Notice 2005-38

Part III. Administrative, Procedural, and Miscellaneous
Section 965 — Limitations on
Dividends Received Deduction
and Other Guidance
Notice 2005–38
SECTION 1. OVERVIEW
This notice is the second in a series of
items of published guidance regarding new
section 965 of the Internal Revenue Code
(Code). It supplements guidance previously set forth in Notice 2005–10, 2005–6
I.R.B. 474, which primarily addressed requirements regarding a domestic reinvestment plan described in section 965(b)(4).
This notice primarily addresses the limitations, described in section 965(b)(1), (2),
and (3), on the amount of dividends that a
corporation that is a U.S. shareholder of a
controlled foreign corporation may treat as
eligible for the dividends received deduction under section 965(a) (DRD or section
965(a) DRD), including the effects of certain transactions on such limitations.
The Treasury Department and the Internal Revenue Service (IRS) intend to issue additional guidance concerning section 965 to address certain issues arising
with respect to a U.S. corporation’s computation of its tax liability, including the
availability of foreign tax credits, when
section 965 is applied. The Treasury Department and the IRS expect to issue regulations that incorporate the guidance provided in Notice 2005–10, this notice, and
any subsequent guidance addressing section 965.
The remainder of this notice is divided
into 14 sections. Section 2 provides background with respect to the issues addressed
in this notice. Section 3 sets forth general principles that apply in determining
the amount of cash dividends received
by a U.S. shareholder that is considered
extraordinary for purposes of section
965(b)(2). Section 4 sets forth general
principles that apply in determining the
maximum amount of dividends eligible
under section 965(b)(1) to be taken into
account under section 965(a). Section 5
addresses the taxable year to which sec-

tion 965 applies. Section 6 then addresses
the effects of certain transactions on the
determination of a U.S. shareholder’s
limitations determined under sections 3
and 4. Section 7 sets forth guidance and
principles for determining under section
965(b)(3) the amount of related party indebtedness that reduces the amounts taken
into account under section 965(a), including special adjustments made as a result
of certain transactions. Section 8 provides
guidance regarding the impact of certain
transactions on domestic reinvestment
plans. Section 9 addresses other issues
arising under section 965, including the
application of section 78, the expenses
disallowed under section 965(d)(2), and
the computation of the alternative minimum tax. Section 10 addresses reporting
and other administrative requirements.
Section 11 sets forth transition rules that
apply to certain taxpayers that, prior to
the issuance of this notice, either adopted
a domestic reinvestment plan or filed a
tax return for a taxable year to which section 965 applies. Section 12 describes the
effect of this notice on other documents.
Section 13 provides the effective date of
this notice, and section 14 provides information required under the Paperwork
Reduction Act of 1995. Finally, section
15 provides drafting information.
SECTION 2. BACKGROUND
.01 Section 965 — In General
The American Jobs Creation Act of
2004 (P.L. No. 108–357) (the Act), enacted on October 22, 2004, added new
section 965 to the Code. In general, and
subject to limitations discussed below,
section 965(a) provides that a corporation
that is a U.S. shareholder of a controlled
foreign corporation (CFC) may elect, for
one taxable year, an 85 percent DRD with
respect to certain cash dividends it receives from its CFCs.
Section 951(b) defines the term “U.S.
shareholder” with respect to any foreign
corporation as a U.S. person who owns
(within the meaning of section 958(a)), or
is considered to own (under the construc-

tive ownership rules of section 958(b)),
10 percent or more of the total combined
voting power of all classes of stock entitled to vote of such foreign corporation.
Section 965(c)(5)(A) provides that all U.S.
shareholders that are members of an affiliated group filing a consolidated return under section 1501 are treated as one U.S.
shareholder. For purposes of this notice,
the term “U.S. shareholder” means, unless otherwise indicated, a domestic corporation that, at any time after the beginning of the base period (defined below),
is a U.S. shareholder (as defined in section 951(b)) with respect to a CFC and
that owns (within the meaning of section
958(a)) stock of such CFC.
For purposes of section 965, the term
“dividends” includes cash amounts included in gross income as dividends under
sections 302 and 304, but does not include
amounts treated as dividends under section 78 or 1248 or, in certain cases, section
367.1 H.R. Conf. Rep. No. 108–755, at
314–15 (2004). Also for this purpose, a
cash dividend includes a cash distribution
from a CFC that is excluded from gross
income under section 959(a) (regarding
distributions of previously taxed income
(PTI)) to the extent of inclusions under
section 951(a)(1)(A) as a result of a cash
dividend during the election year to: (1)
such CFC from another CFC in a section
958(a) chain of ownership; or (2) any other
CFC in such chain of ownership from another CFC in such chain of ownership,
but only to the extent of cash distributions
described in section 959(b) made during
such year to the CFC from which such
U.S. shareholder received such distribution.
Section 965(b) imposes four limitations
on the section 965(a) DRD. These limitations are discussed in detail below in paragraphs .02 through .05 of this section.
Section 965(d) and (e) provide special
rules that limit the use of foreign tax credits
and the deduction of certain expenses to
offset the nondeductible portion of section
965(a) dividends, respectively. See section
9.01 of this notice. These rules will be
addressed in greater detail in a subsequent

1 Dividends resulting from liquidations qualifying under section 332 to which section 367(b) applies qualify as cash dividends to the extent the U.S. shareholder actually receives cash as part
of the liquidation. Section 965(c)(3). A deemed liquidation effectuated through an election under Treas. Reg. §301.7701–3(c), however, does not by itself result in an actual distribution of
cash as required under section 965. See H.R. Conf. Rep. No. 108–755, at 315, n. 108 (2004).

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notice that the Treasury Department and
the IRS expect to issue soon.
Section 965(f) provides that taxpayers
may elect the application of section 965
for either the taxpayer’s last taxable year
which begins before October 22, 2004, or
the taxpayer’s first taxable year which begins during the one-year period beginning
on October 22, 2004. The election must be
made on or before the taxpayer’s due date
(including extensions) for filing its Federal
income tax return. See Notice 2005–10;
see also H.R. Conf. Rep. No. 108–755,
at 314, n. 107 (2004). The taxable year
for which a taxpayer elects to apply section 965 will be referred to in this notice as
the “election year.”
.02 Extraordinary Dividends
Section 965(b)(2) provides that only
those cash dividends (within the meaning of section 965(a)) received from CFCs
during the U.S. shareholder’s election year
that are considered “extraordinary” are eligible for the section 965(a) DRD. Cash
dividends received by the U.S. shareholder
during the election year are considered
extraordinary only to the extent such dividends exceed the annual average for the
base period years of the following items
reported on the U.S. shareholder’s tax
return as filed (including any amended returns that were filed on or before June 30,
2003): (1) dividends received during each
base period year by such shareholder from
CFCs2; (2) amounts includible in such
shareholder’s gross income for each base
period year under section 951(a)(1)(B)
(regarding investments in United States
property under section 956) with respect
to CFCs; and (3) amounts that would
have been included for each base period
year but for section 959(a) with respect to
CFCs.3
The term “base period” in this notice
means the five most recent taxable years
of the U.S. shareholder that end on or
before June 30, 2003. The term “base
period inclusion” in this notice means any
amount described in (1), (2), or (3) of the
preceding paragraph, for any of the U.S.
shareholder’s taxable years in the base
period. Under section 965(c)(2)(A), the
term “base period years” generally in2

cludes only three taxable years in the U.S.
shareholder’s base period, determined by
disregarding the years in the base period
for which the base period inclusions are
the highest and the lowest. However, if
the taxpayer has fewer than five taxable
years ending on or before June 30, 2003,
then all taxable years ending on or before
that date are considered base period years.
The average of the U.S. shareholder’s base
period inclusions for its base period years
is referred to in this notice as the “base
period amount.”
Section 965(c)(2)(C)(i) sets forth a general rule applicable to companies entering
and exiting corporate groups, which provides that for purposes of determining the
base period inclusions (and ultimately the
base period amount), rules similar to the
rules of section 41(f)(3)(A) and (B) apply.
Section 41 generally provides for an incremental credit for qualified research activities, but only to the extent that current
year research expenditures exceed the base
amount for that year. For purposes of section 41, the base amount is computed by
multiplying a measure of the taxpayer’s
qualified research expenses during a specified historical period by its average annual
gross receipts for the four years immediately preceding the credit year. Section
41(f)(3)(A) and (B) generally provide that,
as a result of certain acquisitions and dispositions, a taxpayer may increase or decrease the amount of its qualified research
expenses and gross receipts to the extent
that such amounts are attributable to the
acquired or disposed of portion of a trade
or business of the taxpayer.
In addition to the general references
to section 41(f)(3)(A) and (B), section
965(c)(2)(C)(ii) provides a special rule
for distributions during the base period
of stock of a U.S. shareholder to which
section 355 (or so much of section 356
that relates to section 355) applies. Under
this special rule, the U.S. shareholder, the
stock of which is distributed, is treated
as having been in existence for the same
period that the distributing corporation
has been in existence. Further, the base
period inclusions of the distributing and
controlled corporations prior to the distribution are, in general, allocated between

such corporations on the basis of their respective interests in the CFCs giving rise
to such inclusions immediately after such
distribution. Section 965(c)(2)(C)(ii) also
provides that this rule does not apply if
neither the controlled corporation nor the
distributing corporation is a U.S. shareholder of such CFCs immediately after the
distribution.
.03 Maximum Amount Eligible for Section
965(a) — Greater of $500 Million or
Permanently Reinvested Earnings
Section 965(b)(1) limits the amount of
dividends eligible for the section 965(a)
DRD to the greatest of the following three
amounts: (1) $500 million ($500 million
limitation); (2) the amount shown on the
taxpayer’s applicable financial statement
as earnings permanently reinvested outside the United States; or (3) in the case of
an applicable financial statement that does
not show a specific amount of earnings
permanently reinvested outside the United
States but that does show a specific amount
of tax liability attributable to such earnings, the amount of such liability divided
by 0.35. If the applicable financial statement does not show a specific earnings or
tax liability amount, then the $500 million
limitation applies. The section 965(b)(1)
amount shown on the taxpayer’s applicable financial statement as earnings permanently reinvested outside the United States
and the amount shown as a specific amount
of tax liability attributable to such earnings
divided by 0.35 is referred to in this notice
as “APB 23 limitation.”
Under section 965(c)(1), the term “applicable financial statement” means the
most recently audited financial statement
(including notes and other documents
which accompany such statement) which
is certified on or before June 30, 2003, as
being prepared in accordance with generally accepted accounting principles, and
which is used for the purposes of a statement or report to creditors or shareholders
or for any other substantial nontax purpose. If the taxpayer is required to file
with the Securities and Exchange Commission, the audited financial statement
must be so filed on or before June 30,

For this purpose, both cash and non-cash dividends received are taken into account. See section 965(b)(2)(B)(i).

3

For this purpose, distributions of PTI for any base period year do not include distributions excluded from gross income by reason of an amount described in section 965(b)(2)(B)(ii) (relating
to investments in United States property) with respect to a prior taxable year.

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2003, to qualify as an applicable financial
statement. The legislative history states:
[APB 23 limitation] refers to elements
of Accounting Principles Board Opinion 23 (“APB 23”), which provides an
exception to the general rule of comprehensive recognition of deferred taxes
for temporary book-tax differences.
The exception is for temporary differences related to undistributed earnings
of foreign subsidiaries and foreign
corporate joint ventures that meet the
indefinite reversal criterion in APB 23.
H. R. Conf. Rep. No. 108–755, at 315,
n. 111 (2004). The last day covered by the
applicable financial statement is referred
to in this notice as the “APB 23 determination date.”
Section 965(c)(5) provides special rules
for applying section 965 to controlled
groups of corporations. First, section
965(c)(5)(B) provides that all corporations treated as a single employer under
section 52(a) (section 52(a) group) are
limited to one $500 million limitation, and
the limitation must be divided among such
corporations under regulations prescribed
by the Secretary. A section 52(a) group includes all corporations that are members of
a controlled group of corporations within
the meaning of section 1563(a) substituting, however, “more than 50 percent” for
“at least 80 percent” throughout section
1563(a)(1), and making the determination
without regard to section 1563(a)(4) and
(e)(3)(C). Second, section 965(c)(5)(C)
provides that if a financial statement is an
applicable financial statement for more
than one U.S. shareholder, APB 23 limitation is divided among such shareholders
under regulations prescribed by the Secretary.
.04 Increase in Related Party Indebtedness
Section 965(b)(3) provides that the
amount of a U.S. shareholder’s dividends
otherwise eligible for the deduction under section 965(a) are reduced by any
increase in the indebtedness of the CFC to
any related person (as defined in section
954(d)(3)) between October 3, 2004, and
the close of the taxable year for which
the election under section 965 is in effect.

For this purpose, all CFCs with respect to
which the taxpayer is a U.S. shareholder
are treated as a single CFC and, therefore,
indebtedness between CFCs is disregarded
for this purpose. See H.R. Conf. Rep. No.
108–755, at 314, n. 109 (2004). Section
965(b)(3) is intended to prevent a deduction from being claimed with respect to a
section 965 dividend where the dividend is
financed, directly or indirectly, by the U.S.
shareholder. In such a case, there may be
no net repatriation of funds, and thus it is
inappropriate to allow a deduction under
section 965(a). H.R. Conf. Rep. No.
108–755, at 315 (2004).
.05 Investment in the United States
Pursuant to a Domestic Reinvestment
Plan
Section 965(b)(4) requires a U.S. shareholder claiming a section 965(a) DRD with
respect to a dividend to invest the amount
of the dividend in the United States pursuant to a domestic reinvestment plan. The
domestic reinvestment plan must be approved by the taxpayer’s president, chief
executive officer, or comparable official
before the payment of the dividend and
subsequently approved by the taxpayer’s
board of directors, management committee, executive committee, or similar body.
The domestic reinvestment plan must provide for the investment of the dividend in
the United States (other than as a payment
for executive compensation), including as
a source for the funding of worker hiring
and training, infrastructure, research and
development, capital investments, or the
financial stabilization of the corporation
for the purposes of job retention or creation. This list is not intended to be exclusive. H.R. Conf. Rep. No. 108–755, at
316 (2004). For additional guidance with
respect to domestic reinvestment plans, see
sections 8 and 9 of this notice and Notice
2005–10.
SECTION 3. BASE PERIOD AMOUNT
— GENERAL PRINCIPLES

base period amount by applying the rules
of section 965(b)(2)(B) and (c)(2) with respect to CFCs for which it was a U.S.
shareholder at any time during its base period.
(b) Consolidated groups. A consolidated group4 determines its base period inclusions by first aggregating the base period inclusions of each of the members in
its group. It then determines its base period amount by determining the average of
such inclusions as provided under section
965(b)(2)(B) and (c)(2).
(c) Short taxable years. Taxable years
of fewer than 12 months are taken into account as taxable years for purposes of determining the base period years pursuant
to section 965(c)(2). In addition, base period inclusions in a taxable year of fewer
than 12 months are not annualized or otherwise adjusted for purposes of calculating
the base period amount.
(d) Intermediary pass-through entities.
The Treasury Department and the IRS expect to issue guidance soon on the treatment of distributions to intermediary passthrough entities owned by U.S. shareholders for purposes of section 965(b)(2)(B)(i).
(e) Example. The following example illustrates the application of section
965(b)(2) and this section 3.01.
Example. (i) Facts. USP is the common parent
of a consolidated group that includes USP’s wholly
owned subsidiaries US1 and US2. US1 and US2 each
wholly owns a foreign corporation, CFC1 and CFC2,
respectively. The USP consolidated group maintains
a taxable year ending July 31. US1 received a $100x
dividend from CFC1 in each of the consolidated taxable years ending July 31, 1996, 1997, and 1998.
US2 received a dividend from CFC2 during each of
the consolidated taxable years ending July 31, 1998,
1999, 2000, 2001, 2002, and 2003 in the amount of
$150x, $150x, $200x, $100x, $50x, and $100x, respectively.
(ii) Result. USP first determines the base period
inclusions of US1 and US2 to determine the consolidated group’s base period inclusions. Pursuant to section 965(c)(2), the base period includes the five most
recent taxable years of the USP group that ended on
or before June 30, 2003, which are the group’s taxable years ending July 31, 1998 (year 1) through July
31, 2002 (year 5). Accordingly, USP will have base
period inclusions as follows:

.01 Determination of Base Period Amount
(a) In general. A U.S. shareholder determines its base period inclusions and its

4 The terms “consolidated group,” “member,” “subsidiary,” and “separate return year” are defined in Treas. Reg. §1.1502–1. In addition, the term “member” also refers, when the context so
requires, to a member of a section 52(a) group.

