# Previously Taxed Earnings and Profits and Related Basis Adjustments

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2024-27227

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** December 2, 2024
- **Citation:** 89 FR 95362

## Text

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-105479-18]
RIN 1545-BO61
Previously Taxed Earnings and Profits and Related Basis Adjustments

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

This document contains proposed regulations regarding previously taxed earnings and profits of foreign corporations and related basis adjustments. The proposed regulations affect foreign corporations with previously taxed earnings and profits and their shareholders.

DATES:

Written or electronic comments and requests for a public hearing must be received by March 3, 2025.

ADDRESSES:

Commenters are strongly encouraged to submit public comments electronically. Submit electronic submissions via the Federal eRulemaking Portal at
www.regulations.gov
(indicate IRS and REG-105479-18) by following the online instructions for submitting comments. Requests for a public hearing must be submitted as prescribed in the “Comments and Requests for a Public Hearing” section. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The Department of the Treasury (Treasury Department) and the IRS will publish for public availability any comment submitted electronically or on paper to its public docket. Send paper submissions to: CC:PA:01:PR (REG-105479-18), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT:

Concerning the proposed regulations generally, Elena M. Madaj at (202) 317-3576; concerning the portions of the proposed regulations relating to section 1502, Jeremy Aron-Dine at (202) 317-6847; concerning the portions of the proposed regulations relating to partnerships, Jennifer N. Keeney at (202) 317-6850; and concerning submissions of comments and requests for a public hearing, contact the Publications and Regulations Section of the Office of Associate Chief Counsel (Procedure and Administration) by email at
publichearings@irs.gov
(preferred) or by telephone at (202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Authority

This document contains proposed additions and amendments to 26 CFR part 1 (proposed regulations) under sections 959 and 961 and certain other provisions of the Internal Revenue Code (Code) regarding previously taxed earnings and profits (PTEP). As discussed in the Explanation of Provisions, the primary provisions of the proposed regulations are issued pursuant to the express delegations of authority under sections 245A(g), 743(b), 904(d)(7), 951A(f)(1)(B), 960(f), 961(a) through (c), 965(o), 986(c)(2), 989(c), and 1502. The proposed regulations are also issued pursuant to the express delegation of authority under section 7805(a).

Background

I. Scope

The Background describes PTEP, including provisions giving rise to PTEP and provisions regarding the treatment of PTEP, and related guidance and issues under existing law. Any term used but not defined in this preamble has the meaning given to it in the proposed regulations.

II. PTEP

A. Overview

Sections 959 and 961 are intended to operate in tandem to prevent double taxation of PTEP, which is earnings and profits (E&P) of a foreign corporation described in section 959(c)(1) or (c)(2). Section 959 designates amounts of E&P as PTEP based on amounts included, or treated as included, in gross income with respect to the foreign corporation under section 951(a).

The remainder of this part II of the Background summarizes provisions giving rise to PTEP, provisions regarding the treatment of PTEP, and existing regulations under sections 959 and 961.

B. Provisions Giving Rise to PTEP

1. Section 951(a)

Section 951(a)(1)(A) requires a United States shareholder (as defined in section 951(b) or, if applicable, section 953(c)(1)(A)) of a foreign corporation to include in gross income its pro rata share of the corporation's subpart F income (as defined in section 952) for a taxable year of the corporation (subpart F income inclusion), if the corporation is a controlled foreign corporation (CFC) (as defined in section 957(a) or, if applicable, section 957(b) or 953(c)(1)(B)) at any time during the taxable year and the shareholder owns (within the meaning of section 958(a)) stock of the corporation on the last day of the taxable year on which the corporation is a CFC (last relevant day). Pursuant to section 951(a)(1)(B), the United States shareholder is generally required to also include in gross income its amount determined under section 956 (section 956 amount) for the taxable year of the foreign corporation (section 956 inclusion). This amount represents an effective repatriation of E&P and is computed based on certain United States property held by the corporation. Ownership of stock within the meaning of section 958(a) means stock owned directly and stock owned indirectly through foreign entities, including domestic partnerships to the extent treated as foreign partnerships under § 1.958-1(d)(1) (discussed in part III.B of the Background). For purposes of the remainder of this preamble, a reference to stock ownership means stock owned within the meaning of section 958(a).

Section 951(a)(2) determines a United States shareholder's pro rata share of a foreign corporation's subpart F income by first allocating a portion of such subpart F income to the United States shareholder, and then reducing such allocation in accordance with section 951(a)(2)(B) to take into account certain distributions where ownership of the stock of the foreign corporation is acquired by the United States shareholder during the corporation's taxable year.
See
§ 1.951-1(b). Subpart F income allocated to a United States shareholder before the application of section 951(a)(2)(B) is computed by multiplying the subpart F income by a fraction, the numerator of which is the portion of the foreign corporation's hypothetical distribution described in § 1.951-1(e) that would be distributed with respect to the shareholder's stock of the corporation, and the denominator of which is the amount of such hypothetical distribution.
See
§ 1.951-1(e). The amount of the hypothetical distribution is equal to the foreign corporation's allocable E&P, which is generally the corporation's E&P for the taxable year (not reduced by distributions during the year).
See
§ 1.951-1(e)(1)(ii).

A special rule under section 245A(e) treats certain hybrid dividends received by a CFC as subpart F income of the receiving CFC for purposes of section 951(a)(1)(A). Similarly, section 964(e)(4) treats certain gain from a sale of stock of a foreign corporation by a CFC as subpart F income of the selling CFC for purposes of section 951(a)(1)(A). Consequently, a United States shareholder of such a receiving CFC or selling CFC includes in gross income

under section 951(a)(1)(A) its pro rata share of such subpart F income.

2. Section 951A(a)

Pursuant to section 951A(a), a United States shareholder of a CFC is required to include in gross income its global intangible low-taxed income (GILTI inclusion).
See
§ 1.951A-1(b). A United States shareholder's GILTI inclusion is determined by taking into account the shareholder's pro rata share of tested items (as defined in § 1.951A-1(f)(5)) of CFCs in which the shareholder owns stock, such as tested income, tested loss, and qualified business asset investment.
See
§ 1.951A-1(c). A United States shareholder's pro rata share of a CFC's tested items is determined in the same manner as a pro rata share of subpart F income under section 951(a)(2), subject to certain modifications.
See
§ 1.951A-1(d).

Section 951A(f)(1)(A) provides that a GILTI inclusion is treated in the same manner as a subpart F income inclusion for purposes of applying certain provisions of the Code, including sections 959 and 961. Section 951A(f)(1)(B) grants the Secretary authority to provide rules for applying section 951A(f)(1)(A) to other provisions of the Code in any case in which the determination of subpart F income is required to be made at the level of the CFC.

3. Section 1248(a) or (f)

Section 1248(a) requires a United States person that satisfies certain ownership requirements with respect to stock in a foreign corporation to include gain recognized on a sale or exchange of stock in such foreign corporation in gross income as a dividend, to the extent of the E&P of the foreign corporation attributable to the stock (including E&P of certain lower-tier foreign corporations pursuant to section 1248(c)(2), but not including PTEP pursuant to section 1248(d)(1)). Section 1248(f) provides similar rules for certain distributions in nonrecognition transactions.

Section 959(e) treats an amount included in gross income of any person as a dividend under section 1248(a) or (f) as an amount included in gross income under section 951(a)(1)(A), for purposes of section 959.

4. Section 965

The transition tax imposed under section 965 as part of the Tax Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054 (2017) (the Act) increased the subpart F income of certain foreign corporations and treated such foreign corporations as CFCs for purposes of section 951 (if not already the case). Section 965(a) and (e). Consequently, a United States shareholder of such a foreign corporation generally included in gross income under section 951(a)(1)(A) its pro rata share of such additional subpart F income, subject to reduction under section 965(b) for certain E&P deficits attributable to stock of other foreign corporations owned by the shareholder.

For purposes of section 959, the transition tax also treated the amount of a reduction to a United States shareholder's inclusion with respect to a foreign corporation under section 965(b) as an amount included in the shareholder's gross income with respect to the foreign corporation under section 951(a). Section 965(b)(4)(A).

C. Provisions Regarding the Treatment of PTEP

1. Gross Income Exclusions Under Section 959

Section 959 prevents double taxation by excluding PTEP from gross income of United States persons and CFCs.
See
H.R. Rep. No. 87-1447, at A101-102 (1962).

Section 959(a) provides that, when PTEP of a foreign corporation is distributed to, or would otherwise be included under section 951(a)(1)(B) in gross income of, a United States shareholder whose inclusion under section 951(a) gave rise to the PTEP, the PTEP is excluded from the United States shareholder's gross income. Under successor rules within section 959(a), the exclusion extends to any other United States person who acquires from any person any portion of the United States shareholder's interest in the foreign corporation (subject to any proof of identity rules that may be prescribed by the Secretary).

Section 959(b) applies for purposes of section 951(a) and provides that, when PTEP of a CFC is distributed through a chain of ownership described under section 958(a), the PTEP is excluded from the gross income of another CFC in the chain for purposes of applying section 951(a) to such CFC with respect to the United States shareholder whose inclusion under section 951(a) gave rise to the PTEP. Under successor rules within section 959(b), the exclusion extends to any CFC of any other United States shareholder who acquires from any person any portion of the United States shareholder's interest in the CFC (subject to any proof of identity rules that may be prescribed by the Secretary).

Section 959(c) treats PTEP as distributed before E&P that is not PTEP. It does so by allocating distributions first to PTEP described in section 959(c)(1) (PTEP resulting from a section 956 inclusion or PTEP that have been excluded under section 959(a)(2)), then to PTEP described in section 959(c)(2) (all other PTEP), and finally to non-PTEP (section 959(c)(3) E&P).

For purposes of section 959, section 951A(f)(1) treats the portion of a United States shareholder's GILTI inclusion that is allocated to a CFC in the same manner as a subpart F income inclusion.

Section 959(f) allocates a section 956 amount first to PTEP described in section 959(c)(2) and then to section 959(c)(3) E&P, taking into account distributions made by the foreign corporation. A section 956 amount is not allocated to PTEP described in section 959(c)(1) because, under section 956(a) and (b)(1), that PTEP is taken into account in determining the section 956 amount.

Thus, under section 959, a CFC's E&P for a taxable year of the CFC is first classified as PTEP to reflect any subpart F income inclusions or GILTI inclusions with respect to the CFC. Next, any distributions made by the CFC during the taxable year are allocated to PTEP (and such PTEP is reduced). Then, any section 956 amount with respect to the CFC is determined for the taxable year, which is allocated to remaining section 959(c)(2) PTEP (and such PTEP is reclassified as section 959(c)(1) PTEP). Finally, the CFC's E&P for the taxable year is classified as PTEP to reflect any inclusion under section 951(a)(1)(B).

2. Basis Adjustments Under Section 961

Section 961 describes rules that provide for basis increases to reflect amounts included in gross income under section 951(a) and basis reductions and gain recognition to reflect distributions of PTEP. Basis increases prevent undistributed PTEP of a foreign corporation from giving rise to gain or a subpart F income inclusion of a covered shareholder, and thus additional tax, in a sale or exchange of stock of the foreign corporation or property through which such stock is owned.
See
H.R. Rep. No. 87-1447, at A106 (1962); H.R. Rep. No. 105-148, at 529-30 (1997). Basis reductions and gain recognition prevent double benefits that would otherwise arise (for example, by ensuring a distribution of PTEP does not create a loss in the stock or other property on which the distribution is made because of basis provided under section 961 for the inclusion that gave rise to the PTEP).

Section 961(a) provides that, under regulations prescribed by the Secretary, a United States shareholder's basis in its

stock in a CFC, and basis in property through which it owns such stock, is increased by the amount included in the shareholder's gross income under section 951(a) with respect to such stock or property.

Section 961(b)(1) provides that, under regulations prescribed by the Secretary, when a United States shareholder or a United States person receives an amount that is excluded from gross income under section 959(a), the basis of the stock or other property with respect to which the amount is received is reduced by the amount so excluded. To the extent that an amount excluded from gross income under section 959(a) exceeds the basis of the stock or other property with respect to which it is received, section 961(b)(2) treats the amount as gain from the sale or exchange of property.

