IRB Notice

Part III. Administrative, Procedural, and Miscellaneous
Foreign Tax Credit and Other
Guidance Under Section 965
Notice 2005–64
SECTION 1. OVERVIEW
This notice is the third in a series of
items of published guidance regarding new
section 965 of the Internal Revenue Code
(Code). This notice supplements the guidance set forth in Notice 2005–10, 2005–6
I.R.B. 474, which primarily addressed the
requirements for a domestic reinvestment
plan described in section 965(b)(4), and
Notice 2005–38, 2005–22 I.R.B. 1100,
which primarily addressed the limitations
described in section 965(b)(1), (2), and
(3) on the amount of dividends eligible
for the dividends received deduction under section 965(a), including the effects
of certain acquisitions, dispositions, and
similar transactions on those limitations.
This notice sets forth guidance on various
issues arising under section 965, including
issues relating to the foreign tax credit and
minimum tax credit, expense allocation
and apportionment, and currency translation. The Treasury Department and the
Internal Revenue Service (IRS) expect to
issue regulations that incorporate the guidance provided in Notice 2005–10, Notice
2005–38, this notice, and any subsequent
guidance that may be issued addressing
section 965.
The remainder of this notice is divided
into 14 sections. Section 2 provides background with respect to the issues discussed
in this notice. Section 3 provides guidance
on the identification of cash dividends and
qualifying dividends and foreign currency
translation rules for certain cash dividends.
Section 4 provides guidance on the disallowance of a credit or deduction under section 965(d)(1) for foreign taxes paid or accrued with respect to the deductible portion of section 965 dividends and related
issues arising under section 78. Section 5
provides guidance on the disallowance of
deductions for certain expenses under section 965(d)(2). Section 6 provides rules for
the treatment of deductions related to sec-

tion 904(d) separate categories containing
qualifying dividends. Section 7 then provides guidance on the limitation under section 965(e)(2) that prevents the reduction
of taxable income below the amount of
nondeductible CFC dividends. Section 8
addresses the application of the overall foreign loss and separate limitation loss allocation and recapture rules of section 904(f)
to taxpayers with nondeductible CFC dividends. Section 9 provides rules for implementing the restrictions under section
965(e)(1) on the use of credits to offset
U.S. tax on nondeductible CFC dividends,
in part through the application of an additional foreign tax credit limitation that is
applied after expenses and losses are allocated and the regular section 904(d) limitation is calculated, and provides rules relating to the computation of alternative minimum tax and the credit for prior year minimum tax in the election year. Section
10 then addresses other issues arising under section 965, including the treatment
of dividends paid to certain intermediary
pass-through entities for purposes of determining base period inclusions under section 965(b)(2)(B)(i). Section 11 sets forth
transition rules that apply to certain taxpayers that approved a domestic reinvestment plan or filed a tax return for a taxable
year to which section 965 applies prior to
the issuance of this notice. Section 12 describes the effect of this notice on other
documents. Section 13 provides the effective date of this notice, and section 14 provides information required under the Paperwork Reduction Act of 1995. Finally,
section 15 provides drafting information.
SECTION 2. BACKGROUND
.01 Section 965—In General
The American Jobs Creation Act of
2004 (P.L. 108–357) (the Act), enacted on
October 22, 2004, added new section 965
to the Code. In general, and subject to limitations discussed below, section 965(a)
provides that a corporation that is a U.S.
shareholder1 of a controlled foreign corporation (CFC) may elect, for one taxable
year, an 85 percent dividends received de-

duction (DRD) with respect to certain cash
dividends it receives from its CFCs.2 For
this purpose, all U.S. shareholders that are
members of an affiliated group filing a
consolidated return under section 1501 are
treated as one U.S. shareholder. Section
965(c)(5)(A).
For purposes of section 965, the term
“cash dividends” includes cash amounts
included in gross income as dividends under sections 302, 304, and 356(a)(2), but
does not include subpart F inclusions or
amounts treated as dividends under section
78 or 1248 or, except in certain cases, section 367. H.R. Conf. Rep. No. 108–755,
at 314–15; see Notice 2005–10, sections
2 and 3. For this purpose, a cash dividend also includes a cash distribution from
a CFC to a U.S. shareholder that is excluded from gross income under section
959(a) to the extent of amounts included
in income by such U.S. shareholder under section 951(a)(1)(A) as a result of a
cash dividend during the election year to:
(1) such CFC from another CFC in a section 958(a) chain of ownership; or (2) any
other CFC in such chain of ownership from
another CFC in such chain of ownership,
but only to the extent of cash distributions
described in section 959(b) made during
such year to the CFC from which such
U.S. shareholder received such distribution. Section 965(a)(2).
The amount of cash dividends eligible for the section 965(a) DRD (qualifying dividends) is determined after applying certain limitations. Notice 2005–38
addressed the rules limiting qualifying dividends to certain dollar threshold amounts
determined with reference to the greater
of $500 million or the amount of earnings permanently reinvested outside the
United States, the amount of dividends received in excess of certain base period average amounts, and certain increases in
related-party indebtedness. See sections
965(b)(1) through (3) and 965(c). Notice
2005–10 addressed the requirement in section 965(b)(4) that the amount of the dividends be invested in the United States pursuant to a domestic reinvestment plan that
meets specified criteria. Notice 2005–10

1

The term U.S. shareholder means, with respect to any foreign corporation, a U.S. person who owns (within the meaning of section 958(a)), or is considered as owning by applying the rules
of ownership of section 958(b), 10 percent or more of the total combined voting power of all classes of stock entitled to vote of such foreign corporation. Section 951(b).

2

Section 965(c)(4) provides that no deduction is allowed under section 243 or 245 for any dividend for which a deduction is allowed under section 965.

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also provided rules for electing the application of section 965 for a taxable year by
filing Form 8895 with a timely-filed tax return. See section 965(b)(4) and (f). The
taxable year for which a taxpayer elects
section 965 to apply is referred to in this
notice as the “election year.”
.02 Disallowance of Credit or Deduction
for Certain Expenses Related to
Deductible Portion of Qualifying
Dividends and Related Matters
Section 965(d)(1) provides that no
credit or deduction is allowed for certain
foreign taxes paid or accrued (or treated
as paid or accrued) with respect to the
deductible portion of any qualifying dividend. Section 965(d)(2) further provides
that no deduction shall be allowed for certain other expenses. Section 9.01 of Notice
2005–38 confirmed that section 78 does
not apply to any tax which is not allowable
as a credit under section 901 by reason of
section 965(d) and that the disallowance
of deductions in section 965(d)(2) applies
only to deductions for expenses that are
directly allocable to the deductible portion
described in section 965(d)(1).
Section 965(d)(3) provides that, unless
the taxpayer otherwise specifies, the deductible portion of any qualifying dividend
is the amount which bears the same ratio to the amount of such dividend as the
amount allowed as a deduction under section 965(a) for the election year bears to
the total amount of dividends the taxpayer
received from its CFCs during the election
year, as described in section 965(b)(2)(A).
For purposes of determining which dividends are subject to the foreign tax credit
and expense disallowance, the taxpayer
may specifically identify which cash dividends are treated as carrying the DRD (and
thus entail proportionate disallowance of
any associated deductions and foreign tax
credits) and which are not. H.R. Conf.
Rep. No. 108–755, at 316. In the absence of such a specification, a pro rata
amount of foreign tax credits and deductions will be disallowed with respect to every cash dividend repatriated during the
election year. See H.R. Conf. Rep. No.
108–755, at 316 n. 112.

