Net Income (Loss) Reconsiliation for Foreign Corporations With Reportable Assets of $10 Million or More

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Instructions for Schedule M-3 (Form 1120-F)

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2007

Department of the Treasury
Internal Revenue Service

Instructions for
Schedule M-3
(Form 1120-F)
Net Income (Loss) Reconciliation for Foreign Corporations with Reportable Assets
of $10 Million or More
Section references are to the Internal
Revenue Code unless otherwise noted.

General Instructions
Purpose of Schedule
Schedule M-3, Part I, determines the
net income (loss) of the
non-consolidated (see
Non-consolidated financial statement
on page 3 for definition) foreign
corporation filing Form 1120-F, U.S.
Income Tax Return of a Foreign
Corporation. Schedule M-3, Parts II and
III, reconcile this financial result with the
corporation’s taxable income before the
NOL deduction and special deductions
on Form 1120-F, Section II, line 29.
For purposes of this reconciliation,
Part I, line 1, provides rules for
determining the financial statement(s)
the taxpayer must use in reporting the
net income (loss) to be reported on Part
I, line 4. Part I, lines 5 through 10 then
provide adjustments to include or
exclude financial results to reconcile the
financial statement results reportable
on Part I, line 4, to the foreign
corporation’s adjusted financial net
income (loss) reportable on Part I, line
11.
For foreign corporations other than
foreign banks (see definition in the
instructions for Part I, line 1 on page 4),
Part I, line 11 includes the worldwide
financial net income (loss) of the
non-consolidated foreign corporation,
adjusted for the results of excludible
entities and includible disregarded
entities. For foreign banks, Part I, line
11, is generally limited to the financial
income (loss) derived from the same
set(s) of books that are reported on
Form 1120-F, Schedule L. Foreign
banks are foreign corporations
described in Temporary Regulations
section 1.882-5T(c)(4).

Who Must File
Any foreign corporation required to file
Form 1120-F, that reports on Schedule
L, line 17 of Form 1120-F, total assets

at the end of the corporation’s tax year
that equal or exceed $10 million, must
complete and file Schedule M-3 in lieu
of Schedule M-1, Reconciliation of
Income (Loss) per Books With Income
per Return.
A foreign corporation filing Form
1120-F that is not required to file
Schedule M-3 may voluntarily file
Schedule M-3. A corporation filing
Schedule M-3 must not also file
Schedule M-1. For the first year that a
corporation files Schedule M-3, it may
exclude reporting in columns (a) and (e)
of Parts II and III.
In determining its reportable assets
for purposes of Schedule M-3, the
corporation must use an overall accrual
method of accounting unless both of
the following apply: (a) the tax return is
prepared using an overall cash method
of accounting, and (b) the corporation
does not prepare or is not included in
financial statements prepared on an
accrual basis. For purposes of
measuring total assets at the end of the
year, assets may not be netted or offset
against liabilities.

When and Where To File
Attach Schedule M-3 (Form 1120-F) to
the foreign corporation’s Form 1120-F
income tax return. Be sure to check the
box at the top of Form 1120-F, page 1,
indicating that Schedule M-3 is
attached.
Effective date. Schedule M-3 is
effective for tax years ending on or after
December 31, 2007. For purposes of
determining whether a corporation with
a 52-53 week tax year must file
Schedule M-3, such corporation’s tax
year is deemed to end or close on the
last day of the calendar month nearest
to the last day of the 52-53 week tax
year. For further guidance on 52-53
week tax years, see Regulations
section 1.441-2(c)(1).
Cat. No. 50152J

Completion of Schedule
M-3
A corporation required to file Schedule
M-3 must complete Parts I, II and III of
the schedule in its entirety and attach
the schedule to Form 1120-F. At the
time the Schedule M-3 is filed, all
applicable questions must be answered
on Part I, all columns must be
completed on Parts II and III, and all
numerical data required by Schedule
M-3 must be provided. All additional
schedules specifically referenced in
these instructions must be completed
and attached to the Schedule M-3
when filed. Part III requires that results
from Schedule I (Form 1120-F), Interest
Expense Allocation Under Regulations
Section 1.882-5, and Schedule H (Form
1120-F), Deductions Allocated to
Effectively Connected Income Under
Regulations Section 1.861-8, also be
included. See instructions for Part III,
lines 26b, 26c, and 31 on pages 23 and
24.

Other Issues Affecting
Schedule M-3 Filing
Requirements
For tax years beginning after 2007, if a
corporation was required to file
Schedule M-3 for the preceding tax
year but reports on Schedule L, line 17,
of Form 1120-F total assets at the end
of the current tax year of less than $10
million, the corporation is not required
to file Schedule M-3 for the current tax
year. The corporation may either (a) file
Schedule M-3 voluntarily, or (b) file
Schedule M-1, for the current tax year.
However, if the corporation chooses to
file Schedule M-1 for the current tax
year, and for a subsequent tax year the
corporation is required to file Schedule
M-3, the corporation must complete
Schedule M-3 in its entirety (including
all of Parts II and III) for that
subsequent tax year.

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Instructions for Schedule M-3 (Form 1120-F)

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Other Form 1120-F
Schedules Affected by
Schedule M-3
Requirements
Schedule L
Generally, the assets and liabilities
required to be reported on Schedule L
are the total assets and liabilities
reflected on the set(s) of books of the
foreign corporation that include assets
that give rise to U.S. effectively
connected income and U.S. booked
liabilities (as defined in Regulations
section 1.882-5(d)(2) and Temporary
Regulations sections
1.882-5T(d)(2)(ii)(A) and (iii)). The total
assets and liabilities include the
interbranch assets and liabilities and
the noneffectively connected assets
reflected on such books. Such books
will reflect the assets of the foreign
corporation located in the United States
and all other of its assets used in its
trade or business within the United
States (other than its assets giving rise
to effectively connected income under
sections 864(c)(6) or (7)). A foreign
corporation may instead elect to report
its worldwide assets and liabilities on
Schedule L under Regulations section
1.6012-2(g)(1)(iii). If a foreign
corporation (including a foreign bank)
elects worldwide reporting on Schedule
L, the same set(s) of books must be
used to report the adjusted worldwide
net income (loss) results in Part I, line
11.
If the foreign corporation has more
than one set of books and records
relating to assets located in the United
States or used in a trade or business
conducted in the United States, it must
report the combined amounts shown on
all such books and records on
Schedule L, as adjusted to eliminate
transactions recorded between the
reportable books. However, amounts
recorded between the set(s) of books
and other divisions of the foreign
corporation or includible entities
reportable on Schedule M-3, Part I, line
5, are not eliminated (except for certain
transactions with disregarded entities
that are also reportable on Schedule L),
unless the taxpayer elects worldwide
reporting under Regulations section
1.6012-2(g)(1)(iii).
Adaptation of Form 1120- F,
Schedule L for treaty-based
reporting. The set(s) of books
reported on Form 1120-F, Schedule L
for treaty-based reporting purposes will
generally be the same set(s) of books
reported on Schedule L as described
above. However, certain books that
give rise to effectively connected
income might not necessarily give rise
to treaty-based reporting. For example,
the assets on a set of books could still

be attributed to a U.S. office for
effectively connected income reporting
purposes even when transferred away
from the U.S. permanent establishment
for treaty reporting purposes (see, for
example, Regulations section
1.864-4(c)(5)(iii)) if under the facts and
circumstances, such assets also
constitute a set of books that give rise
to U.S. booked liabilities under
Regulations 1.882-5(d)(2). Under such
circumstances, the set of books would
remain reportable on Schedule L for
Code-based reporting purposes, but for
treaty-based reporting purposes, such
transfer may effect attribution to
another part of the corporate enterprise
under a functional and factual analysis
and no longer be reportable on
Schedule L as part of the U.S.
permanent establishment after the
transfer is made. Additionally, a set of
books having no effectively connected
income or U.S. booked liabilities under
Regulations section 1.882-5(d)(2) might
still constitute a set of books of the U.S.
permanent establishment because the
items recorded thereon are primarily
attributable to the U.S. permanent
establishment under the application by
analogy of the OECD Transfer Pricing
Guidelines as expressly authorized by
or pursuant to a U.S. tax treaty and
accompanying documents. (For treaties
that expressly provide the right to
determine the attribution of profits to a
U.S. permanent establishment by
application of the OECD Transfer
Pricing Guidelines, see Articles 7 and
the accompanying Exchange of Notes
to the 2001 United States-United
Kingdom and 2003 United
States-Japan Income Tax Treaties.) In
such cases, the set(s) of books that
must be reported on Form 1120-F,
Schedule L are those of the U.S.
permanent establishment as
determined under OECD Transfer
Pricing Guidelines.

Schedule M-2
If the foreign corporation is a bank (and
checked the “Yes” box on Part I, line 1
of Schedule M-3), the amount shown
on Schedule M-2, line 2 (Net income
(loss) per books) must equal the
amount shown on Schedule M-3, Part I,
line 11. Both the foreign bank’s Form
1120-F, Schedule L reporting and
Schedule M-3 (Form 1120-F) reporting
are based on the same set(s) of
Schedule L books which are generally
determined on the basis of Temporary
Regulations section 1.882-5T(d)(2)(iii).
If, however, the foreign bank elects to
complete its Form 1120-F, Schedule L
on the basis of its worldwide books,
then the bank will be required to report
its net income (loss) on Schedule M-3
(Form 1120-F) from the same
worldwide set(s) of books used for
Form 1120-F, Schedule L purposes.

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If the foreign corporation is not a
bank (and checked the “No” box on
Part I, line 1), the amount shown on
Schedule M-2, line 2 (Net income (loss)
per books), will only equal the amount
shown on Schedule M-3, Part I, line 11
if the corporation voluntarily chooses to
complete Form 1120-F, Schedule L on
the basis of the corporation’s worldwide
set(s) of books under Regulations
section 1.6012-2(g)(1)(iii), or, if the
Schedule L books determined under
the facts and circumstances constitute
the same results as worldwide income
reporting under Regulations section
1.882-5(d)(2)(ii). However, the
Schedule M-3 (Form 1120-F) reporting
on Part I, line 11 must always reflect
the worldwide profits and losses of the
foreign corporation filing the Form
1120-F even if the Schedule L books
determined under Regulations section
1.882-5(d)(2)(ii) gives rise to less than
worldwide reporting under the facts and
circumstances.

Entity Considerations for
Schedule M-3
For purposes of Schedule M-3,
references to the classification of an
entity (for example, as a corporation, a
partnership, or a trust) are to the
classification of the entity for U.S.
federal income tax purposes.
For a foreign corporation other than
a bank, an entity that generally is
disregarded as separate from the
foreign corporation filing Form 1120-F
for federal income tax purposes
(“disregarded entity”) is reported on
Schedule M-3, Part I, line 4, if the
foreign corporation’s applicable income
statement includes the net income of
such disregarded entity. Otherwise, the
results of the disregarded entity are
separately reported on Part I, line 5. On
Parts II and III, any item of income,
gain, loss or deduction of a disregarded
entity must be reported as an item of
the foreign corporation, and is not
reported on Part II, lines 9, 10, or 11, as
from a partnership or pass-through
entity. The applicable financial
statement may include a disregarded
entity only if it is owned directly or
indirectly by the foreign corporation. An
applicable financial statement may not
include a disregarded entity that is the
direct or indirect owner of the foreign
corporation filing Form 1120-F.
Foreign bank disregarded entity
books on line 5. For foreign banks,
the net income (loss) of certain
disregarded entities are not combined
with other U.S.-based sets of books
reported on line 4. The set(s) of books
with respect to disregarded entities are
included on Part I, line 5, if the set(s) of
books of such disregarded entities give
rise to U.S. booked liabilities under
Regulations section 1.882-5(d)(2)(iii).
Transactions between the set(s) of

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Instructions for Schedule M-3 (Form 1120-F)

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books reported on line 4 and line 5 are
eliminated on line 8. However, a U.S.
LLC that is a disregarded entity whose
set(s) of books do not give rise to U.S.
booked liabilities of the foreign bank
under Regulations section
1.882-5(d)(2)(iii), are not included in
line 4 or line 5. Transactions between
such disregarded entities and set(s) of
books reported on line 4 are not
eliminated.

Reportable Entity Partner
Reporting Responsibilities
Reportable entity partner. For
purposes of these instructions, a
reportable entity partner with respect to
a partnership filing Form 1065 is an
entity that (1) owns or is deemed to
own, directly or indirectly, under these
instructions a 50% or greater interest in
the income, loss or capital of the
partnership on any day of the tax year
on or after June 30, 2006, and (2) was
required to complete Schedule M-3 on
its most recently filed U.S. federal
income tax return or return of income
filed prior to that day. A corporation
filing a Form 1120-F income tax return
required to complete Schedule M-3 is
subject to the reportable entity partner
reporting responsibilities with respect to
partnership interests it owns or is
deemed to own, directly or indirectly, on
or after January 1, 2008.
For purposes of these instructions,
(1) the owner of a disregarded entity is
deemed to own all corporate and
partnership interests owned or deemed
to be owned under these instructions
by the disregarded entity; (2) the owner
of 50% or more of a corporation by vote
on any day of the corporation’s tax year
is deemed to own all corporate and
partnership interests owned or deemed
to be owned under these instructions
by the corporation during the
corporation’s tax year; (3) the owner of
50% or more of partnership income,
loss, or capital on any day of the
partnership tax year is deemed to own
all corporate and partnership interests
owned or deemed to be owned under
these instructions by the partnership
during the partnership tax year; and (4)
the beneficial owner of 50% or more of
the beneficial interest of a trust or
nominee arrangement on any day of
the trust or nominee arrangement tax
year is deemed to own all corporate
and partnership interests owned or
deemed to be owned under these
instructions by the trust or nominee
arrangement.

instructions, thereafter within 30 days of
the date of any change in the interest it
owns or is deemed to own, directly or
indirectly, under these instructions, in
the partnership: (1) its name, (2) its
mailing address, (3) its taxpayer
identification number (TIN or EIN), if
applicable, (4) its entity or organization
type, (5) the state or country in which it
is organized, (6) the date on which it
first became a reportable entity partner,
(7) the date with respect to which it is
reporting a change in its ownership
interest in the partnership, if applicable,
(8) the interest in the partnership it
owns or is deemed to own in the
partnership, directly or indirectly (as
defined under these instructions), as of
the date with respect to which it is
reporting, and (9) any change in that
interest as of the date with respect to
which it is reporting.
The reportable entity partner must
retain a copy of each required report it
makes to each partnership under these
instructions. Each partnership must
retain copies of the required reports it
receives under these instructions from
reportable entity partners.
Example 1. A, an LLC filing a Form
1065 for 2008, is owned 50% by Z, a
foreign corporation engaged in trade or
business within the United States. A
owns 50% of each of B, C, D, and E,
each of which is also an LLC filing a
Form 1065 for calendar year 2008. Z
was first required to complete Schedule
M-3 (Form 1120-F) for its corporate tax
year ended December 31, 2007, and
filed its Form 1120-F with Schedule M-3
for 2007 on September 15, 2008. As of
September 16, 2008, Z was a
reportable entity partner with respect to
A and, through A, with respect to B, C,
D, and E. On October 5, 2008, Z
reports to A, B, C, D, and E, as it is
required to do within 30 days of
September 16, that Z is a reportable
entity partner directly owning (with
respect to A) or deemed to own
indirectly (with respect to B, C, D, and
E) a 50% interest. Therefore, because
Z was a reportable entity partner for
2008, each of A, B, C, D, and E is
required to complete Form 1065
Schedule M-3 for 2008, regardless of
whether they would otherwise be
required to complete Schedule M-3 for
that year. Z must retain a copy of each
of the required reports it makes to A, B,
C, D, and E under these instructions,
including the reports it makes on
October 5, 2008.

Reporting requirements of
reportable entity partner. A
reportable entity partner with respect to
a partnership (as defined above) must
report the following to the partnership
within 30 days of first becoming a
reportable entity partner and, after first
reporting to the partnership under these

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Part I – Financial
Information and Net
Income (Loss)
Reconciliation
When To Complete Part I
Part I must be completed for any tax
year for which the foreign corporation
files Schedule M-3.
Question A. Treaty position taken on
Form 1120-F, Section II, for taxable
income. If a foreign corporation is
resident in a country having a treaty
with the United States that expressly
permits determining the attribution of
profits to a permanent establishment
under OECD Transfer Pricing
Guidelines principles (e.g., United
States-United Kingdom or United
States-Japan Income Tax Treaties),
answer “Yes” if the corporation reports
income under the treaty method in lieu
of the effectively connected income
rules under sections 864 and 882. For
reporting under this method in Parts II
and III, see Treatment of Items Under
an Eligible Treaty-Based Return
Position to Attribute Business Profits to
a U.S. Permanent Establishment on
page 9.
Questions B through D. For
Schedule M-3, Part I, Questions B
through D, use only the financial
statements of the foreign corporation
filing Form 1120-F. If the foreign
corporation prepares its own financial
statements but is controlled by another
corporation (U.S. or foreign) that
prepares financial statements that
include the foreign corporation, the
foreign corporation must use for its
Schedule M-3, Part I, its own financial
statements and may not use the
financial statements of the controlling
corporation. These financial statements
are used for completing line 4.
Non-consolidated financial
statement. A foreign corporation’s
“non-consolidated” financial statement
may include a financial statement which
reports a consolidation of entities or
subsidiaries that the foreign corporation
owns. In such a case, the net income or
(loss) of such entities or subsidiaries
would be included in the amount
reported on line 4 and, except for
disregarded entities, would be
eliminated by reporting these amounts
on line 7 (see below). Any adjustments
associated with removing such
amounts would be reported on line 8.
Example 2. FC1 is a foreign
corporation other than a bank, resident
in Country X, and engaged in a trade or
business in the United States. FC1 is
required to file Form 1120-F. FC1
reports on Schedule L more than $10
million in assets and therefore, is
required to file Schedule M-3. FC1 is

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Instructions for Schedule M-3 (Form 1120-F)

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owned 100% by FC, its non-banking
parent corporation also resident in
Country X. FC1’s net income (loss)
results are included in a certified
audited consolidated financial
statement of FC. FC1 also has an
unconsolidated financial statement that
is not certified. In answering questions
B through D, FC1 may not use FC’s
consolidated financial statement. FC1’s
“non-consolidated financial statement”
is its own unconsolidated, worldwide
financial statement which is a statement
described in Question C. If FC was also
engaged in a trade or business within
the United States with reportable assets
over $10 million, then FC would be
required to file its own Schedule M-3
and would be required to use its
certified audited financial statement
described in question B. In such
circumstances, FC1 would continue to
use its own non-consolidated statement
described in question C.
Example 3. Same facts as
Example 2, except FC1 is a
disregarded entity. Under U.S. tax
principles, FC is the taxpayer treated as
directly engaged in trade or business
within the United States and is required
to file Form 1120-F and Schedule M-3.
FC’s “non-consolidated” financial
statement is its consolidated certified
audited financial statement, described
in Question B, because it is the
financial statement of the company
engaged in a trade or business within
the United States that is required to file
Form 1120-F and Schedule M-3. FC’s
consolidated entities (other than any
disregarded entities) are eliminated as
“non-includible” entities on Part I, line 7.