Section 961(c) provides that, under regulations prescribed by the Secretary, if a United States shareholder owns stock in a CFC that is owned by another CFC, then adjustments similar to the adjustments provided by section 961(a) and (b) are made to the basis of such stock, and the basis of stock in any other CFC through which the United States shareholder owns the stock of the first mentioned CFC, but only for the purposes of determining the amount included under section 951 in the gross income of such United States shareholder. Under successor rules within section 961(c), basis adjustments carry over to any other United States shareholder who acquires from any person any portion of the interest of the United States shareholder by reason of which the shareholder was treated as owning the relevant CFC stock (subject to any proof of identity rules that may be prescribed by the Secretary). Section 961(c) further provides that the adjustments described in section 961(c) do not apply to any stock owned by the United States shareholder to which a basis adjustment applies under section 961(a) or (b).

For purposes of section 961, section 951A(f)(1) treats the portion of a United States shareholder's GILTI inclusion that is allocated to a CFC in the same manner as a subpart F income inclusion.

Section 1.965-2(f)(1) generally provides that basis is not increased under section 961 to reflect PTEP resulting from section 965(b), but § 1.965-2(f)(2) permits taxpayers to elect to make certain basis adjustments.

3. Foreign Currency Gain or Loss Under Section 986(c)

Section 986(c)(1) requires the recognition of foreign currency gain or loss with respect to distributions of PTEP attributable to movements in exchange rates between the date of the income inclusion that gave rise to the PTEP and the distribution of the PTEP. Section 986(c)(1) further provides that such foreign currency gain or loss is treated as ordinary income or loss from the same source as the associated income inclusion. Section 986(c)(2) provides that the Secretary shall prescribe regulations with respect to distributions of PTEP through tiers of foreign corporations. Section 989(c) provides that the Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of the subpart that includes section 986 (subpart J of part III, subchapter N, chapter 1, subtitle A of the Code).

Notice 88-71, 1988-2 C.B. 374 (1988 notice), provides guidance regarding foreign currency gain or loss with respect to PTEP and announced an intent to issue regulations consistent with the guidance. Under the 1988 notice, such foreign currency gain or loss is determined with respect to each separate category of income listed in section 904(d)(1) pursuant to a formula and is recognized immediately before certain sales or exchanges of stock of a foreign corporation with respect to undistributed PTEP of the foreign corporation.
See also
§ 1.985-5(e)(2) (requiring a United States shareholder to recognize foreign currency gain or loss when a CFC changes its functional currency to the U.S. dollar); § 1.367(b)-2(j)(2)(i) (application of section 986(c) to certain nonrecognitions).

Section 1.986(c)-1 addresses foreign currency gain or loss with respect to distributions of PTEP resulting from section 965. The rules provide that foreign currency gain or loss with respect to PTEP resulting from section 965(a) is determined based on movements in the exchange rate between December 31, 2017, and the time such PTEP is distributed, and that any such gain or loss recognized is reduced in the same proportion as the reduction by a section 965(c) deduction amount (as defined in § 1.965-1(f)(42)) of the section 965(a) inclusion amount (as defined in § 1.965-1(f)(38)) that gave rise to the PTEP. The rules also provide that section 986(c) does not apply with respect to distributions of PTEP resulting from section 965(b).

4. Foreign Income Taxes Under Sections 164(a), 901(a), and 960(b)

Section 164(a) generally provides that a taxpayer is allowed a deduction for certain foreign income taxes paid or accrued by the taxpayer.

Section 901(a) generally provides that a taxpayer choosing to credit foreign income taxes is allowed a credit for certain foreign income taxes paid or accrued by the taxpayer plus, in the case of a domestic corporation, the taxes deemed to have been paid by the domestic corporation under section 960.

Section 960(b) applies for purposes of sections 901 through 909 (relating to the foreign tax credit). Section 960(b)(1) provides that, if PTEP distributed by a CFC to a corporate United States shareholder of the CFC is excluded from gross income under section 959(a), the United States shareholder is deemed to have paid the foreign income taxes that are properly attributable to the PTEP and that have not already been deemed paid by a domestic corporation. Similarly, section 960(b)(2) provides that, if PTEP distributed by a CFC to another CFC is excluded from gross income under section 959(b), the recipient CFC is deemed to have paid the foreign income taxes that are properly attributable to the PTEP and that have not already been deemed paid by a domestic corporation. Section 960(f) provides that the Secretary shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of section 960. Section 904(d)(1) provides that certain provisions including section 960 apply separately with respect to certain categories of income, and section 904(d)(7) provides that the Secretary shall prescribe such regulations as may be necessary or appropriate for the purposes of section 904(d).

For purposes of determining the amount of foreign income taxes deemed paid, § 1.960-3 requires the establishment and maintenance of foreign corporation-level accounts that track a foreign corporation's PTEP and foreign income taxes associated with the PTEP. Those regulations adopt a system of accounting for PTEP in annual accounts for each separate section 904 category (as defined in § 1.960-1(b)(23)) and further segregate each annual account among ten PTEP groups.

Section 965(g) and § 1.965-5 disallow a percentage (referred to as the applicable percentage, as defined in § 1.965-5(d)) of any credit or deduction for foreign income taxes associated with PTEP resulting from section 965(a) or (b). Section 245A(d) and § 1.245A(d)-1 disallow the entirety of any credit or deduction for foreign income taxes associated with PTEP resulting from income inclusions by reason of section 245A(e)(2) (regarding hybrid dividends) or certain income inclusions by reason of section 964(e)(4) (regarding sales of

stock of a foreign corporation by a CFC). Sections 245A(g) and 965(o) provide that the Secretary shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of sections 245A and 965, respectively.

5. Election Under Section 962

Section 962(a) provides that, under regulations prescribed by the Secretary, an individual United States shareholder may elect to be taxed at domestic corporate rates on amounts included in the individual's gross income under section 951(a) and that those amounts are treated as taken into account by a domestic corporation for purposes of applying the relevant provisions of section 960. The election also applies to amounts included in the individual's gross income under section 951A(a) because, for purposes of section 962, such amounts are treated in the same manner as a subpart F income inclusion.
See
section 951A(f)(1). The purpose of section 962 generally is to equate an individual's tax burden with respect to certain earnings of a CFC with the tax burden the individual would have had if the individual were to own the CFC through a domestic corporation.
See
S. Rep. No. 87-1881, at 92-93 (1962).

To carry out this purpose, section 962(d) generally subjects PTEP to an additional level of taxation when distributed. It does so by, notwithstanding section 959(a)(1), requiring that the distributed PTEP be included in gross income to the extent it exceeds the amount of tax paid on the amounts to which the election under section 962 applied.

Section 961(a) also carries out this purpose by, in the case of an election under section 962, limiting a basis increase for an income inclusion to which the election applied to the amount of tax paid by the individual with respect to the income inclusion. Additionally, in a distribution of PTEP, section 961(b)(1) limits a basis decrease to the amount that is excluded from gross income under section 959(a) after the application of section 962(d).

6. Section 1411

Section 1411 generally imposes a 3.8 percent tax on the net investment income of certain individuals, trusts, and estates. Under section 1411(c)(1) and § 1411-4(a), net investment income includes certain income from dividends and net gain from the disposition of property. Section 1.1411-10 provides, in relevant part, rules regarding the application of section 1411 to individuals, trusts, and estates that own stock of a CFC, and § 1.1411-10(g) allows an election with respect to a CFC to treat amounts included in income under section 951(a) with respect to the CFC as net investment income for purposes of § 1.1411-4(a)(1)(i).
See also
§ 1.951A-5(b)(1) (treating a GILTI inclusion in the same manner as a subpart F income inclusion for purposes of applying section 1411). If the election provided under § 1.1411-10(g) is made, a distribution of E&P that is not treated as a dividend pursuant to section 959(d) is generally not treated as a dividend for purposes of section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i).
See
§ 1.1411-10(c)(1)(i)(B). If the election provided under § 1.1411-10(g) is not made, however, net investment income could reflect value attributable to PTEP, either when the PTEP is distributed or when a United States shareholder directly or indirectly disposes of stock of the CFC. Thus, if no election is made, a distribution of E&P that is not treated as a dividend pursuant to section 959(d) is nevertheless a dividend for purposes of determining net investment income under section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i), provided the distribution is attributable to amounts that are or have been included in gross income under section 951(a) in a taxable year beginning after December 31, 2012.
See
§ 1.1411-10(c)(1)(i)(A)(
1
). For purposes of calculating gain on the disposition of stock of a CFC, basis adjustments under section 961(a) and (b) are similarly not taken into account for section 1411 purposes in the absence of the election.
See
§ 1.1411-10(d)(1).

D. Regulations Under Sections 959 and 961

The current regulations under sections 959 and 961 were issued in 1965 and have not been updated to reflect certain statutory changes (for example, the enactment of section 961(c)). The regulations also do not address a number of issues relating to the operation of sections 959 and 961.

In 2006, the Treasury Department and the IRS issued a notice of proposed rulemaking (71 FR 51155) (2006 proposed regulations) to provide more complete rules and address various open issues under sections 959 and 961 and related provisions.

In 2018, the Treasury Department and the IRS issued Notice 2019-01, 2019-02 I.R.B. 275 (2019 notice), which announced an intent to withdraw the 2006 proposed regulations and issue a new notice of proposed rulemaking under sections 959 and 961 to address certain issues arising from the Act. The 2019 notice described rules for the maintenance of PTEP accounts and other aspects relating to the operation of section 959 and requested comments on certain topics. The Treasury Department and the IRS received several written comments in response to the 2019 notice. In 2022, the Treasury Department and the IRS formally withdrew the 2006 proposed regulations (87 FR 63981).

As indicated in the 2019 notice, changes made by the Act had a significant impact on the role of PTEP and how it functions within the U.S. tax system and, in certain cases, exacerbated the need to address longstanding issues. Thus, in addition to the need for updated and more complete rules as contemplated in the 2006 proposed regulations, the issuance of new regulations requires consideration of multiple issues raised by the Act. Certain significant considerations about the role of PTEP in the current U.S. tax system are summarized below.

First, the Act significantly increased the types of income that give rise to PTEP, several of which involve specific rules and limitations to determine foreign currency gain or loss and the availability of foreign tax credits. Giving effect to the various rules and limitations introduced by the Act requires a detailed accounting system to track PTEP in new groups, and to ensure those rules and limitations are appropriately applied by taxpayers and can be administered by the IRS.

The Act also substantially increased the amount of PTEP in the U.S. tax system. In many cases, a considerable portion of a CFC's income has been (or will be) subject to tax under section 951(a)(1)(A) or 951A(a), including by reason of the transition tax imposed under section 965, and thus only the residual amount of the CFC's income constitutes section 959(c)(3) E&P.

At the same time, the Act introduced section 245A, which in certain cases allows a domestic corporation to claim a dividends received deduction for section 959(c)(3) E&P. As a result, unlike before the Act where section 959(c)(3) E&P generally was subject to U.S. tax (with a possible foreign tax credit in some cases) when repatriated to the domestic corporation, such E&P may now generally be repatriated without U.S. tax to a recipient domestic corporation. Nonetheless, there are important distinctions between section 959(c)(3) E&P and PTEP—in particular, the section 245A deduction generally allows E&P to be distributed without a corresponding basis reduction (but see sections 961(d) and 1059), whereas a distribution of PTEP reduces basis (or gives rise to gain) in accordance with section 961(b). Therefore, PTEP may not

be preferable to section 959(c)(3) E&P and taxpayers might take inappropriate positions to maximize the existence of section 959(c)(3) E&P. For example, a taxpayer may wish to claim a section 961 basis increase for an amount included in gross income but apply the section 245A deduction on a distribution of the corresponding E&P so that such E&P is repatriated tax-free without any basis reduction under section 961(b). To prevent this type of planning, it is critical for the system to properly maintain the PTEP character of that E&P so that section 961(b) applies when the E&P is distributed.

Existing rules governing PTEP also do not adequately address structures where a United States shareholder owns only a portion of the stock in an upper-tier CFC that owns stock in a lower-tier CFC. In particular, there are no rules prescribing the manner in which basis under section 961(c) functions in these non-wholly owned structures. Further, after the enactment of section 951A in the Act, it is much more likely for United States shareholders to have disparate amounts of PTEP with respect to the same CFC because a United States shareholder's GILTI inclusion is determined based on items attributable to all the stock of CFCs owned by the United States shareholder, and this can raise issues about how section 959(b) applies in distributions of the PTEP (such as the issues discussed in part II.D.1.ii of the Explanation of Provisions). Thus, changes in the Act have compounded already existing complexities with respect to the treatment of PTEP and basis in stock in non-wholly owned structures.