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Taxable year ending
July
July
July
July
July

31,
31,
31,
31,
31,

1998
1999
2000
2001
2002

To determine its base period years pursuant to
section 965(c)(2), USP disregards the taxable years
in its base period with the highest and lowest base
period inclusions, which are 1998 ($250x) and 2002
($50x). To determine its base period amount, USP
then averages the base period inclusions for the remaining three taxable years (that is, the base period
years). Therefore, USP’s base period amount is
$150x (($150x + $200x + 100x)/3).

.02 Translation of Previously Taxed
Income Distributed During the Base
Period
For purposes of determining the dollar amount of base period inclusions attributable to distributions of PTI described
in section 965(b)(2)(B)(iii), distributions
of foreign currency are valued by multiplying the distributing CFC’s foreign currency amount of the PTI distribution by
the spot rate (as defined in Treas. Reg.
§1.988–1(d)(1)) on the date of distribution.
SECTION 4. MAXIMUM AMOUNT
ELIGIBLE FOR SECTION 965(a) —
GENERAL PRINCIPLES
.01 Applicable Financial Statement
As noted above, the amount of dividends eligible for the section 965(a) DRD
may be limited by section 965(b)(1)(B) or
(C) to either: (1) the amount shown on
the taxpayer’s applicable financial statement as earnings permanently reinvested
outside the United States; or (2) in the case
of an applicable financial statement that
does not show a specific amount of earnings permanently reinvested outside the
United States but that does show a specific amount of tax liability attributable to
such earnings, the amount of such liability divided by 0.35. Also as noted above,
the term “applicable financial statement”
means the most recently audited financial
statement (including notes and other documents which accompany such statement)
which is certified on or before June 30,
2003, as being prepared in accordance with
generally accepted accounting principles,
and which is used for the purposes of a

May 31, 2005

USP group base period inclusions
$250x
$150x
$200x
$100x
$50x

statement or report to creditors or shareholders or for any other substantial nontax purpose. For purposes of determining
an amount shown on a taxpayer’s applicable financial statement pursuant to section 965(b)(1)(B) or (C), the parenthetical reference to notes and other documents
accompanying the statement only includes
notes and documents that form an integral
part of the financial statement; it does not
include work papers or other materials underlying or supporting the statement.

been subject to foreign tax of $10x. The applicable financial statement of the U.S. shareholder that wholly
owns such CFC does not show a specific amount of
earnings permanently reinvested outside the United
States, but instead shows a $25x tax liability attributable to such earnings.
(ii) Result. Although the applicable financial
statement of the U.S. shareholder does not show an
amount of permanently reinvested earnings, it does
show a tax liability of $25x attributable to earnings
permanently reinvested. Thus, the amount described
in section 965(b)(1)(C) is $71.4x ($25x/0.35). This
amount may not be adjusted to take into account the
foreign taxes imposed on such earnings.

.02 Determination of APB 23 Limitation
of a U.S. Shareholder

.04 Allocation of APB 23 Limitation

If an applicable financial statement
fails to show a specific amount of earnings permanently reinvested outside the
United States, but instead shows a specific
amount of tax liability attributable to such
earnings, the APB 23 limitation under section 965(b)(1)(C) is the specific amount
of such tax liability divided by 0.35. This
amount may not be adjusted (for example,
to take into account the foreign taxes imposed on such earnings).
The following example illustrates the
application of section 965(b)(1)(C) and
this section 4.03.

As noted above, section 965(c)(5)(C)
provides that if a financial statement is
an applicable financial statement for more
than one U.S. shareholder, APB 23 limitation is divided among such shareholders
under regulations prescribed by the Secretary. In such a case, the portion of the APB
23 limitation allocated to the U.S. shareholder is the amount from the separate
company financial statements (or supporting work papers) of such U.S. shareholder
that were prepared in connection with determining the amount described in section
965(b)(1)(B) or (C) shown on the applicable financial statement that included such
U.S. shareholder.
Section 965(c)(5)(C) contemplates not
only the situation where the financial statement reflects the operations of affiliated
corporations that are not consolidated for
tax purposes (for example, a U.S. corporation and a domestic subsidiary thereof
that elects to apply section 936), but also
the situation where the financial statement
reflects the operations of corporations
that were formerly affiliated and/or consolidated but are not in such relationship
during a section 965 election year. See
section 6 of this notice for rules regarding
the allocation of APB 23 limitation in such
a case.
The following example illustrates the
application of section 965(b)(1) and this
section 4.04.

Example. (i) Facts. A CFC has earnings permanently reinvested outside the United States that have

Example. (i) Facts. USP is a domestic corporation that files a consolidated return with its

For purposes of section 965(b)(1)(B)
and (C), the specific amount shown on the
applicable financial statement that reflects
the amount determined under paragraph
12 of APB 23 (or, in the case of section
965(b)(1)(C), a specific amount of tax liability) and that is disclosed as required under Financial Accounting Standards Board
Statement 109, is treated as an amount of
earnings permanently reinvested outside
the United States (or, the amount of tax
liability attributable to such earnings), regardless of the specific language used to
describe such specific amount on the applicable financial statement.
.03 Amount of Tax Liability Attributable
to Earnings Permanently Reinvested

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wholly-owned subsidiaries US1 and US2. USP also
wholly owns US3, which does not join in the USP
consolidated return because an election under section
936 is in effect with respect to US3. US1, US2
and US3 each wholly owns a foreign corporation,
CFC1, CFC2, and CFC3, respectively. Even though
US3 is not part of the USP consolidated group for
U.S. tax purposes, US3 is consolidated with USP,
US1, and US2 for financial accounting purposes. On
USP’s applicable financial statement, USP reported
$350x of earnings permanently reinvested outside
the United States. The separate company financial
statements of US1, US2, and US3 that were used
in preparing the USP applicable financial statement
reported earnings permanently reinvested by CFC1,
CFC2, and CFC3 to be $100x, $50x and $200x,
respectively.
(ii) Result. The portion of the USP APB 23 limitation allocated to US1, US2, and US3 is that portion reflected on the separate company financial statements (or supporting work papers) of US1, US2, and
US3 that were used in determining the USP APB 23
limitation on its applicable financial statement. Thus,
US1 is allocated $100x, US2 is allocated $50x, and
US3 is allocated $200x of the $350x APB 23 limitation. Because US1 and US2 are members of the USP
consolidated group and such group is treated as one
U.S. shareholder, the USP consolidated group’s APB
23 limitation equals $150x ($50x + $100x).

.05 Allocation of $500 Million Limitation
As noted above, section 965(c)(5)(B)
provides that all corporations which are included in a section 52(a) group are limited
to one $500 million limitation, which is divided among such corporations under regulations prescribed by the Secretary. Each
qualified member of a section 52(a) group
is allocated a portion of the section 52(a)
group’s single $500 million limitation if it
is a qualified member on the last day of
the election year of the qualified member
with the last election year to end (apportionment date). A “qualified member” is
either: (1) a domestic corporation that files
a separate tax return and is a member of a
section 52(a) group; or (2) a consolidated
group that is part of a section 52(a) group.
Accordingly, if a consolidated group is not
a part of a section 52(a) group, it has its
own $500 million limitation, and, if a consolidated group is part of a section 52(a)
group, the portion of the $500 million allocated to the consolidated group is not
further allocated between and among the
members of the consolidated group.
The section 52(a) group’s single $500
million limitation is allocated to all qualified members in proportion to the aggregate amount of total current and accumulated earnings and profits that are
not previously taxed (non-PTI earnings

2005–22 I.R.B.

and profits) of all CFCs owned (within
the meaning of section 958(a)) by such
qualified members. For purposes of this
rule, a consolidated group is treated as
owning CFCs within the meaning of section 958(a), if any member of the group
owns CFCs within the meaning of section
958(a). The amount of non-PTI earnings
and profits of a CFC owned (within the
meaning of section 958(a)) by a qualified
member is the sum of the amounts of earnings and profits of such CFC appropriately
reported on Schedule J, items 7(a) and
7(b), of the last Form 5471 filed by or on
behalf of such qualified member on or before the apportionment date with respect
to such CFC, translated into U.S. dollars
at the average exchange rate for the CFC’s
taxable year (see section 989(b)(3)).
The following example illustrates the
application of section 965(b)(1) and the
rules of this section 4.05.
Example. (i) Facts. FP, a foreign corporation,
wholly owns two domestic corporations, US1 and
US2. US1 and US2 each wholly owns a foreign corporation, CFC1 and CFC2, respectively. US1 and
US2 each has a taxable year ending July 31, and they
each make an election under section 965 for the taxable year ending July 31, 2006. US1 and US2 have
APB 23 limitations of zero. On US1’s last Form 5471
filed on or before the July 31, 2006 apportionment
date with respect to CFC1, US1 reported an amount
of non-PTI earnings and profits for CFC1, translated
into U.S. dollars using the average exchange rate, of
$100x. On US2’s last Form 5471 filed on or before
the July 31, 2006 apportionment date with respect to
CFC2, US2 reported an amount of non-PTI earnings
and profits for CFC2, translated into U.S. dollars using the average exchange rate, of $300x.
(ii) Result. US1 and US2 do not have an APB
23 limitation and, thus, their maximum amount eligible for the section 965(a) DRD is $500 million. Because US1 and US2 are members of the same section 52(a) group, they are limited to one $500 million limitation, which is allocated between them. Pursuant to this section 4.05, the $500 million limitation
is allocated in proportion to the aggregate U.S. dollar amount of non-PTI earnings and profits reported
on the last Form 5471 filed on or before the apportionment date by US1 and US2 with respect to CFC1
and CFC2, respectively. The apportionment date for
the FP group is July 31, 2006. Consequently, US1
is allocated $125 million of the $500 million limitation ($100x/$400x x $500 million) and US2 is allocated $375 million of the $500 million limitation
($300x/$400x x $500 million).

SECTION 5. TAXABLE YEAR TO
WHICH SECTION 965 APPLIES
.01 In General
Section 965(f) provides that a taxpayer
may elect to apply section 965 to either the

1104

taxpayer’s last taxable year beginning before October 22, 2004, or the taxpayer’s
first taxable year starting during the oneyear period beginning on October 22, 2004
(eligible year). Thus, assuming that the
other requirements of section 965 are met,
a taxpayer may elect to apply the section
965(a) DRD with respect to cash dividends
(as defined for purposes of section 965(a))
received by a U.S. shareholder from its
CFCs in an eligible year. Except as otherwise provided in this section 5, an eligible
year may include a short taxable year.
.02 Consolidated Groups
For taxpayers that are members of a
consolidated group, the common parent
may elect on behalf of all the members to
apply section 965 to one of the group’s eligible years. The election applies to each
member of the group that is included in
the group’s income tax return for that eligible year, but only for the portion of the
eligible year during which such member
is a member of the group. Further, every
member can receive a cash dividend from
a CFC that otherwise qualifies under section 965(a) during any period the recipient
is a member of such group. This rule applies even if: (1) as a result of a subsidiary
entering or leaving the group, the group’s
election year is, with respect to the particular subsidiary, neither the taxable year that
includes October 22, 2004, nor the subsequent taxable year; or (2) a previous separate return year of the subsidiary also was
an election year for the subsidiary. This
rule also applies as a result of the acquisition of a consolidated group by an unrelated consolidated group, where the previous separate return year of the acquired
group was an election year.
Under the rules of the preceding paragraph, if a subsidiary leaves the group
during the group’s election year, cash
dividends received from the subsidiary’s
CFCs during its short taxable year that
ends within the group’s election year are
eligible for the group’s election. As a result, dividends received by the subsidiary
during that initial short taxable year can
be eligible for the section 965(a) DRD.
Moreover, dividends received by the subsidiary during its next short taxable year
as part of an acquiring group may also be
eligible for the section 965(a) DRD.