.03 Limitation on Use of Credits and
Deductions Related to Nondeductible
Portion of Qualifying Dividends
For purposes of this notice, the term
“nondeductible CFC dividends” refers to
the excess of the amount of qualifying
dividends over the 85 percent deduction
allowed for such dividends under section
965(a). See section 965(e)(3). Section
965(e) provides limitations on the extent
to which credits may offset the U.S. tax
on nondeductible CFC dividends, and
also provides that allowable deductions
may not reduce taxable income below the
amount of nondeductible CFC dividends.
Specifically, section 965(e)(1) provides
that the U.S. tax on nondeductible CFC
dividends may not be offset by tax credits, other than a foreign tax credit under
section 27 for taxes attributable to such
dividends and the credit for prior year
minimum tax under section 53.
Section 965(e)(1) further provides that
the U.S. tax on nondeductible CFC dividends is not treated as tax imposed by
chapter 1 for purposes of computing the
alternative minimum tax imposed by section 55 (AMT). Accordingly, the tax on
nondeductible CFC dividends cannot reduce the AMT that otherwise would be
owed by the taxpayer. H.R. Conf. Rep.
No. 108–755, at 316.3 Section 9.01 of Notice 2005–38 provided that for purposes
of calculating AMT for the election year
in accordance with section 965(e)(1)(B),
the taxpayer’s regular tax described in section 55(c) and tentative minimum tax determined under section 55(b)(1)(B) do not
include tax attributable to nondeductible
CFC dividends.
Section 965(e)(2)(A) provides that taxable income shall in no event be less than
the amount of nondeductible CFC dividends received during the election year.
While the income attributable to nondeductible CFC dividends may not be offset
by expenses, losses, or deductions, such
amounts may have the effect of reducing
the taxpayer’s other income. H.R. Conf.
Rep. No. 108–755, at 316 n. 113. Section 965(e)(2)(B) provides that the nondeductible CFC dividends are not taken into
account in determining the amount of any
net operating loss (NOL) for the election
year, or in determining taxable income for

the election year for purposes of the second sentence of section 172(b)(2), which
applies in determining the allowable NOL
carryover or carryback to other years.
SECTION 3. IDENTIFICATION OF
CASH DIVIDENDS, QUALIFYING
DIVIDENDS, AND SEPARATE
CATEGORIES; FOREIGN CURRENCY
TRANSLATION RULES
.01 Identification of Cash Dividends
In order for cash dividends that are paid
to a partnership or a disregarded entity that
is owned by a U.S. shareholder to qualify as cash dividends described in section
965(a), cash in the amount of the dividend
must be received by the U.S. shareholder
in the election year from the partnership
or disregarded entity. See section 3.02 of
Notice 2005–10. In the case of a disregarded entity, cash may be received in a
form other than a distribution. See section 9.06 of Notice 2005–38 and section
10.09 of this notice. In addition, as described in section 2.01 of this notice, under section 965(a)(2) a cash distribution
from a CFC of previously-taxed earnings
and profits attributable to amounts which
are or have been included in income of the
U.S. shareholder and are excluded from
gross income under section 959(a) (previously-taxed income or PTI) is treated
as a cash dividend only to the extent of
amounts included in income by the U.S.
shareholder under subpart F in the election year as a result of cash dividends that
are both paid and distributed through a
chain of CFCs to the U.S. shareholder in
the election year. Finally, a deemed liquidation effected through an election under §301.7701–3(c) results in a cash dividend only to the extent the shareholder
receives cash as part of the liquidation in
the election year. Section 965(c)(3); see
section 2, footnote 2, of Notice 2005–10.
This section 3.01 provides rules for identifying the amounts treated as cash dividends if a U.S. shareholder receives cash
from a partnership or disregarded entity
or cash distributions of PTI from a CFC
that exceed the cash dividends paid to such
partnership, disregarded entity, or CFC (or
the cash deemed received in a deemed liquidation) in the election year. See sec-

3

However, the DRD is not treated as a preference item for purposes of computing the AMT. Section 56(g)(4)(C)(vi). Thus, the deduction is allowed in computing alternative minimum taxable
income notwithstanding the fact that it may not be deductible in computing earnings and profits. H.R. Conf. Rep. No. 108–755, at 316–317.

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tion 3.02 of this notice for rules for identifying specific cash dividends (including
both cash dividends described in this section 3.01 and cash dividends described in
section 965(a)(1) that are paid directly by
a CFC to a U.S. shareholder) as qualifying
dividends eligible for the section 965(a)
DRD.
For purposes of this section 3, the term
“eligible cash amount” refers to (a) cash
received by the U.S. shareholder on any
day in the election year from a partnership or disregarded entity in a form that
satisfies the requirements of section 3.02
of Notice 2005–10 and section 9.06 of Notice 2005–38, and (b) cash distributions of
PTI to the U.S. shareholder on any day in
the election year from a CFC. A taxpayer
that receives eligible cash amounts from
a disregarded entity or partnership that in
the aggregate exceed the total amount of
cash dividends paid to (or the amount of
cash deemed received in a deemed liquidation from) such disregarded entity or the
taxpayer’s distributive share of cash dividends paid to such partnership during the
election year, respectively, may specifically identify which eligible cash amounts
are treated as attributable to the underlying cash dividends (and therefore considered to be a cash dividend described in section 965(a)(1) or (2)). Similarly, a taxpayer that receives eligible cash amounts
of PTI from a CFC in excess of the amount
eligible to be treated as a cash dividend
under section 965(a)(2) may specifically
identify which cash PTI distributions from
that CFC are treated as attributable to the
underlying subpart F inclusions (and therefore considered to be a cash dividend described in section 965(a)(2)).
Taxpayers make this identification by
including the cash dividends and identifying information on Part V of Form 8895.4
Taxpayers may identify all or a portion of
any specific eligible cash amount received
by the U.S. shareholder from a disregarded
entity, partnership or CFC in the election
year as the cash dividend. To the extent
a taxpayer fails to identify specific eligible
cash amounts in an amount equal to the full
amount of the taxpayer’s share of cash div-