Finally, existing rules do not sufficiently address the operation of the PTEP provisions with respect to domestic partnerships (or certain S corporations) in light of the enactment of section 951A and the extension of aggregate treatment to such entities in determining inclusions under both sections 951(a) and 951A(a) (as discussed in part III.A of the Background). Moreover, certain unresolved issues, such as whether a partnership obtains basis in stock of a CFC to account for PTEP, which had previously been limited to foreign partnerships, now apply equally to domestic partnerships (and certain S corporations).

III. Other Guidance and Issues

A. Regulations Under Section 958

Before the Act, domestic partnerships (and S corporations by operation of section 1373(a)) were treated as owning stock of a foreign corporation for purposes of determining inclusions in gross income under section 951(a), and, thus, PTEP accounts under section 959 were maintained, and related basis adjustments under section 961 were made, at the partnership level.

Following the enactment of section 951A in the Act, in 2019 the Treasury Department and the IRS published final regulations treating a domestic partnership (and certain S corporations) as an aggregate of its partners for purposes of applying section 951A and related provisions. TD 9866, 84 FR 29288. That is, partners do not take into account a distributive share of a section 951A inclusion with respect to the domestic partnership and its CFCs, but instead are treated as proportionately owning the stock of those CFCs, with the result that (as with foreign partnerships) income inclusions under section 951A are determined directly (and solely) by partners that are United States shareholders with respect to a CFC. Subsequently, in 2022, the Treasury Department and the IRS published § 1.958-1(d) which, consistent with the approach adopted under section 951A, extends the aggregate treatment of domestic partnerships to section 951. TD 9960, 87 FR 3648.

Under § 1.958-1(d), for purposes of sections 951, 951A, and 956(a), as well as any provision that specifically applies by reference to those sections (or regulations issued under those sections), a domestic partnership is generally not treated as owning stock of a foreign corporation under section 958(a), and stock of a foreign corporation owned by the domestic partnership is instead treated in the same manner as stock of a foreign corporation owned by a foreign partnership under section 958(a)(2) and § 1.958-1(b). Accordingly, because sections 959 and 961 specifically apply by reference to sections 951 and 951A (in the latter case, as a result of section 951A(f)(1)(A)), aggregate treatment of domestic partnerships applies for purposes of sections 959 and 961 pursuant to § 1.958-1(d). Regulations do not, however, specifically address the application of sections 959 and 961 with respect to domestic partnerships or their partners under § 1.958-1(d).

B. Regulations Under Section 1502

Section 1502 authorizes the Secretary to prescribe regulations for an affiliated group of corporations that join in filing (or that are required to join in filing) a consolidated return (consolidated group, as defined in § 1.1502-1(h)) to clearly reflect the U.S. tax liability of the consolidated group and to prevent avoidance of such tax liability. For purposes of carrying out those objectives, section 1502 also permits the Secretary to prescribe rules that may be different from the provisions of chapter 1 of subtitle A of the Code that would apply if the corporations composing the consolidated group filed separate returns. Pursuant to these rules, members of a consolidated group are treated as separate entities for some purposes but as divisions of a single corporation for other purposes.
See, for example,
§ 1.1502-13(a)(2).

Regulations issued under section 1502 address the application of certain provisions of subpart F in the context of consolidated groups.
See, for example,
§ 1.1502-51 (application of section 951A to consolidated groups); § 1.1502-80(j) (addressing determination of section 951(a)(2)(B) reduction for distributions under section 959(b) for purposes of sections 951(a)(1)(A) and 951A(a)). However, regulations do not address the application of sections 959 and 961 with respect to a consolidated group or its members.

Explanation of Provisions

I. Scope

The proposed regulations provide rules addressing core aspects of the PTEP system, including rules that address longstanding issues under sections 959 and 961, account for new provisions and amendments under the Act, and implement the 1988 notice and 2019 notice. Future guidance will address certain issues not addressed in the proposed regulations, for example, issues involving nonrecognition transactions, redemptions, transactions to which section 964(e) applies, and structures where CFCs are partners in a partnership.
See also
Notice 2024-16, 2024-5 I.R.B. 622 (announcing intent to issue proposed regulations addressing the treatment of section 961(c) basis in certain transactions in which a domestic corporation acquires stock of a CFC in a liquidation described in section 332 or an asset reorganization described in section 368(a)(1)). Future guidance may also address any issues regarding the interaction of the proposed regulations with existing rules under other provisions.

II. Section 959 Regulations

A. Overview

The proposed regulations under section 959 provide rules for PTEP accounting (both at the shareholder-level and foreign corporation-level), exclusions from gross income, and related determinations and adjustments.

B. PTEP Accounting (Proposed § 1.959-2)

1. Shareholder-Level Accounts

i. In General

Integral to the proposed regulations are annual PTEP accounts, dollar basis pools, and PTEP tax pools, which are established and maintained by a covered shareholder with respect to a foreign corporation in which the shareholder owns stock.
See
proposed § 1.959-2(b)(1). These are integral aspects of the PTEP system because they ensure proper tracking of amounts described under provisions of the Code such as sections 959(a), 986(c), and 960(b). These rules are issued pursuant to the express delegations of authority under sections 245A(g), 904(d)(7), 960(f), 965(o), and 989(c).

A covered shareholder means any United States person, other than a domestic partnership.
See
proposed § 1.959-1(b)
; see also
part VIII.A of the Explanation of Provisions (providing that an S corporation is generally treated in the same manner as a domestic partnership). Domestic partnerships are excluded from this definition because they are treated as aggregates of their partners in determining stock ownership for purposes of section 959 (discussed in part III.A of the Background). A covered shareholder is not limited to a United States shareholder because the exclusion under section 959(a) is not limited to United States shareholders. For example, section 959(a) applies to any United States person who acquires from any person an interest in a foreign corporation with PTEP.

ii. Annual PTEP Accounts

Annual PTEP accounts track a foreign corporation's PTEP with respect to a covered shareholder.
See
proposed § 1.959-2(b)(1). These accounts represent PTEP distributable exclusively to the covered shareholder (or a successor), directly or indirectly through tiers, on any stock of the foreign corporation.

Each annual PTEP account relates to a single taxable year of the foreign corporation and a single section 904 category, and PTEP within an annual PTEP account is maintained in the foreign corporation's functional currency and assigned among ten PTEP groups and two subgroups.
See
proposed § 1.959-2(b)(2). Tracking PTEP on an annual basis is necessary to apply the “last-in, first-out” rule for distributions of PTEP in section 959(c), and PTEP is maintained in the foreign corporation's functional currency pursuant to section 986(b). Tracking PTEP by section 904 category and by PTEP groups is necessary to implement rules determining foreign currency gain or loss and foreign tax credits with respect to PTEP.

The ten PTEP groups fall within two categories—section 959(c)(2) PTEP groups and section 959(c)(1) PTEP groups.
See
proposed § 1.959-2(b)(2)(i). The section 959(c)(2) groups separately track PTEP resulting from subpart F income inclusions, GILTI inclusions, application of section 965(a) or 965(b), or income inclusions to which section 245A(d) applies (PTEP resulting from section 245A(e)(2) or certain PTEP resulting from section 959(e) (concerning section 1248) or section 964(e)(4) (concerning certain dispositions of foreign stock)). The section 959(c)(1) PTEP groups correspond to the section 959(c)(2) PTEP groups and account for the reclassification of PTEP pursuant to section 959(a)(2). PTEP arising from section 956 inclusions is combined with reclassified PTEP arising from subpart F income inclusions.

The two subgroups track PTEP arising from income inclusions of certain covered shareholders.
See
proposed § 1.959-2(b)(2)(ii). One subgroup tracks PTEP arising from an income inclusion of an individual and includible in gross income under section 962(d) when distributed in a distribution to which section 959(a) would otherwise apply (taxable section 962 PTEP). The second subgroup tracks PTEP arising from an income inclusion of an individual, estate, or trust that would be includible in net investment income under section 1411(c) when distributed (that is, the election under § 1.1411-10(g) is not made and, thus, the income inclusion giving rise to the PTEP was not taken into account in determining net investment income).

Additionally, for PTEP resulting from the application of section 965(a) or (b), an adjusted applicable percentage must be maintained, which tracks the percentage of a credit or deduction for foreign income taxes associated with PTEP that is disallowed under § 1.965-5.
See
proposed § 1.959-2(b)(2)(iii)(A). Similarly, for PTEP resulting from the application of section 965(a), a section 965(c) deduction percentage must be maintained, which tracks the percentage of foreign currency gain or loss with respect to PTEP that is not recognized under § 1.986(c)-1.
See
proposed § 1.959-2(b)(2)(iii)(B). The adjusted applicable percentage and the section 965(c) deduction percentage are tracked by section 904 category. Each is determined using a single weighted average across that section 904 category, which is intended to reduce the compliance burden and facilitate administrability in cases in which the applicable percentage or section 965(c) deduction amount differs with respect to PTEP in the section 904 category by not requiring the separate tracking of those percentages or amounts.
See also
part IX.B.3. of the Explanation of Provisions (describing transition rules for the initial determination of the adjusted applicable percentage and section 965(c) deduction percentage).

iii. Dollar Basis Pools and PTEP Tax Pools

Dollar basis pools track the basis in U.S. dollars of a foreign corporation's PTEP with respect to a covered shareholder, and such dollar basis is used to determine foreign currency gain or loss under section 986(c).
See
proposed § 1.959-2(b)(1). PTEP tax pools track the U.S. dollar amount of foreign income taxes associated with a foreign corporation's PTEP with respect to a covered shareholder, and such taxes are assigned to a creditable PTEP tax group to the extent eligible to be deemed paid under section 960(b).
See
proposed § 1.959-2(b)(1) and (4)(ii). The creditable PTEP tax group tracks foreign income taxes that are eligible to be deemed paid under section 960(b).

Furthermore, together, dollar basis and the U.S. dollar amount of associated foreign income taxes determine basis reductions under section 961 for distributions of PTEP.
See also
part III.C.2 of the Explanation of Provisions.

Tracking foreign income taxes associated with PTEP in a shareholder-specific manner (consistent with how PTEP is tracked) differs from the approach under existing § 1.960-3 (and the 1988 notice), which tracks such taxes only at the CFC-level (without regard to the shareholder whose PTEP account was reduced by the taxes). This new approach ensures that, in structures involving multiple covered shareholders, foreign income taxes are associated with PTEP with respect to a particular covered shareholder and do not include foreign income taxes that were imposed on PTEP with respect to another covered shareholder. Thus, in a distribution of PTEP to a covered shareholder, the covered shareholder's basis is reduced under section 961(b) by the foreign income taxes that are (i) associated with (and consequently reduced) PTEP with respect to the covered shareholder, and (ii) deemed paid by the covered shareholder. This method is intended to prevent each covered shareholder from incurring double taxation on a single item of income, by ensuring that a covered

shareholder is able to take into account the foreign income taxes associated with the PTEP with respect to the covered shareholder.

Generally, dollar basis pools and PTEP tax pools are maintained on a year-by-year basis, with one pool for each PTEP group within each annual PTEP account.
See
proposed § 1.959-2(b)(3) and (4). Maintenance of separate dollar basis pools for each PTEP group prevents the commingling of dollar basis of PTEP that is subject to different rules with respect to the recognition of foreign currency gain or loss under section 986(c). Maintenance of separate PTEP tax pools for each PTEP group prevents the commingling of foreign income taxes for which the related PTEP is subject to different rules regarding the applicability of section 960(b).

Under an exception intended to simplify PTEP accounting, a covered shareholder may elect to combine dollar basis pools and PTEP tax pools across years.
See
proposed § 1.959-2(c). In such a case, each dollar basis pool and PTEP tax pool relates to PTEP assigned to a single PTEP group and a single section 904 category (without regard to the taxable years to which the PTEP relates).
See
proposed § 1.959-2(b)(3) and (4). This election is consistent with a comment in response to the 2019 notice that recommended allowing taxpayers to pool dollar basis across years within section 904 categories.