May 31, 2005

In addition, if the departing subsidiary
is not immediately thereafter a subsidiary
member of another group, it may treat its
next short taxable year as an eligible year
and make an election under section 965
for that year, even if that next taxable year
is neither the taxable year for that subsidiary that includes October 22, 2004, nor
the subsequent taxable year, provided that
the two short taxable years together do not
exceed twelve months (or an equivalent
52–53 week year).
General consolidated return principles
apply to reverse acquisitions as defined in
Treas. Reg. §1.1502–75(d)(3), so that
the taxable year of the continuing group
governs its available eligible years and the
terminating group members are subject to
the general rules for members leaving and
entering groups, with the common parent
in effect treated as having become a subsidiary of the continuing group.
.03 Examples
The following examples illustrate the
application of the rules of section 965(f)
and this section 5.
Example 1. Member included in election year of
different consolidated groups. (i) Facts. USP is the
common parent of a calendar year consolidated group
that elects to apply section 965 for its taxable year
ending December 31, 2004. US1 is a member of
the USP group and a U.S. shareholder. USB is the
common parent of an unrelated consolidated group
that elects to apply section 965 to its taxable year
ending June 30, 2005. A member of the USB group
acquires all the stock of US1 on November 15, 2004.
(ii) Result. Because US1 is included in the USP
group during the USP group’s section 965 election
year (January 1, 2004, through December 31, 2004),
US1’s taxable year beginning January 1, 2004, and
ending on November 15, 2004 is an election year
during which cash dividends received from US1’s
CFCs may be eligible for the section 965(a) DRD. In
addition, because US1 is included in the USB group
during the USB group’s election year (July 1, 2004
through June 30, 2005), cash dividends from US1’s
CFCs during US1’s taxable year beginning on
November 16, 2004 and ending June 30, 2005, may
be eligible for the section 965(a) DRD of the USB
group.
(iii) Alternative facts. If USB instead makes an
election under section 965 for its taxable year ending
June 30, 2006, cash dividends from US1’s CFCs during the USB group’s election year may still be eligible for the section 965(a) DRD. In this case, however,
that election year is US1’s taxable year from July 1,
2005, through June 30, 2006. Section 965 will not
apply to US1’s year beginning November 16, 2004,
and ending June 30, 2005.
Example 2. Special rule for member departing
but not joining a consolidated group. (i) Facts. Assume the same facts as in Example 1, except instead

May 31, 2005

of being acquired by an unrelated consolidated group,
the stock of US1 is distributed to the shareholders of
USP on November 15, 2004, and US1 becomes the
common parent of a new consolidated group which
also maintains a taxable year ending December 31.
(ii) Result. Because the taxable year ending
December 31, 2004, is the USP group’s election
year, US1’s taxable year beginning January 1, 2004,
and ending on November 15, 2004, is an election
year during which cash dividends received from
US1’s CFCs may be eligible for the section 965(a)
DRD. Further, because US1 ceased to be a member
of the USP group during its election year and did not
become a subsidiary member of another consolidated
group, US1 may make an election under section 965
for the subsequent short taxable year, which begins
on November 16, 2004, and ends on December 31,
2004. This election will also apply to the other
members of the US1 group during that short taxable
year. US1 will not be able to make an election under
section 965 for 2005.
Example 3. Acquisition of target resulting in single short election year. (i) Facts. USP is the common parent of a calendar year consolidated group that
elects to apply section 965 for its taxable year ending December 31, 2004. US1 is a member of the
USP group and a U.S. shareholder. On November
15, 2004, the stock of US1 is distributed to the shareholders of USP; after such distribution, US1 is not a
member of a consolidated group and therefore files
a separate return. USB is the common parent of
an unrelated consolidated group that plans to apply
section 965 to its taxable year ending December 31,
2005. On December 15, 2005, US1 purchases all the
stock of USB for cash. US1 and its subsidiaries elect
to file a consolidated return for the taxable year ending December 31, 2005.
(ii) Result. Because the taxable year ending
December 31, 2004, is the USP group’s election
year, US1’s taxable year beginning January 1, 2004,
and ending on November 15, 2004, is an election
year during which cash dividends received from
US1’s CFCs may be eligible for the section 965(a)
DRD. Further, because US1 ceased to be a member
of the USP group during its election year and did not
become a subsidiary member of another consolidated
group, US1 may make an election under section 965
for its short taxable year that begins on November
16, 2004, and ends on December 31, 2004. However, 2005 is not an eligible year for US1 or its
consolidated group. The USB group’s final taxable
year ends on December 15, 2005, when it is acquired
by US1. That short taxable year is an eligible year
for which the USB group may make an election
under section 965. Thereafter, the members of the
former USB group will become members of the
US1 group. Because the USB group was acquired
after the US1 election year, the former USB group
members may not participate in an election under
section 965 for any period after December 15, 2005.
Example 4. Effect of reverse acquisition. (i)
Facts. Assume the same facts as in Example 3, except that US1’s acquisition of USB is for US1 stock
rather than cash and the acquisition is a reverse acquisition described in Treas. Reg. §1.1502–75(d)(3).
(ii) Result.
Under Treas. Reg. §1.1502–
75(d)(3)(i), the USB group is treated as continuing
to exist after the reverse acquisition with US1 as its
common parent. The USB group’s taxable year end-

1105

ing December 31, 2005, is an eligible year for which
the group may make an election under section 965.
This election applies to cash dividends received by
US1 after the acquisition when US1 was in the USB
consolidated group (the period beginning December
16, 2005, and ending December 31, 2005), as well
as to dividends received by the USB group members
during the calendar year while USB was the common
parent. As in Example 3, US1’s short taxable year
that begins on November 16, 2004 and ending on
December 31, 2004, is an eligible year. However,
US1’s taxable year beginning January 1, 2005, and
ending December 15, 2005, is not an eligible year
for US1.
Example 5. Consolidated group included in election year of different consolidated groups. (i) Facts.
Assume the same facts as in Example 1 (i), except that
a member of the USB group acquires the USP group
on November 15, 2004, and the USP group makes an
election under section 965(a) for the taxable year January 1, 2004 through November 15, 2004.
(ii) Result. Because the USP group’s election
year is January 1, 2004 through November 15, 2004,
USP’s taxable year beginning January 1, 2004, and
ending on November 15, 2004, is an election year
during which cash dividends received from the USP
group’s CFCs may be eligible for the section 965(a)
DRD. In addition, because USP is included in the
USB group during the USB group’s election year
(July 1, 2004 through June 30, 2005), cash dividends
from the USP group’s CFCs during USP’s taxable
year beginning on November 16, 2004 and ending
June 30, 2005 may be eligible for the section 965(a)
DRD of the USB group. If, in the alternative, USB
elects to apply section 965 to its taxable year ending
June 30, 2006, cash dividends from the USP consolidated group’s CFCs during USP’s taxable year beginning July 1, 2005, and ending June 30, 2006, may
be eligible for the section 965 DRD of the USB consolidated group.

SECTION 6. EFFECTS OF CERTAIN
TRANSACTIONS ON BASE PERIOD
INCLUSIONS AND MAXIMUM
AMOUNT ELIGIBLE FOR SECTION
965(a) DRD
.01 Base Period Inclusions and APB 23
Limitation as U.S. Shareholder Attributes
(a) In general. For purposes of section
965, base period inclusions and APB 23
limitation are historical amounts that are
treated as tax attributes particular to a U.S.
shareholder as of the date these amounts
are fixed under section 965(b)(1) and (2).
See section 2.01 of this notice for the definition of the term “U.S. shareholder” for
this purpose. Consequently, base period
inclusions and APB 23 limitation remain
with a particular U.S. shareholder (for example, when a U.S. shareholder ceases to
be a member of a consolidated group). See
Example 1 of section 6.01(d) of this notice. In addition, base period inclusions

2005–22 I.R.B.

and APB 23 limitation are treated in the
same manner as items described in section 381(c). Therefore, if a corporation acquires the assets of a U.S. shareholder in
a transaction described in section 381(a),
the acquiring corporation succeeds to and
takes into account the base period inclusions and APB 23 limitation of the transferor U.S. shareholder under the principles
of section 381. See Example 5 of section
6.01(d) of this notice. For exceptions to
these general rules, see section 6.01(b) and
(c) of this notice.
Because these amounts are not treated
as tax attributes particular to a CFC, they
are unaffected by a disposition of a CFC.
Thus, these rules apply even if the U.S.
shareholder no longer owns the CFC that
gave rise to the base period inclusions
or APB 23 limitation. Similarly, because
these amounts are tax attributes of the U.S.
shareholder rather than the CFC, a domestic corporation that acquires the assets of a
CFC in a transaction described in section
381(a) does not succeed to and take into
account base period inclusions and APB
23 limitation attributable to the transferor
CFC under the principles of section 381.
See Example 1 of section 6.01(d) of this
notice.
(b) Adjustments for acquisitions and
dispositions of U.S. shareholders that
are included in consolidated returns. (1)
In general. Members of a consolidated
group generally are treated as a single
U.S. shareholder for the purpose of determining the group’s base period amount
or APB 23 limitation. However, when
a member exits or enters a U.S. consolidated group, adjustments are required to
the selling5 and/or acquiring group’s base
period inclusions and APB 23 limitation
to reflect that base period inclusions and
APB 23 limitation generally remain with
a particular U.S. shareholder (that is, with
the specific member rather than with the
group itself). The selling group reduces its
base period inclusions and APB 23 limitation by the amounts that are attributable
to a departed member, and the acquiring
group correspondingly increases its base
period inclusions and APB 23 limitation to
account for the new member. For exceptions to these general rules, see paragraph

(2), below, and Examples 1, 4, 8 and 9 of
section 6.01(d) of this notice. For specific
rules addressing the determination of base
period inclusions, see section 6.01(b)(3)
of this notice.
When adjusting a consolidated group’s
base period inclusions to reflect the entry
or exit of a U.S. shareholder, the consolidated group makes the adjustment to the
specific base period inclusions (as opposed
to the base period amount) for the group
to reflect the particular base period inclusions of the acquired or disposed of U.S.
shareholder or its successor. In the same
way, the consolidated group makes an adjustment to its APB 23 limitation to reflect
the APB 23 limitation attributable to the
acquired or disposed of U.S. shareholder
or its successor.
The rules of this paragraph that apply
to dispositions or acquisitions of a member of a consolidated group also apply, as
relevant, in the context of the acquisition
of an entire consolidated group.
(2) Special adjustment rules dependent
upon timing of certain acquisitions or
dispositions of U.S. shareholders. Certain adjustments to base period inclusions
and/or APB 23 limitation provided under
paragraph (b)(1) of this section are not
made if certain transactions occur during
the selling group’s election year, or certain
transactions occur before or after a selling
group’s or acquiring group’s6 APB 23
determination date. In addition, special
rules are provided in section 6.01(c) of
this notice with respect to certain spin-off
transactions.
Specifically, under this paragraph
(b)(2), when a U.S. shareholder ceases to
be a member of a selling group during the
selling group’s election year, the selling
group’s base period inclusions and APB
23 limitation are not reduced by amounts
attributable to the departing U.S. shareholder. Nonetheless, the acquiring group
still increases its base period inclusions
and, subject to the special rules of this
paragraph (b)(2), its APB 23 limitation attributable to the acquired U.S. shareholder
under the general rules of paragraph (b)(1)
of this section. See Example 1 of section
6.01(d) of this notice. In addition, dividends received by the U.S. shareholder

from its CFCs in any other election year
may be taken into account in that year for
purposes of section 965. See also section
5 of this notice for a discussion of taxable
years to which section 965 applies.
This paragraph provides special rules
to ensure that an acquiring consolidated
group appropriately reflects an APB 23
limitation with respect to an acquired
member when: (1) that member ceases
to be a member of a selling consolidated
group before the selling group’s APB 23
determination date; and/or (2) that member joins an acquiring group before the
acquiring group’s APB 23 determination
date. Specifically, if a U.S. shareholder
joins a consolidated group before the acquiring group’s APB 23 determination
date, there is no adjustment to the acquiring group’s APB 23 limitation because the
U.S. shareholder’s membership in the new
group (and such U.S. shareholder’s ownership of CFCs at the relevant time with
permanently reinvested earnings) will be
taken into account when determining the
acquiring group’s APB 23 limitation. Under the preceding sentence, if the selling
group’s APB 23 determination date has
passed, the selling group reduces its APB
23 limitation to account for the departed
U.S. shareholder. If a U.S. shareholder
ceases to be a member of a consolidated
group before the selling group’s APB 23
determination date, there is no downward
adjustment to the selling group’s APB 23
limitation to reflect the departure because
the selling group’s APB 23 limitation will
reflect such disposition. However, if a
U.S. shareholder ceases to be a member
of a consolidated group before the selling
group’s APB 23 determination date but
after the acquiring group’s APB 23 determination date, the acquiring group’s APB
23 limitation is increased by the amount of
the selling group’s APB 23 limitation that
would be allocated to the acquired U.S.
shareholder under section 4 of this notice
if the selling group substituted “the date
of the acquisition” for “June 30, 2003” in
applying section 965(c)(1).
The rules of this paragraph that apply
to dispositions or acquisitions of a member of a consolidated group also apply, as

5 For purposes of this section 6, the term “selling group” also includes a group in which a U.S. shareholder ceases to be included as a member as a result of transactions other than sales (for
example, through the distribution of the stock of the member).
6

For purposes of section 6, the term “acquiring group” includes a consolidated group that comes into existence after the acquisition of a corporation.

2005–22 I.R.B.

1106

May 31, 2005

relevant, in the context of the acquisition
of an entire consolidated group.
(3) Determining the base period inclusions to be inherited. When an acquiring
group adjusts its base period inclusions
to take into account an acquisition of a
U.S. shareholder or consolidated group,
the acquiring group takes into account five
taxable years in the relevant base period
for any acquired shareholder or group,
assuming at least five taxable years are
available. The inclusions are aggregated
for taxable years one through five without regard to whether they are short or
full taxable years on either side. An acquired U.S. shareholder or group cannot
contribute more than five taxable years
of inclusions to the base period history of
the acquirer. The fifth taxable year in the
acquiring group’s base period is the last
potential taxable year in its base period.
If the acquired U.S. shareholder or
group joins the acquiring group after the
end of the acquiring group’s base period,
the acquired U.S. shareholder’s or acquired group’s base period inclusions in
its last five taxable years ending on or
before June 30, 2003, are aggregated with
the acquiring group’s base period inclusions in its five base period taxable years,
on a year-by-year basis.
Similarly, if an acquired U.S. shareholder or group joins the acquiring group
before the end of the acquiring group’s
base period, the acquiring group inherits
a base period inclusion history for the
acquired U.S. shareholder or group for
each of the taxable years in the acquiring
group’s base period that end on or before
the date of the acquisition. The acquired
U.S. shareholder’s or acquired group’s
taxable year ending on the date of the acquisition shall correspond to the taxable
year in the acquiring group’s base period
that ends on or before the date of the acquisition. The acquiring group then takes
into account base period inclusions from
the acquired U.S. shareholder’s or group’s
taxable years prior to the taxable year ending with the date of the acquisition to the
extent necessary to assemble a base period
inclusion history for the inherited years.
An acquired U.S. shareholder or acquired
group may contribute five taxable years
to the acquiring group’s history even if
the acquiring group did not itself exist for
its full five taxable year base period. For

May 31, 2005

illustrations of these rules, see Example 7
and Example 8 of section 6.01(d).
(c) Special rules for spin-offs. (1) In
general. Except as provided in paragraphs
(c)(2) and (3) of this section, a distribution
to which section 355 (or so much of section
356 as relates to section 355) applies is
treated in the same manner as a disposition
of the stock of the controlled corporation
(controlled) by the distributing corporation
(distributing) for purposes of section 965
and this notice. See sections 5, 6.01(a) and
(b) of this notice and Example 2 of section
6.01(d) of this notice.
(2) Spin-off of a U.S. shareholder that
occurs during the base period — allocation of base period inclusions. In the
case of a spin-off of the stock of a U.S.
shareholder to which section 355 (or so
much of section 356 that relates to section
355) applies that occurs during the base
period, and after which either distributing
or controlled is a U.S. shareholder of a
CFC (applicable base period spin-off),
any base period inclusions received by
either distributing or controlled from such
CFC are allocated as provided in section
965(c)(2)(C)(ii). For purposes of determining distributing’s and controlled’s base
period inclusions and base period amounts
under section 965(c)(2)(C)(ii), section
965(c)(2)(C)(ii)(I) treats controlled as
having been in existence for the same
period that distributing has been in existence. Further, section 965(c)(2)(C)(ii)(II)
allocates base period inclusions that are
received or includible by distributing and
controlled from a CFC prior to an applicable base period spin-off of controlled
based on the fair market values of distributing’s and controlled’s interests in
such CFC immediately after such spin-off.
However, if stock of a member of a consolidated group is distributed pursuant to
an applicable base period spin-off and, as
a result of such distribution a controlled
corporation leaves the consolidated group,
the base period inclusions of the consolidated group with respect to each of the
group’s CFCs before the applicable base
period spin-off are instead allocated between the members of the consolidated
group that remain in the distributing corporation’s group (distributing group) and
the members, if any, that leave the group
and thereafter file a consolidated return
with the controlled corporation (controlled
group) in proportion to the fair market

1107

values of the distributing group’s and the
controlled group’s respective interests in
each CFC owned by the distributing group
and the controlled group immediately after the applicable base period spin-off. The
base period inclusions allocated to the distributing group and the controlled group
are further allocated amongst the members
of such groups in proportion to the fair
market value of such members’ respective interests in each CFC immediately
after the applicable base period spin-off.
See paragraph (c)(3) for the treatment of
APB 23 limitations as a result of applicable base period spin-offs described in this
paragraph (c)(2).
Section 965(c)(2)(C)(ii)(II) does not
apply to any distribution that is not an
applicable base period spin-off, such as
a distribution that occurs after the base
period; nor does it apply to allocate inclusions from CFCs with respect to which
neither controlled nor distributing is a U.S.
shareholder at the time of the spin-off. Instead, the rules of section 6.01(c)(1) of
this notice apply to such distributions or
inclusions.
(3) Spin-off of a U.S. shareholder that
occurs during the base period — allocation of APB 23 limitation. If an applicable
base period spin-off (as defined in paragraph (c)(2) of this section) occurs with
respect to a U.S. shareholder that is not a
member of a consolidated group after the
APB 23 determination date of either distributing or controlled, the APB 23 limitation of distributing or controlled is adjusted to the extent that distributing’s or
controlled’s APB 23 limitation is attributable to the stock of a CFC that is transferred between distributing and controlled
in connection with the spin-off. Consistent with the treatment of base period inclusions, such adjustment is made by allocating the portion of any APB 23 limitation attributable to distributing or controlled with respect to the earnings of a
CFC that is transferred between distributing and controlled in proportion to the fair
market values of such corporations’ respective interests as U.S. shareholders of
such CFC immediately after the spin-off.
If a spin-off occurs before the APB 23 determination dates of both distributing and
controlled, the general rules of section 4
apply. See Example 3 of section 6.01(d)
of this notice.