Line 1. Foreign Banks
Described in Temporary
Regulations Section
1.882-5T(c)(4)
If a foreign corporation is a foreign bank
described in Temporary Regulations
section 1.882-5T(c)(4), answer “Yes” to
Part I, line 1. Special rules pertain to
the corporation for Part I, lines 4
through 11. For Schedule M-3
purposes, a foreign bank is defined
based on section 581 principles with
respect to the conduct of its banking
activities on a worldwide level, without
regard to whether it conducts a banking
trade or business within the United
States. These requirements include
having a substantial part of its
worldwide business consist of receiving
deposits and making loans and
discounts, or of exercising fiduciary
powers similar to those permitted to
national banks. In addition, the foreign
corporation must be subject to bank
regulatory supervision in its country of
incorporation.

Line 2. Questions Regarding
Income Statement Period and
Restatements
Enter the beginning and ending dates
on line 2a for the corporation’s annual
income statement period ending with or
within the current tax year.
Part I, lines 2b and 2c, regarding
restatements of income statements,
refer to the income statement issued by
the corporation filing the U.S. income
tax return. Answer “Yes” on lines 2b
and/or 2c if the corporation’s annual
income statement has been restated for
any reason. Attach a short explanation
of the reason for the restatement for
each applicable period, including the
original amount and restated amount of
each annual statement period’s net
income.

Line 3. Publicly Traded Stock
If the foreign corporation’s stock is
traded on any exchange, domestic or
foreign, please report the name of the
exchange(s) on the line provided. If
additional room is needed, attach a
schedule.
For purposes of line 3, if the foreign
corporation’s stock is not publicly
traded (as defined above) and its voting
stock is owned or controlled 50% or
more by another foreign corporation
whose stock is publicly traded (as
defined above), check the “Yes” box
and report the name of the exchange(s)
on the line provided. The foreign
corporation whose stock is publicly
traded need not file Schedule M-3
(Form 1120-F) unless such corporation
is also engaged in a trade or business
within the United States and has
reportable assets of $10 million or
more. If the foreign corporation whose
stock is publicly traded is not engaged
in a trade or business within the United
States, its foreign subsidiary
corporation that is engaged in a trade
or business with $10 million or more of
reportable assets must still file
Schedule M-3 with its Form 1120-F.

Line 4. Net Income (Loss) from
the Income Statement Identified
in Part I, Line 1
Part I, line 4, reports the net income
(loss) from the applicable income
statement identified in Part I, line 1.
Foreign banks. If the foreign bank
has the type of non-consolidated,
worldwide financial statement described
in Question B or C, the foreign bank
should check the “Yes” box for the
applicable question B or C. However,
do not report these results on Part I,
line 4 unless the foreign bank also
chooses worldwide reporting of the
set(s) of books on Form 1120-F,
Schedule L under Regulations section
1.6012-2(g)(1)(iii). If the foreign bank
has certified audited financial
statements for the set(s) of books from

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which the balance sheet reported on
Form 1120-F, Schedule L is derived (as
described in Question D), the net
income (loss) from such statements is
used to complete line 4, except that any
disregarded entities whose results are
reportable on Schedule L are excluded
from line 4 unless they are included in
the corporation’s financial consolidation
of its Schedule L books in accordance
with the bank’s ordinary and
consistently applied internal accounting
practices. Disregarded entities
includible in Schedule L, that are not
included in a non-tax financial
consolidation of the corporation’s
Schedule L books in accordance with
the bank’s ordinary and consistently
applied internal accounting practices,
are separately reported on Part I, line 5.
Ordinary and consistent internal
accounting practices. If the foreign
bank’s ordinary and consistently
applied accounting practices include
the consolidation of more than one set
of books that is reportable on Schedule
L as determined under Temporary
Regulations section 1.882-5T(d)(2)(iii),
the foreign bank may use such set(s) of
books as a starting point for completing
Part I, line 4. If additional set(s) of
books also constitute Schedule L books
that are not included in the
consolidation of other Schedule L
books, then such other Schedule L
books must also be reported on line 4,
or if such other books are set(s) of
books of disregarded entities, they must
be reported on line 5. Interbranch
transactions between the Schedule L
books must be eliminated and the
eliminating transactions reported, if
necessary, on line 8.
If the foreign bank does not have the
certified audited financial statements
described in Question D, the bank
should use any other financial
statement derived from the set(s) of
books from which the balance sheet
reported on Form 1120-F, Schedule L
is derived. For this purpose, the term
“any other financial statement” includes
unaudited financial statements
prepared by the corporation under the
method of accounting generally used by
the corporation’s U.S. operations. If no
such statements are available, trial
balances prepared from general
ledgers or similar other records should
be used.
Foreign corporations other than
banks. If the foreign corporation is not
a bank, Part I, questions B, C, and D,
provide a hierarchy of applicable
income statements for reporting on Part
I, line 4. If the corporation has the
non-consolidated, worldwide, certified
audited financial statement described in
Question B, report the net income (loss)
from such statements on line 4. If the
corporation does not have a financial
statement of that type but does have

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Instructions for Schedule M-3 (Form 1120-F)

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the non-consolidated, worldwide
unaudited financial statement described
in question C, report the net income
(loss) from such statements on line 4.
These unaudited financial statements
should first include those prepared by
the corporation under the method of
accounting generally used by the
corporation. If no such unaudited
statements are available, other financial
statements may be used, including trial
balances prepared from the
corporation’s worldwide books and
records that are based on the method
of accounting generally used by the
corporation.
If the foreign corporation has none of
these financial statements, then the net
income (loss) derived from the set(s) of
books described in Question D is used
to report net income (loss) on line 4,
excluding disregarded entities. All
disregarded entities are reported on
Part I, line 5. For corporation’s other
than banks, the set(s) of books
described in Question D are those that
give rise to U.S. booked liabilities under
Regulations section 1.882-5(d)(2) and
Temporary Regulations section
1.882-5T(d)(2)(ii), and not under
Temporary Regulations section
1.882-5T(d)(2)(iii).
All foreign corporations. The
amount on line 4 must equal the
financial statement net income (loss) for
the income statement period ending
with or within the tax year as indicated
on line 2a.
If the income statement period
differs from the corporation’s tax year,
the income statement period indicated
on line 2a applies for purposes of Part
I, lines 4 through 8.
Reporting with Schedule L set(s)
of books. Question D filers. All foreign
banks (and any other foreign
corporation that reports on Part I, line 4,
the financial results from the set(s) of
books used in preparing Form 1120-F,
Schedule L, excluding disregarded
entities), must attach a schedule that
identifies each book (e.g., New York
Branch, International Banking Facility,
Cayman Branch) and its net income
(loss) that is included on Part I, line 4.
However, if a foreign bank in its
ordinary business practice prepares a
consolidation of one or more books
required to be reported on Schedule L,
such consolidated results may be
reported on line 4 in lieu of reporting
the separate results for each book in
the consolidation. If a consolidation of
reportable books does not exist, then
transactions recorded between these
books must be separately eliminated
and shown in the aggregate as a
separate reconciling elimination line
item on this schedule. Do not include
eliminations for transactions with
disregarded entities reported on line 5.
Report on line 8, the eliminations for

transactions between set(s) of books
reported on line 4 and disregarded
entities reported on line 5.

Line 5. Net Income (Loss) from
Includible Disregarded Entities
(“Includible Entities”)
Include the net income (loss) of any
disregarded entity that is not included in
the income reported on Part I, line 4,
but should be included in Part I, line 11.
The financial results of disregarded
foreign entities are reported on lines 5a
(income) and 5b (loss); disregarded
U.S. entities are reported on lines 5c
(income) and 5d (loss). The applicable
financial statement of the disregarded
entity to be used is determined first
under Question B if available, then
under Question C. However, a foreign
bank should only use the set(s) of
books from the disregarded entity that
give rise to U.S. booked liabilities under
Temporary Regulations section
1.882-5T(d)(2)(iii) and are reportable on
Schedule L.
Foreign banks. A foreign bank
should include on line 5 each
disregarded entity that meets the
following two conditions.
1. The entity is either itself engaged
in a trade or business within the United
States and has generated income
effectively connected with it or, it is not
engaged itself in a trade or business
within the United States but has income
effectively connected with another trade
or business within the United States of
the foreign bank; and
2. The net income (loss) of the
entity would be includible on Part I, line
4, if the assets and liabilities of such
entity were held directly by the foreign
bank rather than by the disregarded
entity. This determination is made
separately for each disregarded entity.
If the income of the includible entity
is effectively connected with a trade or
business within the United States but
would not have been includible on Part
I, line 4, if it were held directly by the
foreign corporation rather than by the
includible entity, then any effectively
connected income of the includible
entity is reported on Part II, line 23,
columns (b) through (e), instead of Part
I, line 5. Income of this latter type will
be income that is treated as effectively
connected income under section
864(c)(6) or (7), or it will be individual
items of effectively connected income
from the set(s) of books of a
disregarded entity that does not give
rise to U.S. booked liabilities as defined
in Temporary Regulations section
1.882-5T(d)(2)(iii).
Foreign corporations other than a
bank. If the foreign corporation is not
a bank, include on line 5, all
disregarded entities not included on
Part I, line 4. When a foreign

-5-

corporation reports income (loss) from
a financial statement identified in
Question B or C, net income (loss) of a
disregarded entity may or may not be
included on line 4, depending on the
foreign corporation’s accounting
principles. However, inclusion of
disregarded entities will be necessary
on line 5 when a taxpayer has reported
on Part I, line 4, amounts from financial
statements described in Question D or
similar unaudited statements.
Adjustments for intercompany
transactions between the foreign
corporation and includible disregarded
entities may be required. See the
instructions for Part I, line 8 below.
All foreign corporations. Attach a
supporting schedule that lists for each
includible disregarded entity reported
on lines 5a through 5d the name, EIN
(if applicable), and net income (loss)
per the financial statement of that
includible disregarded entity.

Line 6. Net Income (Loss) Not
Included on Lines 4 and 5 from
Includible Foreign Locations
Line 6 applies only to foreign
corporations other than banks whose
books and records are not sufficient to
report worldwide income on lines 4 and
5. Line 6 reporting will be necessary
only when the corporation does not
have a worldwide trial balance to report
its worldwide income as satisfaction of
the requirements of Question C. In
such circumstances, the corporation will
have used Form 1120-F, Schedule L
books determined under Regulations
section 1.882-5(d)(2)(ii) on lines 4 and
5 and will need to report the net income
(loss) from all non-Schedule L books on
line 6. This is a “bottom up”
reconciliation to worldwide income that
the Schedule M-3 reporting
requirements apply as a last resort.
Line 6 reporting does not apply to
foreign banks or to corporations other
than banks that are able to report
worldwide net income (loss) on lines 4
and 5 from financial statements
described in Questions B or C, or from
worldwide trial balances.
Attach a supporting schedule that
provides by country, the name and net
income (loss) per the financial
statement on Part I, line 6, of all foreign
locations. Foreign corporations other
than banks that have effectively
connected income with respect to
transactions entered into as a global
dealer in securities must report
separately in this supporting schedule
the net income (loss) for each set(s) of
books for which the effectively
connected dealer income is recorded
within each separate country. All
foreign corporations must report their
effectively connected global dealing
income in Part II, line 16.

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Line 7. Net Income (Loss) of
Nonincludible Entities
This line will generally not apply to
foreign banks (unless a nonincludible
entity is financially consolidated in the
Schedule L set(s) of books), nor does it
apply to foreign corporations other than
banks that report on Part I, lines 4 and
5, income (loss) from the financial
statements described in Question D.
For any other corporations, remove the
net income (in line 7a) or loss (in line
7b) of any other entity whose income
(loss) is reported on Part I, line 4, but
should be excluded from Part I, line 11.
Examples of such entities are the
foreign corporation’s subsidiaries (other
than disregarded entities) and
partnerships that were combined with
the corporation in the type of
consolidated financial statement
described in Questions B or C. Do not
remove in Part I the financial statement
net income (loss) of any nonincludible
entity accounted for in the financial
statements on the equity method.
Adjustments are made for these entities
on Part II, lines 8 through 11.
In addition, on Part I, line 8,
adjustments for intercompany
transactions between the foreign
corporation and nonincludible entities
may be required. See instructions for
line 8.
Attach a supporting schedule that
provides the name, EIN (if applicable),
and net income (loss) per the financial
statement or books and records
included on line 4 that is removed on
this line 7 for each separate
nonincludible entity.

Line 8. Adjustments to
Intercompany Transactions
Include on Part I, line 8: (i) adjustments
to consolidation entries and elimination
entries that are contained in the amount
reported on Part I, line 4, required as a
result of adding amounts on Part I, lines
5 and 6; and (ii) amounts of any
additional consolidation entries and
elimination entries that are required as
a result of removing amounts on Part I,
line 7.
Foreign banks. For foreign banks,
adjustments are necessary to ensure
consistency with the financial results of
the set(s) of books reported on Form
1120-F, Schedule L. Adjustments on
line 8 are necessary to account for
elimination of certain transactions
recorded between the Schedule L
books reported on line 4 and for
transactions between the foreign bank
and each disregarded entity reported
on Part I, line 5. For example,
adjustments must be reported on line 8
to eliminate any intercompany
dividends received by the foreign
corporation from any disregarded entity
whose results are included on Part I,
line 5. However, if a disregarded entity

is not reportable in Part I (e.g., because
it does not give rise to U.S. booked
liabilities under Temporary Regulations
section 1.882-5T(d)(2)(iii)), the dividend
received by the foreign bank is not
eliminated on Part I, line 8. Instead, the
dividend is eliminated as an interbranch
transaction on Part II, line 3, column
(c).
Foreign corporations other than a
bank. For foreign corporations other
than a bank, adjustments are
necessary in order to ensure that the
consolidation entries and intercompany
elimination entries included in the
amount reported on Part I, line 11, are
only those applicable to worldwide
income of the non-consolidated foreign
corporation. Adjustments on line 8 may
be with respect to transactions between
the foreign corporation and either a
disregarded entity reported on Part I,
line 5, or a nonincludible entity reported
on Part I, line 7. Adjustments for
transactions with nonincludible entities
are required only when the foreign
corporation reports worldwide income
on Part I, line 4, from a financial
statement described in Part I,
Questions B through C. For example,
adjustments must be reported on line 8
to remove minority interests and to
reverse the elimination of intercompany
dividends included on Part I, line 4, that
relate to the net income of entities
removed on Part I, line 7, because the
income to which the consolidation or
elimination entries relate has been
removed. In addition, consolidation or
elimination entries must be reported on
line 8 to eliminate any intercompany
dividends received by the foreign
corporation from any disregarded entity
whose results are included on Part I,
line 5.
Special treatment of equity
method inclusions for a foreign
corporation other than a bank. If a
foreign corporation other than a bank
reports worldwide income on Part I, line
4, and is an owner of an interest in
another entity that (1) is accounted for
in the foreign corporation’s separate
general ledger on the equity method,
and (2) is fully consolidated in the
foreign corporation’s worldwide
financial statements thus eliminating
the equity inclusion, and if that entity is
also reported on Part I, line 7, as a
nonincludible entity, then an adjustment
on Part I, line 8, must be made. The
foreign corporation must restore on
Schedule M-3, Part I, line 8, the equity
income inclusion from that entity. If the
foreign corporation does not account for
the entity on the equity method on its
own general ledger, it will not have
eliminated the equity income for
non-consolidated, worldwide financial
statement purposes, and therefore will
have no elimination of equity income to
reverse.

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The attached supporting schedule
for Part I, line 8, must identify the type
(e.g., minority interest, intercompany
dividends, etc.) and amount of
consolidation or elimination entries
reported, as well as the names of the
entities to which they pertain. It is not
necessary to report intercompany
eliminations that net to zero on Part I,
line 8, such as intercompany interest
income and expense. For instance, if
the foreign corporation reports interest
income on Part I, line 4, from
transactions with a disregarded entity
included on Part I, line 5, it is not
necessary (but allowable) to report the
offsetting gross interest income and
gross interest expense on Part I, line 8.
Example 4. F is a foreign
corporation other than a bank and has
a fiscal financial and tax year end. F
files Form 1120-F because it engaged
in a trade or business within the United
States and is required to file Schedule
M-3. F owns two U.S. subsidiaries, S1
and S2, and has made a check the box
election for S1 to be treated as a
disregarded entity. Both S1 and S2
have the same fiscal year end as F. In
addition, F’s home country accounting
rules require the inclusion of S2’s
income and expenses in F’s
non-consolidated, worldwide, certified
audited financial statements. However,
S1’s income and expenses are not
included in F’s non-consolidated,
worldwide, certified audited financial
statements.
On Schedule M-3, F must check
“Yes” to Question B. F must report its
net income (loss) from its
non-consolidated, worldwide, certified
audited financial statements on Part I,
line 4. On Part I, line 5, F must include
the net income (line 5c) or loss (line 5d)
generated by S1, the disregarded U.S.
entity. Because S2 is included in the
non-consolidated, worldwide, certified
audited financial statements it is not
reported on Part I, line 5, since it is
already included on Part I, line 4.
Any adjustments necessary to
remove intercompany transactions
between F and S1 must be reported on
Part I, line 8.

Line 9. Adjustment to Reconcile
Income Statement Period to Tax
Year
Include on line 9 any adjustments
necessary to reconcile differences
between the income statement period
reported on line 2a and the
corporation’s tax year. Attach a
supporting schedule identifying the type
of transaction and amount of each
adjustment.

Line 10. Other Adjustments to
Reconcile to Amount on Line 11
Include on line 10 any other
adjustments, not reportable on lines 5

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through 9, to reconcile net income
(loss) on Part I, line 4, with net income
(loss) on Part I, line 11.
For any adjustments reported on
Part I, line 10, attach a supporting
schedule that provides, for each entity
to which an adjustment relates: the
name and EIN (if applicable) of the
entity, the nature of the adjustment, the
amount of net income (loss) included in
Part I before any adjustments on line
10, and the amount of net income (loss)
included on Part I, line 11.