If a covered shareholder elects to combine dollar basis pools and PTEP tax pools across years, the election applies to the covered shareholder's dollar basis pools and PTEP tax pools with respect to each foreign corporation in which the covered shareholder owns stock.
See
proposed § 1.959-2(c)(1). This ensures consistent treatment by not permitting a covered shareholder to maintain combined pools with respect to some foreign corporations but not others. A combined pool election may be revoked only with the consent of the Commissioner.
See
proposed § 1.959-2(c)(2).

2. Foreign Corporation-Level Accounts

Foreign corporation-level accounts track a foreign corporation's PTEP and associated foreign income taxes (corporate PTEP accounts and corporate PTEP tax pools, respectively).
See
proposed § 1.959-2(d)(1) and (d)(2). A corporate PTEP account and corporate PTEP tax pool each relate to a single covered shareholder, and PTEP or foreign income taxes within such an account are assigned to section 904 categories and PTEP groups (as is the case in shareholder-level accounts). These accounts reflect that PTEP and associated foreign income taxes are foreign corporation-level attributes (which, as discussed in part II.B.1 of the Explanation of Provisions, are tracked in a shareholder-specific manner). These accounts also are necessary to allocate and apportion current year taxes paid or accrued by a foreign corporation among the relevant statutory and residual groupings of the foreign corporation, as discussed in part II.F of the Explanation of Provisions, as well as for computations under section 956, which take into account E&P described in section 959(c)(1). Finally, as with shareholder-level accounts, these rules are issued pursuant to the express delegations of authority under sections 245A(g), 904(d)(7), 960(f), 965(o), and 989(c).

A corporate PTEP account relating to a covered shareholder represents all PTEP within the covered shareholder's annual PTEP accounts with respect to the foreign corporation (therefore, unlike shareholder-level accounts, a corporate PTEP account does not relate to a single taxable year of the foreign corporation). Similarly, a corporate PTEP tax pool for a covered shareholder represents all foreign income taxes within the covered shareholder's PTEP tax pools with respect to the foreign corporation. Thus, as a covered shareholder's annual PTEP accounts and PTEP tax pools with respect to a foreign corporation are adjusted, the foreign corporation-level accounts (including the PTEP groups within the accounts) are also adjusted.

The proposed regulations do not provide rules for maintaining a foreign corporation-level account for section 959(c)(3) E&P because the Treasury Department and the IRS are studying whether such E&P should be separately computed with respect to each covered shareholder in certain instances and related issues (for example, coordination with section 1248). For example, assume a case in which US1 and US2, each a covered shareholder, own 60% and 40%, respectively, of the stock of CFC1, a foreign corporation. CFC1 has $75x and $0 of PTEP with respect to US1 and US2, respectively, but only $50x of total E&P as a result of incurring a deficit in E&P after generating the PTEP. Under a shareholder-specific approach to computing CFC1's section 959(c)(3) E&P, such E&P would be negative $45x with respect to US1 ($50x × 60%−$75x) and $20x with respect to US2 ($50x × 40%−$0). Under a non-shareholder-specific approach to computing section 959(c)(3) E&P, CFC1's section 959(c)(3) E&P would be negative $25x ($50x−$75x).

The proposed regulations clarify that a foreign corporation's E&P is determined independently of the foreign corporation's PTEP.
See
proposed § 1.959-2(d)(3). For example, in a distribution by a foreign corporation with respect to its stock, section 316 determines the extent to which the distribution is made out of the foreign corporation's E&P, and section 959 determines the extent to which the portion that is made out of E&P is a distribution of PTEP.
See also
proposed § 1.959-10(c)(2)(iii) (
Example 2, alternative facts,
regarding a distribution of built-in loss property). Additionally, as in the example in the preceding paragraph, the proposed regulations clarify that a foreign corporation's E&P may be less than the foreign corporation's PTEP because a loss does not reduce PTEP.

C. Shareholder-Level Account Adjustments (Proposed § 1.959-3)

1. In General

The proposed regulations describe the adjustments made to a covered shareholder's annual PTEP accounts (including PTEP groups within those accounts and, if applicable, relevant percentages for section 965 PTEP and PTEP subgroups), dollar basis pools, and PTEP tax pools with respect to a foreign corporation.
See
proposed § 1.959-3. The rules for making these adjustments are issued pursuant to the express delegations of authority under sections 245A(g), 904(d)(7), 986(c)(2), 960(f), 965(o), and 989(c).

These adjustments reflect income inclusions and transactions related to a taxable year of the foreign corporation, and the adjustments preserve the character of the foreign corporation's PTEP with respect to the covered shareholder (for example, the taxable year, section 904 category, and PTEP group to which PTEP relates). In applying these rules to tiers of foreign corporations, the adjustments are applied successively from the lowest-tier foreign corporation to the highest-tier foreign corporation.
See
proposed § 1.959-3(g).

An adjustment to annual PTEP accounts is treated as made at one of three points in time (each of which is discussed below in this part II.C of the Explanation of Provisions), which determines when PTEP becomes (or ceases to be) available for distribution to the covered shareholder: (i) at the beginning of the first day of the foreign corporation's taxable year, (ii) concurrently with the transaction giving rise to the adjustment, or (iii) at the end of the last day of the foreign

corporation's taxable year.
See
proposed § 1.959-3(f). An adjustment to dollar basis pools and PTEP tax pools is treated as made concurrently with the related adjustment to annual PTEP accounts.

2. Beginning of Year Adjustments

Three types of PTEP are added to annual PTEP accounts at the beginning of the foreign corporation's taxable year (even if, for example, the determination of the amount giving rise to the PTEP occurs at the end of such taxable year). This timing ensures that PTEP generated or received during the taxable year is available for distribution as of the start of the taxable year, consistent with sections 316(a)(2) and 959(c) (which determine dividend treatment and the application of section 959(a) or (b) based on E&P for the taxable year).

The first type is PTEP arising from the covered shareholder's subpart F income inclusion or GILTI inclusion with respect to the foreign corporation for the taxable year.
See
proposed § 1.959-3(c)(1)(i) and (ii). To reflect the addition of this PTEP, basis equal to the U.S. dollar amount of the income inclusion giving rise to the PTEP is added to related dollar basis pools.
See
proposed § 1.959-3(d)(1)(i).

The second type is PTEP with respect to the covered shareholder that is distributed to the foreign corporation during the taxable year (discussed in part II.D of the Explanation of Provisions).
See
proposed § 1.959-3(c)(1)(iii). To reflect the addition of this PTEP, the dollar basis and associated foreign income taxes of the PTEP are added to related dollar basis pools and PTEP tax pools, and such taxes are assigned to the creditable PTEP tax group to the extent the foreign corporation is deemed to pay the taxes under section 960(b)(2) and proposed § 1.960-3(c).
See
proposed § 1.959-3(d)(1)(ii), (e)(1)(i). Further, the PTEP is reduced by current year taxes allocated and apportioned to the PTEP (that is, by foreign income taxes imposed on the PTEP and paid or accrued by the foreign corporation in the taxable year, as distinguished from foreign income taxes described in the preceding sentence, which were paid or accrued by another foreign corporation in a prior distribution of the PTEP).
See
proposed § 1.959-3(c)(1)(v);
see also
part II.F of the Explanation of Provisions (rules for allocating and apportioning current year taxes to PTEP). Such current year taxes reduce related dollar basis pools and are added to related PTEP tax pools, where the taxes are assigned to the creditable PTEP tax group to the extent the foreign corporation is a CFC and a credit for the taxes is not disallowed or suspended at the level of the CFC.
See
proposed § 1.959-3(d)(1)(iii), (e)(1)(ii).

The third type is PTEP with respect to the covered shareholder that results from the application of the foreign corporation's section 961(c) basis to gain recognized by the foreign corporation during the taxable year (discussed in part III.E of the Explanation of Provisions).
See
proposed § 1.959-3(c)(1)(iv). To reflect the addition of this PTEP, the dollar basis of the PTEP is added to related dollar basis pools.
See
proposed § 1.959-3(d)(1)(ii). Further, current year taxes allocated and apportioned to the PTEP reduce the PTEP, reduce related dollar basis pools, and are added to related PTEP tax pools, where (like in a distribution) the taxes are assigned to the creditable PTEP tax group to the extent the foreign corporation is a CFC and a credit for the taxes is not disallowed or suspended at the level of the CFC.
See
proposed § 1.959-3(d)(1)(iii), (e)(1)(ii).

3. Time of Transaction Adjustments

Three types of PTEP are added to, or removed from, annual PTEP accounts concurrently with the relevant transaction occurring during the foreign corporation's taxable year.

The first type is PTEP distributed by the foreign corporation during the taxable year.
See
proposed § 1.959-3(c)(1)(vi). To reflect the removal of this PTEP, the dollar basis and associated foreign income taxes of the PTEP are removed from related dollar basis pools and PTEP tax pools.
See
proposed § 1.959-3(d)(1)(iv), (e)(1)(iii).

The second type is PTEP arising from gain recognized by the covered shareholder on the sale or exchange of stock during the taxable year that is recharacterized and included in gross income as a dividend under section 1248 by reason of E&P attributed to stock of the foreign corporation under section 1248.
See
proposed § 1.959-3(c)(1)(vii);
see also
section 959(e). This timing prevents iterative computations that could result if the PTEP were available for distribution earlier in the taxable year. To reflect the addition of this PTEP, basis equal to the U.S. dollar amount of the income inclusion giving rise to the PTEP is added to related dollar basis pools.
See
proposed § 1.959-3(d)(1)(i). The Treasury Department and the IRS are studying whether a foreign corporation's PTEP should similarly be increased to reflect gain treated as a dividend under section 964(e)(1) by reason of E&P of the foreign corporation, which amount generally increases the selling CFC's PTEP, and welcome comments on whether increasing the foreign corporation's PTEP would be appropriate notwithstanding the duplicative result (that is, PTEP would be in the selling CFC and the foreign corporation whose E&P gave rise to the dividend).

The third type is PTEP that transfers from (or to) the covered shareholder under section 959's successor rules (discussed in part II.G of the Explanation of Provisions).
See
proposed § 1.959-3(c)(1)(viii), (ix). To reflect the removal (or addition) of this PTEP, the dollar basis and associated foreign income taxes of the PTEP are removed from (or added to) related dollar basis pools and PTEP tax pools.
See
proposed § 1.959-3(d)(1)(iv) and (v), (e)(1)(iii) and (iv).

4. End of Year Adjustments

Two types of adjustments are made at the end of the foreign corporation's taxable year. These adjustments relate to the covered shareholder's section 956 amount with respect to the foreign corporation for the taxable year.

First, PTEP to which the section 956 amount is allocated (which, as discussed in part II.E of the Explanation of Provisions, is excluded from the covered shareholder's gross income under section 959(a)(2)) is reassigned within annual PTEP accounts from section 959(c)(2) PTEP groups to section 959(c)(1) PTEP groups.
See
proposed § 1.959-3(c)(1)(x). To reflect the reclassification, the dollar basis and associated foreign income taxes of the PTEP are moved from dollar basis pools and PTEP tax pools relating to section 959(c)(2) PTEP groups to dollar basis pools and PTEP tax pools relating to section 959(c)(1) PTEP groups.
See
proposed § 1.959-3(d)(1)(vi), (e)(1)(v).

Next, PTEP arising from the portion of the section 956 amount included in the covered shareholder's gross income under section 951(a)(1)(B) is added to annual PTEP accounts.
See
proposed § 1.959-3(c)(1)(xi). In addition, an amount of basis equal to the U.S. dollar amount of the section 956 inclusion giving rise to the PTEP is added to related dollar basis pools.
See
proposed § 1.959-3(d)(1)(i).

Further, additional rules address cases where the covered shareholder acquires ownership of stock of the foreign corporation on or after the last relevant day of the foreign corporation's taxable year (that is, the last day of such taxable year on which the foreign corporation is a CFC) and a portion of a section 956 amount of a United States shareholder is attributable to such stock.
See
proposed § 1.959-3(c)(4). Under these rules, PTEP of the foreign corporation that has transferred to the

covered shareholder but to which such portion of the section 956 amount is ultimately allocated (discussed in part II.E of the Explanation of Provisions) is reclassified from section 959(c)(2) PTEP groups to section 959(c)(1) PTEP groups. Moreover, the foreign corporation's PTEP with respect to the covered shareholder is increased to reflect the inclusion in income by the United States shareholder of such portion of the section 956 amount.