2005–22 I.R.B.

If the stock of a member of a consolidated group is distributed pursuant to an
applicable base period spin-off and, as a result of such distribution a controlled corporation leaves the consolidated group and,
the spin-off occurs after the APB 23 determination date of the consolidated group,
the APB 23 limitation that is attributable
to each CFC owned by the consolidated
group before the applicable base period
spin-off is, instead, allocated between the
distributing group and the controlled group
in proportion to the fair market values of
the distributing group’s and the controlled
group’s respective interests in each CFC
owned by the distributing group and the
controlled group immediately after the applicable base period spin-off. The APB
23 limitation allocated to the distributing
group and the controlled group is further
allocated between and among the members
of such groups in proportion to the fair
market values of such members’ respective interests in each CFC immediately after the applicable base period spin-off.
(d) Examples. The following examples illustrate the application of section
965(b)(1) and (2) and this section 6.01.
Unless otherwise indicated, the following
facts are assumed for purposes of these
examples. All corporations and consolidated groups maintain calendar taxable
years and were in existence prior to 1997.
USP is a domestic corporation and the
common parent of the USP consolidated
group. USP wholly owns US1 and US2.
US1 and US2 are U.S. shareholders and
members of the USP consolidated group.
US1 and US2 each wholly owns a foreign corporation, CFC1 and CFC2, respectively. USP elects to apply section 965 to
its 2005 taxable year. USB is a domestic
corporation and the common parent of the
USB consolidated group, which is a consolidated group prior to any transactions
described below. All domestic corporations acquired by the USB group that are
eligible to do so elect to join in filling a
consolidated return with the USB group.
USB elects to apply section 965 for its
2005 taxable year. No elections are made
under section 338 with respect to stock
purchases.
Example 1. Sale of U.S. shareholder by consolidated group. (i) Facts. On December 31, 2003, USP
sells the stock of US1 to an unrelated foreign person,
FP. US1 files a separate return for the taxable years
following such sale. On October 25, 2004, US2 sells
CFC2 to USB for cash.

2005–22 I.R.B.

(ii) Result. On January 1, 2004, US1 is no longer
a member of the USP consolidated group as a result of the sale of the US1 stock to FP. Accordingly,
the USP group reduces its base period inclusions and
APB 23 limitation attributable to US1. In addition,
because US1 files a separate return after it ceases to
be a member of the USP consolidated group, it takes
into account its individual base period inclusions and
APB 23 limitation. In contrast, US2’s sale of CFC2
does not affect US2’s base period inclusion history
or APB 23 limitation, because base period inclusions
and APB 23 limitation are not tax attributes of CFCs.
Consequently, the USP group does not reduce its base
period inclusions or APB 23 limitation as a result of
the sale of CFC2. Similarly, USB does not make any
adjustment to its base period inclusions or APB 23
limitation as a result of the acquisition of CFC2.
(iii) Alternative Facts. Assume the same facts as
above, except that USP sells the stock of US1 to FP
on February 15, 2005. On February 16, 2005, US1 is
no longer a member of the USP consolidated group as
a result of the sale of the US1 stock to FP. Because the
transaction occurs within the USP election year, the
USP group does not reduce its base period inclusions
and APB 23 limitation attributable to US1. Further,
US1 still takes into account its individual base period inclusions and APB 23 limitation should it make
an election with respect to section 965(a) in its short
taxable year following the acquisition (February 16,
2005 through December 31, 2005). The result with
respect to USB is not changed under the alternative
facts.
Example 2. Spin-off of U.S. shareholder by consolidated group. (i) Facts. The facts are the same as
in Example 1, except that instead of USP selling the
stock of US1, it distributes such stock in a distribution
to which section 355 applies. US1 files a separate return for the taxable years following the distribution.
(ii) Result. The result is the same as that in Example 1. The special rules under section 965(c)(2)(C)(ii)
and section 6.01(c)(2) of this notice do not apply because the distribution did not occur during USP’s
base period (which ended December 31, 2002).
Example 3. Section 368(a)(1)(D) reorganization/section 355 distribution. (i) Facts. USP owns
CFC3. USP has base period inclusions and APB
23 limitation attributable to CFC3. On December 31, 2002, USP transfers the stock of CFC3 to
controlled, a newly formed domestic corporation
wholly-owned by USP, in a transaction to which section 368(a)(1)(D) applies, and immediately thereafter
distributes the stock of controlled in a distribution to
which section 355 applies.
(ii) Result. The distribution occurs during the
USP group’s base period and, therefore, the special rules under section 965(c)(2)(C)(ii) and section
6.01(c)(2) and (3) of this notice apply. As a result,
USP’s base period inclusions and APB 23 limitation that are attributable to CFC3 are allocated
as provided in section 965(c)(2)(C)(ii) and section
6.01(c)(2) and (3) of this notice. Therefore, all of
the base period inclusions and APB 23 limitation of
USP attributable to CFC3 are allocated to controlled
because controlled owns all the CFC3 stock immediately after the section 355 distribution.
(iii) Alternative facts. The facts are the same
as in Example 3, except that the transaction occurs
on December 31, 2003. Because the distribution
does not occur during USP’s base period, section

1108

965(c)(2)(C)(ii) and section 6.01(c)(2) and (3) of
this notice do not apply. Instead, the general rules
of section 6.01(c)(1) of this notice apply. Therefore,
none of the base period inclusions, and no portion
of the APB 23 limitation, attributable to CFC3 are
allocated to controlled; such amounts remain with
USP.
Example 4. Internal spin-off of CFC followed by
applicable base period spin-off. (i) Facts. US1 has
base period inclusions with respect to CFC1. On June
30, 2002, US1 distributes the stock of CFC1 to USP
in a transaction to which section 355 applies (first
spin-off). On December 31, 2002, USP transfers the
stock of CFC1 to controlled, a newly formed domestic corporation wholly owned by USP, in a transaction
to which section 368(a)(1)(D) applies, and immediately thereafter distributes the stock of controlled in
a distribution to which section 355 applies (second
spin-off).
(ii) Result. The first and second spin-offs occur during the USP group’s base period. Section
965(c)(2)(C)(ii)(II) does not apply to the first spin-off
because CFC1 is not a United States shareholder. As
a result US1’s base period inclusions attributable to
CFC1 are not allocated between US1 and USP in accordance with US1’s and USP’s proportional ownership of CFC1 after the first spin-off. However, in
the second spin-off controlled is distributed out of
USP’s consolidated group. Accordingly, the USP
group’s base period inclusions with respect to each
of its CFCs before the spin-off of controlled are allocated between the USP group and controlled (or controlled’s group if controlled’s affiliated group files a
consolidated return) in proportion to the USP group’s
and controlled’s (or the controlled group’s) interests
in each CFC owned by the USP group and controlled
(or the controlled group) immediately after the second spin-off.
Example 5. Merger of a U.S. shareholder and
other transactions. (i) Facts. On January 3, 2003,
US1 sells its stock in CFC1 to USB for cash. On
December 31, 2003, in an unrelated transaction US1
merges into US2. The merger of US1 into US2 is a reorganization under section 368(a)(1)(A). On December 31, 2004, in a transaction unrelated to the merger
of US1 into US2, USP sells the shares of US2 to USB
for cash. The APB 23 determination date for the USP
and USB groups is December 31, 2002.
(ii) Result. The sale of CFC1 stock to USB has
no effect on the USP group’s base period inclusions
and APB 23 limitation. The merger of US1 into US2
on December 31, 2003, is a transaction described in
section 381(a), and US2 therefore succeeds to and
takes into account US1’s base period inclusions and
APB 23 limitation.
Because US2 ceases to be a member of the USP
consolidated group as a result of the sale of its stock
to USB, the USP group reduces its base period inclusions and APB 23 limitation attributable to US2,
including those amounts US2 succeeds to and takes
into account as a result of the merger. Further, because US2 becomes a member of the USB consolidated group on January 1, 2005, USB’s base period
inclusions and APB 23 limitation are increased by the
same amounts by which USP’s base period inclusions
and APB 23 limitation amount were decreased.
(iii) Alternative facts. The facts are the same as
Example 5 (i), except that instead of USP selling the
shares of US2 to USB, US2 sells its assets to USB in

May 31, 2005

exchange for cash (and the assumption of any liabilities of US2) and distributes the cash proceeds to USP
pursuant to a liquidation described in section 332.
Under the alternative facts, the result is the same
as Example 5 (ii), except as follows. USP does not
make any adjustments to its base period inclusions
or APB 23 limitation as a result of the sale of US2’s
assets to USB because the transaction with USB is
not described in section 381(a) (this may not be the
case, however, if the assets sold by US2 to USB include stock of a U.S. shareholder that is a member
of the USP consolidated group). Further, USP continues to take into account the base period inclusions
and APB 23 limitation attributable to US2 after the
liquidation of US2 because the liquidation into USP
is a transaction described in section 381(a). In addition, the USB consolidated group does not take into
account the base period inclusions and APB 23 limitation attributable to US2, because US2 does not become a member of the USB consolidated group (nor
does the USB consolidated group acquire the assets
of US2 pursuant to a transaction described in section
381(a)).
(iv) Alternative facts. The facts are the same as
Example 5 (i), except that USP and USB make an
election pursuant to section 338(h)(10) with respect
to the sale of the stock of US2. The result under the
alternative facts in this paragraph (iv) is the same as
under the alternative facts of paragraph (iii) of this
Example 5. This is the case regardless of whether an
election under section 338 is made with respect to the
CFC2 stock owned by US2.
Example 6. Acquisition of U.S. shareholder consolidated group. (i) Facts. USB acquires all the stock
of USP on January 3, 2003, a date subsequent to the
APB 23 determination dates for both the USP and
USB groups. As a result of the acquisition, the USP
group terminates and all the members of the USP
group become members of USB consolidated group.
(ii) Result. USB’s acquisition of all the stock of
USP causes the USP consolidated group to cease to
exist as of the end of January 3, 2003, a date after
the end of the base periods of both the USP and USB
groups. The USP group’s base period inclusions for

each of the five taxable years in its base period is
added to the USB group’s base period inclusions for
each corresponding taxable year in its base period
to determine the USB group’s base period amount.
In addition, because the acquisition occurs after the
APB 23 determination dates of both the USB and
USP groups, the USB group’s APB 23 limitation is
increased by the USP group’s APB 23 limitation.
Example 7. Taking into account base period inclusions of acquired U.S. shareholder transferred after the end of the acquirer’s base period. (i) Facts.
The USB consolidated group uses a taxable year ending March 31. The USB group elects to apply section
965 to its taxable year that begins on April 1, 2005
and ends on March 31, 2006. On May 31, 2005, USB
acquires from USP 100% of the stock of US1 for cash.
(ii) Result. The acquisition of US1 occurs during
the section 965 election year of the USP group and
the section 965 election year of the USB group.
Therefore, the special rules set forth in section
6.01(b)(2) apply. Under those rules, the USB consolidated group takes into account the base period
inclusions of US1 for purposes of determining its
base period amount under section 965(b)(2). Because
US1 ceases to be a member of the USP consolidated
group during the election year of such group, the
USP consolidated group will also take into account
the base period inclusions of US1 for purposes of
determining its base period amount under section
965(b)(2). Accordingly, there is no corresponding
decrease by the selling group for the increase by the
buying group of base period inclusions and APB 23
amounts as a result of the transaction.
The USB consolidated group’s base period includes the five taxable years ending on or before June
30, 2003 (that is, taxable years ending March 31,
1999 through March 31, 2003). Similarly, the base
period of US1 and USP includes the five taxable years
ending on or before June 30, 2003 (that is, the taxable
years ending December 31, 1998 through December
31, 2002).
To determine the USB group’s base period
amount, US1’s base period inclusions for each taxable year in its base period are added to the base

US1 base period
year-ends

USB group base period
year-ends

3/31/03
3/31/02
2/15/02
12/31/01
12/31/00
12/31/99
12/31/98
US1’s taxable years ending on December 31,
1999, and December 31, 1998, correspond to taxable
years of the USB group that precede the USB group’s
base period. Accordingly, the USB group does not
take into account the base period inclusions of US1
in those years. Nevertheless, the USP group will
reduce its base period inclusions attributable to US1
for these taxable years.
US1’s base period inclusions after February 15,
2002, are naturally taken into account by the USB
group in determining its base period inclusions because such inclusions will occur during the time that

May 31, 2005

period inclusions for each corresponding taxable
year in the USB group’s base period. Thus, US1’s
base period inclusions for its taxable year ending
December 31, 2002 are added to the base period
inclusions for the USB group’s year ended March
31, 2003, and US1’s base period inclusions for the
other four years in its base period are added to the
USB group base period inclusions for the other four
corresponding years in the USB group’s base period.
Because the acquisition of US1 occurs during the
election years of both the USP group and the USB
group, both groups will also take into account the
APB 23 limitation attributable to US1.
Example 8. Taking into account base period inclusions of acquired U.S. shareholder transferred before the end of the acquirer’s base period. (i) Facts.
The facts are the same as Example 7, except as follows. USB acquired US1 on February 15, 2002, a
date prior to the APB 23 determination dates of both
USP and USB. The USB group’s base period includes
the five taxable years ending March 31, 1999, through
March 31, 2003. As a result of its acquisition, the
base period of US1 includes its five taxable years that
end on the following dates: February 15, 2002; December 31, 2001; December 31, 2000; December 31,
1999; and December 31, 1998.
(ii) Result. To determine the USB group’s base
period amount, US1’s base period inclusions for each
taxable year in US1’s base period are added to the
USB group’s base period inclusions for each corresponding taxable year in the USB group’s base period. US1’s short taxable year ending February 15,
2002, corresponds to the last taxable year in the acquirer’s base period that ends on or before the date
of the acquisition (that is, the USB group’s taxable
year that ends March 31, 2001). The USB group also
succeeds to that portion of US1’s base period inclusion history for US1’s taxable years that precede the
short taxable year ending on February 15, 2002, that
correspond to the USB group taxable years in its base
period.
The corresponding taxable years in the respective
base periods may be illustrated as follows:

3/31/03
3/31/02
3/31/01
3/31/00
3/31/99

US1 is a part of the USB consolidated group. That is,
US1 base period inclusions for its taxable year that
ends March 31, 2002, and March 31, 2003, are taken
into account in determining the USB group’s inclusions for such taxable years.
US1 ceased being a member of the USP consolidated group and joined the USB consolidated group
before the APB 23 determination dates of both the
USP and USB consolidated groups. As a result, no
adjustment is made to the APB 23 amount of the USP
or USB consolidated groups as a result of the sale of

1109

US1 stock as provided in section 6.01(a)(2) of this
notice.
(iii) Alternative facts. The facts are the same as
in Example 8, except that the USB group’s first taxable year begins on April 1, 2000. The results are
unchanged.
Example 9. Acquisition of U.S. shareholder stock
before Acquirer’s but after Seller’s APB 23 determination date. (i) Facts. The USP group’s applicable
financial statement provides for an APB 23 limitation of $700 million. The limitation is comprised of,
as of the APB 23 determination date (December 31,

2005–22 I.R.B.