idends received by the disregarded entity,
partnership or CFC, a pro rata portion of
each eligible cash amount received but not
otherwise identified by the taxpayer as a
cash dividend will be treated as a cash dividend. The pro rata portion is the amount
which bears the same ratio to the eligible
cash amount as the unidentified portion of
the taxpayer’s share of the cash dividends
paid to the disregarded entity, partnership
or CFC bears to the total amount of eligible
cash amounts received during the election
year but not otherwise identified as cash
dividends.
If a U.S. shareholder receives eligible cash amounts from a disregarded
entity owned by the U.S. shareholder in
an amount less than or equal to the total
amount of cash dividends paid to the disregarded entity during the election year, then
100 percent of each eligible cash amount
received from such disregarded entity is a
cash dividend described in section 965(a).
Similarly, if a U.S. shareholder receives
eligible cash amounts from a partnership
in an amount less than or equal to the total
amount of the U.S. shareholder’s distributive share of cash dividends paid to the
partnership during the election year, then
100 percent of each eligible cash amount
received from such partnership is a cash
dividend described in section 965(a).
Finally, if a U.S. shareholder (or a disregarded entity or partnership owned by the
U.S. shareholder) receives cash distributions of PTI from a CFC in an amount less
than or equal to the amount of earnings
and profits included in income by the U.S.
shareholder under section 951(a)(1)(A) as
a result of one or more cash dividends paid
to the distributing CFC or another CFC in
the same chain of ownership described in
section 958(a), then 100 percent of each
cash distribution of PTI from that CFC
is a cash dividend described in section
965(a)(2).
The taxpayer may choose to associate
each cash dividend received from a disregarded entity or partnership with one or
more of the cash dividends paid to that disregarded entity or partnership during the
election year. Similarly, the taxpayer may

choose to associate each cash dividend described in section 965(a)(2) that is received
from a CFC with the earnings and profits attributable to the taxpayer’s subpart F
inclusion from one or more of the CFCs
in the ownership chain. Taxpayers make
this identification by including the identifying information required by Part V of
Form 8895 and consistently calculating the
tax consequences under section 965 and
this notice for those cash dividends that are
qualifying dividends, determined as provided in section 3.02 of this notice.5
.02 Identification of Qualifying Dividends
and Separate Categories
In addition to other limitations, the
amount of cash dividends eligible for the
DRD is limited to the excess of the cash
dividends received by the taxpayer from
its CFCs during the election year over
the taxpayer’s base period amount. See
section 965(b)(2) and sections 2 and 3 of
Notice 2005–38. A taxpayer may specifically identify which cash dividends are
treated as qualifying dividends carrying
the DRD and which cash dividends are
treated as meeting the base-period repatriation level or are otherwise ineligible for
the DRD. H.R. Conf. Rep. No. 108–755,
at 316. Taxpayers identify the qualifying
dividends by completing Form 8895, Part
V, column (e).6
A taxpayer generally must identify each
cash dividend received during the election
year as either a qualifying dividend or a
non-qualifying dividend in its entirety, but
may identify a portion of one dividend as
a qualifying dividend to the extent necessary to prevent the total amount identified
in Part V, column (e) of Form 8895 from
exceeding the total amount of qualifying
dividends. To the extent a taxpayer fails
to identify specific cash dividends equal to
the full amount of qualifying dividends, a
pro rata portion of each cash dividend received by the taxpayer during the election
year that is not otherwise identified by the
taxpayer as a qualifying dividend will be
treated as a qualifying dividend. The pro
rata portion is the amount which bears the

4 Any taxpayer that had filed its return for the election year before Form 8895 was made available to the public in final form need not file Form 8895 to identify the cash dividends, but should
retain the information requested on the Form to be made available to the IRS on request.
5

See footnote 4.

6

Section 7.06 of Notice 2005–38 provides that an increase in a CFC’s related party indebtedness is allocated among U.S. shareholders that are related persons with respect to the CFC in the
order that cash dividends are received. The provision of Notice 2005–38 allocates among the U.S. shareholders the reduction in the amount of cash dividends eligible for the section 965(a)
DRD, but does not preclude a U.S. shareholder from identifying any specific cash dividend as a qualifying dividend.

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same ratio to the amount of the dividend
as the total amount of qualifying dividends
not otherwise identified bears to the total amount of cash dividends received during the election year described in section
965(b)(2)(A) that are not otherwise identified as qualifying dividends. See Example
3 of section 3.05 of this notice.
Qualifying dividends described in section 965(a)(1) will be considered paid
pro rata out of the non-previously-taxed
earnings and profits in the CFC’s separate
categories from which the dividend was
paid, in accordance with the look-through
rules of section 904(d)(3)(D). Subpart
F inclusions attributable to dividends
paid to a CFC from another CFC in the
same chain of ownership (including CFCs
engaged in section 304 transactions described in section 9.04 of Notice 2005–38)
are treated as income in the same separate categories to which the dividend is
assigned, under the look-through rules of
section 904(d)(3)(B) and (D). See Treas.
Reg. §1.904–5. Cash dividends described
in section 965(a)(2), whether or not identified by the U.S. shareholder as qualifying
dividends, will be considered paid first
out of the previously-taxed earnings and
profits described in section 959(c)(2) that
are attributable to the amount included in
the United States shareholder’s income
under section 951(a)(1)(A) in the election
year as a result of the CFC-to-CFC cash
dividend described in section 965(a)(2), to
the extent thereof.
.03 Allocation of Dividends Received
Deduction
The DRD allowed under section 965(a)
is definitely related to and allocated to
reduce gross income in the U.S. shareholder’s separate categories to which the
qualifying dividends described in section
965(a)(1) and the subpart F inclusions underlying qualifying dividends described in
section 965(a)(2) are assigned. See Treas.
Reg. §1.861–8(a)(2) and (b)(2).
.04 Foreign Currency Exchange Rate
Conventions
(a) Cash dividends described in section
965(a)(1). Cash dividends described in
section 965(a)(1) that are paid directly

to the U.S. shareholder are translated
into U.S. dollars at the spot rate on the
date of distribution as provided in section
989(b)(1).7 A cash dividend paid by a CFC
to a pass-through entity that is owned by
a U.S. shareholder is treated as received
by such U.S. shareholder for purposes of
section 965(a) only if and to the extent
that such shareholder receives cash in the
amount of the CFC dividend during the
election year. See Notice 2005–10, section 3.02, Notice 2005–38, section 9.06,
and section 10.09 of this notice. Such
cash dividends are translated from the
functional currency of the payor CFC into
U.S. dollars at the spot rate on the date the
amount of the cash dividend is received by
the U.S. shareholder, rather than at the spot
rate on the date the dividend is received
by the partnership or disregarded entity.
Accordingly, the receipt of cash itself will
not result in currency gain or loss to the
U.S. shareholder.
(b) Cash dividends described in section
965(a)(2). Cash dividends described in
section 965(a)(2) are distributions of PTI
to the U.S. shareholder in an amount that
does not exceed the subpart F inclusions
in the election year that result from cash
dividends that are paid by lower-tier CFCs
and that are distributed as PTI through a
chain of CFCs and received by the U.S.
shareholder during the election year. The
subpart F inclusions that result in cash dividends will be translated from the functional currency of the CFC receiving the
dividend into U.S. dollars at the spot rate
on the date the PTI is distributed to the U.S.
shareholder, rather than at the average rate
generally used to translate subpart F inclusions under section 989(b)(3), and the PTI
distribution will not result in currency gain
or loss under section 986(c).
.05 Examples
The following examples illustrate the
application of section 965(d)(3) and this
section 3. Unless otherwise indicated, the
following facts are assumed for purposes
of these examples. All corporations use
calendar taxable years for U.S. tax purposes. USP is a domestic corporation that
elects to apply section 965 to its 2005 taxable year and meets all applicable requirements to claim the section 965(a) DRD