Line 11. Adjusted Financial Net
Income (Loss) of the
Non-Consolidated Foreign
Corporation
The sum of lines 4 through 10
constitutes the adjusted
non-consolidated financial net income
(loss) of the foreign corporation that is
to be reconciled in Parts II and III with
the foreign corporation’s taxable
income reported on Form 1120-F,
Section II, line 29.
In all cases, Part I, line 11, includes
the net income of only those entities
whose income is eligible to be included
under U.S. tax principles, in whole or
part, on the U.S. income tax return for
the tax year. It is not permissible to
remove the net income of
non-includible entities reportable on line
7 above and then add back such
income on lines 8 through 10, such that
the amount reported on line 11 includes
the net income of entities not eligible to
be includible in the U.S. income tax
return.
Example 5. Foreign corporations
other than a bank. FC is a foreign
corporation other than a bank engaged
in trade or business within the United
States and required to file Form 1120-F
and Schedule M-3. FC does not have
income statements that report its
non-consolidated, worldwide income,
but FC does have unaudited income
statements for the set(s) of books it
reports on Schedule L with respect to
its trade or business within the United
States. Included in these results are
foreign disregarded entity FDE1 with
net income of $20,000 and foreign
disregarded entity FDE2 with net loss of
($5,000). FDE1 and FDE2 do not have
any effectively connected income and
do not have books that give rise to U.S.
booked liabilities under Temporary
Regulations section 1.882-5T(d)(2)(ii).
FC reports net income on these
financial statements of $50,000. In
addition, FC has foreign locations that
are not included in such income
statements. These locations do not
have effectively connected income on
set(s) of books that give rise to U.S.
booked liabilities. The financial net
income of such foreign locations is
$25,000.

FC must answer “No” to Questions B
through D in Part I. FC must report on
Part I, line 4, $35,000 (total income
reported of $50,000, excluding the
results of FDE1 and FDE2). On Part I,
line 5a, FC will include the $20,000 of
net income of FDE1 and will include on
Part I, line 5b, the ($5,000) net loss of
FDE2. The net income of $25,000 from
foreign locations must be included on
Part I, line 6.
Example 6. Foreign corporations
other than a bank. FC is a foreign
corporation other than a bank engaged
in trade or business within the United
States and is required to file Form
1120-F and Schedule M-3. FC owns NI,
a C corporation for federal income tax
purposes. FC has certified audited
income statements that report its
worldwide income and that of NI. FC
reports net income on these statements
of $120,000. Included in these results
are foreign disregarded entity FDE1
with net income of $30,000, foreign
disregarded entity FDE2 with net loss of
($5,000), and NI’s net income of
$40,000. FDE1 and FDE2 both have
effectively connected income that give
rise to U.S. booked liabilities. Interest
income of $5,000 received by FC from
NI is eliminated in the preparation of
these statements.
FC must answer “Yes” to Question
B. FC must report on Part I, line 4,
$120,000. The results of FDE1 and
FDE2 are not reported on Part I, line 5,
since their results are already included
on Part I, line 4. NI’s income of $40,000
is reported on Part I, line 7, because NI
is a nonincludible entity. The $5,000 of
interest income is reported on Part I,
line 8. Assuming no other adjustments
are required on Part I, lines 9 and 10,
the total income reported on Part I, line
11 is $85,000 ($120,000 – $40,000 +
$5,000).
Example 7. Foreign bank. FC is a
foreign corporation that is a bank
engaged in trade or business within the
United States and required to file Form
1120-F and Schedule M-3. FC has
certified audited income statements that
report its non-consolidated, worldwide
net income and unaudited income
statements for the set(s) of books it
reports on Schedule L for its trade or
business within the United States. FC
reports net income on the set(s) of
books of its trade or business within the
United States of $50,000, which
includes the results of U.S. disregarded
entity USDE1 with net income of
$15,000 and U.S. disregarded entity
USDE2 with a net loss of ($5,000).
Although FC must answer “Yes” to
Question B, FC must not report on Part
I, line 4, the results of these
non-consolidated, worldwide, certified
audited income statements. FC must
also answer “No” to Question D. FC
must report on Part I, line 4, the amount

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from the unaudited income statements
for the set(s) of books it reports on
Schedule L of $40,000 (total income
reported of $50,000, excluding the
results of USDE1 and USDE2 which
also give rise to effectively connected
income and are set(s) of books
included in Form 1120-F, Schedule L).
On Part I, line 5c, FC will include the
$15,000 of net income of USDE1 and
will include on Part I, line 5d, the
($5,000) net loss of USDE2. Assuming
no other adjustments are required on
Part I, lines 8 through 10, the net
income reported on Part I, line 4, is
$40,000, and the net income reported
on line 11 is $50,000.

How to Complete Columns in
Parts II and III
Columns (a) and (e). For each line
item in Parts II and III, report in column
(a) the amount of the item included in
the net income (loss) reported on Part I,
line 11. For each line item, report in
column (e) the amount included in
determining taxable income (loss) on
Form 1120-F, Section II, line 29.
A foreign corporation is not required
to complete columns (a) and (e) for the
first tax year the foreign corporation is
required to file Schedule M-3. The
corporation must complete columns (a)
and (e) for all tax years it is required to
file Schedule M-3 that are subsequent
to the first tax year the corporation is
required to file Schedule M-3.
If, for any tax year (or tax years)
prior to the first tax year a foreign
corporation is required to file Schedule
M-3, a foreign corporation voluntarily
files Schedule M-3 in lieu of Schedule
M-1, then in those voluntary filing years
the corporation is not required to
complete columns (a) and (e). In
addition, in the first tax year the foreign
corporation subsequently is required to
file Schedule M-3, the corporation is not
required to complete columns (a) and
(e) of Parts II and III.
If a foreign corporation chooses not
to complete columns (a) and (e) in the
first tax year the foreign corporation is
required to file Schedule M-3 (or in any
year in which the corporation voluntarily
files Schedule M-3), then Part II, line
28, is reconciled by the corporation in
the following manner:
1. Report the amount from Part I,
line 11, on Part II, line 28, column (a);
2. Do not complete Part II, lines 1
through 27, columns (a) and (e);
3. Do not complete Part III, columns
(a) and (e);
4. Report on Part II, line 28,
columns (b) through (d), the total of
Part II, lines 1 through 27, columns (b)
through (d) respectively, and
5. Report on Part II, line 28, column
(e), the sum of Part II, line 28, columns
(a), (b), (c) and (d).

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Note. Part II, line 28, column (e), must
equal the amount on Form 1120-F,
Section II, line 29.
Example 8. For the 2007, 2008,
and 2009 tax years, foreign corporation
A has total assets on the last day of the
tax year as reported on Schedule L,
line 17, column (d), of $8 million, $11
million, and $12 million, respectively. A
is required to file Schedule M-3 for its
2008 and 2009 tax years.
For its 2007 tax year, A voluntarily
files Schedule M-3 in lieu of Schedule
M-1 and does not complete columns (a)
and (e) of Parts II and III.
For A’s 2008 tax year, the first tax
year that A is required to file Schedule
M-3, A is only required to complete Part
I and columns (b), (c) and (d) of Parts II
and III.
For A’s 2009 tax year, A is required
to complete Schedule M-3 in its
entirety.
In addition, for A’s 2008 tax year, A
may voluntarily complete Schedule M-3
in its entirety.

Columns (b), (c), and (d)
The temporary and permanent
differences reportable in columns (b)
and (c) are those book tax differences
determined through a comparison of
the financial statement and tax
amounts, under the Code or an
applicable treaty, for each of the line
items included in Part I, line 11 and
shown on Parts II and III.
Column (b). Temporary book tax
differences. In column (b), report the
book tax difference for each item
expected to reverse in a future year or
which reverses a prior year difference
(whether or not so reported on a prior
year’s Schedule M-3). Temporary
differences that increase the amount
shown in column (a) are reported as a
positive number.
Column (c). Permanent book tax
differences. In column (c) report any
book tax difference not expected to
reverse in a future year, and that also
does not constitute a reversal of a prior
year difference. The determination
whether a difference is temporary or
permanent should be based on the
facts available at the time the foreign
corporation files its U.S. tax return. If
the foreign corporation is unable to
determine whether a difference
between column (a) and column (e) for
an item will reverse in a future tax year
or reverses a prior year book tax
difference, report the difference for that
item in column (c).
Amounts that are permanent
differences that reduce the income or
expense amount shown in column (a)
are recorded as negative numbers. For
example, interbranch income and
expense amounts recorded on a foreign
bank’s books reportable on Schedule L

(and therefore included in column (a))
that are disregarded under U.S. tax
principles are permanent differences
reportable as negative amounts in
column (c).
If interbranch amounts recorded on
Schedule L books are treated as
third-party amounts under Proposed
Regulations section 1.863-3(h) of the
global dealing rules, or recognition
treatment is otherwise provided under
an Advance Pricing Agreement or
Mutual Agreement Procedure, then
such interbranch amounts are treated
as amounts subject to apportionment
between non-ECI and ECI in columns
(d) and (e) and not as permanent
differences in column (c).
Amounts that are apportionable to
non-ECI are generally reportable only in
column (d). However, some amounts
may be both permanent differences
under U.S. tax principles and also be
apportioned to non-ECI under section
864(c).
A permanent difference may not be
double-counted by including it a second
time in column (d). In such
circumstances, where an amount
includible in column (a) is both a
permanent difference and
apportionable to non-ECI, the amount is
reported in column (c) and not in
column (d). Accordingly, non-ECI
tax-exempt interest is reported in
column (c) as a permanent difference
under U.S. tax principles. No additional
apportionment is necessary in column
(d) for such amounts.
Special treatment may apply for
column (c) reporting on Part III, lines
26d (U.S. source substitute interest
payments), 26e (interest equivalents),
and 27 (U.S. source substitute dividend
payments). See instructions for those
lines below.
Apportionments between
effectively and non-effectively
connected income (ECI and
non-ECI). The combination of
columns (a), (b) and (c) results in the
gross taxable income or deduction
amount under U.S. tax principles for
each line item in Parts II and III that is
eligible for allocation and apportionment
between ECI and non-ECI.
Columns (d) and (e). Foreign
bank. Column (d) is used to report the
combined amount of columns (a), (b),
and (c) that is allocated and
apportioned to non-ECI. If an amount
apportioned to non-ECI is included in
column (a), then report such amount as
a negative number in column (d). If the
apportioned amount included in column
(a) is a loss, then include the
apportioned loss as a positive number
in column (d). Certain income may be
apportioned to ECI that is not reported
on the Schedule L books and is not
reportable in column (a). These
amounts include allocable global

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dealing income in Part II, line 16 and
other income from non-Schedule L
books reportable in Part II, line 23.
Such income is apportioned to ECI and
reported in column (d) as a positive
number. For amounts reportable in Part
II, if the apportioned amount is a loss,
report such loss as a negative number
in column (d). In column (e), combine
the amounts in columns (a), (b), (c) and
(d), to determine the amount of each
line item apportioned to ECI. See
special reporting instructions for
reporting amounts in column (d) for
substitute dividend and substitute
interest income in Part II, lines 3c and
4b and for the allocation and
apportionment of interest expense in
Part III, line 26. Expenses allocable
from Schedule H, line 21 are reportable
in Part III, line 31 in columns (d) and (e)
as a positive number.
Columns (d) and (e). Foreign
corporations other than banks.
Foreign corporations other than banks
use column (d) to report
apportionments only to non-ECI. In Part
II, column (d) report apportionments of
income as a negative amount and
report losses as a positive number.
Combine columns (a), (b), (c) and (d) to
reconcile the amount apportioned to
ECI in column (e). For Part III, except
for lines 26 and 31, report expenses
that are apportioned to non-ECI as a
negative number in column (d). See
special instructions for the reporting of
interest expense on line 26.
Corporations other than banks do not
report the allocation of expenses under
Regulations section 1.861-8 from
Schedule H (Form 1120-F), line 21, on
Schedule M-3, Part III, line 31.
Part III, lines 26d, 26e and 27. In
Part III, line 26d (substitute interest
payments), line 26e (interest
equivalents) and line 27 (substitute
dividend payments), amounts in these
categories paid by the foreign
corporation that are not included in
column (a) are reported in column (c)
as a positive number. Amounts
described in lines 26d, 26e and 27 are
reported in column (c) whether or not
any of the amount is apportionable in
whole or in part to ECI in column (e).
Column (d) is used for these line items
only to apportion amounts to non-ECI.
Example 9. FC is a foreign bank
that is required to file Form 1120-F and
Schedule M-3. FC included on Part I,
line 11, $100 of interest income, of
which $60 is effectively connected
tax-exempt interest income and $40 is
noneffectively connected tax-exempt
interest income. In addition, FC
included on Part I, line 11, $300 of fee
and commission income that was
recognized for U.S. tax purposes in a
prior year. FC also included $400 of
meals and entertainment expenses of
which $200 is deductible under section
274. FC determines that 60% of its

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deductions under U.S. tax principles
are allocable to noneffectively
connected income.
FCs reports on Part II, line 4a,
column (a), the $100 of tax-exempt
interest income. FC reports ($100) of
permanent book tax difference on line
4a, column (c) to eliminate the
tax-exempt interest income. No amount
is reportable on line 4a, column (d)
since all of the income is a permanent
difference under U.S. tax principles
without regard to its allocation between
effectively and noneffectively connected
income. FC also includes on Part II, line
7, column (a), the $300 of fee and
commission income. Since this amount
was already recognized in a prior year
for U.S. tax purposes, FC reports on
line 7, column (b), a temporary
difference of ($300). On Part III, line 10,
column (a), FC includes the $400 of
meals and entertainment expenses. FC
first computes its limitation under
section 274 before determining the
amount allocable to noneffectively
connected income for purposes of
column (d). Therefore, FC reports in on
Part III, line 10, column (c), a
permanent difference of ($200). FC
then determines the 60% of remaining
meals and entertainment expense that
is allocable to noneffectively connected
income and reports this $120 on Part
III, line 10, column (d) as a negative
amount. FC combines columns (a), (b),
(c) and (d) and reports the $80
deductible amount in line 10, column
(e).
Example 10. The facts are the
same as in Example 9, except the $100
of tax-exempt interest is not included
on Part I, line 11, and is therefore
excluded from Part II, line 4, column
(a). Because the $100 of tax-exempt
interest income is allocable to both ECI
and non-ECI, it has significance in
determining the allocation of expenses
under indirect methods under
Regulations section 1.861-8, and is
therefore required to be reported on
Part II, line 23 as income not included
in the Schedule L books that is
allocable and apportionable to ECI.
Because no amount is includible in
column (a), the full $100 of tax-exempt
interest is reported in column (d) as a
positive number and in column (c) as a
negative number . As a result, there is
no amount reportable in column (e).

Treatment of Items Under an
Eligible Treaty-Based Return
Position to Attribute
Business Profits to a U.S.
Permanent Establishment
If a foreign corporation elects to use an
eligible treaty (e.g., Article 7 and
accompanying Exchange of Notes of
the 2001 United States-United Kingdom
and 2003 United States-Japan Income
Tax treaties) that provides a

permissible method other than the rules
of section 864(c) and 882 to determine
its profits attributable to a U.S.
permanent establishment, check the
“Yes” box for Question A on Part I of
Schedule M-3. If an eligible treaty is
elected, the foreign corporation must
report on Form 1120-F, Section II, its
business profits attributable to its U.S.
permanent establishment under such
income tax treaty that applies the
OECD Transfer Pricing Guidelines in
lieu of the effectively connected income
rules of sections 864 and 882. When
business profits are reported on Form
1120-F, Section II under an eligible
treaty in lieu of the effectively
connected income rules of the Code,
the treatment of items in columns (c)
and (d) must be adapted to apply the
concepts of the applicable treaty.
Foreign bank treaty-based reporting.
If the foreign corporation is a foreign
bank, interbranch income and expense
and noneffectively connected income
are not treated as permanent
differences to the extent such items are
attributable to the U.S. permanent
establishment and are also included in
the net income (loss) reported on Part I,
line 11. For any item reported on Part I,
line 11 that is attributable to the foreign
corporation’s U.S. permanent
establishment, such amounts may have
temporary differences under U.S. tax
principles (e.g., depreciation deductions
includible in column (a) may have
temporary book tax differences
reportable in column (b)). For amounts
reported in Part II, column (a), do not
report as permanent differences,
interbranch interest or other interbranch
income in column (c) or noneffectively
connected income including foreign
related party interest, dividends or
royalties that are not effectively
connected income under section
864(c)(4)(D) in column (d) to the extent
such amounts are attributable to the
U.S. permanent establishment under
the OECD Transfer Pricing Guidelines,
applied by analogy. For foreign banks,
if any amounts are not reported in Part
II, column (a), as part of the set(s) of
books that constitute the books of the
U.S. permanent establishment, but are
attributable to the U.S. permanent
establishment under application of the
OECD Transfer Pricing Guidelines,
such amounts are included as
permanent differences in columns (c)
and (d). Report in column (e) all
amounts that are attributable to the
permanent establishment.
Treaty-based reporting for foreign
corporations other than banks.
Foreign corporations other than banks
must include interbranch income and
expense as book tax differences to the
extent such items are not included in
worldwide income reported on Part I,
line 11, and such items are attributable
to the U.S. permanent establishment.

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Interbranch income should have been
eliminated in arriving at the adjusted
non-consolidated income reportable on
Part I, line 11. To the extent such
interbranch amounts are attributable to
a U.S. permanent establishment under
Article 7 of an applicable income tax
treaty, the amounts are also includible
as a book tax difference if they are
reported in business profits under an
eligible treaty-based tax return position.
Such amounts are reported as
permanent differences in column (c)
and included in column (e). Third-party
amounts included in worldwide income
that are not attributable to the U.S.
permanent establishment should be
reported in the following manner:
Columns (b) and (c). Temporary
and permanent differences are
determined in accordance with the
above instructions for these columns,
except that each line in column (e) is as
determined below.
Column (d). Differences for
amounts not attributable to a U.S.
permanent establishment are reported
as a negative number in column (d).
Differences for losses not attributable to
a U.S. permanent establishment are
reported as a positive number in Part II.
Column (e). Combine columns (a),
(b), (c) and (d) and report the income or
deduction for each line item that is
includible in business profits attributable
to the U.S. permanent establishment in
column (e).
Example 11. Treaty-based
reporting of business profits. FC is
a foreign bank that has three sets of
books that give rise to U.S. book
liabilities under Regulations section
1.882-5(d)(2)(iii) and that are reportable
on Form 1120-F, Schedule L. Two of
the books are maintained in the United
States by its U.S. branch. The third
book is a portfolio of effectively
connected loans that are recorded,
managed and funded in FC’s home
office in Country X. The three books
are consolidated for Form 1120-F,
Schedule L reporting purposes. FC files
its Form 1120-F and Schedule M-3
under an eligible treaty to report its
business profits attributable to its U.S.
permanent establishment in lieu of
reporting its net effectively connected
income under sections 864 and 882.
The two books maintained in the United
States are primarily attributable to FC’s
U.S. permanent establishment. The
third set of books that constitutes a set
of books for Regulations section
1.882-5(d)(2)(iii) purposes is not
attributable to FC’s permanent
establishment in the year FC files its
Form 1120-F under the treaty-based
method.
On the two books that are
attributable to FC’s U.S. permanent
establishment, FC records net book
income of $175. (FC has the following

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income: $500 of interbranch interest
income, $200 of noneffectively
connected interest income, and $1,200
of effectively connected income under
Code-based principles. FC has $1,000
of third party interest expense and $400
of interbranch interest expense on the
books of its U.S. permanent
establishment that is priced at arm’s
length with its home office. Each type of
interest expense is also attributable to
its U.S. permanent establishment. On
the two sets of books maintained in the
United States, FC has other third party
expenses of $325 attributable to the
permanent establishment.) FC also has
$100 of income attributable to its U.S.
permanent establishment that is
recorded in its home office on set(s) of
books that are predominantly not
attributable to FC’s U.S. permanent
establishment. FC determines that $75
of its book interest expense must be
disallowed after equity capital is
allocated to the U.S. permanent
establishment under the OECD
Transfer Pricing Guideline principles
applicable to Article 7 of the treaty.
FC reports $350 of treaty-based
profits attributable to its U.S. permanent
establishment as follows:
On Part II, line 4a, column (a),
$1,900 of interest income is reported
for the total interest income of the set(s)
of books attributable to the U.S.
permanent establishment. In column
(c), $100 is reported as a permanent
difference for the income not included
on the set(s) of books reported on Form
1120-F, Schedule L. In column (e), the
total interest of $2,000 is reported as
income attributable to the U.S.
permanent establishment.
On Part III, line 26a, the U.S.
permanent establishment’s book
interest expense of $1,400 is reported
in column (a). The total book amount is
reversed on line 26a in either column
(b) or (c). The $1,400 from column (a)
is reported in columns (b) and/or (c) as
a negative number. This includes the
$75 portion of the $1,400 that
constitutes equity capital allocated to
the U.S. permanent establishment. On
Part III, line 26b, column (d), the $1,325
tax amount of the interest expense
(after the $75 allocation of equity
capital is taken into account) is
reported. This $1,325 amount reported
in column (d) is carried to column (e)
and constitutes the amount from line
26a that is treated as interest expense
attributable to the business profits of
the U.S. permanent establishment.
On Part III, the $325 of book
expenses attributable to the U.S.
permanent establishment are recorded
in columns (a) and (e) in their
respective categories. No adjustments
are made in this example in column (b)
for temporary differences or to business
profits that are not attributable to the

U.S. permanent establishment in
column (d). No additional expenses are
attributable to the U.S. permanent
establishment from the home office,
which would have been reportable in
column (d).