2002), earnings permanently reinvested in CFC1 of
$400 million and in CFC2 of $300 million. The $400
million of CFC1 earnings is attributable to US1, and
the $300 million of CFC2 earnings is attributable to
US2. USB maintains a taxable year ending January
31. On January 3, 2003, USP sells to USB 81% of
US1’s outstanding stock and 60% of the outstanding
stock of US2. The USB group’s APB determination
date is January 31, 2003.
(ii) Result. By reason of the transactions, US1
and US2 cease to be members of the USP consolidated group on January 3, 2003, a date that is after
the USP group’s APB 23 determination date. Therefore, the USP consolidated group reduces its APB 23
limitation by $700 million because US1 and US2 are
no longer members of the USP consolidated group.
Similarly, the USP group reduces its base period inclusions to the extent they are attributable to US1 and
US2. Further, the acquisition of US1 and US2 occurred prior to USB’s APB 23 determination date.
Therefore, the USB group does not increase its APB
23 limitation with respect to the transactions because
the USB group will take into account permanently
reinvested earnings of US1 and US2 for financial accounting purposes on its APB 23 determination date.
Finally, USB inherits the relevant base period inclusion history of US1 because US1 joins the USB consolidated group. After the transaction, US2 is not a
member of a consolidated group and therefore will
file a separate return for subsequent taxable years. If
US2 elects to apply section 965 in an eligible year, it
will take into account its base period inclusion history
and its APB 23 limitation.
(iii) Alternative facts. The facts are the same as in
Example 9 (i), except that US1 and US2 are sold on
February 1, 2003. The USB group’s reported APB
23 limitation is increased by $400 million as a result
of USB’s purchase of 81% of the shares of US1 because US1 joins the USB consolidated group after the
USB group’s APB 23 determination date; it is not increased by the $300 million attributable to US2 because US2 does not join the USB consolidated group.
The base period inclusion results are unchanged.

.02 Allocated Portion of $500 Million
Limitation
Pursuant to section 4.05 of this notice,
the $500 million limitation described in
section 965(b)(1)(A) is allocated among
qualified members of a section 52(a) group
on a single date, the apportionment date (as
defined in section 4.05 of this notice), and
only amongst the qualified members of the
group on such date. A corporation or consolidated group is not allocated any of the
$500 million limitation and it has a $0 limitation for an election year during which the
corporation or consolidated group was a
qualified member of a section 52(a) group
if, on or after the end of its election year but
before the section 52(a) group’s apportionment date (or, if none, the date that would
have been the apportionment date had the
transaction not occurred), the corporation

2005–22 I.R.B.

or consolidated group becomes unrelated
to the other qualified members of the section 52(a) group or ceases to exist.
Once an allocation occurs on an apportionment date, the allocated limit applies
to a corporation or consolidated group that
is a qualified member of the section 52(a)
group for its election years ending while it
is a qualified member of such group, including those years that end before the apportionment date. However, if a corporation or consolidated group becomes unrelated to the other qualified members of a
section 52(a) group before the end of an
election year of such corporation or consolidated group, the corporation or group
is entitled to its own $500 million limitation, unless it becomes part of a different section 52(a) group on or before that
group’s apportionment date. If it becomes
part of a different section 52(a) group on
or before that group’s apportionment date,
it may be allocated a portion of that section 52(a) group’s $500 million limitation.
Accordingly, if a corporation or consolidated group is no longer a qualified member of a section 52(a) group, the former
member does not retain any of the section
52(a) group’s $500 million limitation after
it leaves such group.
The following examples illustrate the
application of section 965(b)(1) and this
section 6.02. Unless otherwise indicated,
it is assumed in each example that all U.S.
shareholders have APB 23 limitations of
zero.
Example 1. Disposition of a member which joins
an unrelated consolidated group. (i) Facts. A, an
individual, wholly owns two domestic corporations,
US1 and US2. US1 and US2 in turn each wholly
own a foreign corporation, CFC1 and CFC2, respectively. US1 and US2 maintain the calendar year as
their taxable year.
On September 30, 2005, A sells US1 to
USB. USB is an unrelated domestic corporation
and the common parent of a consolidated group that
maintains a June 30 taxable year.
US1 elects section 965 for its taxable year ending
September 30, 2005. US2 elects section 965 for its
taxable year ending December 31, 2005. The USB
group elects section 965 for its taxable year ending
June 30, 2006.
(ii) Result. US2 is entitled to a full $500 million
limitation for its election year ending December 31,
2005, because it is not a member of a section 52(a)
group on December 31, 2005. US1 has a limitation
of $0 for its election year ending September 30, 2005,
because US1 and US2 would have been members of
a section 52(a) group on an apportionment date, December 31, 2005, but for the disposition of US1 on
or after the end of US1’s election year but before December 31, 2005. The apportioned limitation does

1110

not apply to US1’s second election year as a member
of the USB group. The USB group has its own $500
million limitation, which is not adjusted upward as a
result of the acquisition of US1.
Example 2. Disposition of a member which
does not join an unrelated consolidated group. (i)
Facts. The facts are the same as in Example 1 except
that the buyer of US1 is B, an individual unrelated to
A. As in Example 1, US1 elects section 965 for its
taxable year, which however ends on December 31,
2005.
(ii) Result. On December 31, 2005, there is no
section 52(a) group, and the election year of neither
corporation ended before that date. Therefore, US1
and US2 each has its own $500 million limitation.
Example 3.
Merger into unrelated corporation. (i) Facts. The facts are the same as in Example
1 except that instead of the stock of US1 being sold,
US1 merges into USB in a reorganization described
in section 368(a)(1)(A).
(ii) Result. The result is the same as in Example
1.
Example 4. Merger into related corporation. (i)
Facts. The facts are the same as in Example 3 except that US1 merges into US2 in a reorganization
described in section 368(a)(1)(A).
(ii) Result. US2 is entitled to a full $500 million
limitation for its election year ending December 31,
2005, because it is not a member of a section 52(a)
group on December 31, 2005. US1 has a limitation
of $0 for its election year ending September 30, 2005,
because US1 and US2 would have been members of a
section 52(a) group on their apportionment date, December 31, 2005, but for the merger of US1 which
results in the end of US1’s election year before December 31, 2005.
Example 5.
Spin-off resulting in unrelated
corporation. (i) Facts. USP is a publicly held corporation and the parent of a consolidated group. C
and US1 are wholly owned domestic subsidiaries
of USP. US1 cannot be included in the USP consolidated group by virtue of section 1504(a)(3) (relating
to the five-year period required to elapse before
reconsolidation). The USP group and US1 each
maintain the calendar year as their taxable years and
USP, C, and US1 are each U.S. shareholders of CFCs.
On September 30, 2005, USP distributes the stock
of C to its shareholders. Thereafter, USP and C are
not members of the same section 52(a) group.
The USP group and US1 each elect section 965
for their taxable years ending December 31, 2005. C
also elects section 965 for its short taxable year starting on October 1, 2005, and ending on December 31,
2005.
(ii) Result. December 31, 2005, is the apportionment date for the section 52(a) group that consists of
the USP group and US1, and the $500 million limitation is allocated between the USP group and US1
on that date. None of the limitation is allocated to C
separately for its short taxable year ending September
30, 2005 (its limitation is $0), but the apportionment
does not apply to C’s second election year, the short
taxable year ending December 31, 2005. C has its
own $500 million limitation for that second election
year.
Example 6. Spin-off resulting in related corporation. (i) Facts. The facts are the same as in Example
5 except that all the stock of USP is owned by A, an
individual, and A acquires all the stock of C in the

May 31, 2005

distribution. As a result, USP and C remain members
of a single section 52(a) group after the distribution.
(ii) Result. December 31, 2005, is the apportionment date for the section 52(a) group that consists of
the USP group, US1, and C, and the $500 million limitation is allocated between the USP group, US1, and
C on that date. C’s allocation applies to its second
election year, the short taxable year ending December 31, 2005. During the time that C is a member of
the USP group, it is not separately allocated any of the
$500 million limitation of the section 52(a) group.
Example 7. Interaction of APB 23 limitation and
$500 million limitation. (i) Facts. The facts are the
same as in Example 1, except that US1 has an APB
23 limitation of $300 million, and USB has an APB
23 limitation of $400 million.
(ii) Result. The result is the same as in Example
1 with respect to the $500 million limitation. The
maximum repatriations allowed under section 965 for
US1 in its election year ending September 30, 2005,
is the greater of its allocated portion of the $500 million limitation or its APB 23 limitation. US1’s APB
23 limitation of $300 million exceeds its portion of
the $500 million, which is $0. Thus, US1’s maximum amount under section 965(b)(1) is $300 million. As in Example 1, the USB group’s $500 million
limitation is not adjusted as a result of USB’s acquisition of US1. However, the USB group’s APB 23
limitation is adjusted upward to reflect the $300 million APB 23 limitation attributable to US1. Because
the maximum repatriations allowed under section 965
for the USB group is the greater of $500 million or
APB 23 limitation, the USB group’s APB 23 limitation exceeds $500 million as a result of the acquisition. Thus, USB’s maximum amount under section
965(b)(1) is $700 million ($400 million + $300 million).

SECTION 7. REDUCTION OF
BENEFIT FOR INCREASES IN
RELATED PARTY INDEBTEDNESS
.01 Background
(a) General. Section 965(b)(3) provides that a U.S. shareholder reduces the
amount of dividends otherwise eligible for
the deduction under section 965(a) by any
increase in the indebtedness of its CFC to
any related person (as defined in section
954(d)(3)) between October 3, 2004, and
the close of the taxable year for which the
election under section 965 is in effect. For
purposes of section 965(b)(3), all CFCs
with respect to which the taxpayer is a U.S.
shareholder are treated as a single CFC.
(b) Definitions. For purposes of section
965(b)(3) and this section 7, the following
definitions apply:
(i) The term “CFC” means all CFCs
with respect to which the taxpayer is a U.S.
shareholder, treating such CFCs as a single
CFC pursuant to section 965(b)(3).

May 31, 2005

(ii) The term “individual CFC” is used
to refer to a single CFC (for example, to
identify a single CFC that is acquired or
disposed of by a consolidated group U.S.
shareholder).
(iii) The term “U.S. shareholder” as
used in this section 7 is defined in section
951(b).
(iv) The term “related person” means a
person that is related to a CFC within the
meaning of section 954(d)(3).
(v) The term “related party indebtedness” means the amount of indebtedness
of a CFC to a related person. However,
indebtedness between individual CFCs of
a U.S. shareholder is disregarded for purposes of section 965(b)(3).
(vi) The term “initial measurement
date” means the close of October 3, 2004
or, if the U.S. shareholder so chooses, an
alternative date which is provided as a
matter of administrative convenience for
taxpayers and the IRS. The alternative date
is either: (i) the close of September 30,
2004, if such shareholder used a calendar
year or a fiscal year as its taxable year; or
(2) the close of the last day of such shareholder’s fiscal-year month ending nearest
October 3, 2004, if such shareholder used
a 52–53 week taxable year. However, the
U.S. shareholder uses the same date as its
initial measurement date for all purposes
of section 965.
(vii) The term “last measurement date”
means the close of a U.S. shareholder’s
taxable year for which an election is in
effect.
.02 Definition of Indebtedness
(a) In general. Except as provided
in this section, for purposes of section
965(b)(3), “indebtedness” is defined under general Federal income tax principles.
Further, the amount of indebtedness of
a CFC to any related person pursuant to
section 965(b)(3) is not reduced or otherwise offset by indebtedness of any related
person to the CFC. Thus, for example,
if on the initial measurement date or the
last measurement date, there is $100x of
indebtedness of a CFC to its U.S. shareholder, and $10x of indebtedness from
such U.S. shareholder to the CFC, the
amount of indebtedness under section
965(b)(3)(A) as of such date is $100x (and
not $90x).