D. Distributions of PTEP (Proposed § 1.959-4)

1. Application of Exclusions

i. In General

The proposed regulations provide rules regarding the exclusions from gross income under section 959(a)(1) and (b) for PTEP that is distributed to a covered shareholder or a CFC.
See
proposed § 1.959-4;
see also
part II.D.2 of the Explanation of Provisions (determining distributed PTEP).

Under the section 959(a)(1) exclusion, PTEP distributed to a covered shareholder, other than taxable section 962 PTEP, is excluded from the covered shareholder's gross income.
See
proposed § 1.959-4(b)(1);
see also
section 962(d) and proposed § 1.312-8(c) (domestic corporation's receipt of PTEP does not increase E&P, discussed in part VIII.I of the Explanation of Provisions).

Under the section 959(b) exclusion, PTEP distributed by a CFC to another CFC is excluded from the recipient CFC's gross income for purposes of determining the recipient CFC's subpart F income and tested income or tested loss, provided that the PTEP relates to a covered shareholder that is a United States shareholder in both CFCs.
See
proposed § 1.959-4(b)(2);
see also
§ 1.312-6(b) (the distribution generally increases the recipient CFC's E&P) and proposed § 1.952-1(c)(4) (the distribution does not increase the recipient CFC's current year E&P for purposes of the limitation in section 952(c)(1)(A), discussed in part VIII.I of the Explanation of Provisions).

Applying the section 959(b) exclusion for purposes of determining the recipient CFC's tested income or tested loss prevents double taxation (and thus is consistent with the policy of section 959) in cases where the distribution is not a related party dividend described in section 951A(c)(2)(A)(i)(IV) and therefore could otherwise result in tested income. The Treasury Department and the IRS are of the view that this approach, which is issued under the express delegation of authority in section 951A(f)(1)(B), is consistent with section 951A(f)(1)(A) (treating an inclusion under section 951A(a) in the same manner as an inclusion under section 951(a)(1)(A) for purposes of section 959), which should be interpreted as allowing references to section 951(a) in section 959 to be treated as including a reference to section 951A(a).

Applying the section 959(b) exclusion only to PTEP distributed by a CFC to another CFC is consistent with the statute. However, under the express delegation of authority in section 965(o), the proposed regulations provide a special rule pursuant to which a specified foreign corporation (as defined in § 1.965-1(f)(45)(i)(B)) that is not a CFC is treated as a CFC for purposes of applying the section 959(b) exclusion to section 965 PTEP distributed by the specified foreign corporation, which ensures that the section 959(b) exclusion applies to such PTEP when received by a CFC.
See
proposed § 1.959-4(b)(2)(ii). The Treasury Department and the IRS are studying the application of section 959(b) to other PTEP distributed by a foreign corporation that is not a CFC (for example, in a case where the foreign corporation was a CFC when the PTEP was generated but is no longer a CFC when the PTEP is distributed). Irrespective of whether the section 959(b) exclusion applies to PTEP distributed to a foreign corporation, the PTEP remains PTEP and, in a subsequent distribution, may be excluded from gross income under section 959(a)(1) or (b).
See
proposed §§ 1.959-2 and 1.959-3 (describing shareholder-level annual PTEP accounts and related adjustments with respect to a foreign corporation without regard to CFC status). This treatment is required to give effect to section 959(a), which does not depend on the CFC status of any intermediary entities through which a covered shareholder ultimately receives PTEP.

ii. Split-Ownership Structures

Under the proposed regulations, the section 959(b) exclusion applies at the CFC-level by excluding a distribution of PTEP from the recipient CFC's gross income for certain purposes. In structures where stock of a CFC is not all owned by a single United States shareholder, the application of the section 959(b) exclusion at the CFC-level could, absent special rules, result in all United States shareholders of the CFC sharing any benefits of the exclusion (rather than just the United States shareholder to which the excluded PTEP relates) and partial double taxation to the United States shareholder to which the excluded PTEP relates (to the extent the exclusion benefits other United States shareholders).

Guidance issued before the Act generally used a “gross-up” mechanism to address this issue. Rev. Rul. 82-16, 1982-1 C.B. 106, considered a scenario where a United States shareholder owned 70% of the stock of an upper-tier CFC, with the remaining 30% owned by non-United States shareholders, and the upper-tier CFC owned all the stock of a lower-tier CFC. The lower-tier CFC earned $100x of subpart F income, which gave rise to a $70x subpart F income inclusion and, thus, $70x of PTEP with respect to the United States shareholder. In a later year, the lower-tier CFC distributed $200x to the upper-tier CFC. The ruling concluded that section 959(b) looks to the total amount of E&P of the lower-tier CFC that caused the United States shareholder's subpart F income inclusion, with the result that section 959(b) excluded $100x (rather than $70x) from the upper-tier CFC's subpart F income in applying section 951(a) to the United States shareholder. Conversely, a $70x exclusion under section 959(b) would have caused the upper-tier CFC to have an additional $30x of subpart F income from the distribution, which would have led to a $21x ($30x × 70%) subpart F income inclusion for the United States shareholder even though its share of the distribution was all attributable to PTEP.

However, a gross-up mechanism raises certain issues. For example, computing a gross-up may be complex or burdensome in light of the increased prevalence of PTEP that is not pro rata with respect to United States shareholders following the Act (for instance, PTEP resulting from a GILTI inclusion, which is not determined solely by reference to a particular CFC). Additionally, a gross-up mechanism could result in the need for different determinations of a CFC's subpart F income (and tested income or tested loss) for different United States shareholders of the CFC, which is inconsistent with the way that these types of income are treated under existing regulations for other purposes of the Code such as the expense allocation rules or foreign tax credit rules.

Accordingly, instead of a gross-up mechanism, the proposed regulations coordinate the section 959(b) exclusion with revisions to the pro rata share rules of section 951(a) (discussed in part IV.C of the Explanation of Provisions). Under this approach, a CFC's subpart F income is determined with respect to all

shareholders by excluding the same amount of PTEP received by the CFC, and United States shareholders' pro rata shares of the CFC's subpart F income are computed in a manner so that any benefits of the application of the section 959(b) exclusion to PTEP with respect to a United States shareholder generally inure only to that United States shareholder. For instance, if two United States shareholders own equal interests in a CFC, and the CFC receives a distribution half of which is PTEP with respect to one United States shareholder (because there is PTEP with respect to the United States shareholder at least equal to its share of distribution) and the other half of which gives rise to subpart F income (because there is no PTEP with respect to the other United States shareholder and no exception from subpart F income applies), then only the United States shareholder with respect to which there is no PTEP has a pro rata share of the subpart F income resulting from the distribution.

The Treasury Department and the IRS are of the view that the approach in the proposed regulations appropriately carries out the shareholder-specific nature of section 959(b) (that is, excluding PTEP with respect to a United States shareholder from a CFC's gross income for purposes of the application of section 951(a) to the CFC with respect to the United States shareholder). Additionally, this approach conforms with the approach for applying section 961(c) which, under the proposed regulations (as discussed in part III.E of the Explanation of Provisions), also provides for a gross income exclusion at the CFC-level that is coordinated with the section 951(a) pro rata share rules to ensure its benefits generally inure only to the appropriate United States shareholder.

iii. Issues Involving Allocation Rules Under Section 861

The approach in the proposed regulations discussed in part II.D.1.ii of the Explanation of Provisions (applying the section 959(b) exclusion, as well as section 961(c), at the CFC-level) can lead to issues involving the rules of section 861 for allocating and apportioning deductions because a CFC's deductions that are not current year taxes are not allocated and apportioned under section 861 to PTEP.
See
§ 1.960-1(c)(1)(ii) and proposed § 1.959-6(d)(1).

For example, in a case where some, but not all, of a distribution received by a CFC is PTEP, an amount of the CFC's deductible interest expense could reduce the non-PTEP portion of the distribution.
See also
proposed § 1.951-1(h)(2)(ii)(C) (
Example 1, alternative facts
). This may result in a benefit if the non-PTEP portion would give rise to subpart F income or tested income, but otherwise may not be beneficial if the interest deductions reduce section 959(c)(3) E&P and thus the potential for a dividends received deduction under section 245A. Comments are requested on how to appropriately allocate and apportion deductions of a CFC when some, but not all, of a distribution (or gain recognized) is PTEP.

For example, comments are requested on whether deductions that are not current year taxes, such as deductible interest expense, should be allocated and apportioned to, and therefore reduce, the CFC's PTEP. Under this approach, to the extent PTEP with respect to a United States shareholder is reduced by deductions that are not current year taxes, the shareholder could be allowed to retain an equivalent amount of adjusted basis in property directly owned by the shareholder and on which the remaining PTEP is ultimately distributed, with the result that the shareholder would receive a benefit equivalent to a deduction (similar to the result discussed in Part III.C.2.ii of the Explanation of Provisions in the case of foreign income taxes that are associated with PTEP but not credited under section 901).

Comments are also requested on whether, as an alternative to the approach in the proposed regulations, sections 959(b) and 961(c) should apply at the shareholder-level. Under this type of approach, instead of section 959(b) preventing a distribution to a CFC from giving rise to subpart F income (as it has historically been interpreted, but with respect to a particular shareholder), section 959(b) would generally reduce a United States shareholder's pro rata share of the CFC's subpart F income, to the extent attributable to distributed PTEP. Furthermore, section 961(c) would apply in a similar manner in the case of a CFC's gain from a sale or other disposition of stock of a foreign corporation. Comments should address whether a CFC's deductions that are not current year taxes, such as deductible interest expense, should be allocated and apportioned to gross income of the CFC that does not give rise to an inclusion at the shareholder-level under section 959(b) or 961(c) or whether CFC-level provisions (such as section 954(c)(3) or (c)(6) or 964(e)(1)) apply to such income and, if so applied, whether the E&P from the income should be treated as section 959(c)(3) E&P or PTEP to ensure that the CFC-level and shareholder-level provisions interact appropriately.

2. Determining Distributed PTEP

i. Covered Distributions

For a distribution to be considered a distribution of PTEP under section 959, the proposed regulations first require that the distribution be a covered distribution, which is generally defined as any distribution made by a foreign corporation with respect to its stock to the extent that the distribution is a dividend (as defined in section 316), determined without regard to section 959(d).
See
proposed § 1.959-4(c)(1). While a covered distribution may include deemed distributions treated as dividends (for example, distributions under section 304), a covered distribution does not include an amount treated as a dividend by reason of section 78, 367(b), 964(e)(1), or 1248. A deemed dividend under section 78 is determined without regard to E&P (and does not represent a distribution of E&P to any shareholder), and deemed dividends under the other provisions, regardless of whether they constitute deemed distributions of E&P, are determined by excluding PTEP (apart from § 1.367(b)-2(j)(2)(ii), which separately provides for a deemed distribution of PTEP in certain nonrecognition transactions, and § 1.367(b)-3(g)(1), which separately provides for a deemed distribution of E&P, including PTEP, in certain inbound nonrecognition transactions described in § 1.367(b)-3). The proposed regulations do not address the treatment of dividends arising under section 356(a)(2) as covered distributions, which will be addressed in future guidance regarding reorganizations (although no inference is intended as to the treatment of such dividends under current law).
See
proposed § 1.959-4(c)(2).

Comments on the 2019 notice asserted that a distribution of PTEP should not depend on the existence of E&P that would result in a dividend under section 316, stating that section 959(c) requires applying section 316 separately to sections 959(c)(1), (c)(2), and (c)(3) in determining whether there is sufficient E&P under section 316 to support a distribution of E&P under that paragraph. Comments noted that the approach described in the 2019 notice was contrary to section 959(a) and inconsistent with the policy of section 959 to facilitate the repatriation of PTEP. The Treasury Department and the IRS remain of the view described in the 2019 notice under which the reference to section 316(a) in section 959(c) indicates that, under the statute, a distribution of PTEP cannot occur unless there is sufficient current or

accumulated E&P to support what would otherwise be a dividend under section 316. This reading of the statute is consistent with the principle underlying section 959 that PTEP represents a type of E&P. Thus, the proposed regulations do not adopt the comments.

ii. Analyzing Covered Distributions

The proposed regulations provide rules for determining the extent to which PTEP is distributed in a covered distribution.
See
proposed § 1.959-4(d). Under these rules, each covered shareholder first determines its share of the covered distribution, which is the portion of the covered distribution that is made to the covered shareholder or any portion of the covered distribution that is made to an upper-tier foreign corporation and assigned to the covered shareholder under proposed § 1.951-2 (discussed in part IV.B of the Explanation of Provisions).
See
proposed § 1.959-4(d)(1). For this purpose, the portion of a covered distribution that is made to a partnership, or that is treated as made to the partnership in the case of tiered partnerships, is treated as made to the partnership's partners in accordance with their respective distributive shares of such portion.
See
proposed § 1.959-4(c)(3). Thus, if a covered shareholder is a partner in an upper-tier partnership, the covered shareholder's share of a covered distribution would include a portion of the covered distribution that is made to a lower-tier partnership because an amount of the covered distribution made to the lower-tier partnership would be treated as made to the upper-tier partnership by reason of the upper-tier partnership being a partner in the lower-tier partnership and, in turn, an amount of the covered distribution treated as made to the upper-tier partnership would be treated as made to the covered shareholder by reason of the covered shareholder being a partner in the upper-tier partnership.