with respect to the qualifying dividends
described in the examples.
Example 1. Identification of cash dividends
where PTI distributions exceed subpart F inclusions
attributable to cash dividends. (i) Facts. USP owns
all the stock of CFC1, which owns all the stock of
CFC2. CFC1 and CFC2 are organized under the laws
of different foreign countries and each uses the “u”
as its functional currency. On September 1, 2005,
CFC2 pays a cash dividend of 200u to CFC1 that is
subpart F income of CFC1 under sections 952(a) and
954(c)(1)(A), resulting in a 200u income inclusion to
USP under section 951(a)(1)(A). On each of March
1, 2005, when the spot exchange rate is 1u = $1,
and November 1, 2005, when the spot exchange
rate is 1u = $1.25, CFC1 distributes 200u to USP.
Each of the 200u distributions is a distribution of
previously-taxed earnings and profits of CFC1 that
is excluded from USP’s gross income under section
959(a).
(ii) Result. USP received cash distributions of
PTI from CFC1 in the election year in an amount
(400u) that exceeds the amount included in income
by USP under section 951(a)(1)(A) as a result of
cash dividends during the election year to CFC1
from CFC2, another CFC in a chain of ownership
described in section 958(a) (200u). Pursuant to section 3.01 of this notice, USP may identify either the
March 1, 2005 PTI distribution of 200u = $200 or the
November 1, 2005 PTI distribution of 200u = $250
as the cash dividend described in section 965(a)(2) of
previously-taxed earnings attributable to the subpart
F inclusion resulting from the cash dividend paid by
CFC2 to CFC1. Pursuant to section 3.04 of this notice, USP’s subpart F inclusion of 200u is translated
into U.S. dollars at the spot exchange rate on the
date of the associated PTI distribution, and that PTI
distribution does not result in currency gain or loss
under section 986(c). The other PTI distribution may
result in currency gain or loss under section 986(c).
Example 2. Identification of amounts underlying
cash dividends where multiple subpart F inclusions
exceed PTI distributions. (i) Facts. USP owns all the
stock of CFC1, which owns all the stock of CFC2
and CFC3. CFC2 owns all the stock of CFC4. The
four CFCs are each organized under the laws of a
different foreign country and each uses the U.S. dollar as its functional currency. In 2005, CFC3 pays a
$100 cash dividend to CFC1 that, after taking into account $10 of allocable foreign taxes and $5 of other
expenses, is subpart F income of CFC1 under sections 952(a) and 954(c)(1)(A) that results in an $85
income inclusion to USP with respect to CFC1 under section 951(a)(1)(A). Also in 2005, CFC4 pays
a $100 cash dividend to CFC2 that, after taking into
account $30 of allocable taxes and $10 of other expenses, is subpart F income of CFC2 under sections
952(a) and 954(c)(1)(A) that results in a $60 income
inclusion to USP under section 951(a)(1)(A). CFC2
distributes $60 of cash to CFC1 and CFC1 distributes
$60 of cash to USP in 2005.
(ii) Result. USP received cash distributions of
PTI from CFC1 in the election year in an amount
($60) that is less than $145, the total of amounts included in income by USP under section 951(a)(1)(A)
as a result of cash dividends during the election year

7

In the case of cash received as part of a deemed liquidation resulting from an election under Treas. Reg. §301.7701–3(c), the date of distribution is the date the cash is received, not the date
of the deemed liquidation.

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from CFC3 to CFC1 ($85), and cash dividends during the election year from CFC4 to CFC2 that were
distributed in cash to CFC1 ($60). Accordingly, pursuant to section 3.01 of this notice, the entire $60 cash
PTI distribution is a cash dividend described in section 965(a)(2). Furthermore, also pursuant to section
3.01 of this notice, USP may associate the $60 cash
dividend with either the $60 cash PTI distribution to
CFC1 that is attributable to the subpart F inclusion
from CFC2 or a ratable portion of the $85 subpart F
inclusion from CFC1.
Example 3. Identification of qualifying dividends.
(i) Facts. USP owns all the stock of CFC1 and CFC2,
and CFC1 owns all the stock of CFC3. CFC1, CFC2,
and CFC3 are organized under the laws of different
foreign countries, and each uses the “u” as its functional currency. In 2005, CFC3 pays an 80u cash dividend to CFC1. The dividend is subpart F income
of CFC1 under sections 952(a) and 954(c)(1)(A), resulting in an income inclusion to USP under section
951(a)(1)(A). Also in 2005, CFC1 distributes to USP
160u with a value of $200 at the 0.8u = $1 spot exchange rate on the date of distribution, all of which
constitutes previously-taxed earnings of CFC1 described in section 959(c)(2). In addition, USP receives a 100u cash dividend, equal to $100 at the
spot rate on the date of distribution, from each of
CFC1 and CFC2 in 2005. USP’s base period amount
described in section 965(b)(2)(B) is $100, and, taking into account the other limitations under section
965(b), USP’s total amount of qualifying dividends
is $150.
(ii) Result. Under section 3.04 of this notice,
USP’s subpart F inclusion attributable to the 80u cash
dividend paid by CFC3 to CFC1 is translated into dollars at the spot rate on the date an equivalent amount
of cash is distributed to USP, rather than at the average exchange rate for the year. Accordingly, USP
includes $100 in income under section 951(a)(1)(A),
and 80u of the PTI distribution, which has a value
of $100 on the date of distribution, is excluded from
USP’s gross income under section 959(a) and results
in no currency gain or loss under section 986(c). The
remaining 80u of the 160u PTI distribution, which
also has a value of $100 on the date of distribution,
is excluded from USP’s gross income under section
959(a) and may result in currency gain or loss under
section 986(c).
USP received three $100 cash dividends described in section 965(b)(2)(A) during 2005, of
which $150 is eligible to be taken into account under
section 965(a): the $100 dividend from CFC2, the
$100 dividend from CFC1, and $100 of the $200 PTI
distribution received from CFC1. The remaining
$100 of the PTI distribution received from CFC1 is
not a cash dividend described in section 965(a)(2)
because it exceeds the amount included in income
by USP under section 951(a)(1)(A) as a result of
the cash dividend paid by CFC3 to CFC1. Pursuant
to section 3.02 of this notice, USP may identify
any one of the three distributions in its entirety, and
one-half of either of the remaining two distributions,
as qualifying dividends on Form 8895. If USP does
not identify specific distributions as the qualifying
dividends, $50 ($150 total qualifying dividends not
otherwise identified divided by $300 total cash dividends received during the election year, multiplied
by $100 cash dividend) of each of the three $100 cash
dividends will be treated as a qualifying dividend.