1111

For purposes of section 965(b)(3), indebtedness of a CFC to a foreign disregarded entity that is owned for Federal tax
purposes by a related person is treated as
related party indebtedness. Thus, for example, if on the initial measurement date
there is $100x of indebtedness from a CFC
to a foreign disregarded entity owned by a
U.S. shareholder, which is a related person
to the CFC, such amount is indebtedness
described in section 965(b)(3)(B).
(b) Exception for Intercompany Trade
Payables.
For purposes of section
965(b)(3), the term “indebtedness” does
not include indebtedness arising in the
ordinary course of a business from sales,
leases, or the rendition of services provided to or for a CFC by a related person,
provided that such indebtedness is actually
paid within 183 days.
.03 Determination of Related Party
Indebtedness
A U.S. shareholder considers the indebtedness of its CFC to related persons
only if the U.S. shareholder is a related
person with respect to such CFC. For
purposes of determining the related party
indebtedness of a CFC pursuant to section 965(b)(3), the relationship between
the CFC, its creditors, and any of its U.S.
shareholders is determined independently
on the initial measurement date and the
last measurement date, respectively. For
example, if on such date the creditor of the
CFC is a related person and a U.S. shareholder is a related person with respect to
such CFC, the U.S. shareholder has an
amount of indebtedness that is considered
under section 965(b)(3) and the rules of
this section.
.04 Amount of Reduction under Section
965(b)(3)
(a) In General. Pursuant to section
965(b)(3) and the rules of this section, a
U.S. shareholder reduces the amount of
cash dividends that would otherwise be
taken into account under section 965(a)
by the excess (if any) of its last measurement date RPI (as determined under section 7.05(b)) over its initial measurement
date RPI (as determined under sections
7.05(a) and 7.05(c)). If two or more U.S.
shareholders may otherwise be considered
to have an amount that is considered under

2005–22 I.R.B.

section 965(b)(3) attributable to the same
CFC indebtedness, such shareholders take
into account such indebtedness under the
rules of 7.06 of this section.
(b) Indirect Financing of Cash Dividend by a U.S. Shareholder. Section
965(b)(3) is intended to prevent a U.S.
shareholder from directly or indirectly financing a cash dividend qualifying under
section 965(a). In addition to the application of the related party indebtedness rule
under section 965(b)(3), general tax law
principles such as the substance-over-form
doctrine and circular cash-flow principles
may apply to various financing structures.
However, a related party guarantee of
CFC indebtedness is not considered to be
an indirect financing of a cash dividend for
purposes of section 965(b)(3), provided
that the CFC is treated as the obligor on
the indebtedness for Federal income tax
purposes. See Plantation Patterns, Inc.
v. Comm’r, 462 F.2d 712 (5th Cir. 1972),
cert. denied, 409 U.S. 1076 (1972).
.05 Amount of Related Party Indebtedness
on the Initial Measurement Date and the
Last Measurement Date
(a) Initial Measurement Date RPI —
General Rule. A U.S. shareholder determines the amount of the related party indebtedness of its CFC on the initial measurement date and such amount is the “initial measurement date RPI” of such U.S.
shareholder. The amount of the initial
measurement date RPI is adjusted pursuant
to section 7.05(c) of this notice in certain
instances. See Example 1 of section 7.08
of this notice.
(b) Last Measurement Date RPI —
General Rule. A U.S. shareholder determines the amount of the related party
indebtedness of its CFC on the last measurement date and such amount is the
“last measurement date RPI” of such U.S.
shareholder. Thus, to the extent that a
CFC pays all or a portion of the principal
on the related party indebtedness before
the last measurement date and does not
incur any new related party indebtedness
before such date, the U.S. shareholder’s
last measurement date RPI will be less
than its initial measurement date RPI. See
Examples 4 and 6 of section 7.08 of this
notice.
(c) Special Adjustments to Initial Measurement Date RPI. A U.S. shareholder

2005–22 I.R.B.

reduces its initial measurement date RPI
to the extent the U.S. shareholder’s initial measurement date RPI is attributable to
any individual CFC with respect to which
such shareholder ceases to be a U.S. shareholder or a related person as the result of
a transaction before the last measurement
date. However, the prior sentence does not
apply to the extent, before or as a result
of such transaction, all or a portion of the
principal on the indebtedness is paid by the
debtor (for example, as a result of the liquidation of an individual CFC).
A domestic corporation that becomes a
U.S. shareholder and a related person with
respect to an individual CFC after such
corporation’s initial measurement date, but
before the last day of its election year (or
a U.S. shareholder that files a separate return for its short taxable year immediately
after a transaction during the same period),
and that remains a U.S. shareholder and a
related person with respect to such individual CFC on its last measurement date,
increases its initial measurement date RPI
by the amount of related party indebtedness of such individual CFC immediately
after the transaction, excluding any indebtedness arising in connection with or as a
result of the transaction (for example, as
a result of the incorporation of a branch).
See Examples 3, 4, and 10 of section 7.08
of this notice.
If two or more U.S. shareholders may
otherwise be considered to have an amount
that is considered under section 965(b)(3)
attributable to the same CFC indebtedness,
such shareholders take into account such
indebtedness under the rules of section
7.06 of this notice.
.06 Related Party Indebtedness —
Multiple U.S. Shareholders
An increase in a CFC’s related party
indebtedness may not reduce the total
amount of dividends otherwise eligible for
the section 965(a) DRD on anything but
a dollar-for-dollar basis. Consequently,
if more than one U.S. shareholder is a
related person with respect to a CFC, then
the effect of the increase in the related
party indebtedness of the CFC pursuant to
section 965(b)(3) is allocated among and
between such U.S. shareholders. For this
purpose, such increase is allocated on a
dollar-for-dollar basis to cash dividends
received by such U.S. shareholders that are

1112

otherwise eligible for the section 965(a)
DRD in the order that those dividends are
received. If such dividends are received
by more than one U.S. shareholder on the
same day, each U.S. shareholder takes
into account the remaining amount of the
increase in related party indebtedness of
such CFC based on the relative amount of
cash dividends received on such day. The
overall reduction in dividends of all U.S.
shareholders eligible for the section 965(a)
DRD under this rule may not exceed the
total increase in related party indebtedness
under section 965(b)(3). See Examples 8
and 9 of section 7.08 of this notice.
.07 Translation of Foreign
Currency-Denominated Related Party
Indebtedness
The initial measurement date RPI and
the last measurement date RPI of a U.S.
shareholder is determined in U.S. dollars.
The amount of any indebtedness on both
the initial measurement date and the last
measurement date is translated into U.S.
dollars using the spot rate (as defined in
Treas. Reg. §1.988–1(d)(1)) on the initial
measurement date. See Example 7 of section 7.08 of this notice.
.08 Examples
The following examples illustrate the
application of section 965(b)(3) and this
section 7. Unless otherwise indicated, the
following facts are assumed for purposes
of these examples. USP, a domestic corporation and the common parent of the
USP consolidated group that uses the calendar year as its taxable year, wholly owns
US1. US1 is a domestic corporation and
a member of the USP consolidated group.
US1 wholly owns CFC1, a foreign corporation that owes US1 $100x at the close of
September 30, 2004, evidenced by a note
($100x note). USP wholly owns CFC2,
a foreign corporation with no indebtedness owed to persons described in section 954(d)(3). The USP group chooses
September 30, 2004, as its initial measurement date and it elects to apply section 965
to its 2005 calendar year tax year.
Example 1. Determination of the amount of initial
measurement date RPI. (i) Facts. The general facts
apply.
(ii) Result. US1 and USP are each U.S. shareholders with respect to CFC1 and CFC2 and are considered one U.S. shareholder for purposes of section
965(b)(3). Further, CFC1 and CFC2 are considered

May 31, 2005

one CFC for purposes of section 965(b)(3). The USP
group’s CFC (CFC1 and CFC2) has indebtedness of
$100x owed to the USP group (and directly to US1 as
a member of that group), a related party. Therefore,
the USP group has initial measurement date RPI of
$100x.
Example 2. Determination of initial and last measurement date RPI when CFC transferred or sold. (i)
Facts. On December 31, 2004, US1 sells all the stock
of CFC1 and the $100x note to USB, an unrelated
U.S. corporation that is the common parent of a consolidated group. Immediately after the transaction,
CFC1 owes $100x to USB. USB makes an election
under section 965 for its calendar year ending December 31, 2005. As of USB’s last measurement date, it
is a U.S. shareholder and related person with respect
to CFC1.
(ii) Result. Under section 965(b)(3) all CFCs of a
U.S. shareholder are treated as one CFC. Moreover,
for purposes of section 965(b)(3), all U.S. shareholders that are members of a consolidated group are considered one U.S. shareholder. Therefore, CFC1 and
CFC2 are considered one CFC and US1 and USP
are considered one U.S. shareholder (the USP group).
Only the relationship between CFC1, CFC2 and the
USP group is taken into account for purposes of determining the initial measurement date RPI of the USP
group, while only the relationship between CFC1 and
USB is taken into account for purposes of determining the last measurement date RPI of the USB group.
As of the initial measurement date the USP
group’s CFC (CFC1 and CFC2) owes $100x to
related parties. Therefore, under section 7.05(a),
and without regard to the disposition of CFC1, the
USP group’s initial measurement date RPI is $100x.
Under section 7.05(c), however, the USP group
reduces its initial measurement date RPI to account
for the disposition of CFC1. Therefore, the USP
group’s initial measurement date RPI is $0. As of
the last measurement date, CFC1 is not related to
the USP group. Accordingly, the USP group’s last
measurement date RPI is $0.
With respect to the USB group, CFC1 is not related to the USB group on the USB group’s initial
measurement date. Therefore, the USB group’s initial measurement date RPI, without consideration of
the acquisition of CFC1 is $0. Under section 7.05(c),
however, the USB group increases its initial measurement date RPI by $100x, the amount of the CFC1’s
related party indebtedness immediately after the acquisition. Therefore, the USB group has initial measurement date RPI of $100x. Further, as of its last
measurement date, CFC1 owes USB, a related party,
$100x. Therefore, the USB group’s last measurement
date RPI is $100x.
(iii) Alternative facts. The facts are the same as
in (i), except that USB does not purchase the $100x
note due from CFC1. Under section 7.05(c), the USP
group reduces its initial measurement date RPI from
$100x to $0, to account for the disposition of CFC1
(the same result reached in (ii)). Under section 7.05,
the USP group’s last measurement date RPI is $0 (the
same result reached in (ii)). Under the alternative
facts, however, the USB group does not adjust its initial measurement date RPI to take into account the
acquisition of CFC1 because immediately after the
acquisition CFC1 will owe an indebtedness to US1,
which is not a related person. As a result, the USB
group has an initial measurement date RPI of $0. Fur-

May 31, 2005

ther, the USB group has a last measurement date RPI
of $0.
(iv) Alternative facts. The facts are the same as in
(i) except that CFC1 liquidates (whether by reason of
an actual liquidation or by reason of an election under Treas. Reg. §301.7701–3) into US1 instead of
being sold to USB. Under section 7.05(c), the USP
group does not decrease its initial measurement date
RPI to account for the liquidation. Consequently, the
USP group’s initial measurement date RPI is $100x.
Under section 7.05(b), the USP group’s last measurement date RPI is $0.
Example 3. Determination of initial and last measurement date RPI when a U.S. shareholder is transferred to an unrelated person. (i) Facts. The facts are
the same as in Example 1, except that on December
31, 2004, all the stock of US1 (and indirectly CFC1),
is sold to an unrelated U.S. shareholder, USB. US1
joins the USB consolidated group and USB makes an
election under section 965 for the taxable year ending
December 31, 2005. As of its last measurement date,
USB is a U.S. shareholder and related person with respect to CFC1.
(ii) Result. Without regard to the disposition of
US1, the USP group’s initial measurement date RPI
is $100x. Under section 7.05(c), the USP group’s initial measurement date RPI is decreased by $100x, resulting in the USP group having initial measurement
date RPI of $0.
USP computes its last measurement date RPI under section 7.05(b) of this notice. As of the last measurement date, CFC1 owes an indebtedness to US1,
a party that is not related within the meaning of section 954(d)(3) to USP. Therefore, the USP group’s
last measurement date RPI is $0.
Without regard to the acquisition of US1, the USB
group’s initial measurement date RPI is $0. However,
under section 7.05(c), the USB group increases its
initial measurement date RPI by $100x, the amount
of the related party indebtedness of its CFC (CFC1)
immediately after the transaction. Further, the USB
group’s last measurement date RPI is $100x because
as of its last measurement date, CFC1 owed $100x to
US1, a related person.
(iii) Alternative facts. Assume that the stock of
US1 is sold to USB on March 31, 2005, which is
during the USP group’s and the USB group’s election
year. The results are the same as set forth in (ii),
above.
Example 4. Determination of initial and last measurement date RPI when a new CFC is formed. (i)
Facts. The facts are the same as in Example 1, except
that USP incorporates CFC2 on November 1, 2004,
and during the USP election year USP acquires all the
stock of USB (and indirectly all of USB’s individual
CFCs), an unrelated U.S. shareholder. Further, USB
is a member of the USP consolidated group on the last
day of the USP election year. In part, CFC2 is capitalized with $100x of related party indebtedness and
USP is a U.S. shareholder and a related person with
respect to CFC2 on its last measurement date. USB
has initial measurement date RPI of $400x, attributable to its CFCs. Immediately after the acquisition,
USB’s CFCs continue to have indebtedness owed to
USB in the amount of $400x.
(ii) Result. Without regard to the acquisition of
USB or the formation of CFC2, under section 7.05(a),
the USP group has initial measurement date RPI of
$100x. Under section 7.05(c), the USP group in-

1113

creases its initial measurement date RPI by the related party indebtedness of the USB CFCs immediately after the transaction. Note, however, that no adjustment is made to the USP group’s initial measurement date RPI to account for CFC2’s related party indebtedness under section 7.05(c). Thus, after adjustment, the USP group’s initial measurement date RPI
is $500x. Under section 7.05(b), the USP group’s last
measurement date RPI is $600x, which includes the
indebtedness of CFC1 ($100x), CFC2 ($100x), and
the acquired CFCs of USB ($400x).
(iii) Alternative facts. The facts are the same
as in Example 6 (i), except that CFC1 pays US1
$70x of the $100x indebtedness on November 1,
2005. The USP group’s initial measurement date
RPI is $500, the same as in (ii). Under section
7.05(b), the USP group’s last measurement date RPI
is $530x, which includes the indebtedness of CFC1
($30x), CFC2 ($100x), and the acquired CFCs of
USB ($400x). Under section 7.04 of this notice and
section 965(b)(3), USP group reduces its dividends
otherwise eligible for the section 965(a) DRD by
$30x.
Example 5. Determination of initial and last measurement date RPI when a U.S. shareholder and its
CFC are transferred but the note due from the CFC
is left behind. (i) Facts. The facts are the same as in
Example 1, except that all the stock of US1 (and indirectly CFC1) is sold to an unrelated U.S. shareholder,
USB, on December 31, 2004, before USP group’s
election year ending December 31, 2005. Assume
that CFC1’s related party indebtedness on the initial
measurement date ($100x) was the result of the indebtedness being owed to USP instead of US1. US1
is a member of the USB group on the USB group’s
last measurement date.
(ii) Result. Without regard to acquisitions and
dispositions, the USP group has initial measurement
date RPI of $100x. Because USP was a U.S. shareholder and a related person with respect to CFC1 on
the USP group’s initial measurement date, but is not
a U.S. shareholder or a related person on its last measurement date, section 7.05(c) requires the USP group
to reduce its initial measurement date RPI from $100x
to $0.
On the USP group’s last measurement date, CFC1
is not a related person. Therefore, the USP group’s
last measurement date RPI is $0.
USB has initial measurement date RPI of $0,
without regard to the acquisition of US1 (and CFC1).
No adjustment is made to this amount under section
7.05(c) because immediately after the acquisition
CFC1 owed an indebtedness to USP, an unrelated
party. Further, the USB group’s last measurement
date RPI is $0 because its CFC (CFC1) does not
have an indebtedness to a related party on the last
measurement date.
Example 6. Determination of initial and last measurement date RPI when a U.S. shareholder is transferred without the debtor CFC. (i) Facts. The facts
are the same as in Example 1, except that on December 31, 2004, before the USP group’s election year,
US1 distributed CFC1 to USP, and then US1 was sold
to USB. In addition, CFC1’s related party indebtedness on the USP group’s initial measurement date was
owed to USP instead of US1. Finally, USB has initial
measurement date RPI of $0.
(ii) Result. Without regard to the distribution
of CFC1 or the disposition of US1, the USP group