Next, each covered shareholder allocates its share of the covered distribution to the distributing foreign corporation's PTEP with respect to the covered shareholder, to the extent thereof and in accordance with the composition rules described in part II.D.2.iii of the Explanation of Provisions, and then allocates any remaining portion of such share to the distributing foreign corporation's section 959(c)(3) E&P.
See
proposed § 1.959-4(d)(2) and (e)(1). For this purpose, the distributing foreign corporation's PTEP is determined immediately before the covered distribution (and thus includes PTEP resulting from a subpart F income inclusion or GILTI inclusion for the distributing foreign corporation's taxable year in which the covered distribution is made because such PTEP is added to the covered shareholder's annual PTEP accounts at the beginning of the taxable year).

Further, because the amount of a covered shareholder's share of a covered distribution is determined on an aggregate basis rather than on a share-specific basis, the proposed regulations treat a pro rata portion of all PTEP distributed in each covered shareholder's share of the covered distribution as distributed with respect to each share of stock of the distributing foreign corporation on which the covered shareholder's share of the covered distribution is made.
See
proposed § 1.959-4(d)(4);
see also
proposed § 1.959-10(c)(1) (
Example 1
). In this way, basis adjustments resulting from distributed PTEP can be made on each share of stock of the foreign corporation in accordance with section 961 and, if applicable, PTEP of a recipient foreign corporation can be increased.

iii. Composition Rules

As discussed in part II.C of the Background, different types of PTEP can have different tax effects, including with respect to foreign currency gain or loss under section 986(c) or deemed paid taxes under section 960(b). Thus, once a covered shareholder has identified the portion of its share of a covered distribution that is allocated to PTEP, it is necessary to determine the specific PTEP that is distributed. The proposed regulations include composition rules for this purpose.
See
proposed § 1.959-4(d)(3) and (e)(2) through (5);
see also
proposed § 1.959-10(c)(2) (
Example 2
).

Under these composition rules, PTEP is sourced from section 959(c)(1) PTEP groups before section 959(c)(2) PTEP groups and then from each group within the section 959(c)(1) PTEP groups or section 959(c)(2) PTEP groups, respectively, on a “last-in, first-out” basis, subject to a priority rule for PTEP resulting from section 965 (section 965 priority rule).
See
proposed § 1.959-4(e)(2), (3). Additionally, PTEP that otherwise has the same priority is sourced first from PTEP that is not taxable section 962 PTEP and then from taxable section 962 PTEP, consistent with the rules currently in § 1.962-3.
See
proposed § 1.959-4(e)(4). Lastly, PTEP that has the same priority is sourced on a pro rata basis.
See
proposed § 1.959-4(e)(5).

The section 965 priority rule sources PTEP in section 959(c)(1) PTEP groups first from the reclassified section 965(a) PTEP group, then from the reclassified section 965(b) PTEP group, and finally from the remaining section 959(c)(1) PTEP groups.
See
proposed § 1.959-4(e)(2)(ii). Similarly, for PTEP in section 959(c)(2) PTEP groups, the section 965 priority rule sources such PTEP first from the section 965(a) PTEP group, then from the section 965(b) PTEP group, and finally from the remaining section 959(c)(2) PTEP groups.
See
proposed § 1.959-4(e)(2)(iii). The section 965 priority rule, which is issued under the express delegation of authority in section 965(o), is consistent with the 2019 notice and is intended to simplify PTEP recordkeeping and IRS administration.

Comments on the 2019 notice stated that the section 965 priority rule (as described in the notice) would be a departure from the last-in, first-out approach for sourcing distributions from E&P, and also argued that there is no suggestion in section 965 or its legislative history that such a departure was intended or is necessary or appropriate. Other comments asserted that the policy for the section 965 priority rule was unclear, stating that a pure last-in, first-out approach does not impose additional burdens on taxpayers because once a taxpayer has determined its section 965 PTEP the additional burden of maintaining that information is minimal. Further, even if the section 965 priority rule simplifies PTEP recordkeeping, comments noted that this may be outweighed by the reduction in foreign tax credits under section 960(b) that accompanies distributions of section 965 PTEP. Another comment noted that the section 965 priority rule would adversely affect certain individuals who made section 962 elections and are economically compelled to distribute their PTEP every year to pay taxes arising under section 951(a) because it would accelerate the distribution of PTEP that is not excluded from gross income under section 962(d). Given these concerns, and because the section 965 priority rule departs from the longstanding approach in existing § 1.959-3(b), comments requested that taxpayers be able to elect to apply a last-in, first-out approach with no prioritization of section 965 PTEP.

The Treasury Department and the IRS continue to be of the view that the section 965 priority rule will simplify PTEP recordkeeping and IRS administration in the future by eventually eliminating section 965 PTEP (which, as noted in part II.C of the Background requires specific and detailed rules to apply sections 960(b)

and 986(c)) and reducing the overall number of PTEP groups that need to be tracked. The Treasury Department and the IRS are of the view that, on balance, this benefit outweighs the concerns raised in comments. Additionally, the section 965 priority rule is within the scope of the authority delegated to the Treasury Department and the IRS to administer section 965, including through sections 965(o) and 7805(a). Further, the proposed regulations do not adopt comments suggesting that taxpayers be allowed to not apply the section 965 priority rule because this would undermine the simplification and burden reduction policy of the rule.

iv. Dollar Basis and Associated Foreign Income Taxes Rules

The proposed regulations provide a pro rata approach for determining the dollar basis and associated foreign income taxes of PTEP distributed in a covered shareholder's share of a covered distribution.
See
proposed § 1.959-4(e)(3), (f) and (g). Under this approach, the portion of a dollar basis pool or PTEP tax pool, as applicable, attributed to distributed PTEP is determined based on the percentage that such PTEP represents of all PTEP relating to the dollar basis pool or PTEP tax pool. As discussed in part II.B.1.iii of the Explanation of Provisions, dollar basis pools and PTEP tax pools are maintained separately within each annual PTEP account for each PTEP group unless a combined pool election is in effect, in which case each dollar basis pool and PTEP tax pool relates to PTEP assigned to a single PTEP group and a single section 904 category (without regard to the taxable years to which the PTEP relates).

E. PTEP to Which a Section 956 Amount Is Allocated (Proposed § 1.959-5)

The proposed regulations provide rules regarding the exclusion from gross income under section 959(a)(2) for PTEP that would otherwise be included under section 951(a)(1)(B).
See
proposed § 1.959-5;
see also
proposed § 1.959-10(c)(4) (
Example 4
). Under these rules, a covered shareholder allocates its section 956 amount (that is, the amount determined under section 956 and § 1.956-1 with respect to the covered shareholder and a CFC) first to the CFC's PTEP that is with respect to the covered shareholder and assigned to section 959(c)(2) PTEP groups, to the extent thereof and in accordance with the principles of the composition rules for distributions of PTEP, and then allocates any remaining portion of such section 956 amount to the CFC's section 959(c)(3) E&P.
See
proposed § 1.959-5(c)(1) and (d)(1).

For purposes of these rules, the CFC's PTEP is determined on the last relevant day of the CFC's taxable year to which the section 956 amount relates (that is, the last day of such taxable year on which the foreign corporation is a CFC).
See
proposed § 1.959-5(d)(2). However, the CFC's PTEP is reduced to the extent it is distributed on or after the last relevant day to ensure that the section 956 amount is allocated only to section 959(c)(2) PTEP that remains after accounting for all covered distributions during the CFC's taxable year, in accordance with section 959(f)(2). Moreover, the PTEP is determined without regard to any transfer of PTEP from the covered shareholder to a successor covered shareholder on (or after) the last relevant day, thereby ensuring that section 959(c)(2) PTEP that exists with respect to the covered shareholder when the covered shareholder's ownership of stock of the CFC is determined for purposes of sections 951(a)(1)(B) and 956 may be taken into account for purposes of section 959(a)(2).

As with distributions of PTEP, the proposed regulations use a pro rata approach to determine the dollar basis and associated foreign income taxes of PTEP to which a section 956 amount is allocated.
See
proposed § 1.959-5(e) and (f).

F. Allocating and Apportioning Current Year Taxes to PTEP (Proposed § 1.959-6)

The proposed regulations provide rules for the application of § 1.861-20 to allocate and apportion current year taxes to the statutory groupings (as generally described in § 1.861-8(a)(4)) of PTEP of a foreign corporation.
See
proposed § 1.959-6(b) (describing the statutory groupings for purposes of proposed § 1.959-6 as the corporate PTEP accounts of the foreign corporation described in proposed § 1.959-2(d)(1)). These rules are issued pursuant to the express delegations of authority under sections 245A(g), 904(d)(7), 960(f), and 965(o).

Under the proposed regulations, current year taxes are generally associated with PTEP to the extent the foreign corporation pays or accrues such taxes with respect to PTEP arising by reason of a PTEP realization event that occurs in the same taxable year.
See
proposed § 1.959-6(b);
see also
proposed § 1.959-10(c)(3) (
Example 3
). A PTEP realization event occurs if there is a distribution of PTEP or gain recognized on a sale, exchange, or other disposition of foreign stock that is treated as PTEP as a result of the application of section 961(c) basis. Current year taxes that are paid or accrued with respect to a PTEP realization event that occurs in a different taxable year may not be associated with PTEP of a foreign corporation (consistent with the rule in current § 1.960-1(d)(3)(ii)(B)).
See
proposed § 1.959-6(b) and 1.960-1(d)(3)(ii)(B).

Proposed § 1.959-6(c) provides rules relating to the application of the allocation and apportionment rules in § 1.861-20. Current year taxes (in the foreign corporation's functional currency) are allocated and apportioned to each corporate PTEP account of the foreign corporation that is increased during the taxable year as the result of a PTEP realization event by applying the rules in § 1.861-20 and treating PTEP with respect to each covered shareholder arising by reason of a PTEP realization event as an amount of dividend income (in the case of a distribution of PTEP) or gain from the sale, exchange, or other disposition of foreign stock (in the case of PTEP resulting from the application of section 961(c) basis).
See
proposed § 1.959-6(c) for purposes of identifying the corresponding U.S. item under § 1.861-20(b) through (c). While certain United States shareholders (taking into account the application of § 1.958-1(d)) must take into account a pro rata share of a CFC's subpart F income and tested income (or loss), the CFC's deductions are not divided into pro rata shares allocable to particular shareholders, and instead, must be allocated and apportioned to gross income of the CFC before the determination of each United States shareholder's pro rata share of subpart F income and tested income (or loss). As a result, because deductions must be allocated and apportioned to a CFC's income (rather than being allocated directly to United States shareholders), it is necessary to allocate and apportion current year taxes with respect to the statutory groupings of PTEP of the foreign corporation, which the proposed regulations provide are the corporate PTEP accounts described in proposed § 1.959-2(d)(1).

The proposed regulations also clarify other aspects of allocations of deductions involving PTEP. In particular, the proposed regulations provide that no deductions, other than current year taxes, may be allocated and apportioned to the statutory groupings of PTEP of a foreign corporation (consistent with the rule in current § 1.960-1(c)(1)(ii)).
See
proposed § 1.959-6(d)(1).
See also
the request for comments in Part II.D.1.iii of the

Explanation of Provisions on an approach that would also allocate and apportion deductions, other than current year taxes, to PTEP.