2005–36 I.R.B.

Example 4. Cash dividend equivalent to cash received in actual inbound liquidation. (i) Facts. USP
owns all the stock of CFC1, which owns all the stock
of CFC2. CFC1 and CFC2 are organized in Country
X and each uses the “u” as its functional currency. On
June 30, 2005, in an inbound liquidation of CFC1 described in sections 332 and 367(b), CFC1 legally dissolves and, in connection with such dissolution, USP
acquires all the assets of CFC1, consisting of 100u of
cash in a Country X bank account and certain other
noncash assets (including all of the stock of CFC2).
In connection with the liquidation USP includes in income as a dividend an all earnings and profits amount
of 300u equal to $600 on June 30, 2005, when the spot
exchange rate is 1u = $2. After the liquidation, USP
continues to operate the business of CFC1 in Country
X with the Country X bank account.
(ii) Result. Pursuant to section 3.02 of this notice,
USP may identify as a qualifying dividend described
in section 965(a)(1) the 100u of cash received by USP
in the liquidation of CFC1 that is taxed as a dividend
under section 367(b). Pursuant to section 3.04 of this
notice, the amount of the cash dividend from CFC1 is
$200 (100u of cash received by USP in the liquidation
of CFC1, translated at the spot rate of 1u = $2 on the
date of the liquidating dividend).
Example 5. Cash dividends less than cash received in check-the-box liquidation plus cash dividend received by disregarded entity. (i) Facts. The
facts are the same as in Example 4, except that, instead of actually liquidating CFC1, USP elects to treat
CFC1 as a disregarded entity by filing an entity classification election under Treas. Reg. §301.7701–3,
effective July 1, 2005, CFC2 pays a dividend of 100u
to the disregarded entity CFC1 on September 1, 2005,
when the spot exchange rate is 1u = $1.50, and the disregarded entity CFC1 distributes 100u of cash to USP
on October 1, 2005, when the spot exchange rate is 1u
= $1.75.
(ii) Result. USP’s check-the-box election with respect to CFC1 does not give rise to an eligible dividend under section 965(c)(3) because the resulting
deemed liquidation in and of itself does not result in
an actual receipt by USP of the 100u of cash owned
by CFC1. In addition, the cash dividend paid from
CFC2 to CFC1, at that time a disregarded entity, is
treated as a cash dividend received by USP in the
election year only to the extent USP receives cash
from the disregarded entity during the election year.
See Notice 2005–10, section 3.02. Because the disregarded entity CFC1 distributed 100u of cash to USP
in the year of the liquidation, the 100u cash distribution is a cash dividend within the meaning of section 965(c)(3). Pursuant to section 3.01 of this notice, USP may identify the October 1, 2005 100u cash
dividend as attributable to either the deemed dividend resulting from the check-the-box election or the
cash dividend paid by CFC2. If USP treats the cash
dividend as attributable to cash actually received by
USP in connection with the deemed liquidation, the
deemed dividend constitutes a dividend described in
section 965(c)(3) to the extent of 100u. Alternatively,
USP may treat the 100u cash dividend as attributable to the cash dividend paid from CFC2 to CFC1,
a disregarded entity, which is eligible to be treated as
a cash dividend because USP received 100u of cash
from CFC1 during the election year.
If USP chooses to treat the dividend from CFC2
as the cash dividend underlying the 100u cash div-

475

idend on October 1, 2005, then pursuant to section
3.04 of this notice the dollar amount of the 100u dividend from CFC2 is $175, the spot value of 100u
on October 1, 2005, the date CFC1 distributes an
amount of cash equal to the CFC2 dividend to USP,
and CFC1’s distribution of 100u to USP does not give
rise to currency gain or loss. As in Example 4, the
entire 300u all earnings and profits amount is $600,
translated into dollars at the 1u = $2 exchange rate,
the spot rate on the date of the deemed dividend.
If, instead, USP chooses to treat the 100u cash
dividend as cash received in connection with the
deemed liquidation, pursuant to section 3.04 of this
notice the dollar amount of 100u of the 300u deemed
dividend from CFC1 is $175, the spot value of 100u
on October 1, 2005, the date USP receives that
amount of cash in connection with the deemed liquidation. The dollar amount of the 200u remainder of
the deemed dividend is $400, translated into dollars
at the 1u = $2 exchange rate, the spot rate on the date
of the deemed dividend. The dollar amount of the
100u dividend from CFC2 is $150, the spot value of
100u on September 1, 2005, the date CFC2 paid the
dividend to the disregarded entity CFC1.
Example 6. CFC-to-CFC dividend and equivalent PTI distribution. (i) Facts. USP owns all the
stock of CFC1, which owns all the stock of CFC2.
CFC1 is organized in Country X and uses the “u” as
its functional currency. CFC2 is organized in Country Y and uses the euro as its functional currency.
On June 30, 2005, when the spot exchange rate is 1u
= €2, CFC2 pays a cash dividend of €200 to CFC1.
CFC1 has no other items of income or expense in
2005. The dividend from CFC2 is subpart F income
of CFC1 under sections 952(a)(2) and 954(c)(1)(A)
that is included in income by USP under section
951(a)(1)(A)(i). On September 1, 2005, when the
spot exchange rate is 1u = $1, CFC1 distributes 100u
in cash to USP. The 100u cash distribution is PTI of
CFC1 that is excluded from USP’s income under section 959(a). The average exchange rate determined
under section 989(b)(3) for 2005 is 1u = $.90.
(ii) Result. Pursuant to section 989(b)(1), the “u”
amount of CFC1’s subpart F income attributable to
the €200 dividend from CFC2 is 100u, the spot value
of €200 on the date CFC1 includes the CFC2 dividend in income. The 100u cash distribution from
CFC1 to USP is a cash dividend described in section
965(a)(2) because it is PTI in an amount not in excess
of the 100u subpart F income of CFC1 that results
from a cash dividend paid during the election year
by CFC2, another CFC in the chain of ownership described in section 958(a). Regardless of whether USP
identifies the PTI distribution from CFC1 as a qualifying dividend, pursuant to section 3.04 of this notice
the dollar amount of USP’s subpart F inclusion with
respect to CFC1 under section 951(a)(1)(A) attributable to the CFC2 dividend is $100, the spot rate on the
date CFC1 distributes an amount of cash equal to the
CFC2 dividend to USP. The PTI distribution does not
result in currency gain or loss under section 986(c).
Example 7. CFC-to-CFC dividend and smaller
PTI distribution. (i) Facts. The facts are the same as
in Example 6, except that CFC2’s dividend to CFC1
is €400 rather than €200.
(ii) Result. The €400 dividend, translated at the
spot rate on the date of distribution from CFC2 to
CFC1, results in 200u of subpart F income of CFC1
that is included in USP’s income in the election year.

