of the property over the quarter close would, without regard to the temporary ownership rule, increase the DTIR of an applicable U.S. shareholder for its taxable year. See § 1.951A-3(h)(1)(i).

The final regulations also clarify that a CFC's holding period for purposes of this rule does not include the holding period for which the property was held by any other person under section 1223. See § 1.951A-3(h)(1)(v). The final regulations do not adopt the request to permit a tacking of holding periods for purpose of the temporary ownership rule, because temporary acquisitions of property through nonrecognition transactions, particularly between related parties, can artificially increase a U.S. shareholder's DTIR by, for instance, causing the property to be taken into account for an additional quarter close for purposes of calculating QBAI.

The final regulations also modify the 12-month per se rule to make it a presumption rather than a per se rule. Therefore, under the final regulations the temporary ownership rule is presumed to apply only if property is held for less than 12 months. See § 1.951A-3(h)(1)(iv)(A). This presumption may be rebutted if the facts and circumstances clearly establish that the subsequent transfer of the property was not contemplated when the property was acquired by the acquiring CFC and that a principal purpose of the acquisition of the property was not to increase the DTIR of the applicable U.S. shareholder. See id. As a result of this change, a taxpayer generally will know when it files its return whether the temporary ownership rule will apply. In order to rebut the presumption, a taxpayer must attach a statement to the Form 5471 filed with the taxpayer's return for the taxable year of the CFC in which the subsequent transfer occurs disclosing that it rebuts the presumption. See id. In response to a comment, the final regulations include a second presumption that generally provides that property is presumed not to be subject to the temporary ownership rule if held for more than 36 months. See § 1.951A-3(h)(1)(iv)(B).

The final regulations clarify that the adjusted basis in property may be disregarded under the rule for multiple quarter closes. See § 1.951A-3(h)(1)(ii). However, in the case that the temporary holding results in the property being taken into account for only one additional quarter close of a tested income CFC in determining the DTIR of a U.S. shareholder inclusion year, the adjusted basis in the property is disregarded under this rule only as of the first tested quarter close that follows the acquisition. See id.; see also § 1.951A-3(h)(1)(vii)(C) (

Example 2

) (disregarding the adjusted basis in specified tangible property for a single quarter due to differences in CFC taxable years). This rule ensures that the adjusted basis in property is not inappropriately disregarded in excess of the amount necessary to eliminate the increase in the DTIR of the applicable U.S. shareholder by reason of the temporary holding.

The final regulations also include a safe harbor for certain transfers involving CFCs. See § 1.951A-3(h)(1)(iii). Under the safe harbor, the holding of property as of a tested quarter close is not treated as increasing the DTIR if certain conditions are satisfied. In general, the safe harbor applies to transfers between CFCs that are owned in the same proportion by the U.S. shareholder, have the same taxable years, and are all tested income CFCs. The safe harbor is intended to exempt non-tax motivated transfers from the rule when the temporary holding of the property does not have the potential for increasing the DTIR of an applicable U.S. shareholder. The addition of the safe harbor responds to the comment requesting that the rule be tailored depending on whether the transfers involve related or unrelated parties.

In addition, in response to comments, the final regulations include four new examples to illustrate the application of the rule. See § 1.951A-3(h)(1)(vii). The examples identify a transaction that is not subject to the rule due to the application of the safe harbor, and three transactions that are subject to the rule, including transfers of property between CFCs that have different taxable years, and an acquisition of property by a tested income CFC from a tested loss CFC, which cannot have QBAI pursuant to § 1.951A-3(b) and (c)(1).

The final regulations do not adopt the comments requesting a de minimis or ordinary course transaction exception. The Treasury Department and the IRS have determined that these types of exceptions are unnecessary due to the narrowed and refined scope of the rule in the final regulations, including as a result of converting the 12-month per se rule into a rebuttable presumption, adding the safe harbor, and illustrating certain transactions that are targeted by the rule through new examples. Moreover, because the rule is limited to the temporary holding of depreciable property used in a CFC's trade or business (that is, specified tangible property), the Treasury Department and the IRS do not anticipate that many such assets will be acquired and disposed of in the “ordinary course” of a CFC's business, however that standard is defined.

Finally, the final regulations do not adopt the comment requesting an exception for acquisitions of property that result in effectively connected income or subpart F income to the transferor. The Treasury Department and the IRS have concluded that, unlike the rule that addresses disqualified basis in § 1.951A-2(c)(5) and § 1.951A-3(h)(2), the treatment of gain recognized by the transferor (if any) is not relevant for purposes of determining whether it is appropriate to take into account specified tangible property held temporarily for purposes of determining QBAI. Nothing in section 951A(d)(4) or the legislative history suggests that transfers of property that result in income or gain that is subject to U.S. tax should be exempt from the rule. Indeed, the policy concern underlying this rule—the temporary holding of specified tangible property with a principal purpose of increasing the DTIR of a U.S. shareholder—is present regardless of whether the basis in the specified tangible property reflects gain that is subject to U.S. tax.

G. Determination of Disqualified Basis

The determination of disqualified basis is relevant for purposes of both the rule in § 1.951A-2(c)(5) (allocating deductions attributable to disqualified basis to residual CFC gross income) and the rule in § 1.951A-3(h)(2) (disregarding disqualified basis for purposes of calculating QBAI). This part V.G of the Summary of Comments and Explanation of Revisions section describes comments and revisions related to the computation of disqualified basis both for purposes of § 1.951A-2(c)(5) and § 1.951A-3(h)(2). For other comments and revisions related to the computation of

disqualified basis discussed in the context of the application of § 1.951A-2(c)(5), see part IV.E.3 and 4 of this Summary of Comments and Explanation of Revisions section.

As described in part IV.E.1 of this Summary of Comments and Explanation of Revisions section, the proposed regulations define “disqualified basis” in property as the excess of the property's adjusted basis immediately after a disqualified transfer, over the sum of the property's adjusted basis immediately before the disqualified transfer and the qualified gain amount with respect to the disqualified transfer. See proposed § 1.951A-3(h)(2)(ii)(A). In addition, the proposed regulations define “disqualified transfer” as a transfer of property by a transferor CFC during a transferor CFC's disqualified period to a related person in which gain was recognized, in whole or in part. See proposed § 1.951A-3(h)(2)(ii)(C). One comment recommended that the definition of disqualified transfer not be expanded to include transfers of property to unrelated persons. The final regulations do not modify the definition of disqualified transfer, and therefore the term continues to be limited to transfers of property by a CFC to a related person. See § 1.951A-3(h)(2)(ii)(C)(

2

).

A comment noted that the proposed regulations do not explain whether the computation of disqualified basis in property takes into account basis adjustments under section 743(b) or section 734(b) allocated to that property under section 755 during the disqualified period. The final regulations clarify that adjustments under sections 732(d), 734(b), and 743(b) can create, increase, or reduce disqualified basis in property. See § 1.951A-3(h)(2)(ii)(A) and (B).

The proposed regulations provide that disqualified basis may be reduced or eliminated through depreciation, amortization, sales or exchanges, section 362(e), and other methods. See proposed § 1.951A-3(h)(2)(ii)(A). The final regulations clarify the circumstances under which disqualified basis is reduced. Specifically, the final regulations prov

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