Schedule M-3 Reporting
Requirements for
Regulations Section
1.6011-4(b) Reportable
Transactions
If an amount is attributable to a
reportable transaction described in
Regulations section 1.6011-4(b), the
amount must be reported in columns
(a), (b), (c), (d) and (e), as applicable,
of Part II, line 12 (items relating to
reportable transactions), regardless of
whether the amount would otherwise be
reported on Part II or Part III of
Schedule M-3. Thus, if a taxpayer files
Form 8886, Reportable Transaction
Disclosure Statement, the amounts
attributable to that reportable
transaction must be reported on Part II,
line 12.
A corporation is required to report in
column (a) of Parts II and III the amount
of every item specifically listed on
Schedule M-3 that is in any manner
included in the foreign corporation’s
current year income statement net
income (loss) or in an income or
expense account maintained in the
corporation’s books and records, even
if there is no difference between that
amount and the amount included in
taxable income. However, this reporting
is not required in cases where (a) these
instructions provide otherwise, or (b)
the amount is attributable to a
reportable transaction described in
Regulations section 1.6011-4(b) and is
therefore reported on Part II, line 12.
For example, with the exception of
interest income reflected on a Schedule
K-1 received by a foreign corporation
as a result of the corporation’s
investment in a partnership or other
pass-through entity, and interest
equivalents, all interest income included
on Part I, line 11, whether from
unconsolidated affiliated companies,
third parties, banks, or other entities,
whether from foreign or domestic
sources, whether taxable or exempt
from tax, and whether classified as
some other type of income for U.S.
income tax purposes (such as
dividends), must be included on Part II,
line 4a, column (a). For the exceptions,
look for the specific line in Part II.
Similarly, all fines and penalties
included in Part I, line 11, paid to a
government or other authority for the
violation of any law for which fines or
penalties are assessed, must be
included on Part III, line 11, column (a),
regardless of the authority that imposed
the fines or penalties, regardless of

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whether the fines or penalties are civil
or criminal, regardless of the
classification, nomenclature, or
terminology attached to the fines or
penalties by the imposing authority in
its actions or documents.
Assume that a foreign corporation
would be required to report in column
(a) of Parts II and III the amount of an
item specifically listed on Schedule M-3
in accordance with the preceding
paragraphs, except for the fact that the
corporation has capitalized the item of
income or expense and reports the
amount in its income statement balance
sheet or in asset and liability accounts
maintained in the corporation’s books
and records instead of in its income
statement. In that case, the foreign
corporation must report the proper tax
treatment of the item in columns (b),
(c), (d), and (e), as applicable.
Furthermore, in applying the
preceding paragraphs, a foreign
corporation is required to report in
column (a) of Parts II and III the amount
of any item specifically listed on
Schedule M-3 that is included on Part I,
line 11, regardless of the nomenclature
associated with that item in the income
statements or books and records.
Accurate completion of Schedule M-3
requires reporting amounts according to
the substantive nature of the specific
line items included in Schedule M-3 and
consistent reporting of all transactions
of like substantive nature that occurred
during the tax year.
For example, all expense amounts
that are included in the income
statements or exist in the books and
records that represent some form of
“Bad debt expense” must be reported
on Part III, line 24, column (a),
regardless of whether the amounts are
recorded or stated under different
nomenclature in the income statements
or the books and records such as:
“Provision for doubtful accounts,”
“Allowance for uncollectible notes
receivable,” or “Impairment of trade
accounts receivable.” Likewise, as
stated above, all fines and penalties
must be included on Part III, line 11,
column (a), regardless of the
terminology or nomenclature attached
to them by the corporation in its books
and records or income statements.
Similarly, if the fine and penalty, for
example, is included in another item,
the amount of the fine or penalty should
be segregated and included on Part III,
line 11.
With limited exceptions, Part II
includes lines for specific items of
income, gain, or loss (“income items”).
If an income item is described in Part II,
lines 1 through 23, report the amount of
the item on the applicable line,
regardless of whether or not there is
any difference for the item. If there is a
difference for the income item, or only a

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portion of the income item has a
difference and a portion of the item
does not have a difference, and the
item is not described in Part II, lines 1
through 23, report and describe the
entire amount of the item on Part II, line
24.
With limited exceptions, Part III
includes lines for specific items of
expense, allocation, or deduction
(“expense items”). If an expense item is
described on Part III, lines 1 through
31, report the amount of the item on the
applicable line, regardless of whether or
not there is a difference for the item. If
there is a difference for the expense
item, or only a portion of the expense
item has a difference and a portion of
the item does not have a difference and
the item is not described in Part III,
lines 1 through 31, report and describe
the entire amount of the item on Part III,
line 32.
If there is no difference between the
financial accounting amount and the
taxable amount of an entire item of
income, loss, expense, or deduction
and the item is not described or
included in Part II, lines 1 through 24,
or Part III, lines 1 through 32, report the
entire amount of the item in columns (a)
and (e) of Part II, line 27.
Separately stated and adequately
disclosed. Each difference reported in
Parts II and III must be separately
stated and adequately disclosed. In
general, a difference is adequately
disclosed if the difference is labeled in
a manner that clearly identifies the item
or transaction from which the difference
arises. For further guidance about
adequate disclosure, see Regulations
section 1.6662-4(f), Rev. Proc.
2004-45, 2004-31 I.R.B. 140, and Rev.
Proc. 2005-75, 2005-50 I.R.B. 1137. If
a specific item of income, gain, loss,
expense, allocation or deduction is
described on Part II, lines 1 through 24,
or Part III, lines 1 through 32, and the
line does not indicate to “attach
schedule” or “attach details,” and the
specific instructions for the line do not
call for an attachment of a schedule or
statement, then the item is considered
separately stated and adequately
disclosed if the item is reported on the
applicable line and the amount(s) of the
item(s) are reported in the applicable
columns of the applicable line.
Note. A schedule or explanation may
be attached to any line even if none is
required.
Except as otherwise provided,
differences for the same item must be
combined or netted together and
reported as one amount on the
applicable line of Schedule M-3.
However, differences for separate items
must not be combined or netted
together. Each item (and corresponding

amount attributable to that item) must
be separately stated and adequately
disclosed on the applicable line of
Schedule M-3, or any schedule
required to be attached, even if the
amounts are below a certain dollar
amount.
Example 12. Temporary
differences. Foreign corporation FC
has been filing a Form 1120-F from its
2000 tax year through the present. The
income statement year is identical to
the tax year. FC placed in service ten
depreciable, fixed, U.S. assets during
its 2000 tax year. FC was required to
file Schedule M-3 for its 2007 tax year
and is required to file Schedule M-3 for
its 2008 tax year. FC’s total
depreciation expense for its 2008 tax
year for five of the assets is $50,000 for
income statement purposes and
$70,000 for U.S. income tax purposes.
FC’s total annual depreciation expense
for its 2008 tax year for the other five
assets is $40,000 for income statement
purposes and $30,000 for U.S. income
tax purposes. In its income statements,
FC treats the differences between
income statement and U.S. income tax
depreciation expense as giving rise to
temporary differences that will reverse
in future years. FC must combine all of
its depreciation adjustments.
Accordingly, for its 2008 tax year, FC
must report on Part III, line 23
depreciation expense as shown on its
income statement of $90,000 in column
(a), a temporary difference of $10,000
in column (b), and U.S. income tax
depreciation expense of $100,000
apportionable between non-ECI and
ECI in column (d) and column (e).
Example 13. Bad debt and
warranty reserves. Foreign
Corporation D was required to file
Schedule M-3 for its 2007 tax year and
is required to file Schedule M-3 for its
2008 tax year. The income statement
year is identical to the tax year. On the
last day of its 2008 tax year, D
establishes two reserve accounts in the
amount of $100,000 for each account.
One reserve account is an allowance
for accounts receivable that are
estimated to be uncollectible. The
second reserve is an estimate of future
warranty expenses. Both reserves are
only for assets that give rise to
effectively connected income. In its
income statements, D treats the two
reserve accounts as giving rise to
temporary differences that will reverse
in future years. The two reserves are
expenses for D’s 2008 income
statements but are not deductions for
U.S. income tax purposes in 2008. D
must not combine the Schedule M-3
differences for the two reserve
accounts. D must report the amounts

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attributable to the allowance for
uncollectible accounts receivable on
Part III, line 24, Bad debt expense, and
must separately state and adequately
disclose the amounts attributable to the
other reserve, for warranty costs, on a
required attached schedule that
supports the amounts on Part III, line
32.
Example 14. Non-ECI and ECI
apportionment of temporary
differences. Corporation E was
required to file Schedule M-3 for its
2007 tax year and is required to file
Schedule M-3 for its 2008 tax year. The
income statement year is identical to
the tax year. At the beginning of the
2008 tax year, E establishes an
allowance for uncollectible accounts
receivable (bad debt reserve) of
$100,000, all of which is related to
assets that give rise to effectively
connected income. During 2008, E
increased the reserve by $250,000 for
additional accounts receivable that may
become uncollectible, of which
$150,000 is related to assets that give
rise to effectively connected income.
Additionally, during 2008, E decreases
the reserve by $75,000 for accounts
receivable that were discharged in
bankruptcy during 2008, of which
$50,000 is related to assets that give
rise to effectively connected income.
The balance in the reserve account on
the last day of the 2008 tax year, is
$275,000, of which $200,000 relates to
assets that give rise to effectively
connected income. The $100,000
amount to establish the reserve
account and the $250,000 to increase
the reserve account are expenses on
E’s 2008 income statements, but are
not deductible for U.S. income tax
purposes in 2008. However, of the
$75,000 decrease to the reserve, only
$50,000, which is attributable to assets
that give rise to effectively connected
income, is deductible for U.S. income
tax purposes in 2008.
In its income statements, E treats
the reserve account as giving rise to a
temporary difference that will reverse in
future tax years. E must report on Part
III, line 24, Bad debt expense, for its
2008 tax year income statement bad
debt expense of $350,000 in column
(a). The temporary difference of
($275,000) is determined under U.S.
tax principles and reported in column
(b) without regard to its effectively or
noneffectively connected character.
The amounts allocable to noneffectively
connected income are then determined
and reported in column (d). FC must
report the $(25,000) allocable to
noneffectively connected income in
column (d) and U.S. income tax bad
debt expense of $50,000 in column (e).

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Part II. Reconciliation of
Net Income (Loss) per
Income Statement of
Non-Consolidated
Foreign Corporations
with Taxable Income per
Return
Note. Foreign corporations report, on
lines 1 through 25 and 27 in column (a),
the gross income amounts included in
the financial net income (loss) reported
on Part I, line 11. See the instructions
for Part I, line 11 for reporting
differences between foreign banks and
foreign corporations other than a bank.

Line 1. Gross Receipts or Sales
Enter total gross receipts or sales net of
returns and allowances. In column (e),
enter the amount from Form 1120-F,
Section II, line 1c. Do not report gross
receipts resulting from reportable
transactions (line 12), sale of securities
that are marked to market (line 14),
currency gains and losses from other
section 988 transactions (line 15), or
receipts or sales of securities from
global securities dealings (line 16).

Line 2. Cost of Goods Sold
Report on line 2 any amounts deducted
as part of cost of goods sold during the
tax year, regardless of whether the
amounts would otherwise be reported
elsewhere in Part II or Part III.
However, do not report the items
mentioned in the next paragraph on this
line 2. Examples of amounts that must
be included on line 2 are amounts
attributable to inventory valuation, such
as amounts attributable to cost-flow
assumptions, additional costs required
to be capitalized (including
depreciation) such as section 263A
costs, inventory shrinkage accruals,
inventory obsolescence reserves, and
lower of cost or market (LCM)
write-downs. Attach a schedule
separately stating each item included
on this line and the amount for each
column.
Do not report the following on this
line 2:
• Amounts reportable on Part II, line
12;
• Any gain or loss from inventory
hedging transactions reportable on Part
II, line 13;
• Mark-to-market income or (loss)
under section 475 reportable on Part II,
line 14;
• Global dealing income reportable on
Part II, line 16;
• Section 481(a) adjustments related to
cost of goods sold or inventory
valuation reportable on Part II, line 18;

• Original issue discount, imputed

interest, and phantom income
reportable on Part II, line 20;
• Fines and penalties reportable on
Part III, line 11;
• Judgments, damages, awards and
similar costs, reportable on Part III, line
12;
• Amounts reported on Part II, line 17,
Sales versus lease; and
• Amounts reported on Part III, line 25,
Purchase versus lease.

Lines 3a through 3b. Dividends
Report on the lines 3a through 3b,
column (a), the amount of dividends
included in Part I, line 11 from foreign
and U.S. entities. Report on lines 3a
through 3b, column (e), the amount of
any dividends included in taxable
income on Form 1120-F, Section II, line
4. Do not include on lines 3a through
3b dividends from global securities
dealing which are reportable on Part II,
line 16c, or dividends reported
elsewhere (e.g., line 12 for reportable
transactions). Any effectively connected
dividends from corporations reported by
the foreign corporation under the equity
method are reported in columns (c) and
(e) of this line, as described in the
instructions for Part II, line 8.

Line 3c. Substitute Dividend
Payments Received
Report on line 3c, the gross substitute
dividend payments received with
respect to securities loans under
section 1058 or substantially similar
transactions, or from sale repurchase
transactions, as described in
Regulations sections 1.861-3(a)(6),
1.864-5(b)(2)(ii), and 1.881-2(b)(2). Do
not net substitute dividend payments
received against any substitute
dividend payments made by the foreign
corporation to another securities lender.
Foreign banks must also report in
column (c) all U.S. source substitute
dividend payments received as
beneficial owner to the extent they are
not already included in Part I, line 11.
The U.S. source substitute payments
are reportable on line 3c whether or not
such payments received are effectively
connected income. For example,
substitute dividends received by a
foreign bank that are all recorded on
set(s) of books that are not reported on
Form 1120-F, Schedule L, must report
these U.S. source payments received
as a positive number in column (c) and
reverse the non-ECI portion of the total
in column (c) as a negative number in
column (d). Reporting in column (c) and
(d) for substitute dividends is required
even if no amount would be reported in
columns (a) and (e). Any U.S. source
substitute dividends that are effectively
connected with the foreign corporation’s
trade or business within the United
States are reportable in column (e),
however. Do not report on any line

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substitute dividend payments received
in custody for another owner of the
substitute payment.
Note. U.S. source substitute dividend
payments are characterized as
dividends only to the extent they are
not effectively connected with the
foreign corporation’s trade or business
within the United States. U.S. source
effectively connected substitute
dividends are characterized as “other
income.” See Rev. Rul. 60-177, 1960-1
CB 9. U.S. source substitute dividends
received by the foreign corporation may
also be reportable on Form 1120-F,
Section I.
Example 15. FC, a foreign bank
resident in Country X, is engaged in a
banking trade or business within the
United States through a U.S.
permanent establishment. FC has an
income tax treaty with the United States
that imposes a 15% tax on gross
portfolio dividends received by the
corporation that are not attributable to a
U.S. permanent establishment. FC
records securities lending transactions
with respect to U.S. and foreign stocks
on its home office set(s) of books.
These set(s) of books do not give rise
to U.S. booked liabilities under
Regulations section 1.882-5(d)(2)(iii)
and are not reportable on Form 1120-F,
Schedule L. FC receives $200 of
substitute dividends from transactions
described in section 1058, all of which
are not effectively connected with FC’s
trade or business within the United
States and are not attributable to FC’s
U.S. permanent establishment. Under
Regulations sections 1.861-3(a)(6) and
1.881-2(b)(2), the substitute dividends
are sourced and characterized as U.S.
source dividends. Under FC’s treaty
with the United States, the dividends
are subject to a 15% gross basis tax.
The substitute payments are not
reportable on Part I, line 11, or Part II,
line 3c, column (a). FC must report
$200 of dividends on line 3c, column (c)
as a positive number. On line 3d,
column (d), the $200 is reported as a
negative number. FC enters zero in
column (e). On Form 1120-F, Section I,
FC must report the substitute dividends
received that are not reported by the
withholding agent on Form 1042-S.