September 6, 2005

The result with respect to the 100u of the subpart F
inclusion and resulting PTI that CFC1 distributes to
USP in the election year are the same as in Example
6. USP’s subpart F inclusion with respect to the remaining 100u of CFC1’s subpart F income that is not
distributed is $90 (100u translated at the average exchange rate of 1u = $.90). CFC1’s distribution of the
remaining 100u of PTI to USP after the election year
is not subject to the rules of this notice and may give
rise to currency gain or loss under section 986(c).

SECTION 4. DISALLOWANCE OF
CREDIT OR DEDUCTION FOR
FOREIGN TAXES ON DEDUCTIBLE
PORTION OF QUALIFYING
DIVIDENDS
.01 Identification of Foreign Income
Taxes Paid or Accrued with Respect to
the Deductible Portion of Qualifying
Dividends
Under section 965(d)(1), no credit or
deduction is allowed for foreign taxes
described in section 901 that are paid or
accrued (or treated as paid or accrued)
with respect to the deductible portion of
each qualifying dividend, including distributions of PTI that are treated as cash
dividends under section 965(a)(2). This
disallowance applies to 85 percent of the
U.S. dollar amount of (1) foreign taxes
paid or accrued by the U.S. shareholder
with respect to the qualifying dividend
(including the U.S. shareholder’s distributive share of foreign taxes that are paid
or accrued by a partnership with respect
to the dividend and that are properly allocated to the U.S. shareholder-partner
under the rules of sections 702 and 704
and the regulations thereunder and separately stated to the partner under Treas.
Reg. §1.702–1(a)(6)); (2) foreign taxes
deemed paid under section 902 with respect to a qualifying dividend described
in section 965(a)(1); and (3) foreign taxes
deemed paid under section 960, including
taxes described in section 960(a)(3), with
respect to a subpart F inclusion resulting from a CFC-to-CFC dividend and the
associated PTI distribution described in
section 965(a)(2).
Section 965 does not modify the computation of foreign taxes deemed paid under sections 902 and 960. As a result,
for purposes of section 902 the post-1986
undistributed earnings, post-1986 foreign
income taxes, pre-1987 accumulated profits, pre-1987 foreign income taxes, and
previously-taxed earnings and profits and

September 6, 2005

tax accounts of CFCs paying qualifying
dividends are reduced by the full amount
of earnings distributed and the full amount
of foreign taxes attributable to the distributed earnings, without regard to the
amount of the DRD or the amount of foreign tax for which section 965(d)(1) disallows a credit or deduction.
.02 Section 78 Gross-Up
Under section 78, an amount equal to
the taxes deemed paid under section 902(a)
or section 960(a)(1) by a domestic corporation generally is included in income as
a dividend if the domestic corporation
chooses the benefits of the foreign tax
credit for the taxable year. Section 78 does
not apply to any tax which is not allowable
as a credit under section 901 by reason of
section 965(d). See also section 9.01 of
Notice 2005–38.
.03 Examples
The following examples illustrate the
application of section 965(d)(1) and this
section 4. Unless otherwise indicated, the
following facts are assumed for purposes
of these examples. All corporations use
calendar taxable years for U.S. tax purposes. USP is a domestic corporation that
elects to apply section 965 to its 2005
taxable year and meets all applicable requirements to claim the section 965(a)
DRD with respect to the qualifying dividends described in the examples. All the
earnings and profits and creditable foreign
taxes of each CFC constitute general limitation post-1986 undistributed earnings
and general limitation post-1986 foreign
income taxes, and no exceptions apply to
prevent USP from including in income
its pro rata share of any CFC’s subpart
F income in the election year. Except as
specifically provided, a CFC has no other
items of gross income or expense for the
election year, has no previously-taxed
earnings and profits described in section
959(c)(1) or (2), and makes no distributions in the election year.
Example 1. Qualifying dividend under section
965(a)(1) from first-tier CFC. (i) Facts. USP owns
all the stock of CFC1, a foreign corporation that uses
the “u” as its functional currency. On June 30, 2005,
CFC1 pays a cash dividend of 80u, equal to $100
translated at the spot rate on that date of 0.8u = $1,
out of its post-1986 undistributed earnings to USP.
The dividend is subject to a 10 percent withholding
tax of 8u = $10, so USP receives cash of $90. USP

476

has a base period amount of $0 and its total amount of
qualifying dividends is $100. As of the close of 2005,
computed without regard to the June 30 distribution
to USP, CFC1 has post-1986 undistributed earnings
of 800u and post-1986 foreign income taxes of $200.
(ii) Result.
Under section 902(a), $20
((80u/800u) x $200) of foreign income taxes are
deemed paid by USP with respect to the $100
dividend from CFC1. Subject to other applicable
limitations, USP may claim a foreign tax credit or
deduction for $1.50 (15 percent of the $10 withholding tax), and may also claim a credit for $3 (15
percent of the $20 of deemed-paid taxes). Under
section 965(d)(1), no credit or deduction is allowed
for the remaining $8.50 of withholding tax or $17 of
deemed-paid tax, which represent the taxes paid or
deemed paid with respect to the 85 percent deductible
portion of the $100 dividend. USP includes $100 in
gross income and claims an $85 DRD under section
965(a) with respect to the qualifying dividend of
$100 described in section 965(a)(1). If USP elects
to credit foreign taxes in 2005, USP also includes $3
in income under section 78. No gross-up is required
under section 78 for the $17 of deemed-paid tax
which is not allowed as a credit. CFC1’s post-1986
undistributed earnings and post-1986 foreign income
taxes are reduced by the full amount of earnings
distributed and foreign taxes deemed paid in 2005,
without regard to the amount of the DRD under
section 965(a) or the disallowance under section
965(d)(1) of a credit for taxes deemed paid with
respect to the deductible portion of the qualifying
dividend. Accordingly, CFC1’s post-1986 undistributed earnings and post-1986 foreign income
taxes, computed as of January 1, 2006, are 720u
(800u - 80u) and $180 ($200 - $20), respectively.
Example 2. Qualifying dividend under section
965(a)(1) from first-tier CFC to disregarded entity.
(i) Facts. USP is the sole owner of DE, a disregarded
entity organized in Country X. DE owns all the stock
of CFC1, which is incorporated in Country Y. Each
of DE and CFC1 uses the U.S. dollar as its functional
currency. On June 30, 2005, CFC1 pays a cash dividend of $135 to DE, with respect to which USP is
deemed under section 902(a) to pay $20 of foreign
income tax paid by CFC1. DE pays Country Y withholding tax of $20 and Country X net income tax of
$15 with respect to the dividend from CFC1. Also on
June 30, 2005, DE distributes $135 to USP. The distribution from DE is not subject to Country X withholding tax. USP has a base period amount of $0 and
qualifying dividends of $135.
(ii) Result. USP is entitled to a DRD of $114.75
(.85 x $135) under section 965(a) with respect to the
$135 dividend paid by CFC1 to DE and distributed
in cash to USP in 2005. Subject to other applicable
limitations, USP may claim a foreign tax credit or deduction for $5.25 (15 percent of the $35 of foreign
tax paid by DE), and may also claim a credit for $3
(15 percent of the $20 of foreign taxes paid by CFC1
that are deemed paid by USP with respect to the dividend paid by CFC1). If USP elects to credit foreign
taxes in 2005, USP includes $3 in income under section 78. No gross-up is required under section 78 for
the $17 of deemed-paid tax which is not allowed as a
credit. Under section 965(d)(1), no credit or deduction is allowed for the remaining $29.75 of tax paid
under section 901 or $17 of tax deemed paid under
section 902, which represent the taxes paid or deemed