Finally, the proposed regulations provide that current year taxes paid or accrued by a foreign corporation that are denominated in a currency other than the functional currency of the foreign corporation are translated into the functional currency of the foreign corporation at the spot rate on the day on which the current year taxes are paid or accrued.
See
proposed § 1.959-6(d)(2). This currency translation rule applies for purposes of (i) making certain adjustments to accounts maintained under section 959 and the proposed regulations in the foreign corporation's functional currency and (ii) allocating and apportioning functional currency amounts at the level of the foreign corporation.

G. General Successor Transactions (Proposed § 1.959-7)

1. In General

If there is an acquisition of stock of a foreign corporation that results in a change of ownership of stock of the foreign corporation, successor rules in section 959 generally transfer the foreign corporation's PTEP with respect to the covered shareholder that relinquishes ownership of stock of the foreign corporation to the covered shareholder that acquires ownership of the stock.
See
section 959(a) (applying the rules of section 959(a) to any other United States person who acquires any portion of a United States shareholder's interest in a foreign corporation from any person); section 959(b) (similarly applying to any other United States shareholder who acquires any portion of a United States shareholder's interest in a CFC from any person). These successor rules generally ensure that PTEP is not subject to U.S. tax again in the hands of the acquiring covered shareholder when received in a distribution, even though that shareholder did not own the stock of the foreign corporation when the PTEP was generated and therefore did not have the inclusion that gave rise to the PTEP. Additionally, the rules ensure that E&P retains its PTEP status and thus remains subject to the rules under sections 959 and 961, rather than reverting to section 959(c)(3) E&P and potentially becoming eligible for a deduction under section 245A without a reduction in basis.

The proposed regulations address certain transactions subject to the successor rules in section 959, which the proposed regulations refer to as general successor transactions.
See
proposed § 1.959-7(b)(1);
see also
part III.C.4 of the Explanation of Provisions (discussing rules for section 961(c) basis in general successor transactions). A general successor transaction occurs when a covered shareholder (successor covered shareholder) acquires ownership of stock of one or more foreign corporations (each, an acquired foreign corporation) that, immediately before the transaction, is owned by another covered shareholder (transferor covered shareholder). The acquisition may be direct or indirect. For example, a sale of stock of a foreign corporation by a covered shareholder (or by an upper-tier foreign corporation owned by the covered shareholder) to another covered shareholder (or to an upper-tier foreign corporation owned by such other covered shareholder) is a general successor transaction.

However, a general successor transaction is determined without regard to any portion of an acquisition of ownership of stock of a foreign corporation that results from any of the following: (i) an issuance of stock or a partnership interest, (ii) a redemption of stock (within the meaning of section 317(b)) or a liquidating distribution in redemption of a partnership interest, or (iii) a transfer of stock of a foreign corporation, or any property through which stock of a foreign corporation is owned, if such stock or property is substituted basis property.
See
proposed § 1.959-7(b)(2). For example, an exchange of stock of a foreign corporation solely for stock of another foreign corporation in an exchange under section 351(a) or 354(a), or as part of an exchange described in section 361, is not a general successor transaction because such stock is substituted basis property, even if covered shareholders' ownership of stock of the foreign corporation changes in the exchange. Alternatively, to the extent stock of a foreign corporation is not substituted basis property in such transactions (for example, if basis in the stock is determined under section 301(d) or 358(a)(2)), then the acquisition of ownership of stock of the foreign corporation is a general successor transaction. The Treasury Department and the IRS intend to issue additional rules regarding the transfer of PTEP in acquisitions that are not general successor transactions and proposed §§ 1.959-8 and 1.959-9 are reserved for this purpose. In these acquisitions, the Treasury Department and the IRS are considering adding a rule as part of finalization of the proposed regulations providing that, for any period before those additional rules apply and after existing § 1.959-1(d) (successor in interest rules) is removed upon finalization of the proposed regulations, PTEP will transfer automatically (that is, without any requirement to submit proof of identity to the IRS) in accordance with the statute and consistent with the manner in which PTEP transfers in general successor transactions (as discussed in part II.G.2 of the Explanation of Provisions). The Treasury Department and the IRS request comments on this potential rule.

2. Categories of Transferred PTEP

The proposed regulations provide that two categories of an acquired foreign corporation's PTEP transfer from the transferor covered shareholder to the successor covered shareholder (and thus become PTEP with respect to the successor covered shareholder) in a general successor transaction.
See
proposed § 1.959-7(c);
see also
§ 1.959-10(c)(5) (
Example 5
). For both categories of PTEP, the transfer is not subject to any requirement to submit proof of identity to the IRS (in contrast to current § 1.959-1(d)) and, thus, the transfer occurs automatically, although taxpayers should maintain sufficient records to substantiate the transfer on examination.
See also
§ 1.245A-5(c)(4) (automatically transferring certain shareholder-level accounts in certain acquisitions of stock); § 1.245A(e)-1(d)(4)(iii) (similar). The automatic transfer ensures that E&P retains PTEP status and, therefore, will be excluded from income under section 959 and give rise to basis reductions under section 961 in subsequent distributions.

The first category of PTEP that transfers is PTEP of the acquired foreign corporation with respect to the transferor covered shareholder, as determined immediately before the general successor transaction. However, if the general successor transaction occurs before the last relevant day of the acquired foreign corporation's taxable year, certain current year PTEP does not transfer because such current year PTEP relates to shares of stock either retained by the transferor covered shareholder or acquired by the transferor covered shareholder concurrently with or after the general successor transaction.
See
proposed § 1.959-7(c)(1). Only a pro rata portion of this PTEP (called general successor PTEP) transfers, and the amount is determined based on the percentage of a hypothetical distribution by the acquired foreign corporation that would be made with respect to the stock of the corporation acquired by the successor covered shareholder.
See
proposed § 1.959-7(d). In this way, distributions made by the acquired

foreign corporation after the general successor transaction will generally be allocated to PTEP to the same extent the distributions would be so allocated if the general successor transaction did not occur.

The second category of PTEP that transfers is PTEP resulting from the application of section 1248 to gain recognized by the transferor covered shareholder in the general successor transaction.
See
proposed § 1.959-7(c)(2). Because section 1248 only applies to the extent of E&P of the acquired foreign corporation that is attributable to the stock being sold or exchanged in the general successor transaction, the Treasury Department and the IRS determined that it is appropriate for PTEP described in this category (called section 959(e) successor PTEP) to transfer in the general successor transaction. The transfer of all PTEP arising under section 1248 in a sale or exchange of a foreign corporation is consistent with existing guidance.
See
Rev. Rul. 90-31, 1990-1 C.B. 147.

Like for distributions, the proposed regulations use a pro rata approach to determine the dollar basis and associated foreign income taxes of general successor PTEP.
See
proposed § 1.959-7(e)(1) and (f)(1). The dollar basis of section 959(e) successor PTEP is the U.S. dollar amount of the income inclusion giving rise to the PTEP.
See
proposed § 1.959-7(e)(2). There are no associated foreign income taxes with respect to section 959(e) successor PTEP because the PTEP is newly created PTEP to which foreign income taxes will not yet have been allocated and apportioned.
See
proposed § 1.959-7(f)(2).

3. Deemed Covered Shareholder

Section 959(a) applies to any other United States person “who acquires from any person” any portion of a United States shareholder's interest in a foreign corporation.
See also
section 959(b) (similarly applying to an acquisition from “any person”). Accordingly, if there is an acquisition of stock of a foreign corporation, section 959 does not condition a transfer of the foreign corporation's PTEP on whether the transfer is by or from a covered shareholder (or United States shareholder).

For example, if a nonresident alien individual acquires ownership of all the stock of a foreign corporation that has PTEP from a covered shareholder and another covered shareholder subsequently acquires ownership of all the stock from the individual, then, absent an election under section 338(g), the foreign corporation's PTEP transfers to the second covered shareholder. This prevents double taxation of the PTEP and ensures that PTEP does not become section 959(c)(3) E&P (potentially eligible for a dividends received deduction under section 245A(a)). However, existing guidance does not clearly address whether the amount of PTEP that transfers is reduced for transactions during the individual's ownership period (for example, for E&P distributed by the foreign corporation to the individual).

To address the transfer of a foreign corporation's PTEP among covered shareholders where there is intervening foreign ownership, the proposed regulations treat any stock of a foreign corporation not owned by a covered shareholder as owned by a single hypothetical person that is deemed to be a covered shareholder (the deemed covered shareholder).
See
proposed § 1.959-7(g). Under these rules, the deemed covered shareholder is treated in the same manner as a covered shareholder for purposes of transferring PTEP under section 959, and a reference to a covered shareholder includes the deemed covered shareholder.
See
proposed § 1.959-7(g)(1). Thus, in the example described in the preceding paragraph, the foreign corporation's PTEP transfers in the first acquisition from the first covered shareholder to the deemed covered shareholder (who is a hypothetical person treated as owning all the stock of the foreign corporation owned by the nonresident alien individual). Then, in the second acquisition, the foreign corporation's PTEP, adjusted using a reasonable method to reflect transactions during the deemed covered shareholder's ownership period (for example, reductions for distributions), transfers from the deemed covered shareholder to the second covered shareholder.
See
§ 1.959-7(g)(2). In cases where there are no previous covered shareholders or PTEP, the deemed covered shareholder rules have no effect.

The Treasury Department and the IRS are of the view that alternative approaches such as “freezing” a foreign corporation's PTEP during periods in which its stock is not owned by a covered shareholder could inappropriately separate a foreign corporation's PTEP from its E&P and give rise to double taxation or other distortions. For example, under such an alternative, a covered shareholder could transfer the stock of an upper-tier foreign corporation that owns stock of a lower-tier foreign corporation with PTEP to a nonresident alien individual, the lower-tier foreign corporation could distribute all its E&P to the upper-tier foreign corporation without affecting its PTEP, and then the stock of the upper-tier foreign corporation could be transferred to another individual covered shareholder that would succeed to the PTEP that remains with the lower-tier foreign corporation even though it has no E&P. If the form of the transaction were respected for Federal income tax purposes, the result would be that a distribution by the upper-tier foreign corporation would not be sourced from PTEP and the transferred PTEP of the lower-tier foreign corporation could be distributed only to the extent that the lower-tier foreign corporation earns section 959(c)(3) E&P.

The Treasury Department and the IRS recognize that shareholders of a foreign corporation may not track PTEP of the foreign corporation that transfers to the deemed covered shareholder. In these cases, a covered shareholder that eventually succeeds to the PTEP must determine the amount and character of the PTEP, including by reconstructing transactions that affected the PTEP while the foreign corporation was under foreign ownership. This reconstruction is similar to other determinations that shareholders must make in certain acquisitions of stock of a foreign corporation for which an election under section 338(g) is not made, for example determinations regarding the foreign corporation's basis in assets or its E&P. The use of a single deemed covered shareholder to represent all foreign ownership of a foreign corporation is intended to ease the burden of this reconstruction by focusing only on whether and how PTEP moves under foreign ownership rather than, for example, by attributing portions of PTEP to each shareholder that is a nonresident alien individual and separately analyzing such portions. The Treasury Department and the IRS welcome comments about how to decrease the compliance burden and improve the administrability of this regime while still ensuring that the correct amount and character of PTEP is transferred from one covered shareholder to another even when there is intervening foreign ownership. For instance, the Treasury Department and the IRS welcome comments on whether a majority United States shareholder of a CFC should be permitted or required to track PTEP that transfers from a minority United States shareholder of that CFC to the deemed covered shareholder.

III. Section 961 Regulations

A. Overview

As discussed in part II.C.2 of the Background, section 961 authorizes regulations that provide for basis increases to reflect income inclusions under section 951 and basis reductions and gain recognition to reflect distributions of PTEP. Generally, the purpose of basis increases is to prevent PTEP of a foreign corporation from giving rise to additional U.S. tax in a sale or exchange of stock of the foreign corporation or property through which such stock is owned (for example, an interest in a partnership) when the stock or other property is sold before the PTEP is distributed. The purpose of basis reductions and gain recognition is to prevent double benefits from the basis increases provided under section 961.

Thus, the proposed regulations under section 961 adjust the basis in shares of stock of a foreign corporation owned by a covered shareholder, and the basis in any items of property through which the covered shareholder owns stock of the foreign corporation, to reflect the foreign corporation's PTEP with respect to the covered shareholder (for example, to reflect income inclusions giving rise to the PTEP or distributions of the PTEP). Unlike annual PTEP accounts, basis adjustments under the proposed regulations are specific to a share of stock or other item of property, consistent with each item of property having separate basis under the Code. Timing of basis adjustments generally matches the timing of related adjustments to annual PTEP accounts. Further, the proposed regulations under section 961 provide rules for different types of basis under section 961, including the tax consequences of the basis, and are issued pursuant to the express delegations of authority in section 961(a), (b), and (c).