Line 4a. Interest Income
Excluding Interest Equivalents
Report on Part II, line 4a, column (a),
the total amount of interest income
included in Part I, line 11, and report on
Part II, line 4a, column (e), the total
amount of interest income included on
Form 1120-F, Section II, line 5, that is
not required to be reported elsewhere
in Part II. In columns (b) or (c), as
applicable, adjust for amounts treated
for U.S. income tax purposes as
interest income that are treated as
some other character of income in the

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income statements, or vice versa. All
interbranch interest income included on
Part I, line 11, that is excluded from
taxable income is reported as a
permanent difference in column (c). For
foreign corporations other than banks,
see the instructions for Part I, line 8,
regarding eliminations of interbranch
transactions.
Do not report on this line 4a, in any
column, amounts reported in
accordance with instructions for Part II,
lines 4b, 4c, 9, 10, 11, 12, 13, 16a, 20
and 23.
Example 16. FC is a foreign bank
that is required to file Form 1120-F and
Schedule M-3. FC included on Part I,
line 11, the following interest income
items totaling $2,000: $600 of
interbranch interest income; $100 of
tax-exempt interest, $60 of which is
effectively connected; $300 of interest
income with respect to securities
described in Regulations section
1.864-4(c)(5)(ii)(b)(3) (“10% rule
securities”), $150 of which is allocable
to noneffectively connected income
under the rule of that paragraph; and
$1,000 of other effectively connected
interest income.
FC reports on Part II, line 4a, column
(a) all $2,000 of this interest income.
FC reports ($700) as a permanent
difference on line 4a, column (c), to
eliminate all $100 of the tax-exempt
interest income (including the
noneffectively connected portion) and
all $600 of the interbranch interest
income. FC must also report ($150) of
noneffectively connected interest
income from its “10% rule securities” in
column (d) as a negative amount. FC
combines columns (a), (b), (c) and (d)
and reports $1,150 of effectively
connected interest income in column
(e).

Line 4b. Substitute Interest
Payments Received
Report on line 4b, the gross substitute
interest payments received with respect
to securities loans under section 1058,
sale repurchase transactions, or similar
transactions, as described in
Regulations sections 1.861-2(a)(7),
1.864-5(b)(2)(ii) and 1.881-2(a)(2). Do
not net substitute interest payments
received against substitute interest
payments made by the foreign
corporation with respect to any section
1058 sale repurchase transactions,
including payments made with respect
to “matched book” transactions, or any
similar transaction.
Foreign banks must report all U.S.
source substitute interest payments
received as beneficial owner, whether
or not such payments are included in
Part I, line 11, and whether or not such
payments are effectively connected
income. All U.S. sourced substitute
interest received by a foreign bank that

is recorded on set(s) of books that are
not reported on Form 1120-F, Schedule
L, are reportable in column (c) and the
non-ECI portion is reversed as a
negative amount in column (d). Both
U.S. and foreign source substitute
interest that is effectively connected
with the foreign corporation’s trade or
business within the United States is
reportable in line 4b, column (e).
Do not report on line 4b substitute
interest payments received in custody
for another owner of the substitute
payment.
Report all substitute interest
payments received on line 4b whether
or not such amounts are characterized
as interest or other income under the
Code.
Note. U.S. source substitute interest
payments received are characterized
as “other income” to the extent such
amounts are effectively connected with
the foreign corporation’s trade or
business within the United States. See
Rev. Rul. 80-135, 1980-12 C.B. 18.
U.S. source substitute interest received
by the foreign corporation may also be
reportable on Form 1120-F, Section I.
Example 17. FC, a foreign bank,
receives $1,000 of gross U.S. source
substitute interest payments with
respect to sale repurchase agreements.
FC also has $200 of gross U.S. source
substitute interest with respect to
securities loans of municipal bonds in
transactions described in section 1058.
All of the substitute interest received
was included on FC’s set(s) of books
reported on Form 1120-F, Schedule L
and is reportable on Part I, line 11.
FC must report all $1,200 of the
substitute interest in column (e) as
effectively connected income. The $200
of U.S. source ECI substitute interest
received from the municipal bond
securities loans is not characterized as
tax-exempt municipal bond interest, but
is U.S. source “other income”
consistent with the characterization
provisions applicable only to substitute
interest payments described in
Regulations section 1.881-2(a)(2).
Accordingly, no amount of the payment
is reportable in column (c) as a
permanent difference.

Line 4c. Interest Equivalents
Other Than Substitute Interest
Reported on Line 4b
Report on line 4c, interest income
equivalents other than substitute
interest reportable on line 4b or other
interest equivalents reportable on other
lines in Part II. Interest equivalents
reportable on line 4c generally consist
of fees and commission income with
respect to certain financial transactions
that do not give rise to interest under
section 163 (e.g., financial guarantee
fees, and acceptance confirmation and
standby letter of credit fees). Do not

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report periodic income with respect to
notional principal contracts on Part II,
line 4c. Such amounts are generally
reportable on other lines, such as that
for hedging transactions (line 13),
global dealing (line 16c) or if the
corporation is a mere investor in
notional principal contracts, on line 24
(other income (loss) items with
differences).
Do not report on this line 4c,
amounts reported in accordance with
instructions for Part II, lines 4a, 4b, 9,
10, 11, 12, 13, 16a, 20 and 23.

Line 5. Gross Rental Income
Report on line 5, gross rental income
that is treated as rental income for both
the taxpayer’s financial reporting
purposes and for U.S. income tax
purposes. Gross rents that are
recorded as a sale for financial
purposes and as rental income for
federal tax purposes or vice-versa, are
reportable on Part II, line 17, instead of
line 5.

Line 7. Fee and Commission
Income
Report on line 7, column (a), any
amounts included on Part I, line 11, as
gross fee and commission income.
Such income generally includes income
with respect to services performed
(e.g., fees for brokerage service
transactions and negotiation letters of
credit). Do not include amounts
reportable on Part II, line 4c.

Line 8. Income (Loss) From
Equity Method Corporations
Report on line 8, column (a), the
income statement income (loss)
included in Part I, line 11, for any
corporation accounted for on the equity
method. Remove such amount in
column (b) or (c), as applicable. Include
on Part II, line 3, columns (c) and (e),
dividends received from any
corporation accounted for on the equity
method to the extent the dividends
constitute effectively connected income.

Lines 9 and 10. Income (Loss)
from Partnerships
Note. The income (loss) reported in
column (e) must reconcile with the
effectively connected taxable income
reportable to the foreign corporation on
Schedule K-1 and by the foreign
corporation on Schedule P (Form
1120-F).
Except as provided below for certain
foreign partnership interests of
corporations other than a bank, report
amounts on Part II, line 9 or 10, as
described below:
1. Report in column (a), the sum of
the corporation’s distributive shares of
all items of income, gain, deduction and
loss from a U.S. or foreign partnership
that are included in Part I, line 11;

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2. Report in column (b) or (c), as
applicable, except for amounts
described for column (e) below, the
sum of all differences, if any,
attributable to the corporation’s
distributive share of income or loss from
a U.S. or foreign partnership. In column
(c), the corporation’s distributive share
of interest expense from all of its
partnership interests reported in column
(a) must be reversed as a permanent
difference. Enter the amount of all such
interest expense as a negative number
in column (c). The amount of
partnership interest expense allowed as
a deduction against effectively
connected income is reported in Part
III, lines 26b and 26c from Schedule I
(Form 1120-F), lines 23 and 24. Note:
The amount of partnership interest
expense reported as a permanent
difference in column (c) on lines 8 and
9 may not be the same amount of total
interest expense reported on Schedule
P, line 14a (total column) if the M-3
filing corporation reports its worldwide
non-consolidated financial statement
income in Part I, line 11, and for each
line item in Parts II and III;
3. Report in column (d), the total
amount of non-effectively connected
income that relates to the distributive
share of income or loss from a U.S. or
foreign partnership;
4. Report in column (e), except for
amounts described below, the sum of
all amounts attributable to the
corporation’s distributive shares of
income or loss from a U.S. or foreign
partnership (i.e., the sum of all amounts
reportable on the corporation’s
Schedule(s) K-1 received from the
partnership (if applicable)) that is
included in taxable income.
Do not report on Part II, line 9 or 10,
as applicable, any portion of a
corporation’s deduction under section
199 (income attributable to domestic
production activities) attributable to a
partnership interest of the corporation.
A corporation must report this
deduction only on Part III, line 17.
Exclusion of certain foreign
partnership interests from line 10.
Foreign corporations other than banks
that have foreign partnership interests
with no effectively connected income
for the year need not separately report
those interests on this line. If, however,
the foreign corporation reports a
partnership interest on the equity
method in the income statement used
for Part I, line 4, it may report such
amounts in column (a) of this line. The
corporation should report effectively
connected amounts in column (e)
consistent with the reporting equity
method amounts in column (a). For
example, if the foreign corporation does
not report the partnership interest on
Part II, line 10, column (a), it should not
report any amounts in column (e) for

the partnership interest. It would
instead report the income and other
items from the partnership interest for
column (e) purposes based on the
reporting for each line included in the
income statement. However, if a foreign
corporation allocates interest expense
under the separate currency pools
method in Regulations section
1.882-5(e) or allocates excess interest
expense under Regulations section
1.882-5(d)(5), and interest expense
included in the foreign corporation’s
distributive share of a foreign
partnership is included in such
allocation, see the instructions for Part
III, line 26a, for the required reporting.
Example 18. FC is a calendar year
taxpayer that was required to file
Schedule M-3 for its 2007 tax year and
is required to file Schedule M-3 for its
2008 tax year. FC, which is not a
foreign bank, is a partner in foreign
partnership FP. FC prepares income
statements in accordance with home
country GAAP. In its income
statements, FC treats the difference
between income statement net income
and taxable income from its investment
in FP as a permanent difference. For its
2008 tax year, FC’s income statement
includes $10,000 of income attributable
to its share of FP’s net income. FC’s
Schedule K-1 from FP reports $5,000
of ordinary income, $7,000 of long-term
capital gains, $4,000 of charitable
contributions, and $200 of section 179
expense. It has been determined that
all of these amounts are effectively
connected to FC’s trade or business
within the United States. Consequently,
FC must enter the following amounts on
Part II, line 9: $10,000 in column (a), a
($200) temporary difference in column
(b) for the section 179 deduction that is
effectively connected with FC’s trade or
business, a permanent difference of
($2,000) in column (c), and $7,800 in
column (e). The ($2,000) permanent
difference reported in column (c) is
determined as the aggregate difference
between column (a) and column (e)
after temporary differences in column
(b).
Example 19. Same facts as
Example 18 except that FC’s charitable
contribution deduction is wholly
attributable to its partnership interest in
FP and is limited to $90 pursuant to
section 170(b)(2) due to other
investment losses incurred by FC. In its
income statements, FC treated this
limitation as a temporary difference. FC
must not report the charitable
contribution limitation of $3,910 ($4,000
-$90) on Part II, line 9. FC must report
the limitation on Part III, line 16, and
report the disallowed charitable
contributions of ($3,910) in columns (b)
and (e).

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Line 11. Income (Loss) from
Other Pass-Through Entities
For any interest in a pass-through entity
(other than an interest in a partnership
reportable on Part II, line 9 or 10, as
applicable) owned by the corporation,
report the following on line 11:
1. Report in column (a), the sum of
the corporation’s distributive share of
income or loss from the pass-through
entity that is included in Part I, line 11;
2. Report in column (b) or (c), as
applicable, the sum of all differences, if
any, attributable to the pass-through
entity. In column (c), the corporation’s
distributive share of interest expense
from all of its partnership interests
reported in column (a), must be
reversed as a permanent difference.
Enter the amount of all such interest
expense as a negative number in
column (c). The amount of partnership
interest expense allowed as a
deduction against effectively connected
income is reported on Part III, lines 26b
and 26c, from Schedule I (Form
1120-F), lines 23 and 24. Note: The
amount of partnership interest expense
reported as a permanent difference in
column (c) on lines 8 and 9 may not be
the same amount of total interest
expense reported on Schedule P, line
14a (total column) if the M-3 filing
corporation reports its worldwide
non-consolidated financial statement
income in Part I, line 11, and for each
line item in Parts II and III;
3. Report in column (d), the total
amount of noneffectively connected
income related to the distributive share
of income or loss from the pass-through
entity;
4. Report in column (e), the sum of
all taxable amounts of income, gain,
loss, or deduction reportable on the
corporation’s Schedules K-1 received
from the pass-through entity (if
applicable).
Do not report on Part II, line 11, any
portion of a corporation’s deduction
under section 199 (income attributable
to domestic production activities) even
if some or all of the corporation’s
deduction under section 199 is
attributable to an interest in a
pass-through entity held by the
corporation. A corporation must report
its deduction under section 199 only on
Part III, line 19.
Foreign corporations other than
banks that have interests in foreign
pass-through entities with no effectively
connected income for the year need not
separately report those interests on this
line. If, however, the foreign corporation
reports a pass-through interest on the
equity method in the income statement
used for Part I, line 4, it may report
such amounts in column (a) of this line.
The corporation should report
effectively connected amounts in

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column (e) consistent with the reporting
equity method amounts in column (a).
For example, if the foreign corporation
does not report the pass-through
interest on Part II, line 1a, column (a), it
should not report any amounts in
column (e) for the pass-through
interest. It would instead report the
income and other items from the
pass-through interest for column (e)
purposes based on the reporting for
each line included in the income
statement. However, if a foreign
corporation allocates interest expense
under the separate currency pools
method in Regulations section
1.882-5(e) or allocates excess interest
expense under Regulations section
1.882-5(d)(5), and interest expense
included in the foreign corporation’s
pass-through amount is included in
such allocation, see the instructions for
Part III, line 26a, for the required
reporting.
For each pass-through entity
reported on line 11, attach a supporting
schedule that provides that entity’s
name, EIN (if applicable), the
corporation’s end of year profit-sharing
percentage (if applicable), the
corporation’s end of year loss-sharing
percentage (if applicable), and the
amounts reported by the corporation in
column (a), (b), (c), (d), or (e) of line 11,
as applicable.

Line 12. Items Relating to
Reportable Transactions
Any amounts attributable to any
reportable transactions (as described in
Regulations section 1.6011-4) must be
included on Part II, line 12, regardless
of whether the difference, or
differences, would otherwise be
reported elsewhere in Part II or Part III.
Thus, if a taxpayer files Form 8886 for
any reportable transaction described in
Regulations section 1.6011-4, the
amounts attributable to that reportable
transaction must be reported on Part II,
line 12. In addition, all income and
expense amounts attributable to a
reportable transaction must be reported
on Part II, line 12, columns (a) and (e)
even if there is no difference between
the financial amounts and the taxable
amounts.
Each difference attributable to a
reportable transaction must be
separately stated and adequately
disclosed. A corporation will be
considered to have separately stated
and adequately disclosed a reportable
transaction on line 12 if the corporation
sequentially numbers each Form 8886
and lists by identifying number on the
supporting schedule for Part II, line 12,
each sequentially numbered reportable
transaction and the amounts required
for Part II, line 12, columns (a) through
(e).

In lieu of the requirements of the
preceding paragraph, a corporation will
be considered to have separately
stated and adequately disclosed a
reportable transaction if the corporation
attaches a supporting schedule that
provides the following for each
reportable transaction:
1. A description of the reportable
transaction disclosed on Form 8886 for
which amounts are reported on Part II,
line 12;
2. The name and tax shelter
registration number, if applicable, as
reported on lines 1a and 1b,
respectively, of Form 8886; and
3. The type of reportable transaction
(i.e., listed transaction, confidential
transaction, transaction with contractual
protection, etc.) as reported on line 2 of
Form 8886.
If a transaction is a listed transaction
described in Regulations section
1.6011-4(b)(2), the supporting schedule
also must include the information
requested on line 3 of Form 8886. In
addition, if the reportable transaction
involves an investment in the
transaction through another entity such
as a partnership, the supporting
schedule must include the name and
EIN (if applicable) of that entity as
reported on line 5 of Form 8886.
Example 20. Corporation J is a
calendar year taxpayer that was
required to file Schedule M-3 for its
2007 tax year and is required to file
Schedule M-3 for its 2008 tax year. J
incurred seven different abandonment
losses during its 2008 tax year. One
loss of $12 million results from a
reportable transaction described in
Regulations section 1.6011-4(b)(5),
another loss of $5 million results from a
reportable transaction described in
Regulations section 1.6011-4(b)(4), and
the remaining five abandonment losses
are not reportable transactions. J
discloses the reportable transactions
giving rise to the $12 million and $5
million losses on separate Forms 8886
and sequentially numbers them X1 and
X2, respectively. J must separately
state and adequately disclose the $12
million and $5 million losses on Part II,
line 12. The $12 million loss and the $5
million loss will be adequately disclosed
if J attaches a supporting schedule for
line 12 that lists each of the
sequentially numbered forms, Form
8886-X1 and Form 8886-X2, and with
respect to each reportable transaction
reports the appropriate amounts
required for Part II, line 12, columns (a)
through (e). Alternatively, J’s
disclosures will be adequate if the
description provided for each loss on
the supporting schedule includes the
names and tax shelter registration
numbers, if any, disclosed on the
applicable Form 8886, identifies the
type of reportable transaction for the

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loss, and reports the appropriate
amounts required for Part II, line 12,
columns (a) through (e). J must report
the losses attributable to the other five
abandonment losses on Part II, line
21e, regardless of whether a difference
exists for any or all of those
abandonment losses.
Example 21. Corporation K is a
calendar year taxpayer that was
required to file Schedule M-3 for its
2007 tax year and is required to file
Schedule M-3 for its 2008 tax year. K
enters into a transaction with
contractual protection that is a
reportable transaction described in
Regulations section 1.6011-4(b)(4).
This reportable transaction is the only
reportable transaction for K’s 2008 tax
year and results in a $7 million capital
loss for both financial statement
purposes and U.S. income tax
purposes. It was determined that the
entire amount is attributable to
effectively connected income. Although
the transaction does not result in a
difference, K is required to report on
Part II, line 12, the following amounts:
($7 million) in column (a), zero in
columns (b) and (c), and ($7 million) in
column (e). The transaction will be
adequately disclosed if K attaches a
supporting schedule for line 12 that (a)
sequentially numbers the Form 8886
and refers to the sequentially-numbered
Form 8886-X1 and (b) reports the
applicable amounts required for line 12,
columns (a) through (e). Alternatively,
the transaction will be adequately
disclosed if the supporting statement for
line 12 includes a description of the
transaction, the name and tax shelter
registration number, if any, and the type
of reportable transaction disclosed on
Form 8886.