2005–36 I.R.B.

paid with respect to the 85 percent deductible portion
of the $135 qualifying dividend. CFC1’s post-1986
undistributed earnings and post-1986 foreign income
taxes, computed as of January 1, 2006, are reduced
by $135 and $20, respectively.
Example 3. Qualifying dividend under section
965(a)(2) attributable to dividend from second-tier
CFC, subpart F inclusion, and PTI distribution from
first-tier CFC to USP. (i) Facts. USP owns all the
stock of CFC1, which owns all the stock of CFC2.
CFC1 is incorporated in Country X, and CFC2 is incorporated in Country Y. Each of CFC1 and CFC2
uses the U.S. dollar as its functional currency. On
June 30, 2005, CFC2 pays a cash dividend of $135 to
CFC1. CFC1 pays Country Y withholding tax of $20
and Country X net income tax of $15 with respect to
the dividend from CFC2. CFC1 has no other items of
income or expense in 2005, so its subpart F income
and earnings and profits for 2005 are $100, all attributable to the dividend from CFC2, and USP includes
$100 in income under section 951(a)(1)(A) with respect to CFC1 for 2005. Also on June 30, 2005, CFC1
distributes $100 of cash to USP. The PTI distribution
is subject to Country X withholding tax of $10. As of
the close of 2005, including taxes paid and deemed
paid under section 902(b) by CFC1 with respect to
the distribution from CFC2 but before accounting for
the effect of the subpart F inclusion or distribution to
USP, CFC1 has post-1986 undistributed earnings of
$1,000 and post-1986 foreign income taxes of $200.
USP has a base period amount of $0 and qualifying
dividends of $100.
(ii) Result. Under sections 960(a)(1) and 902(a),
$20 (($100/$1,000) x $200) of foreign income taxes
are deemed paid by USP with respect to the $100 subpart F inclusion attributable to CFC1. Under section
965(a)(2), the cash distribution of PTI from CFC1 is a
qualifying dividend to the extent of $100, the amount
USP included in income under section 951(a)(1)(A)
in 2005 as a result of the cash dividend paid from
CFC2 to CFC1 in 2005. USP is entitled to a DRD of
$85 under section 965(a) with respect to the $100 subpart F inclusion and associated PTI distribution. Subject to other applicable limitations, USP may claim
a foreign tax credit or deduction for 15 percent of
the $10 withholding tax, or $1.50, and may claim
a credit for 15 percent of the $20 of deemed-paid
taxes, or $3. If USP elects to credit foreign taxes
in 2005, USP includes $3 in income under section
78. No gross-up is required under section 78 for
the $17 of deemed-paid tax which is not allowed as
a credit. Under section 965(d)(1), no credit or deduction is allowed for the remaining $8.50 of withholding tax or $17 of deemed-paid tax, which represent the taxes paid or deemed paid with respect to the
85 percent deductible portion of the $100 qualifying
dividend. CFC1’s post-1986 undistributed earnings
and post-1986 foreign income taxes, computed as of
January 1, 2006, are $900 ($1,000 - $100) and $180
($200 - $20), respectively.
Example 4. Qualifying dividend under section
965(a)(2) attributable to multiple dividends from second-tier CFCs, subpart F inclusion, and distribution
from first-tier CFC to USP. (i) Facts. USP owns
all the stock of CFC1, which owns all the stock of
CFC2 and CFC3. CFC1, CFC2, and CFC3 are organized under the laws of different foreign countries,
and each uses the “u” as its functional currency. In
2005, CFC2 and CFC3 each pays an 80u cash divi-

2005–36 I.R.B.

dend to CFC1 that is subpart F income of CFC1 under sections 952(a) and 954(c)(1)(A) that results in an
income inclusion to USP under section 951(a)(1)(A).
Under section 902(b)(1), CFC1 is deemed to pay foreign taxes of $8 with respect to the 80u dividend from
CFC2, and CFC1 is deemed to pay foreign taxes of
$40 with respect to the 80u dividend from CFC3.
Also in 2005, CFC1 makes two distributions of
80u, totaling 160u, to USP, all of which constitutes
previously-taxed earnings and profits of CFC1 described in section 959(c)(2). The first 80u distribution has a value of $100 at the 0.8u = $1 spot exchange rate on the date of distribution, and the second 80u distribution has a value of $80 at the 1u =
$1 spot exchange rate on the date of distribution. Under section 3.04 of this notice, USP’s subpart F inclusion attributable to CFC1’s 160u of foreign personal holding company income attributable to cash
dividends paid by CFC2 and CFC3 is translated into
dollars at the spot rate on the dates an equivalent
amount of cash is distributed to USP, rather than at
the average exchange rate for the year. Accordingly,
USP includes $180 ($100 + $80) in income under section 951(a)(1)(A), and neither of the 80u PTI distributions results in exchange gain or loss under section
986(c). USP’s total cash dividends are $180. USP
has a base period amount of $80 and qualifying dividends of $100.
As of the close of 2005, taking into account the
dividends received from CFC2 and CFC3 and the associated deemed-paid taxes but before giving effect to
the subpart F inclusion to USP, CFC1 has post-1986
undistributed earnings of 1,600u and post-1986 foreign income taxes of $400.
(ii) Result. Under sections 960(a)(1) and 902(a),
$40 ((160u/1,600u) x $400) of foreign income taxes
are deemed paid by USP with respect to the 160u
subpart F inclusion attributable to CFC1. Of this
amount, $20 is attributable to the first cash dividend
of 80u = $100, and $20 is attributable to the second
cash dividend of 80u = $80. If USP identifies the
first distribution in its entirety as the qualifying dividend, USP is entitled to a DRD of $85 under section 965(a) with respect to the $100 subpart F inclusion and associated PTI distribution. Subject to other
applicable limitations, USP may claim a foreign tax
credit for $23, equal to the sum of $3 (.15 x $20)
of deemed-paid taxes attributable to the qualifying
dividend and $20 of deemed-paid taxes attributable
to the remaining $80 of the subpart F inclusion. If
USP elects to credit foreign taxes in 2005, USP includes $23 in income under section 78. Under section
965(d)(1), no credit is allowed for the remaining $17
of deemed-paid taxes, which are attributable to the 85
percent deductible portion of the $100 qualifying dividend. No gross-up is required under section 78 for
the $17 of deemed-paid tax which is not allowed as a
credit.
If, instead, USP identifies $20 of the $100 first
cash dividend and the entire $80 of the second cash
dividend as the qualifying dividends, USP is entitled to a DRD of $17 (.85 x $20) with respect to the
first qualifying dividend and $68 (.85 x $80) with
respect to the second qualifying dividend, for a total DRD of $85. Subject to other applicable limitations, USP may claim a foreign tax credit for $19.60,
equal to the sum of $0.60 (.15 x ($20/$100) x $20)
of deemed-paid taxes attributable to the $20 qualifying dividend, $16 (($80/$100) x $20) of deemed-paid