2005–22 I.R.B.

has initial measurement date RPI of $100x. No
adjustment is made under section 7.05(c) to the USP
group’s initial measurement date RPI as a result
of the distribution of CFC1 because after the distribution the USP group is a U.S. shareholder and
related person with respect to CFC1. Further, under
section 7.05(c), the sale of US1 does not require the
USP group to reduce its initial measurement date
RPI because after the disposition USP is still a U.S.
shareholder and related person with respect to CFC1.
Therefore, USP has initial measurement date RPI of
$100x. The USP group’s last measurement date RPI
is also $100x because on the last measurement date
CFC1’s indebtedness is owed to USP, a related party.
USB acquires US1, but US1 has no CFCs when it
enters the USB consolidated group. Therefore, under
section 7.05(c), the USB consolidated group does not
increase its initial measurement date RPI. In addition,
USB’s last measurement date RPI is $0.
(iii) Alternative facts. The facts are the same as
in (i), except that the CFC1 indebtedness is owed
to US1. Under the alternative facts, the USP group
would still have initial measurement date RPI in the
amount of $100x. No adjustment is made to this
amount under section 7.05(c) because on the USP
group’s initial measurement date and last measurement date the USP group was a U.S. shareholder and
a related person with respect to CFC1. However, as
of the last measurement date, CFC1 will owe an indebtedness to US1, an unrelated party. Therefore, the
USP group’s last measurement date RPI is $0. The
results with respect to the USB group are the same as
set forth in (ii).
Example 7. Translating RPI denominated in a
non-U.S. dollar currency. (i) Facts. CFC1’s indebtedness to US1 is denominated in currency u. As of
the close of September 30, 2004 (the initial measurement date), CFC1 owed 100u to US1. As of the close
of December 31, 2005, CFC1 continued to owe 100u
to US1. As of September 30, 2004, the spot rate is
1u/$1. As of December 31, 2005, the spot rate is
1u/$1.5.
(ii) Result. Pursuant to section 7.05 of this notice, the indebtedness of CFC1 to US1 on the initial
measurement date and the last measurement date is
converted into U.S. dollars on the spot rate on the initial measurement date. As a result, the indebtedness
of CFC1 to US1 on both dates is $100x.
Example 8. U.S. shareholder not related to CFC
(i) Facts. FP, a foreign corporation, wholly owns
US1, a domestic corporation. US1 owns 60% of
CFC. US2, a domestic corporation that is unrelated
to FP or US1, owns the remaining 40% of CFC. As
of the initial measurement date of US1 and US2, CFC
has related party indebtedness in the amount of $100x
that is owed to FP.
(ii) Result. US1 is a related person with respect
to CFC on its initial measurement date. As a result,
US1 takes into account the related party indebtedness
of CFC for purposes of section 965(b)(3). Because
US2 is not a related person with respect to CFC, the
$100x of related party indebtedness is not taken into
account by US2 for purposes of section 965(b)(3).
Example 9. Application of Section 965(b)(3) reduction to multiple U.S. shareholders (i) Facts. USP
is a domestic corporation and the common parent of
a consolidated group. USP wholly owns US1, a domestic corporation that is not a member of the USP
group because an election under section 936 is in ef-

2005–22 I.R.B.

fect with respect to US1. USP and US1 wholly own
CFC1 and CFC2, respectively. The USP group and
US1 both maintain a calendar taxable year and elect
to apply section 965 to the taxable year ending December 31, 2005. USP receives a cash dividend of
$200x from CFC1 on February 1, 2005. US1 receives
a cash dividend from CFC2 of $300x on March 1,
2005. Both cash dividends received by USP and US1
during 2005 are otherwise eligible for the deduction
under section 965(a). There is a $300x increase in
CFC1’s related party indebtedness pursuant to section 965(b)(3). CFC2 does not have related party indebtedness at any time.
(ii) Result. Under section 965(d)(3), the USP
group and US1 are both U.S. shareholders and related persons with respect to CFC1. Thus, both the
USP group and US1 are required to take into account CFC1’s increase in related party indebtedness.
Based upon the rules set forth in section 7.06, above,
CFC1’s $300x increase in related party indebtedness
reduces the amount of the USP group’s and US1’s
dividends eligible for the deduction under section
965(a) based on the earliest cash dividends eligible
for the section 965(a) DRD received by the USP
group and US1 during the election year. As a result,
the USP group takes into account $200x of the $300x
increase in RPI because it received a cash dividend
of $200x on February 1, 2005. US1 takes into account the remaining $100x of such increase because
it received its cash dividend on March 1, 2005.
(iii) Alternative Facts. The facts are the same as
Example 2, except that USP and US1 received the
cash dividends from CFC1 and CFC2, respectively,
on the same day during the election year. Under section 7.06, the USP group and US1 take into account
the $300x increase in RPI attributable to CFC1 in
proportion to their receipt of cash dividends on such
date. Thus, the USP group takes into account $120x
of the increase (($200x/($200x + $300x)) x $300x).
US1 takes into account the remaining $180x of the
increase (($300x/($200x + $300x)) x $300x).
Example 10. Determination of initial and last
measurement date RPI when related party indebtedness arises in connection with or as a result of a transaction. (i) Facts. The facts are the same as in Example 3, except that in connection with or as a result of
USB’s purchase of the stock of US1 (and indirectly
CFC1), US1 lends CFC1 $50x.
(ii) Result. With respect to the USP group, the
initial measurement date RPI and the last measurement date RPI are the same as in Example 3. The
USB group’s initial measurement date RPI and last
measurement RPI are affected. Without regard to the
acquisition of US1, the USB group’s initial measurement date RPI is $0. However, under section 7.05(c),
the USB group increases its initial measurement date
RPI by $100x, the amount of the related party indebtedness of its CFC (CFC1) immediately after the transaction, but excluding the indebtedness arising in connection with, or as a result of, the transaction. The
USB group’s last measurement date RPI, however, is
$150x because as of its last measurement date, CFC1
owes $150x to US1, a related person. Therefore, under section 7.04 of this notice and section 965(b)(3),
the USB group reduces its dividends otherwise eligible for the section 965(a) DRD by $50x.

1114

SECTION 8. EFFECT OF CERTAIN
TRANSACTIONS ON DOMESTIC
REINVESTMENT PLANS
.01 In General
This section addresses the effect of
certain transactions on domestic reinvestment plans adopted pursuant to section
965(b)(4) and Notice 2005–10. Section
8.02 of this notice addresses the effect of
members entering and exiting a consolidated group. Section 8.03 addresses the
effect of certain asset acquisitions. Section 8.04 then provides rules that apply
to a corporation that may make permitted
investments pursuant to more than one domestic reinvestment plan. Finally, section
8.05 of this notice provides reporting and
administrative requirements for transactions addressed by this section 8.
.02 Members Entering and Exiting a
Consolidated Group
A consolidated group may rely on
any domestic corporation (regardless of
whether such corporation is a U.S. shareholder) to fulfill the group’s obligations
to make permitted investments under a
domestic reinvestment plan if that corporation is a member of the group at any time
on or after the first day of the group’s election year. For example, if a consolidated
group adopts a domestic reinvestment plan
and a member leaves the group during or
after the group’s election year, the group
may rely on the former member’s subsequent domestic investment activity to
satisfy the group’s obligations under its
domestic reinvestment plan. Similarly, if a
domestic corporation joins a consolidated
group during or after the first day of the
group’s election year, the group may rely
on the new member’s domestic investment
activity after it joins the group to satisfy
the group’s obligations under its domestic
reinvestment plan. The rules of this paragraph apply regardless of the amount of
cash or property held by the former member or new member at the time it leaves or
joins the consolidated group, as the case
may be.
In addition, a domestic corporation may
rely on any other domestic corporation (regardless of whether such corporation is a
U.S. shareholder) to fulfill its obligations
to make permitted investments under a domestic reinvestment plan if both corpora-

May 31, 2005

tions are members of the same consolidated group at the time the investment is
made, even if they were not members of
the same consolidated group during the
corporation’s election year. For example,
if a corporation adopts a domestic reinvestment plan and the corporation joins a consolidated group after the end of the corporation’s election year, the acquired corporation may rely on the subsequent domestic investment activity of any member of
the acquiring consolidated group to satisfy
the corporation’s obligations under its domestic reinvestment plan. Similarly, if a
consolidated group adopts a domestic reinvestment plan and the group is acquired
by another consolidated group after the acquired group’s election year, the acquired
group may rely on the subsequent domestic investment activity of any member of
its new consolidated group to satisfy the
acquired group’s obligations under its domestic reinvestment plan.
.03 Asset Acquisitions
In general, if a corporation acquires assets of another corporation, the acquiring
corporation will not succeed to the obligations of the transferor corporation under a domestic reinvestment plan, and investments made by the acquiring corporation therefore are not eligible to satisfy
such domestic reinvestment plan. However, if the corporation acquires the assets
of a transferor corporation in a transaction
described in section 381(a), subsequent investments made by the acquiring corporation (or by members of the acquiring corporation’s consolidated group) therefore
may be eligible to satisfy the transferor’s
domestic reinvestment plan.
If, prior to the transaction described in
section 381(a), the acquiring corporation
was also required or permitted to make
permitted investments in order to satisfy a
domestic reinvestment plan, the acquiring
corporation will continue to be required or
permitted to satisfy obligations under that
domestic reinvestment plan in addition to
any obligations under the transferor’s domestic reinvestment plan.
.04 Designation of Permitted Investment
Activity
A single corporation may be able to
make permitted investments in satisfaction
of more than one domestic reinvestment

May 31, 2005

plan. However, the same expenditure
of funds may not satisfy the investment
requirement of more than one domestic
reinvestment plan. For example, a single
$100x investment made by an acquired
domestic corporation cannot be counted
toward the investment requirements of
both the selling consolidated group and
the acquiring consolidated group. If a
permitted investment by a corporation
would satisfy the investment requirement
of more than one domestic reinvestment
plan, the corporation may designate which
plan is being satisfied. If a corporation
fails to so designate, its domestic investment activities will be treated as fulfilling
domestic reinvestment plan obligations
in the following order: first, under any
plan adopted with respect to its own earliest election year; second, under any plan
adopted with respect to its own subsequent
election years, if any; and third, with respect to any plan adopted with respect
to any other corporation (for example, a
transferor in a transaction described in
section 381(a) or a consolidated group the
corporation later joined) in the order the
corporation became required or permitted
to make investments in satisfaction of such
plan.
.05 Reporting and Other Administration
Requirements under Section 8 of Notice
2005–10
If a former member of a consolidated
group contributes to the completion of the
group’s domestic reinvestment plan (in
whole or in part), the obligation to comply
with the reporting and other administrative requirements contained in section 8
of Notice 2005–10 will remain with the
group if such group continues to exist,
or otherwise with the common parent (or
successor agent) for the election year, or
the common parent of any consolidated
group that includes such former common
parent (or successor agent).
.06 Examples
The following examples illustrate the
application of section 965(b)(4) and this
section 8. Unless otherwise indicated, the
following facts are assumed for purposes
of these examples: USP is a domestic
corporation and the common parent of a
consolidated group that uses the calendar
year as its taxable year. USP wholly owns

1115

US1 and US2, which are domestic corporations and members of the USP consolidated group. US1 and US2 each wholly
owns a foreign corporation, CFC1 and
CFC2, respectively. The USP group elects
to apply section 965 for its taxable year
ending December 31, 2005. The domestic reinvestment plan approved pursuant
to section 965(b)(4) and Notice 2005–10
on behalf of the USP group requires that
an amount of cash equal to the $100x
cash dividends that are received from the
USP group’s CFCs will be invested in
the United States to fund research and
development activities (performed in the
United States) of the USP group over a
two-year period. On December 31, 2005,
CFC1 and CFC2 each distributes $50x of
dividends that are eligible for the section
965(a) DRD.
Example 1. Member exiting a consolidated
group. (i) Facts. On July 1, 2006, all of the stock
of US2 is acquired for cash by USB, a domestic
corporation and the common parent of the USB consolidated group. Any permitted investments required
to be made by the USB group under any domestic
reinvestment plan (other than that of the USP group)
are made prior to June 30, 2006. Between July 1,
2006 and December 31, 2007, US2 funds $100x of
research and development activities.
(ii) Result. Because US2 is a member of the USP
group after the beginning of the USP group’s election year, US2’s funding of $100x of research and
development activities made while it is a member of
the USB group will satisfy the USP group’s obligations to make such permitted investments specified
under the USP group’s domestic reinvestment plan.
However, the USP group satisfies the reporting and
administrative requirements contained in section 8 of
Notice 2005–10 with respect to such investment.
Example 2. Member entering a consolidated
group. (i) Facts. On March 31, 2006, USP acquires
for cash all the stock of US3, a domestic corporation
that is not a member of a consolidated group. US3
elected to apply section 965 to its taxable year ending
December 31, 2005. US3’s domestic reinvestment
plan requires that US3 expend $5x to compensate
existing employees for services performed in the
United States over a two-year period. Between April
1, 2006 and December 31, 2007, US3 funds $100x
of research and development activities. During the
same period, US2 expends $5x to compensate existing employees for services performed in the United
States.
(ii) Result. Because US3 is a member of the USP
group after the beginning of the USP group’s election year, US3’s funding of $100x of research and development activities after joining the group will satisfy the USP group’s obligations to make such specified permitted investments under the USP group’s
plan. In addition, because US2 is a member of the
same consolidated group as US3 when it expends $5
to compensate existing employees for services performed in the United States (a permitted investment
pursuant to section 965(b)(4) and Notice 2005–10),

2005–22 I.R.B.