Line 13. Hedging Transactions
Report on line 13, column (a), the net
gain or loss from hedging transactions
included in net income per the income
statement other than:
• Hedging transactions entered into by
a global dealing operation (see line 16
instructions);
• Qualified integrated foreign currency
hedging transactions under Regulations
section 1.988-5 (report these
transactions on either Part II, line 4, or
in Part III, line 26(a), column (a) as
applicable);
• Hedging transactions of securities
dealer property (other than a global
dealing operation) that is
marked-to-market under section 475(a)
(see instructions for line 14a);
• Hedging transactions entered into by
a commodities dealer that makes a
mark-to-market election under section
475(e) (see instructions for line 14b);
and
• Hedging transactions entered into by
a securities or commodities trader that
makes a mark-to-market election under

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section 475(f) (see instructions for line
14c).
Do not report the income from the
hedged item(s) on line 13. For hedging
transactions reportable on line 13,
report in column (e) the amount of
taxable income from hedging
transactions as defined in section
1221(b)(2). Use columns (b) and (c) to
report all differences caused by treating
hedging transactions differently for
financial accounting purposes and for
U.S. income tax purposes. For
example, if a portion of a hedge is
considered ineffective under GAAP but
still is a valid hedge under section
1221(b)(2), the difference must be
reported on line 13. The hedge of a
capital asset, which is not a valid hedge
for U.S. income tax purposes, must
also be reported here if it is considered
a hedge under the corporation’s
method of accounting. For instance,
transactions that would constitute a
valid hedge for U.S. income tax
purposes but constitute hedges of
capital assets solely because the asset
gives rise to noneffectively connected
income and is not eligible for ordinary
treatment under section 582(c), are
also reported on line 13.
Report on Part II, line 16c, hedging
transactions entered into by a global
dealing operation including those that
are “risk transfer agreements” defined
in Proposed Regulations section
1.475(g)-2. However, income with
respect to a risk transfer agreement
that is held by the foreign corporation’s
non-global dealing operations is
reported on this line 13 unless the
foreign corporation is a foreign bank
and its non-global dealing operations is
not reported on Part I, line 11. If a
foreign bank does not report a
risk-transfer agreement held by a
non-global dealing operation on line 13,
column (a), any ECI treatment of such
risk-transfer agreement must be
reported on line 23, column (d).
Report on this line 13, hedging gains
and losses with respect to non-dealer
transactions that are determined under
the mark-to-market method of
accounting on the income statement
(other than those that are subject to
mark-to-market treatment under a valid
election under sections 475(e) or (f)).
Report any gain or loss from
inventory hedging transactions on line
13 and not on Part II, line 2.
Example 22. FC is a foreign bank
that enters into a U.S. dollar interest
rate notional principal contract to hedge
a portfolio of securities held for
investment on its U.S. set(s) of books
that are reportable on Form 1120-F,
Schedule L. The hedged portfolio
consists of four securities of equal
amounts, only two of which give rise to
effectively connected income. For
financial statement purposes, the

notional principal contract is treated as
a hedging transaction. For U.S. tax
purposes, the two securities that give
rise to noneffectively connected income
are capital assets that are not eligible
for ordinary treatment on disposition
under section 582(c). Consequently the
notional principal contract does not
constitute a hedging transaction under
section 1221(b). Regardless, the
income gain or loss with respect to the
notional principal contract (including
any mark-to-market income from the
hedge) is reportable as a hedging
transaction on line 13 and is not
reported on line 4b or 14b.

Lines 14a through 14c.
Mark-to-Market Income (Loss)
Except as provided for global dealing
operations reportable on line 16 and for
certain hedging transactions reported
on line 13, report on lines 14a through
14d, column (a) any amount that is
subject to mark-to-market treatment
under section 475. Report on line 14a,
income or (loss) for securities held by a
dealer in securities, in its capacity as a
dealer under section 475(a). On line
14b, report the mark-to-market
treatment of securities held by a dealer
other than in its capacity as a dealer
that is subject to the characterization
provisions of section 475(d)(3)(B).
Report on line 14c, the mark-to-market
income of a dealer in commodities
having made a valid election under
section 475(e), and on line 14d, report
the mark-to-market income of a trader
in securities or commodities having
made a valid election under section
475(f). “Securities” for these purposes
are securities described in section
475(c)(2) and section 475(e)(2).
“Securities” do not include any items
specifically excluded from sections
475(c)(2) and 475(e)(2), such as certain
contracts to which section 1256(a)
applies.
Report hedging gains and losses
from transactions held in investment
capacity or trader capacity not subject
to a securities or commodities trading
election, but which is determined under
the mark-to-market method of
accounting, on Part II, line 13 (hedging
transactions), and not on line 14.
Example 23. Foreign corporation
FC, a broker-dealer that is not a foreign
bank, is a dealer in securities under
section 475(a) and conducts its entire
securities dealing operation within the
United States. All of the income is
recorded on set(s) of books reported on
Form 1120-F, Schedule L; is effectively
connected with FC’s trade or business
within the United States; and
constitutes income of a securities
dealer as defined in section
1.864-2(c)(2)(iv) only, and not of a
global dealing operation. The income of
this securities dealing operation is
reportable on Part II, line 14. If FC

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engaged in a global securities dealing
operation, however, the income
generated from that activity would be
reportable on line 16, columns (d) and
(e) as sourced and allocated under
Proposed Regulations section
1.863-3(h) between non-ECI and ECI. If
the global dealing operation is of a
foreign bank and is not includible in
column (a), the apportionment of the
global dealing operation’s results would
be reportable in column (d) for the
amount of income or loss that is
allocable to ECI. Income would be
reportable as a positive number and
losses would be reportable as a
negative number. If the global dealing
set(s) of books are reportable in column
(a), either because like FC it is a broker
dealer and not a foreign bank, or it is a
foreign bank whose global dealing
operation is reportable on Form 1120-F,
Schedule L, the appportionment of the
global dealing operation’s results would
be reportable in column (d) for the
portion that needs to be allocated to
noneffectively connected income. In
such instance, the amount of income
allocable to non-ECI would be
reportable as a negative amount and
the amount of loss would be reportable
as a positive number in column (d). For
all filers, columns (a), (b), (c) and (d)
are combined to determine the ECI
amount reportable in column (e).

Line 15. Gains (Losses) from
Certain Section 988
Transactions
Report on line 15 gains or (losses) from
certain section 988 transactions. These
are only those section 988 transactions
that are not reportable with respect to
hedging transactions, mark-to-market
gains (losses) or global securities
dealing operations on Part II, lines 13,
14 and 16. Section 988 gains (losses)
reportable on line 15 will generally be
those recognized with respect to foreign
currency denominated instruments that
are acquired and normally held for
investment or otherwise not held by a
global securities dealer. Foreign
currency transactions entered into by a
global securities dealing operation are
reportable exclusively on line 16c. Do
not report on line 15 qualified integrated
foreign currency transactions as
defined in Regulations section 1.988-5.
Example 24. FC is a foreign
corporation that is not a dealer or trader
in securities or commodities. FC
acquires foreign interest bearing bonds
issued by a corporation resident in
Country X. The bonds are denominated
in a functional currency other than FC’s
currency and other than the U.S. dollar.
FC holds the bonds in connection with
its trade or business within the United
States and the bonds give rise to
effectively connected income, gain or
(loss). FC accrues interest income on
its set(s) of books in U.S. dollars and

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accounts for currency gains (losses)
with respect to each accrual period.
When FC receives coupon interest
payments, it records section 988
transaction foreign currency gains
(losses). These gains (losses) are
reportable on line 15.
If FC is a foreign bank and subject to
section 475, generally, these gains
(losses) are still reportable on line 15
and not on line 14 if the bank acquires
and properly identifies the securities as
held for investment or if the securities
are held for proprietary trading that is
not subject to a section 475 trader
election under section 475(f).

Lines 16a and 16b. Interest
Income and Dividends from
Global Securities Dealing
Report on lines 16a and 16b, interest
and dividends (including substitute
interest defined in Regulations section
1.861-2(a)(7) and substitute dividends
defined in Regulations section
1.861-3(a)(6)) earned with respect to
transactions entered into in a global
securities dealing operation as defined
in Proposed Regulations section
1.482-8.

Line 16c. Gains (Losses) and
Other Fixed and Determinable,
Annual or Other Periodic
Income from Global Securities
Dealing
Report on line 16c gains and losses
and other fixed and determinable,
annual or other periodic income or
expense (FDAP) with respect to
notional principal contracts from global
securities dealing operations (as
defined in Proposed Regulations
section 1.482-8) that are subject to
source and allocation under Proposed
Regulations section 1.863-3(h). Foreign
currency gains and losses with respect
to securities transactions entered into
by a global dealing operation are also
included in global dealing gains and
(losses) on line 16c. The foreign
corporation may be a global securities
dealer with respect to some but not all
of its securities dealing activities. Gains
and losses from securities dealing
activities that are not subject to source
and allocation under Proposed
Regulations section 1.863-3(h) are
reportable as mark-to-market income
on line 14, and the interest, dividend
and other FDAP income earned in such
non-global dealer activities is reportable
on Part II, lines 3 and 4. Reporting on
line 16 is determined by whether the
income, gains and losses are subject to
allocation under Proposed Regulations
section 1.863-3(h) and not by whether
all or none of the amount is allocable to
ECI. If income of a global dealing
operation is entirely allocable to ECI or
non-ECI under Proposed Regulations
section 1.863-3(h), the amount is
reportable on line 16 and not on line 14.

If the income or losses from global
dealing operations of foreign banks
reportable on any of lines 16a through
16c are allocable in whole or in part to
effectively connected income but not
reportable in column (a), apportion the
ECI amounts of the global dealing
operation to ECI in columns (d) and (e).
If the foreign bank does include a
global dealing operation in column (a),
then report the apportionment of such
operation to non-ECI in column (d) and
the resulting ECI amount in column (e).
Attach a schedule providing a brief
description of each global dealing
operation (e.g., interest rate notional
principal contracts, equity notional
principal contracts, foreign currency
options (list each foreign currency
separately for each foreign currency
that constitutes a separate global
dealing operation)).
Do not report on this line 16c,
amounts reportable on lines 13, 14, 15,
16a, and 16b.
Example 25. FC, a securities
broker-dealer, is engaged in trade or
business within the United States. FC is
engaged in a global securities dealing
operation in notional principal contracts
that allocates a portion of the income,
gains and (losses) to effectively
connected income. FC is also engaged
in a securities dealing operation that is
not a global dealing operation with
respect to currency option contracts in
foreign currency X, that is recorded on
set(s) of books in FC’s home office.
The foreign currency X dealing
operation is entirely allocable to
noneffectively connected income and is
not reportable on Form 1120-F,
Schedule L. Because FC is not a
foreign bank described in Temporary
Regulations section 1.882-5T(c)(4),
FC’s income, gains and (losses) with
respect to its securities dealing in
foreign currency X is reportable on Part
I, line 11. The income, gains and
(losses) with respect to FC’s notional
principal contracts that allocate in part
to effectively connected income are
reportable on line 16c. The periodic
income with respect to the notional
principal contracts is also reportable on
line 16c. The foreign currency option
contracts in foreign currency X are
reportable on line 14a, column (a), as
mark-to-market gains (losses) of a
securities dealer and not on line 16.
The amount reported on line 14a,
column (a), is reversed on line 14a,
column (d) as an apportionment
allocable to noneffectively connected
income.
Example 26. The facts are the
same as in example 25 except that FC
is a foreign bank. Because the
securities options denominated in
foreign currency X is not included in a
set(s) of books reported on Form
1120-F, Schedule L, the amounts are

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not reported on Part I, line 11, or Part II,
line 14a. If the notional principal
contract book was not reportable on a
set of books reportable in column (a),
such operation would not be included
on line 16, column (a). As a result, the
amount allocable to effectively
connected income from this operation is
reported in column (d) and in column
(e). If the set of books reported on
Form 1120-F, Schedule L had included
the notional principal contract
operation, FC would have reported
such amount in column (a), and the
apportionment in column (d) would
have included a negative number for
the amount of income and gains
allocable to noneffectively connected
income. Losses allocable to non-ECI
would be reported as a positive
number. In column (e), FC combines
columns (a), (b), (c) and (d) to report
the amount allocable to effectively
connected income.

Line 17. Sale Versus Lease (for
Sellers and/or Lessors)
(Also see the instructions for Part III,
line 25, for purchasers and/or lessees.)
Asset transfer transactions with
periodic payments characterized for
financial accounting purposes as either
a sale or a lease may, under some
circumstances, be characterized as the
opposite for tax purposes. If the
transaction is treated as a lease, the
seller/lessor reports the periodic
payments as gross rental income and
also reports depreciation expense or
deduction. If the transaction is treated
as a sale, the seller/lessor reports gross
profit (sale price less cost of goods
sold) from the sale of assets and
reports the periodic payments as
payments of principal and interest
income.
On Part II, line 17, column (a), report
the gross profit or gross rental income
for financial statement purposes for all
sale or lease transactions that must be
given the opposite characterization for
tax purposes. On Part II, line 17,
column (e), report the gross profit or
gross rental income for federal income
tax purposes. Interest income amounts
for such transactions must be reported
on Part II, line 4a (interest income
excluding interest equivalents), in
column (a) or (e), as applicable.
Depreciation expense for such
transactions must be reported on Part
III, line 23 (depreciation), in column (a)
or (e), as applicable. Use columns (b),
(c), and (d) of Part II, lines 4a and 17,
and Part III, line 23, as applicable to
report the differences between column
(a) and (e).
Example 27. Corporation M sells
and leases property to customers. M is
a calendar year taxpayer that was
required to file Schedule M-3 for its
2007 tax year and is required to file
Schedule M-3 for its 2008 tax year. For

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financial accounting purposes, M
accounts for each transaction as a sale.
For U.S. income tax purposes, each of
M’s transactions must be treated as a
lease. In its income statements, M
treats the difference in the financial
accounting and the U.S. income tax
treatment of these transactions as
temporary. During 2008, M reports on
its income statements $1,000 of sales
and $700 of cost of goods sold with
respect to 2008 lease transactions. M
receives periodic payments of $500 in
2008 with respect to these 2008
transactions and similar transactions
from prior years and treats $400 as
principal and $100 as interest income.
For financial income purposes, M
reports gross profit of $300 ($1,000 $700) and interest income of $100 from
these transactions. For U.S. income tax
purposes, M reports $500 of gross
rental income (the periodic payments)
and (based on other facts) $200 of
depreciation deduction on the property.
It was determined that the entire
amount of these items is effectively
connected income/expense. On its
2008 Schedule M-3, M must report on
Part II, line 4a (interest income), $100
in column (a), ($100) in column (b), and
zero in column (e). In addition, M must
report on Part II, line 17, $300 of gross
profit in column (a), $200 in column (b),
and $500 of gross rental income in
column (e). Lastly, M must enter $200
in each of columns (b) and (e) on Part
III, line 23.

Line 18. Section 481(a)
Adjustments
With the exception of a section 481(a)
adjustment that is required to be
reported on Part II, line 12, for
reportable transactions, any difference
between an income or expense item
attributable to an authorized (or
unauthorized) change in method of
accounting made for U.S. income tax
purposes that results in a section
481(a) adjustment must be reported on
Part II, line 18, regardless of whether a
separate line for that income or
expense item exists in Part II or Part III.
Example 28. Corporation N is a
calendar year taxpayer that was
required to file Schedule M-3 for its
2007 tax year and is required to file
Schedule M-3 for its 2008 tax year. N
was depreciating certain fixed assets
over an erroneous recovery period and,
effective for its 2008 tax year, N
receives IRS consent to change its
method of accounting for the
depreciable fixed assets and begins
using the proper recovery period. The
change in method of accounting results
in a positive section 481(a) adjustment
of $100,000 that is required to be
spread over four tax years, beginning
with the 2008 tax year. It has been
determined that the entire amount is
attributable to effectively connected

income. In its income statements, N
treats the section 481(a) adjustment as
a temporary difference. N must report
on Part II, line 18, $25,000 in columns
(b) and (e) for its 2008 tax year and
each of the subsequent three tax years
(unless N is otherwise required to
recognize the remainder of the section
481(a) adjustment earlier). N must not
report the section 481(a) adjustment on
Part III, line 23.
If the section 481(a) adjustment was
not effectively connected to N’s trade or
business within the United States, the
amount would be reportable for each
year in column (b) as a temporary
difference (for U.S. tax principles) and
then reversed as an apportionment to
non-ECI in column (d). If, in addition, N
was a foreign bank, the amount would
only be reportable in this manner if the
section 481(a) adjustment was with
respect to transactions recorded on
set(s) of books reportable on Form
1120-F, Schedule L.

Line 19. Unearned/Deferred
Revenue
Report on line 19, column (a), amounts
of revenues included in Part I, line 11,
which were deferred from a prior
financial accounting year. Report on
line 19, column (e), revenues
recognizable for federal income tax
purposes that are recognized for
financial accounting purposes in a
different year. Also, report on line 19,
column (e), any amount of revenues
reported on line 19, column (a), that are
recognizable for U.S. income tax
purposes in the current tax year. Use
columns (b), (c), and (d) of line 19, as
applicable, to report the differences
between column (a) and column (e). If
the amounts are not includible on set(s)
of books reportable on Form 1120-F,
Schedule L, but are reportable in Part I,
line 11, for a foreign corporation other
than a bank, then report the entire
difference as temporary in column (b).
Any amount allocable to noneffectively
connected income should, to that
extent, be included in column (d) to
reverse some or all of the amount
included in column (b).
Line 19 must not be used to report
income recognized from long-term
contracts. Instead, use line 24 (other
income (loss) items with differences).
Example 29. FC, a foreign
corporation other than a bank, has
prepaid commission income of $1,000
recognizable for U.S. income tax
purposes in the current tax year that is
recognized for financial accounting
purposes in a different year. FC treats
this difference as a temporary
difference on its income statements. Of
this amount, $600 is allocable to
effectively connected income. The
amount recognized for income
statement purposes in 2008 is $250.
FC reports this amount on Part II, line

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19, column (a). In column (b), FC
reports $750 as a temporary book tax
difference to adjust to the amount
recognized by the foreign corporation in
2008 under U.S. tax principles. In
column (d), FC reverses $400 as
income allocable to noneffectively
connected income. Finally, in column
(e), FC reports $600, the amount
includible on FC’s Form 1120-F as
effectively connected income in 2008.
In 2009, assuming no other
commission income is earned or
accrued for either financial or U.S. tax
purposes, FC would include $750 on
Part II, line 20, column (a), the amount
recognized currently for financial
purposes. FC would then reverse the
$750 in column (b) as a temporary
difference since this amount was
previously recognized for U.S. tax
purposes.