As discussed in part III.A of the Background, a covered shareholder does not include a domestic partnership because a domestic partnership is treated as an aggregate of its partners in determining stock ownership for purposes of section 961.
See
proposed § 1.961-1(b);
see also
part VIII.A of the Explanation of Provisions (providing that an S corporation is generally treated in the same manner as a domestic partnership). As also discussed in part III.A of the Background, under section 958(a) stock ownership means stock owned directly and stock owned indirectly through foreign entities, including domestic partnerships to the extent treated as foreign partnerships under § 1.958-1(d)(1). Thus, the adjustments provided for by the proposed section 961 regulations also apply at the partner level to covered shareholders that own stock of a foreign corporation through one or more domestic (or foreign) partnerships.
See
part III.B.3 of this Explanation of Provisions for a discussion of basis provided in stock of a foreign corporation directly owned by a partnership.

B. Types of Property Units and Basis (Proposed § 1.961-2)

1. In General

Under the proposed regulations, the type of basis provided in an item of property depends on whether the direct owner of the item is a covered shareholder, partnership, or CFC. This is because when the direct owner of an item of property is a partnership or CFC, covered shareholder-specific basis is necessary so that the benefits of basis provided in the item to reflect income inclusions of a covered shareholder inure only to that shareholder. Additionally, section 961(c) provides that the basis in the case of an item of property directly owned by a CFC only applies for the purposes of determining the amount included under section 951 in the gross income of a United States shareholder. Specific rules are therefore needed with respect to basis adjustments for property owned by a CFC to reflect the limited purposes of basis under section 961(c).

Thus, the proposed regulations set forth rules for three types of property (each referred to as a property unit) and basis: (i) section 961(a) ownership units and adjusted basis, which is provided to a covered shareholder, (ii) derivative ownership units and derived basis, which is provided to a partnership and is covered shareholder-specific, and (iii) section 961(c) ownership units and section 961(c) basis, which is provided to a CFC and is covered shareholder-specific.
See
proposed § 1.961-2;
see also
proposed § 1.961-12(c) (
Example 1
). Each type of basis is maintained in U.S. dollars to ensure that basis reductions for a distribution of PTEP are commensurate with prior basis increases reflecting the income inclusion giving rise to the PTEP, regardless of movements in exchange rates (with any such movements taken into account under the rules for recognizing foreign currency gain or loss pursuant to section 986(c)).

2. Section 961(a) Ownership Units and Adjusted Basis

A section 961(a) ownership unit is a share of stock of a foreign corporation directly owned by a covered shareholder, or a partnership interest directly owned by a covered shareholder and through which the covered shareholder owns stock of a foreign corporation.
See
proposed § 1.961-2(c). For example, if a covered shareholder directly owns an interest in a partnership and the partnership owns (directly or indirectly) stock of a foreign corporation, the partnership interest is a section 961(a) ownership unit. A covered shareholder is provided adjusted basis in a section 961(a) ownership unit.

3. Derivative Ownership Units and Derived Basis

A derivative ownership unit is a share of stock of a foreign corporation directly owned by a partnership and owned (indirectly) by one or more covered shareholders through only one or more partnerships (for example, not through a foreign corporation), or a partnership interest directly owned by another partnership and through which one or more covered shareholders own stock of a foreign corporation through only partnerships.
See
proposed § 1.961-2(d)(1). For example, if a covered shareholder directly owns an interest in a partnership and the partnership directly owns shares of stock of a foreign corporation, each share of stock of the foreign corporation is a derivative ownership unit (and the interest in the partnership is a section 961(a) ownership unit). If, instead, the partnership is a lower-tier partnership an interest in which is directly owned by an upper-tier partnership and the covered shareholder directly owns an interest in the upper-tier partnership, the upper-tier partnership's interest in the lower-tier partnership is also a derivative ownership unit along with each share of stock of the foreign corporation directly owned by the lower-tier partnership (and the interest in the upper-tier partnership directly owned by the covered shareholder is a section 961(a) ownership unit).

A partnership is provided derived basis in a derivative ownership unit, which is maintained separately with respect to each covered shareholder that owns the derivative ownership unit through only one or more partnerships.
See
proposed § 1.961-2(d)(2). Derived basis may be positive or negative and is treated as an attribute of the partnership but has no effect on the partnership's common basis in the derivative ownership unit (that is, the partnership's basis that is shared among all partners) or any other asset of the partnership.
See
part III.C of the Explanation of Provisions for a

discussion of adjustments to derived basis, including the allowance of negative derived basis. Derived basis is intended to operate in a manner similar to a basis adjustment under section 743(b).
See
parts III.D and F of the Explanation of Provisions for the tax consequences of derived basis.

4. Section 961(c) Ownership Units and Section 961(c) Basis

A section 961(c) ownership unit is a share of stock of a foreign corporation directly owned by a CFC and owned (indirectly) by one or more covered shareholders.
See
proposed § 1.961-2(e)(1). For example, if a covered shareholder directly owns stock of an upper-tier CFC and the upper-tier CFC directly owns shares of stock of a lower-tier foreign corporation, each share of stock of the lower-tier foreign corporation owned by the upper-tier CFC is a section 961(c) ownership unit.

A CFC is provided section 961(c) basis in a section 961(c) ownership unit, which is maintained separately with respect to each covered shareholder that owns the section 961(c) ownership unit.
See
proposed § 1.961-2(e)(2). Section 961(c) basis may be positive or negative and is treated as an attribute of the CFC that generally is taken into account on the sale, exchange, or other disposition of the section 961(c) ownership unit, but has no effect on the CFC's adjusted basis in the section 961(c) ownership unit or any other asset of the CFC.
See
part III.C of the Explanation of Provisions for a discussion of adjustments to section 961(c) basis, including the allowance of negative section 961(c) basis. Section 961(c) basis applies only for the purposes prescribed in the section 961 regulations and, therefore, does not affect the amount of the CFC's gross income or E&P.
See
parts III.E through G of the Explanation of Provisions for the tax consequences of section 961(c) basis.

5. Certain Basis Not Addressed

i. Section 961(c) Basis and Non-CFCs

Consistent with the statutory language of section 961(c), the proposed regulations provide for basis under section 961(c) only with respect to stock of a CFC that is directly owned by another CFC. Although a section 961(c) ownership unit is defined as a share of stock of a foreign corporation directly owned by a CFC, section 961(c) basis adjustments are generally made only with respect to section 961(c) ownership units that are shares of stock in a CFC, as discussed in part III.C of the Explanation of Provisions.
See
proposed § 1.961-3 (basis increases for income inclusions); proposed § 1.961-4(d) (basis reductions for distributions); proposed § 1.961-5(b) (adjustments for foreign currency gain or loss). The Treasury Department and the IRS are studying whether, and to what extent, basis adjustments may or should also be made under section 961(c) in cases where stock of a CFC is owned by a covered shareholder through a foreign corporation that is not a CFC or where a CFC owns stock of a foreign corporation that used to be a CFC.

A CFC's section 961(c) basis with respect to a covered shareholder in stock of a lower-tier foreign corporation that is provided under the proposed regulations when that lower-tier foreign corporation was a CFC continues to exist, however, if that lower-tier foreign corporation ceases to be a CFC (a share of stock of the lower-tier foreign corporation is a section 961(c) ownership unit regardless of CFC status). Thus, for example, section 961(c) basis in stock of a foreign corporation that was a CFC but ceases to be a CFC may transfer to another covered shareholder in a general successor transaction and become section 961(c) basis with respect to that covered shareholder.
See
proposed § 1.961-5(c) (discussed in part III.C.4 of the Explanation of Provisions). Similarly, a CFC's positive section 961(c) basis in stock of a foreign corporation that was a CFC but ceases to be a CFC may be applied to certain gain recognized by the CFC with respect to stock of that foreign corporation.
See
proposed § 1.961-9 (discussed in part III.E of the Explanation of Provisions).

ii. Partnership Interests Owned by Foreign Corporations

Under the proposed regulations, a property unit does not include a share of stock of a foreign corporation or a partnership interest to the extent the share of stock or partnership interest is directly owned by a partnership and the interests of such partnership are owned by foreign corporations (including CFCs). Nor does a property unit include a partnership interest directly owned by a foreign corporation. For example, assume a covered shareholder directly owns all the stock of two upper-tier CFCs, the upper-tier CFCs are the only direct partners in a partnership, and the partnership directly owns all the stock of a lower-tier CFC. In such a case, neither the shares of stock of the lower-tier CFC directly owned by the partnership, nor the upper-tier CFCs' interests in the partnership, are property units. The Treasury Department and the IRS are studying whether the basis that should be provided in these items of property should be similar to derived basis or section 961(c) basis or have characteristics of both. Thus, the proposed regulations do not address the extent to which section 961 provides basis in such items.

C. Basis Adjustments (Proposed §§ 1.961-3, 1.961-4, and 1.961-5)

1. Basis Increases for Certain Income Inclusions

i. In General

To reflect a covered shareholder's income inclusions under sections 951(a) and 951A(a) for a taxable year of a CFC, the proposed regulations provide rules to increase the basis of property units that are shares of stock of the CFC owned by the covered shareholder and the basis of any property units through which the covered shareholder owns such stock.
See
proposed § 1.961-3(b);
see also
proposed § 1.961-12(c) (
Example 2
). For this purpose, a reference to basis means adjusted basis of the covered shareholder in the case of a section 961(a) ownership unit, derived basis with respect to the covered shareholder in the case of a derivative ownership unit, and section 961(c) basis with respect to the covered shareholder in the case of a section 961(c) ownership unit.

Generally, the basis of each property unit is increased by the amount that would be distributed with respect to the property unit in a hypothetical distribution by the CFC equal to the U.S. dollar amount of the covered shareholder's income inclusions (hypothetical distribution rule).
See
proposed § 1.961-3(c)(1) and (4);
see also
part III.C.1.ii of the Explanation of Provisions (discussing additional rules that apply in the case of a midyear transaction). The hypothetical distribution is treated as made through all tiers to the covered shareholder on the last relevant day of the CFC's taxable year (taking into account only stock or other property owned by the covered shareholder).
See
proposed § 1.961-3(e). In this way, under the grant of regulatory authority in section 961, a property unit is generally provided an amount of basis matching the amount by which basis of the property unit is reasonably expected to be reduced under section 961 when PTEP resulting from the income inclusions is subsequently distributed to the covered shareholder. The amount of basis provided to a particular property unit will generally equal the covered shareholder's income inclusion attributable to that property unit, but the amount may differ in certain cases.

For example, consider a case where the covered shareholder owns all the stock of the CFC, with such stock consisting of a single preferred share with a $10x preference and common stock. The CFC has $100x of E&P for its taxable year, consisting of $90x of subpart F income, $0 of tested income or tested loss, and $10x of other income. The covered shareholder includes $90x in gross income under section 951(a)(1)(A) (under § 1.951-1, $9x of the inclusion is attributable to the preferred share and the remaining $81x is attributable to the common stock), and, consequently, the CFC's PTEP with respect to the covered shareholder increases by $90x. While only $9x of the covered shareholder's $90x income inclusion is attributable to the preferred share, the proposed regulations increase the basis of the preferred share by $10x and the basis of the common stock by the remaining $80x. This approach takes into account that, of the first $10x of PTEP distributed by the CFC to the covered shareholder, that amount is likely to be distributed on the preferred share. And, if the basis adjustments to the preferred share were to instead match the income inclusion attributable to that share ($9x), the covered shareholder would receive a $10x distribution on the preferred share, thus potentially giving rise to gain under section 961(b)(2) in an amount equal to that difference. The proposed regulations prevent that result by adjusting the basis in the preferred share by $10x. The Treasury Department and the IRS request comments on this approach, including whether there are ways to improve the accuracy of allocating basis to a property unit without undue complexity and additional compliance and administrative burden, and without creating the possibility of inappropriate results.

However, if the CFC distributes PTEP with respect to the covered shareholder before the last re

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2024-27227. Public record. Not legal advice.