US3 may rely on US2’s expenditure to satisfy its obligation specified under its plan. USP is required to
satisfy the administrative requirements with respect
to investments under US3’s plan.
Example 3. Asset acquisition of U.S. shareholder.
(i) Facts. The facts are the same as in Example 2, except that instead of USP acquiring the stock of US3,
US3 merges into US2 in a reorganization under section 368(a)(1)(A) and (a)(2)(D) on March 31, 2006,
after which US2 remains a member of the USP group.
Between April 1, 2006 and December 31, 2007, US2
funds $100x of research and development activities
and pays $5x to compensate existing employees for
services performed in the United States.
(ii) Result. Because US2 acquired the assets of
US3 in a transaction to which section 381(a) applies,
US2 succeeded to US3’s domestic reinvestment plan
obligations. US2’s payment of $5x to compensate existing employees for services performed in the United
States satisfies its obligation to make a permitted investment specified under US3’s plan. The USP group
may also rely on US2’s funding of $100x of research
and development activities to satisfy the USP group’s
plan obligations. The result would be the same if, after the merger of US3 into US2, US1, instead of US2,
paid $5x to compensate existing employees for services performed in the United States, because US1 is
a member of the same consolidated group as US2 and
the compensation is a permitted investment pursuant
to section 965(b)(4) and Notice 2005–10.
Example 4. Failure to designate sufficient investment activity to fulfill multiple domestic reinvestment
plans. (i) Facts. The facts are the same as in Example
2, except that US3’s plan also required US3 to expend
$5x to fund research and development activities over
a two-year period. The USP group fails to designate
specific investment activities for purposes of section
8.04 of this notice to satisfy either the USP group domestic reinvestment plan or the US3 domestic reinvestment plan. Between March 31, 2006 and December 31, 2007, US3 funds $5x of research and development activities and US2 funds $95x of research and
development activities.
(ii) Result. Because the USP group failed to designate specific investment activities to satisfy US3’s
and the USP group’s domestic reinvestment plans,
US3’s permitted investments will first be taken into
account under the US3 plan, and US2’s permitted investments will first be taken into account under the
USP group plan. Consequently, US3’s $5x expenditure will satisfy the US3 plan and cannot be taken
into account by the USP group to satisfy its obligation to conduct $100x of research and development
activities. As a result, the USP group will have conducted only $95x of research and development activities and the USP group’s 2005 qualifying dividend is
reduced by $5x. If instead, US3 had merged into US2
on March 31, 2006, as in Example 3, and US2 spent
the $100x without designating, all $100x would have
satisfied the USP domestic reinvestment plan. In addition, the US3 plan would fail to have been satisfied,
resulting in a $5x reduction in US3’s qualifying dividends.

SECTION 9. OTHER GUIDANCE
.01 Section 78 Gross-Up, Disallowance of
Expenses Pursuant to Section 965(d)(2),

2005–22 I.R.B.

and Computation of Alternative Minimum
Tax in Election Year

The following example illustrates the
application of section 965(a)(2) and this
section 9.04:

Section 78 does not apply to any tax
which is not allowable as a credit under
section 901 by reason of section 965(d).
The disallowance of expenses in section
965(d)(2) applies only to expenses that are
“directly allocable” to the deductible portion described in section 965(d)(1).
For purposes of calculating alternative
minimum tax for the election year under
section 55(a) in accordance with section
965(e)(1)(B), the taxpayer’s regular tax
described in section 55(c) and tentative
minimum tax determined under section
55(b)(1)(B) do not include tax attributable
to nondeductible CFC dividends.
The IRS and Treasury will incorporate
the rules in this section 9.01 into subsequent guidance. This subsequent guidance
will provide detail regarding these and related rules.

Example. (i) Facts. USP, a domestic corporation, wholly owns two foreign corporations, CFC1
and CFC2. CFC1 wholly owns a foreign corporation, CFC3. CFC2 has $100x of current and accumulated earnings and profits described in sections
304(b)(5)(A) and 959(c)(3). During USP’s section
965 election year, CFC1 sells all its CFC3 stock to
CFC2 for $100x. Also during USP’s election year,
CFC1 distributes $100x to USP that is excluded from
gross income under section 959(a).
(ii) Result. Because CFC1 is in control of both
CFC3 and CFC2 and receives property from CFC2 in
exchange for its CFC3 stock, CFC1’s sale of CFC3
stock to CFC2 is subject to section 304(a)(1). Accordingly, CFC1 is treated as receiving $100x as a
distribution in redemption of CFC2 stock. Because
CFC1 actually owns 100% of CFC3 before the sale
and is treated as owning 100% of CFC3 after the
sale, pursuant to section 302(d), section 302(a) does
not apply to the deemed redemption distribution and
the proceeds of the deemed redemption are treated as
a distribution to which section 301 applies. Therefore, CFC1 is treated as transferring its CFC3 stock
to CFC2 in exchange for CFC2 stock in a transaction to which section 351(a) applies. The CFC2 stock
CFC1 is treated as receiving in the deemed section
351 exchange is then treated as redeemed by CFC2
for $100x. Under section 302, that redemption is
treated as a distribution to which section 301 applies
because CFC1 owns directly 100% of CFC3 before
the redemption of the CFC2 stock that was deemed
issued and is treated as owning 100% of CFC3 after the redemption. The deemed redemption proceeds
are treated as a distribution to which section 301 applies, and CFC1 is treated as receiving a dividend of
$100x from the current and accumulated earnings and
profits of CFC2. For purposes of section 965(a)(2),
because CFC1 is treated under section 304(a)(1) as
receiving CFC2 stock in the deemed section 351 exchange, CFC1 is treated as receiving the $100x dividend from another CFC that is in a chain of ownership
described in section 958(a).

.02 Contiguous Country Branches of
Domestic Life Insurance Companies
Amounts added to the life insurance
company taxable income of a domestic life
insurance company by reason of section
814(e)(2) (dealing with contiguous country branches of a domestic life insurance
company) are not eligible for the section
965(a) DRD.
.03 Cash Dividends in Excess of Amounts
Covered by Domestic Reinvestment Plans
A domestic reinvestment plan may provide for the investment in the United States
of an amount that is less than the entire
amount of cash dividends that are otherwise eligible for the section 965(a) DRD.
In such a case, the section 965(a) DRD applies only to the amount of eligible dividends that are reinvested pursuant to the
plan (assuming that all the other requirements under section 965 are satisfied).
.04 Section 958(a) Chain of Ownership —
Stock Deemed Issued Pursuant to Section
304(a)(1)
If stock of an acquiring CFC is deemed
to be issued to another CFC pursuant to
section 304(a)(1), the acquiring CFC is
treated as being in a chain of ownership
described in section 958(a) for purposes of
applying section 965(a)(2).

1116

.05 Acquisitions of Interests in Business
Entities — Modification of Section 5.06
of Notice 2005–10
Section 5.06 of Notice 2005–10 provides, in part, that in valuing assets with respect to certain acquisitions of interests in
business entities, the taxpayer must use the
same methodology that it uses, under section 864(e) and Treas. Reg. §1.861–9T(g)
(that is, tax book value, alternative tax
book value, or fair market value), for
purposes of allocating and apportioning
its interest expense for the taxable year.
Notwithstanding that section of Notice
2005–10, the Treasury Department and
the IRS have decided that taxpayers may
elect to use the fair market value methodology under Treas. Reg. §1.861–9T(g)

May 31, 2005

for purposes of valuing assets pursuant to
section 5.06 of Notice 2005–10, even if
they use the tax book value or alternative
tax book value methodology for purposes
of allocating and apportioning interest expense under section 864(e). Such election
is made on the annual report (required
under section 8.02(a) of Notice 2005–10)
filed by the taxpayer for the taxable year
of the acquisition.
.06 Distributions to Intermediary
Disregarded Entities — Clarification of
Section 3.02 of Notice 2005–10
Section 3.02 of Notice 2005–10 provides that for purposes of section 965(a),
a cash dividend paid by a CFC to a passthrough entity that is owned by a U.S.
shareholder is treated as received by such
U.S. shareholder only if and to the extent that such shareholder receives cash
in the amount of the CFC dividend during the taxable year for which such election is in effect. For this purpose, a disregarded entity need not actually distribute
cash to a U.S. shareholder of the CFC, provided that the U.S. shareholder otherwise
receives the cash from the disregarded entity and there is no legal obligation for the
U.S. shareholder to repay the cash to the
disregarded entity.7 For purposes of the
preceding sentence, the term U.S. shareholder is defined in section 951(b).
Example. (i) Facts. USP, a domestic corporation,
wholly owns DE, a disregarded entity. DE wholly
owns CFC, a foreign corporation. Since Year 1, USP
has held a $200x obligation of DE. CFC pays a $100x
dividend to DE during Year 3, USP’s election year.
Also during Year 3, DE repays $100x of its obligation
to USP.
(ii) Result. The $100x dividend paid by CFC is
paid to DE, a pass-through entity that is owned by
USP. As a result, pursuant to section 3.02 of Notice
2005–10, such dividend is treated as a cash dividend
for purposes of section 965 only if and to the extent
that USP receives $100x from DE during Year 3 without an obligation to repay those funds to DE. DE’s
repayment of $100x of its $200x obligation held by
USP satisfies this requirement, and the $100x dividend paid by CFC during the election year therefore
qualifies as a cash dividend for purposes of section
965. The result is the same regardless of whether the
$100x repayment by DE is of principal, accrued interest, or both.
(iii) Alternative Facts. The facts are the same except that instead of using the $100x to satisfy a portion of an obligation held by USP, DE uses the $100x
cash to acquire an asset from USP. The result is the
same.

SECTION 10. REPORTING
AND OTHER ADMINISTRATIVE
REQUIREMENTS
Pursuant to section 6001, the taxpayer
must prepare, maintain, and, upon a request by the Commissioner, make available within 30 days of such request, a general description of any transaction that results in: (1) an adjustment to base period
inclusions or APB 23 amounts pursuant
to section 6 of this notice; (2) an adjustment to initial measurement date RPI pursuant to section 7 of this notice; or (3)
a permitted investment being made by a
U.S. shareholder that, at the time of such
investment, is not a member of the consolidated group that adopted the domestic reinvestment plan pursuant to which
such investment is made, as provided under section 8 of this notice. The description must include, as applicable, the name,
address, and tax identification number (if
available), of all parties relevant to the
transaction (for example, selling group,
departing or joining member, and acquiring group). In addition, it must include all
relevant dates and the amount of adjustments resulting from the transactions.
In addition, pursuant to section 6001,
the taxpayer must prepare, maintain, and,
upon a request by the Commissioner, make
available within 30 days of such request:
(1) a list of investments that may satisfy
more than one domestic reinvestment plan
and the taxpayer designation of which plan
the investment satisfies; and (2) those domestic corporations that have participated
in more than one election year.
In the case of an adjustment to base
period inclusions pursuant to section 6 of
this notice, such adjustments may be determined by reference to the separate Form
1120 prepared for the departing U.S. shareholder for the base period years in question, without regard to the fact that the separate Form 1120 does not constitute a processed return, and was prepared to determine the consolidated return of the group
of which it was a member.

SECTION 11. TRANSITION RULES
.01 Domestic Reinvestment Plans
Approved Prior to May 10, 2005
If a domestic reinvestment plan is approved prior to May 10, 2005, the taxpayer
may modify such plan to take into account
the guidance herein not later than July 11,
2005, even if the dividend to which the
domestic reinvestment plan relates has already been paid. Any plan that is so modified must be subsequently approved by the
taxpayer’s president, chief executive officer, or comparable official, and by the
taxpayer’s board of directors, management
committee, executive committee, or similar body.
.02 Tax Returns filed Prior to May 10,
2005
If, prior to May 10, 2005, a taxpayer has
filed its tax return for the taxable year for
which it acquires an interest in a business
entity that qualifies, in whole or in part,
as a permitted investment pursuant to section 5.06 of Notice 2005–10, such taxpayer
may make the election to use the fair market value methodology pursuant to section
9.05 of this notice with respect to such acquisition on an amended tax return that is
filed on or before December 31, 2005.
SECTION 12. EFFECT OF THIS
NOTICE ON OTHER DOCUMENTS
Sections 9.05 and 9.06 of this notice
modify section 5.06 and clarify section
3.02 of Notice 2005–10, respectively.
See also section 11 of this notice, pursuant to which domestic reinvestment
plans approved prior to May 10, 2005
(including domestic reinvestment plans
adopted or modified pursuant to the guidance included in Notice 2005–10), may be
modified to take into account the guidance
in this notice.
SECTION 13. EFFECTIVE DATE
This notice is effective for the taxable
year for which taxpayers have elected section 965 to apply, and other taxable years
as relevant.

7 See section 3.02 of Notice 2005–10 (providing that a loan of cash from the disregarded entity to the U.S. shareholder is not considered a distribution of cash for this purpose because there
is a legal obligation for the U.S. shareholder to repay the cash to the disregarded entity).

May 31, 2005

1117

2005–22 I.R.B.

SECTION 14. PAPERWORK
REDUCTION ACT
The collections of information contained in this notice have been reviewed
and approved by the Office of Management and Budget in accordance with the
Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)) under control number
[1545–1943].
An agency may not conduct or sponsor,
and a person is not required to respond
to, a collection of information unless the
collection of information displays a valid
control number.
The collections of information are in
sections 5, 8, 9, 10, and 11 of this notice. This information is required to provide the IRS sufficient information to determine whether a taxpayer has properly
elected to apply section 965 to a taxable
year and whether the taxpayer has properly
determined the maximum amount of cash
dividends eligible for the DRD under section 965(a), taking into account the limitations on the DRD that are imposed by section 965(b)(1), (b)(2), and (b)(3). The collections of information are required to obtain the benefit of section 965 for a taxable
year. The likely respondents are business
corporations.
Estimated total annual reporting and/or
recordkeeping burden: 1,250,000 hours.
Estimated average annual burden hours
per respondent: 50 hours.

Estimated number of respondents:
25,000.
Estimated annual frequency of responses: on occasion and annually.
The collections of information contained in this notice have been submitted
to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3507(d)). Comments on the collections of
information should be received by June
9, 2005. Comments are specifically requested concerning:
Whether the proposed collections of information are necessary for the proper performance of the functions of the Internal
Revenue Service, including whether the
information will have practical utility;
The accuracy of the estimated burden
associated with the proposed collections of
information (see below);
How the quality, utility, and clarity of
the information to be collected may be enhanced;
How the burden of complying with the
proposed collections of information may
be minimized, including through the application of automated collection techniques
or other forms of information technology;
and
Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of services to provide information.

Comments concerning the accuracy of
the burden estimate and suggestions for reducing the burden of the final or temporary regulations should be sent to the Office of Management and Budget, Attn:
Desk Officer for the Department of the
Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503,
with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP, Washington, DC
20224.
Books or records relating to a collection
of information must be retained as long
as their contents may become material in
the administration of any internal revenue
law. Generally, tax returns and tax return
information are confidential, as required
by 26 U.S.C. 6103.
SECTION 15. DRAFTING
INFORMATION
The principal authors of this notice are
Jeffrey L. Vinnik of the Office of Associate Chief Counsel (International) and
Krishna P. Vallabhaneni, formerly of the
Office of Associate Chief Counsel (Corporate). However, other personnel from
the IRS and the Treasury Department participated in its development. For further
information regarding this notice, contact Mr. Vinnik at (202) 622–3840 (not a
toll-free call).

NOTE: This revenue procedure will be reproduced as the next revision of IRS Publication 1516, Specifications for Filing Form
8596, Electronically or Magnetically.
Use this revenue procedure to prepare Tax Year 2005 and prior year information returns for submission to Internal Revenue Service
(IRS) using any of the following:
- Electronic Filing
- Tape Cartridge

NOTE:
Following is a list of related forms for filing Information Returns Electronically/Magnetically:
Form 4419 — Application for Filing Information Returns Electronically/Magnetically
Form 4804 — Transmittal of Information Returns Reported Magnetically
Notice 210 — Preparation Instructions for Media Label
These forms can be obtained by calling 1-800-TAX-FORM (1-800-829-3676). You can also download forms and publications
from the IRS Web Site at www.irs.gov.

2005–22 I.R.B.

1118

May 31, 2005