Line 20. Original Issue
Discount, Imputed Interest, and
Phantom Income
Report on line 20 any amounts of
original issue discount (OID), other
imputed interest, and phantom income.
The term “original issue discount and
other imputed interest” includes, but is
not limited to:
1. The difference between the issue
price and the stated redemption price at
maturity of a debt instrument, which
may be wholly or partially realized on
the disposition of a debt instrument
under section 1273;
2. Amounts that are imputed
interest on a deferred sales contract
under section 483;
3. Amounts treated as interest or
OID under the stripped bond rules
under section 1286;
4. Amounts treated as OID under
the below-market interest rate rules
under section 7872; and
5. Amounts recognized as phantom
income with respect to a noneconomic
residual interest in a REMIC, including
inducement fees recognized with
respect to such interests.
Note. Phantom income is a term used
to describe taxable income that may be
derived from the holding of ownership
interests in an asset securitization
vehicle. The income is ‘‘phantom’’
because it is not economic income (i.e.,
there is no cash or other property
actually received or available for
distribution to the equity holder).
Income with respect to a residual
interest in REMICs is referred to as
excess inclusion income and is subject
to special rules in the Code and
regulations. In a non-REMIC vehicle, it
may take the form of OID derived from
deep-discount debt held as collateral in
the asset securitization entity.
Foreign corporations that accrue
phantom income with respect to
residual interests in REMICs that are

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not recognized under the foreign
corporation’s accounting regime must
show all book-to-tax gross phantom
income differences as permanent
differences in column (c), whether or
not it is effectively connected with a
trade or business and whether or not
the REMIC interests are recorded on
set(s) of books that are reportable on
Form 1120-F, Schedule L. Amounts
that are not effectively connected with
the foreign corporation’s trade or
business must be reversed and shown
as a negative number in column (d).
Example 30. FC is a foreign bank
that acquires and holds noneconomic
residual interests in a REMIC on set(s)
of books that are reportable on Form
1120-F, Schedule L. Under the foreign
corporation’s accounting system, the
amounts are not recognized for
financial income reporting purposes
and are treated as permanent
differences. FC reports no amounts on
Part II, line 20, column (a), for each
year that phantom income/deduction is
recorded under U.S. tax principles. In
column (c), FC records phantom
income as a permanent difference
because such amounts are not
recognizable under the foreign
corporation’s accounting regime. The
amounts are effectively connected with
FC’s trade or business and therefore,
are also reported in column (e).
Example 31. The facts are the
same as in Example 30, except that the
phantom income is treated as
noneffectively connected income by FC
and subject to tax under section 881(a).
FC must report the phantom income as
a permanent difference on Part II, line
20, column (c) and then reverse the
amount in column (d) as noneffectively
connected income. No amount is
reported in column (e). The full amount
of phantom income recognized in
column (c) is reportable on Form
1120-F, Section I, line 10, as other
fixed or determinable, annual or other
periodic income and subject to tax at
30%.
Example 32. The facts are the
same as in Example 30, except FC
recognizes $100 of residual excess
inclusion income on its set(s) of books
and records reportable on Form
1120-F, Schedule L, for cash received,
and an additional $1,000 of phantom
income not recognized for financial
accounting purposes. FC treats $100
as effectively connected income. FC
reports on Part II, line 20, $100 in
column (a), $1,000 in column (c),
($1,000) in column (d) and $100 in
column (e). The $1,000 reversed in
column (d) is reportable on Form
1120-F, Section I, line 10, as in
example 31.

Line 21a. Income Statement
Gain/Loss on Sale, Exchange,
Abandonment, Worthlessness,

or Other Disposition of Assets
Other Than Inventory and
Pass-Through Entities
Report on line 21a, column (a), all
gains and losses on the disposition of
assets except for (a) gains and losses
on the disposition of inventory, and (b)
gains and losses allocated to the
corporation from pass-through entities
(e.g., on Schedule K-1) that are
included on lines 9, 10, or 11. Reverse
the amount reported in column (a) in
column (b) or (c), as applicable. The
corresponding gains and losses for
U.S. income tax purposes are reported
on Part II, lines 21b through 21g,
columns (b), (c) and (e), as applicable.
Reverse any additional amounts
recognizable under U.S. tax principles
that are allocable to noneffectively
connected income on Part II, lines 21b
through 21g, column (d).

Line 21b. Gross Capital Gains
from Schedule D, Excluding
Amounts from Pass-Through
Entities
Report on line 21b, gross capital gains
reported on Schedule D, excluding
capital gains from pass-through entities
that are included on lines 9, 10, or 11,
as applicable.

Line 21c. Gross Capital Losses
from Schedule D, Excluding
Amounts from Pass-Through
Entities, and Worthless Stock
Losses
Report on line 21c, gross capital losses
reported on Schedule D, excluding
capital losses from (a) pass-through
entities that are included on lines 9, 10
or 11, as applicable; (b) abandonment
losses, which must be reported on Part
II, line 21e; and (c) worthless stock
losses, which must be reported on Part
II, line 21f. Do not report on line 21c
capital losses carried over from a prior
tax year and utilized in the current tax
year. See the instructions for Part II,
line 22, regarding the reporting
requirements for capital loss carryovers
utilized in the current tax year.

Line 21d. Net Gain/Loss
Reported on Form 4797, Line
17, Excluding Amounts From
Pass-Through Entities,
Abandonment Losses, and
Worthless Stock Losses
Report on line 21d the net gain or loss
reported on line 17 of Form 4797, Sales
of Business Property, excluding
amounts from (a) pass-through entities
included on lines 9, 10, or 11, as
applicable; (b) abandonment losses,
which must be reported on Part II, line
21e; and (c) worthless stock losses,
which must be reported on Part II, line
21f.

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Line 21f. Worthless Stock
Losses
Report on line 21f any worthless stock
loss, regardless of whether the loss is
characterized as an ordinary loss or a
capital loss. See Regulations section
1.864-4(c)(2)(iii)(a) for limitations on
effectively connected treatment under
the asset use test and Regulations
section 1.864-4(c)(5)(ii)(a) for limited
effectively connected eligibility of stock
to foreign corporations engaged in a
banking, financing or similar business.
Attach a schedule that separately
states and adequately discloses each
transaction that gives rise to a
worthless stock loss that is treated as
allocable to effectively connected
income and the amount of each loss.
Do not include on the schedule any
worthless stock loss that is wholly
allocable to noneffectively connected
income. Do not include worthless stock
losses that are incurred as part of a
securities dealing or global securities
dealing operation. Report these
securities losses as mark-to-market
loss on line 14a, 14c or 16c.

Line 21g. Other Gain/Loss on
Disposition of Assets Other
Than Inventory
Report on line 21g any gains or losses
from the sale or exchange of property
other than inventory and that are not
reported on lines 21b through 21f.

Line 22. Capital Loss Limitation
and Carryforward Used
Report as a positive amount on line 22,
columns (b) or (c), as applicable, and
(e) the excess of the net capital losses
over the net capital gains reported on
Schedule D, Capital Gains and Losses,
by the corporation.
If the corporation utilizes a capital
loss carryforward on Schedule D in the
current tax year, report the carryforward
utilized as a negative amount on Part II,
line 22, columns (b) or (c), as
applicable, and column (e).

Line 23. Gross Effectively
Connected Income of Foreign
Banks from Books That Do Not
Give Rise to U.S. Booked
Liabilities
Line 23 applies only to foreign banks
(as described in Regulations section
1.882-5T(c)(4)). Foreign banks report in
columns (d) and (e), the gross
effectively connected income (other
than income from a global dealing
operation) that is excluded from the
set(s) of books reportable on Form
1120-F, Schedule L, and excluded from
the net income shown on Part I, line 11.
Gross effectively connected income of
this type is that which is ordinarily
recorded on books of non-U.S.
branches or locations that do not
ordinarily engage in effectively

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connected income producing activities,
such as income from securities
recorded in a home office that are
attributable to a U.S. office under
Regulations section 1.864-4(c)(5)(iii).
Gross effectively connected income
reportable on line 23 is also income of
a type that is recognized under sections
864(c)(6) and 864(c)(7) with respect to
property that ceases to be held in
connection with a trade or business
within the United States (e.g.,
transferred securities of a non-banking,
financing or similar business or of a
former banking, financing or similar
business) or that is recognized under
the Code at a time subsequent to
cessation of the trade or business
within the United States. Amounts from
a global dealing operation that are not
reported in column (a), and that are
apportionable in whole or in part to
effectively connected income, are
reported on line 16 and not on this line
23.
Example 33. FC, a foreign bank,
negotiates and solicits a portfolio of
loans and municipal bonds that are
attributable to its U.S. office under
Regulations section 1.864-4(c)(5)(iii).
FC also enters into a number of forward
contracts for customers through its U.S.
trade or business. These contracts are
not entered into in connection with a
global securities dealing operation. The
transactions are initially recorded on
FC’s set(s) of books that are reported
on Form 1120-F, Schedule L. After a
period of time, FC transfers several of
the loans, the forward contracts and the
municipal bonds to its home office in
Country X to be held other than in
connection with a global securities
dealing operation. These assets are
recorded in FC’s home office on set(s)
of books that do not give rise to U.S.
booked liabilities under Regulations
section 1.882-5(d)(2)(iii). As a result,
the transferred assets are no longer
reportable on Form 1120-F, Schedule
L.
Report on Part II, line 23, column (c),
as a negative number, the amount of
the effectively connected municipal
bond interest. The municipal bond
interest is a permanent difference that
must be reversed in column (d) since it
is no longer taken into account in
column (a) on FC’s set(s) of books
reportable on Schedule L.
Report on Part II, line 23, column (d),
the gross income, gains and (losses)
from the transferred loans and
municipal bond securities and forward
contracts that is effectively connected
with the foreign bank’s trade or
business within the United States.
Report the income and gains as
positive numbers and losses as
negative amounts.
Report on Part II, line 23, column (e),
the combined column (b), (c) and (d)

amounts to determine the aggregate
amount of effectively connected gross
income, gains (losses) from the
transferred loan securities and forward
contracts. The tax-exempt municipal
bond interest is netted to zero in
column (e).

Line 24. Other Income (Loss)
Items with Differences
Report on Part II, line 24, all items of
income (loss) with differences that are
not otherwise listed on Part II, lines 1
through 23. Attach a schedule that
itemizes the type of income (loss) and
the amount of each item. For example,
income (loss) with differences from
long-term contracts are reportable on
line 24.
If any “comprehensive income” as
defined by Statement of Financial
Accounting Standards (SFAS) No. 130
is reported on this line, describe the
item(s) in detail. Foreign corporations
may report on line 24 net income (loss)
from their distributive share of foreign
partnership interests that do not have
any U.S. source or effectively
connected income, that the foreign
corporation does not report on line 10.
The aggregate income from such
partnerships should be reported on line
25, column (d), as a negative number.

Line 26. Total Expense/
Deduction Items
Report on Part II, line 26, columns (a)
through (e), as applicable, the inverse
of the amounts reported on Part III, line
33, columns (a) through (e). For
example, if Part III, line 33, column (a),
reflects an amount of $1 million, then
report on Part II, line 26, column (a),
($1 million). Similarly, if Part III, line 33,
column (b), reflects an amount of
($50,000), then report on Part II, line
26, column (b), $50,000.

Line 27. Other Items with No
Differences
If there is no difference between the
financial accounting amount and the
taxable amount of an entire item of
income, gain, loss, expense, or
deduction and the item is not described
or included in Part II, lines 1 through
24, or Part III, lines 1 through 32, report
the entire amount of the item in
columns (a) and (e) of line 27. If a
portion of an item of income, loss,
expense, or deduction has a difference
and a portion of the item does not have
a difference, do not report any portion
of the item on line 27. Instead, report
the entire amount of the item (i.e., both
the portion with a difference and the
portion without a difference) on the
applicable line of Part II, lines 1 through
24, or Part III, lines 1 through 32. See
Example 12.

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Line 28. Reconciliation Totals
If a corporation chooses not to
complete columns (a) and (e) of Parts II
and III in the first tax year the
corporation is required to file Schedule
M-3 (or for any year in which the
corporation voluntarily files Schedule
M-3), Part II, line 28, is reconciled by
the corporation in the following manner:
1. Report the amount from Part I,
line 11, on Part II, line 28, column (a);
2. Leave blank Part II, lines 1
through 27, columns (a) and (e);
3. Leave blank Part III, columns (a)
and (e);
4. Report on Part II, line 28,
columns (b) through (d), the total of
Part II, lines 1 through 27, columns (b)
through (d) respectively; and
5. Report on Part II, line 28, column
(e), the sum of Part II, line 28, columns
(a), (b), (c) and (d). Note. Part II, line
28, column (e), must equal the amount
on Form 1120-F, Section II, line 29.

Part III. Reconciliation of
Net Income (Loss) per
Income Statement of
Non-Consolidated
Foreign Corporations
with Taxable Income per
Return — Expense/
Deduction Items
For column (a), report the expenses
included on the applicable income
statement as adjusted and reported in
Part I, line 11.

Lines 1 Through 4. Income Tax
Expense
If the corporation does not distinguish
between current and deferred income
tax expense in its applicable financial
statement described in Part I, report
income tax expense as current income
tax expense using lines 1 and 3, as
applicable. U.S. taxes and non-U.S.
deferred income taxes are not
deductible and column (e) is
inapplicable for lines 1, 2, and 4.
Column (e) of line 3 is used to report
only foreign income tax the corporation
is deducting, other than the withholding
taxes reported in line 5 below. If the
corporation is crediting foreign income
tax against the U.S. income tax liability,
no amount is reported on line 3, column
(e).

Line 5. Non-U.S. Withholding
Taxes
Report on line 5, column (a), the
amount of non-U.S. (foreign)
withholding taxes included in
determining adjusted financial net
income on Part I, line 11. If the
corporation is deducting any foreign

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withholding tax, use column (b), (c) or
(d), as applicable, to report any
difference between foreign withholding
tax included in financial accounting net
income and the amount of any foreign
withholding tax deduction reported in
column (e). If the corporation is
crediting foreign withholding taxes
against its U.S. income tax liability, no
amount is reported in column (e).

Line 6. Corporate Officer’s
Compensation with Section
162(m) Limitation
Report on line 6, column (a), the total
amount of non-performance-based
current compensation expense
(“applicable employee remuneration”)
for corporate officers that are “covered
employees” under section 162(m)(3).
Report the nondeductible amount of
current compensation in excess of $1
million in column (c), the noneffectively
connected portion of the deductible
compensation in column (d), and the
deductible portion of the compensation
allocable to effectively connected
income in column (e). Do not report the
“applicable employee remuneration” for
“covered employees” defined under
section 162(m) on lines 8, 9 or 15.

Line 7. Salaries and Other Base
Compensation
Report salary and bonus compensation
of the type reported on Form 1120-F,
Section II, line 13, other than stock
option expense and other equity-based
compensation reported on lines 8 and
9.

Line 8. Stock Options Expense
Report on line 8, column (a), amounts
expensed on Part I, line 11, net income
per the income statement, that are
attributable to all stock options. Report
on line 9, column (e), deduction
amounts attributable to all stock
options.

Line 9. Other Equity-Based
Compensation
Report on line 9 any amounts for
equity-based compensation or
consideration that are reflected as
expense in the financial statements
(column (a)) or deducted in the U.S.
income tax return (column (e)) other
than amounts reportable elsewhere on
Schedule M-3, Parts II and III (e.g., on
Part III, line 8, for stock options
expense). Examples of amounts
reportable on line 9 include payments
attributable to employee stock purchase
plans (ESPPs), phantom stock options,
phantom stock units, stock warrants,
stock appreciation rights, and restricted
stock, regardless of whether such
payments are made to employees or
non-employees, or as payment for
property or compensation for services.

Line 10. Meals and
Entertainment
Report on line 10, column (a), any
amounts paid or accrued by the
corporation during the tax year for
meals, beverages, and entertainment
that are accounted for in financial
accounting income, regardless of the
classification, nomenclature, or
terminology used for such amounts,
and regardless of how or where such
amounts are classified in the
corporation’s financial income
statement or the income and expense
accounts maintained in the
corporation’s books and records.
Report only amounts not otherwise
reportable elsewhere on Schedule M-3,
Parts II and III (e.g., Part II, line 2).

Line 11. Fines and Penalties
Report on line 11 any fines or similar
penalties paid to a government or other
authority for the violation of any law for
which fines or penalties are assessed.
All fines and penalties expensed in
financial accounting income (paid or
accrued) must be included on this line
11, column (a), regardless of the
government or other authority that
imposed the fines or penalties,
regardless of whether the fines and
penalties are civil or criminal,
regardless of the classification,
nomenclature, or terminology used for
the fines or penalties by the imposing
authority in its actions or documents,
and regardless of how or where the
fines or penalties are classified in the
corporation’s financial income
statement or the income and expense
accounts maintained in the
corporation’s books and records. In
addition, report on line 11, column (a)
the reversal of any overaccrual of any
amount described in this paragraph.
See section 162(f) for additional
guidance.
Report on line 11, column (e), any
such amounts as are described in the
preceding paragraph that are includible
in effectively connected taxable income,
regardless of the financial accounting
period in which such amounts were or
are included in financial accounting net
income. Complete columns (b), (c), and
(d), as appropriate.
Do not report on this line 11,
amounts required to be reported in
accordance with instructions for Part III,
line 12.
Do not report on this line 11,
amounts recovered from insurers or
any other indemnitors for any fines and
penalties described above.

Line 12. Judgments, Damages,
Awards, and Similar Costs
Report on line 12, column (a), the
amount of any estimated or actual
judgments, damages, awards,
settlements, and similar costs, however

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named or classified, included in
financial accounting income, regardless
of whether the amount deducted was
attributable to an estimate of future
anticipated payments or actual
payments. Also report on line 12,
column (a) the reversal of any
overaccrual of any amount described in
this paragraph.
Report on line 12, column (e), any
such amounts as are described in the
preceding paragraph that are includible
in taxable income, regardless of the
financial accounting period in which
such amounts were or are included in
financial accounting net income.
Complete columns (b), (c), and (d), as
appropriate.
Do not report on this line 12,
amounts required to be reported in
accordance with instructions for Part III,
line 11.
Do not report on this line 12,
amounts recovered from insurers or
any other indemnitors for any
judgments, damages, awards, or similar
costs described above.

Line 13. Pension and
Profit-Sharing
Report on line 13 the expenses and
deductions attributable to the
corporation’s pension plans,
profit-sharing plans, and any other
retirement plans. Complete columns
(b), (c), and (d), as applicable.

Line 14. Other Post-Retirement
Benefits
Report on line 14 the expenses and
deductions attributable to other
post-retirement benefits not otherwise
includible on Part III, line 13 (for
example, retiree health and life
insurance coverage, dental coverage,
etc.). Complete columns (b), (c), and
(d), as appropriate.

Line 15. Deferred
Compensation
Report on line 15, column (a), any
compensation expense included in the
net income (loss) amount reported in
Part I, line 11, that is not deductible for
U.S. income tax purposes in the current
tax year and that was not reported
elsewhere on Schedule M-3, column
(a). Report on line 15, columns (d) and
(e), the noneffectively connected and
effectively connected portions of any
compensation deductible in the current
tax year that was not included in the net
income (loss) amount reported in Part I,
line 11, for the current tax year and that
is not reportable elsewhere on
Schedule M-3. For example, report
originations and reversals of deferred
compensation subject to section 409A
on line 15.

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Line 16. Charitable
Contributions
Report on line 16 any charitable
contribution of tangible or intangible
property to a U.S. or foreign charity. For
example, include contributions of:
• Cash;
• Buildings;
• Intellectual property, patents
(including any amounts of additional
contributions allowable by virtue of
income earned by donees subsequent
to the year of donation), copyrights,
trademarks;
• Securities (including stocks and their
derivatives, stock options, and bonds);
• Conservation easements (including
scenic easements or air rights);
• Railroad rights of way;
• Mineral rights; and
• Other tangible or intangible property.
Include any temporary differences
for the charitable contribution
carryforward limitation in column (b).
Report any net limitation carryforward
for the current year as a net negative
number. Report any utilization of a prior
year limitation carryforward net of the
current year limitation as a positive
number in column (b). Report any
amounts from column (b) that are
allocable to noneffectively connected
income in column (d) and the effectively
connected portion of the utilization of
charitable contribution carryforward in
column (e).

Line 17. Domestic Production
Activities Deduction
Report on line 17, column (e), the
corporation’s effectively connected
portion of its domestic production
activities deduction under section 199
that is reported on Form 1120-F,
Section II, line 25. Complete columns
(b) and (c), as appropriate. Report in
column (d), the portion of the deduction
permitted under section 199 that is
allocated and apportioned as a
permanent difference to noneffectively
connected income. Do not report any
portion of the corporation’s domestic
production activities deduction on any
other line of Schedule M-3.

Line 18. Current Year
Acquisition or Reorganization
Investment Banking Fees, Legal
and Accounting Fees
Report on line 18 any investment
banking fees, and any legal and
accounting fees paid or incurred in
connection with a taxable or tax-free
acquisition of property (e.g., stock or
assets) or a tax-free reorganization.
Report on this line any investment
banking fees incurred at any stage of
the acquisition or reorganization
process including, for example, fees
paid or incurred to evaluate whether to
investigate an acquisition, fees to
conduct an actual investigation, and

fees to consummate the acquisition.
Also, include on line 18, investment
banking fees incurred in connection
with the liquidation of a subsidiary, a
spin-off of a subsidiary, or an initial
public stock offering.

Line 19. Current Year
Acquisition/Reorganization
Other Costs
Report on line 19 any other fees paid or
incurred in connection with a taxable or
tax-free acquisition of property (e.g.,
stock or assets) or a tax-free
reorganization not otherwise reportable
on Schedule M-3 (e.g., Part III, line 18).
Report on this line any fees paid or
incurred at any stage of the acquisition
or reorganization process including, for
example, fees paid or incurred to
evaluate whether to investigate an
acquisition, fees to conduct an actual
investigation, and fees to consummate
the acquisition. Also, include on line 19
other acquisition/reorganization costs
incurred in connection with the
liquidation of a subsidiary, a spin-off of
a subsidiary, or an initial public stock
offering.

Line 20. Amortization/
Impairment of Goodwill
Report on line 20 amortization of
goodwill or amounts attributable to the
impairment of goodwill.

Line 21. Amortization of
Acquisition, Reorganization,
and Start-Up Costs
Report on line 21 amortization of
acquisition, reorganization, and start-up
costs. For purposes of columns (b), (c),
(d), and (e), include amounts
amortizable under section 167, 195, or
248.

Line 22. Other Amortization or
Impairment Write-Offs
Report on line 22 any amortization or
impairment write-offs not otherwise
includible on Schedule M-3.

Line 23. Depreciation
Report on line 23 any depreciation
expense that is not required to be
reported elsewhere on Schedule M-3
(e.g., on Part II, lines 2, 9, 10, or 11).

column (a), the ECI amount is included
in column (b) if it is a temporary
difference and in column (e) to report
the ECI treatment. If there is no
temporary difference between the
foreign bank’s books and tax treatment,
then such ECI amount that is not
included in column (a) is apportioned in
column (d), and its total is reflected in
column (e).
Foreign corporations, including
foreign banks, must treat their section
166 deductions consistently in the
same tax year whether or not such
amounts are allocable to effectively or
noneffectively connected income. A
foreign bank may not claim a bad debt
expense for Regulations sections
1.882-5(c)(2) and (c)(3) purposes and
treat such expense as an involuntary
charge-off under Regulations section
1.166-2(d)(2) for purposes of its
allocation and apportionment to
effectively connected income. For
example, if a foreign corporation treats
a noneffectively connected loan
security for purposes of determining the
value of its worldwide assets in step 2
of its Regulations section 1.882-5
interest expense allocation, as having a
reduced basis in the current year to
take account of partial worthlessness
under section 166, if such amount is
includible in column (a), then such
current year adjustment to basis is also
reportable in column (d) to apportion
the section 166 deduction to non-ECI.
If, however, a current year section 166
reduction in basis is claimed for
Regulations section 1.882-5(c)(2)
purposes with respect to a security that
is effectively connected, but is not
included on the Form 1120-F, Schedule
L books, such effectively connected
amount must be reported in column (d)
and column (e). If an effectively
connected bad expense is includible in
column (a) that is also currently
deductible for tax purposes, no book
tax difference is reported in column (b),
(c) or (d).

Line 25. Purchase versus Lease
(for Purchasers and/or
Lessees)

Line 24. Bad Debt Expense

Note. Also, see the instructions for
Part II, line 17, on page 14 for sellers
and/or lessors.

Report on line 24, column (a), any
amounts attributable to an allowance
for uncollectible accounts receivable or
actual write-offs of accounts receivable
included in determining net income per
the income statement. Report in
columns (d) and (e) the respective
noneffectively connected and the
effectively connected portions of the
deductible amount of bad debt expense
determined under section 166 for
federal income tax purposes that is also
included in column (a). If a foreign bank
has an effectively connected bad debt
expense that is not reportable in

Asset transfer transactions with
periodic payments characterized for
financial accounting purposes as either
a purchase or a lease may, under some
circumstances, be characterized as the
opposite for tax purposes.
If a transaction is treated as a lease,
the purchaser/lessee reports the
periodic payments as gross rental
expense. If the transaction is treated as
a purchase, the purchaser/lessee
reports the periodic payments as
payments of principal and interest and
also reports depreciation expense or

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deduction with respect to the purchased
asset.
Report on line 25, column (a), gross
rent expense for a transaction treated
as a lease for income statement
purposes but as a sale for U.S. income
tax purposes. Report on line 25,
column (e), gross rental deductions for
a transaction treated as a lease for U.S.
income tax purposes but as a purchase
for income statement purposes. Report
interest expense for such transactions
on Part III, line 26a (interest expense),
in columns (a) and (e), as applicable.
Report depreciation expense or
deductions for such transactions on
Part III, line 23 (depreciation), in
columns (a) and (e), as applicable. Use
columns (b), (c), and (d) of Part III, lines
23, 25, and 26a, as applicable, to report
the differences between column (a) and
(e) for such recharacterized
transactions.

Line 26a. Interest expense
The detail for the foreign corporation’s
interest expense is reported on
Schedule I (Form 1120-F). The scope
of the interest expense lines on Part III,
line 26, is limited to a summarization of
the results from Schedule I that
reconcile the foreign corporation’s book
interest expense to effectively
connected taxable income.
On line 26a, no amount is allocated
and apportioned to effectively or
noneffectively connected income.
Report in line 26a, column (a) interest
expense included in Part I, line 11.
Report amounts in columns (b) or (c),
as applicable. The corresponding
interest expense for U.S. income tax
purposes is reported on Part III, lines
26b through 26e, column (e). Do not
report on this line 26a, column (a),
amounts reportable on:
1. Part II, lines 9, 10, and 11
(income (loss) from U.S. partnerships,
foreign partnerships, and other
pass-through entities);
Note. Interest expense from
partnerships and pass-through entities
is adjusted as a permanent difference
in column (c) of lines 9, 10 and 11. The
deductible portion of such interest
expense reported on lines 9, 10 and 11
is included in the interest expense
allocation under Regulations section
1.882-5 as reported on Schedule I and
in this Part III, lines 26b and 26c.
2. Part II, line 12 (items relating to
reportable transactions); and
3. Part III, lines 26b through 26e.

Line 26b. Interest Expense
Allocable under Regulation
Section 1.882-5
The interest expense deduction under
Regulations section 1.882-5 is based
on a three-step formula required to be
reported on Schedule I (Form 1120-F).
Report the allocable amount of interest

expense from Schedule I (Form
1120-F), line 23, in column (d) and in
column (e).

Line 26c. Regulations Section
1.882-5 Allocation Amount
Subject to Deferral or
Disallowance
Enter in column (e) the amount
reported on Schedule I (Form 1120-F),
line 24d. This amount is generally
entered in column (e) as a negative
number. However, if the deferred
interest expense reportable on
Schedule I, line 24b, from prior years is
deductible in the current year in greater
amount than other current year
disallowances reportable on Schedule I,
lines 24a and 24c, enter the net amount
in column (e) as a positive number.
Enter in column (b) the amount from
Schedule I, line 24b, as a positive or
negative number as the case may be
for the current year. In column (c), enter
the combined amounts from Schedule I,
lines 24a and 24c.

Line 26d. Substitute Interest
Payments
All foreign corporations, report on line
26d, all U.S. source substitute interest
payments with respect to securities
lending transactions described in
Regulations sections 1.861-2(a)(7) and
1.881-2(b)(2). Foreign banks that
record substitute interest payments on
set(s) of books that are not reported on
Form 1120-F, Schedule L, also report
foreign source substitute interest
payments whether or not they are
allocable in whole or in part to ECI.
Foreign banks report in column (c), all
U.S. source and allocable foreign
source substitute interest payments not
already reflected in column (a). The
amounts reported in column (c) are
apportioned to noneffectively connected
income of the foreign corporation in
column (d) and reported as a negative
number. Amounts included in column
(a) that are also apportioned to
non-ECI, are also reported in column
(d) as a negative number. The
combined amounts of columns (a), (b),
(c) and (d) are apportioned to
effectively connected income in column
(e) as the case may be.
Note. Line 26d reporting requirements
are an exception to the general
reporting instructions for Schedule M-3
in that column (d) is also used by
foreign banks to apportion amounts to
ECI that are not included in column (a).

Line 26e. Interest Equivalents
(Guarantee Fees)
All foreign corporations, report on line
26e the foreign corporation’s amounts
with respect to deductions that are not
interest payments but are sourced in
the manner of interest (“interest
equivalents”). These amounts include
fees expensed for financial guarantee

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and confirmation, acceptance and
standby letter of credit transactions.
Foreign banks that record U.S. source
guarantee fees on set(s) of books not
reported on Form 1120-F, Schedule L,
and not reported in column (a), must
report the U.S. source fees as a
permanent difference on line 26e,
column (c), and allocate and apportion
the relevant amounts to noneffectively
connected income in column (d) even if
there is no amount to allocate to
effectively connected amounts in
column (e). Foreign corporations other
than banks must record all interest
equivalent payments in column (a). Do
not include on line 26e, substitute
payments reportable on line 26d.
Note. Line 26e reporting requirements
are an exception to the general
reporting instructions for Schedule M-3
in that column (d) is generally also used
by foreign banks to apportion amounts
to ECI that are not included in column
(a).
Example 34. FC is a foreign bank,
resident in Country X, that files Form
1120-F and Schedule M-3. FC enters
into a guarantee arrangement with FC2,
a wholly owned subsidiary, resident in
Country Y, that guarantees the
transactions in FC’s global dealing
operation. The set(s) of books in FC’s
global dealing operation are booked in
FC’s home office and are not reportable
on Form 1120-F, Schedule L. FC
allocates and apportions 40% of the
income and applicable expenses from
its global dealing operation to
effectively connected taxable income.
FC’s guarantee fee expense paid to its
foreign-related party is allocated directly
to the income of the global dealing
operation and apportioned 40% to FC’s
effectively connected income from such
operation. FC must report the
guarantee fee expense paid to FC2 in
column (c). The amount of expense
reported in column (c) is apportioned
60% to noneffectively connected
income in column (d) and 40% to
effectively connected income in column
(e).

Line 27. Substitute Dividend
Payments
All foreign corporations report on line
27 the amount of U.S. source substitute
dividend payments with respect to
securities lending transactions
described in Regulations sections
1.861-3(a)(6) and 1.881-2(b)(2).
Foreign banks that record substitute
dividend payments on set(s) of books
that are not reported on Form 1120-F,
Schedule L, also report foreign source
substitute dividend payments whether
or not they are allocable in whole or in
part to ECI. Foreign banks report in
column (c), such U.S. source and
allocable foreign source substitute
dividends not already reflected in
column (a). The amounts reported in

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Instructions for Schedule M-3 (Form 1120-F)

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column (c) are apportioned to
noneffectively connected income of the
foreign corporation in column (d) and
reported as a negative number.
Amounts included in column (a) that are
also apportioned to non-ECI, are also
reported in column (d) as a negative
number. The combined amounts of
columns (a), (b), (c) and (d) are
apportioned to effectively connected
income in column (e) as the case may
be.
Note. Line 27 reporting requirements
are an exception to the general
reporting instructions for Schedule M-3
in that column (d) is also used by
foreign banks to apportion amounts to
ECI that are not included in column (a).

Line 28. Fee and Commission
Expense
Enter on Part III, line 28, column (a),
the amounts of fees and commissions
included on Part I, line 11. Fee and
commission expense generally includes
amounts paid or accrued for services
rendered to the foreign corporation
including expenses paid for brokerage
commissions. Fees and commissions
reportable on line 28 do not include
amounts that are interest equivalents
reportable on line 26e.

Line 29. Rental Expense
Report on line 29, column (a), the
amount of rental expense included on
Part I, line 11. Rental expense is the
amount classifiable as rent under U.S.
tax principles.

Line 30. Royalty Expense
Report on line 30, column (a), the
amount of royalty expense included on
Part I, line 11. Include in columns (b)
through (e) amounts that are allocable
as imputed royalties under U.S. tax
principles that are not included in
financial income reported on Part I, line
11.

Line 31. Expenses Allocable
Under Regulations Section
1.861-8
Line 31 applies only to foreign banks.
For purposes of Schedule M-3, all of
the home office and other allocations to
U.S. effectively connected income that
are reportable on Schedule H (Form
1120-F) under Regulations section
1.861-8 (including amounts that are
subject to timing differences under U.S.
tax principles, such as home office
depreciation) are reportable as
apportionments to ECI in column (d).
Report in columns (d) and (e) the
amount from Schedule H (Form
1120-F), line 21.
Note. Foreign corporations other than
banks that are required to file Form
1120-F to report effectively connected
income in Section II of that form, are
still required to complete and attach
Schedule H (Form 1120-F) to their U.S.

income tax return. The amounts from
Schedule H, line 21 are not reportable
by a foreign corporation other than a
bank on Schedule M-3 because
worldwide expenses are already
includible in Part I, line 11, and in each
expense line item in Part III. Such
amounts are subject to individual
line-item apportionment to non-ECI in
column (d).

Line 32. Other Expense/
Deduction Items with
Differences and Reconciliation
to Eliminate Duplicate Amounts
on Line 31
Report on line 32, all items of expense/
deduction that are not otherwise listed
on Part III, lines 1 through 31. Amounts
included on line 31, column (e) from
Schedule H (Form 1120-F), line 21, that
are also included in this Form M-3, Part
III, lines 3, 5 through 23, 25, 26d, 26e
and 27 need to be reversed to avoid
duplicate allocation. The combined
amounts for these lines reported in
column (e) that is duplicative of any
amount included in line 31, column (e)
is reported and reversed on line 32.
Report such duplicative amount as a
negative amount includible in line 32,
column (c) and column (e). Such
negative amount will need to be
combined with other expense/deduction
items that have differences. Attach a
schedule to show the duplicative items
that are being reversed.
Comprehensive income. If any
“comprehensive income” as defined by
SFAS No. 130 is reported on this line,
describe the item(s) in detail.
Reserves and contingent liabilities.
Report on line 32 amounts related to
the change in each reserve or
contingent liability that is not required to
be reported elsewhere on Schedule
M-3. For example: (1) amounts relating
to changes in reserves for litigation
must be reported on Part III, line 12
(judgments, damages, awards, and
similar costs); and (2) amounts relating
to changes in reserves for uncollectible
accounts receivable must be reported
on Part III, line 24 (bad debt expense).
Report on line 32, the amortization of
various items of prepaid expense, such
as prepaid subscriptions and license
fees, prepaid insurance, etc.
Report on line 32, column (a),
expenses included in net income
reported on Part I, line 11, that are
related to reserves and contingent
liabilities. Report on line 32, column (e),
amounts related to liabilities for
reserves and contingent liabilities that
are deductible in the current tax year
for U.S. income tax purposes.
Examples of items that must be
reported on line 32 include warranty
reserves, restructuring reserves,
reserves for discontinued operations,
and reserves for acquisitions and

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dispositions. Only report on line 32
items that are not required to be
reported elsewhere on Schedule M-3,
Parts II and III. For example, the
expense for a reserve for inventory
obsolescence must be reported on Part
II, line 2.
The schedule which is required to be
attached to this Schedule M-3 for line
32 must separately state and
adequately disclose the nature and
amount of the expense related to each
reserve and/or contingent liability. The
appropriate level of disclosure depends
upon each taxpayer’s operational
activity and the nature of its accounting
records. For example, if a corporation’s
net income amount reported in the
income statement includes anticipated
expenses for a discontinued operation
as a single amount, and its general
ledger or other books, records, and
workpapers provide details for the
anticipated expenses under more
explanatory and defined categories
(such as employee termination costs,
lease cancellation costs, loss on sale of
equipment, etc.), a supporting schedule
that lists those categories of expenses
and their details will satisfy the
requirement to separately state and
adequately disclose. In order to
separately state and adequately
disclose the employee termination
costs, it is not required that an
anticipated termination cost amount be
listed for each employee, or that each
asset (or category of asset) be listed
along with the anticipated loss on
disposition.
Amounts incurred as fixed or
determinable or other periodic interest
rate or equity notional principal contract
expense that is not incurred in a
hedging transaction, securities dealing
or global securities dealing operation,
each of which is reportable on Part II,
are reportable on Part III, line 32.
Example 35. Corporation Q is a
calendar year taxpayer that was
required to file Schedule M-3 for its
2007 tax year and is required to file
Schedule M-3 for its 2008 tax year. On
July 1 of each year, Q has a fixed
liability for its annual insurance
premiums that provides a 12-month
coverage period beginning July 1
through June 30. In addition, Q
historically prepays 12 months of
advertising expense on July 1. On July
1, 2008, Q prepays its insurance
premium of $500,000 and advertising
expenses of $800,000. For financial
statement purposes, Q capitalizes and
amortizes the prepaid insurance and
advertising over 12 months. For U.S.
income tax purposes, Q deducts the
insurance premium when paid and
amortizes the advertising over the
12-month period. In its financial
statements, Q treats the differences
attributable to the financial statement

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Instructions for Schedule M-3 (Form 1120-F)

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treatment and U.S. income tax
treatment of the prepaid insurance and
advertising as temporary differences. Q
must separately state and adequately
disclose its prepaid insurance premium
on Part III, line 32. It must report
$250,000 in column (a) ($500,000/12
months X 6 months), $250,000 in
column (b), and $500,000 in column
(e). Q must also separately state and

adequately disclose its prepaid
advertising on Part II, line 24, and
report $400,000 in each of columns (a)
and (e).

Line 33. Total Expense/
Deduction Items
Report on Part II, line 26, columns (a)
through (e), as applicable, the inverse
of the amounts reported on Part III, line

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33, column (a) through (e), as
applicable. For example, if Part III, line
33, column (a), reflects an amount of
$1 million, then report on Part II, line
26, column (a), ($1 million). Similarly, if
Part III, line 33, column (b), reflects an
amount of ($50,000), then report on
Part II, line 26, column (b), $50,000.