477

taxes attributable to the remaining $80 of the subpart
F inclusion associated with the first cash dividend,
and $3 (.15 x $20) of deemed-paid taxes attributable
to the $80 qualifying dividend. If USP elects to credit
foreign taxes in 2005, USP includes $19.60 in income
under section 78. Under section 965(d)(1), no credit
is allowed for the remaining $20.40 ($3.40 + $17) of
deemed-paid taxes, which are attributable to the 85
percent deductible portion of the $20 and $80 qualifying dividends. No gross-up is required under section 78 for the $20.40 of deemed-paid tax which is
not allowed as a credit.
Because under sections 960(a)(1) and 902(a)
USP’s foreign taxes deemed paid with respect to the
subpart F inclusion underlying the qualifying dividends described in section 965(a)(2) are computed on
the basis of CFC1’s year-end post-1986 undistributed
earnings and post-1986 foreign income taxes, a ratable portion of CFC1’s post-1986 foreign income
taxes, and not the specific taxes associated with the
underlying dividends from CFC2 and CFC3, are
considered attributable to the qualifying dividends.
Example 5. Qualifying dividend under section
965(a)(2) attributable to dividend from third-tier
CFC, subpart F inclusion from second-tier CFC,
and distribution through first-tier CFC to USP. (i)
Facts. USP owns all the stock of CFC1, which owns
all the stock of CFC2, which owns all the stock of
CFC3. CFC1 is incorporated in Country X, CFC2 is
incorporated in Country Y, and CFC3 is incorporated
in Country Z. Each of CFC1, CFC2, and CFC3 uses
the U.S. dollar as its functional currency. On June
30, 2005, CFC3 pays a dividend of $150 to CFC2.
CFC2 pays Country Z withholding tax of $20 and
Country Y net income tax of $15 with respect to the
dividend from CFC3. CFC2 has no other items of
income or expense in 2005, so its subpart F income
and earnings and profits for 2005 are $115, all attributable to the dividend from CFC3, and USP includes
$115 in income under section 951(a)(1)(A) with
respect to CFC2 for 2005. Also on June 30, 2005,
CFC2 distributes $115 of cash to CFC1 that is PTI
excluded from CFC1’s gross income under section
959(b). The distribution is subject to $10 of Country
Y withholding tax and $5 of Country X income tax in
the hands of CFC1, which are taxes on PTI excluded
from CFC1’s post-1986 foreign income taxes and
accounted for under section 960(a)(3). Later in 2005,
CFC1 distributes $100 of PTI to USP. USP pays $10
of withholding tax to Country X with respect to the
$100 PTI distribution, receiving cash of $90. As of
the close of 2005, including taxes paid and deemed
paid under section 902(b) by CFC2 with respect to
the distribution from CFC3 but before accounting for
the effect of the subpart F inclusion or distribution to
CFC1, CFC2 has post-1986 undistributed earnings
of $1,150 and post-1986 foreign income taxes of
$200. USP has a base period amount of $0.
(ii) Result. Under sections 960(a)(1) and 902(a),
$20 (($115/$1,150) x $200) of foreign income taxes
paid by CFC2 are deemed paid by USP with respect
to the $115 subpart F inclusion attributable to CFC2.
Under section 960(a)(3), $15 of foreign taxes ($10
of withholding tax and $5 of income tax) paid by
CFC1 with respect to the $115 distribution of PTI
from CFC2 are deemed paid by USP with respect to
the $100 of remaining PTI distributed from CFC1 to
USP. However, under section 965(a)(2), the $100 PTI
distribution from CFC1 is a cash dividend and, there-

September 6, 2005

fore, a qualifying dividend only to the extent of $100,
the lesser of the amount USP included in income under section 951(a)(1)(A) in 2005 as a result of the cash
dividend paid from CFC3 to CFC2 in 2005 ($115)
or the amount of the PTI distribution from CFC1 to
USP ($100). The amount of foreign taxes deemed
paid under section 960(a)(1) with respect to the $100
section 965(a)(2) dividend is $17.39 (($100/$115) x
$20), and the amount of foreign taxes deemed paid
under section 960(a)(3) with respect to the $100 PTI
distribution is $15.
USP is entitled to a DRD of $85 under section
965(a) with respect to $100 of the $115 subpart F inclusion and associated PTI distribution. Subject to
other applicable limitations, USP may claim a foreign tax credit or deduction for $1.50 (15 percent of
the $10 withholding tax imposed on the $100 PTI distribution), and may claim a credit for $2.61 (15 percent of the $17.39 of taxes deemed paid under section
960(a)(1) with respect to the $100 qualifying portion
of the subpart F inclusion from CFC2), plus $2.25
(15 percent of the $15 of tax deemed paid under section 960(a)(3) with respect to the $100 PTI distribution). USP may also claim a credit for the $2.61
of foreign tax deemed paid under section 960(a)(1)
with respect to the $15 of USP’s subpart F inclusion
that does not result in a qualifying dividend. If USP
elects to credit foreign taxes in 2005, USP includes
$5.22 in income under section 78 with respect to the
$2.61 of foreign tax deemed paid under section 902
with respect to the $15 nondeductible CFC dividend
and the $2.61 of foreign tax deemed paid under section 960(a)(1) with respect to the $15 of USP’s subpart F inclusion that does not result in a qualifying
dividend. No gross-up is required under section 78
with respect to the $2.25 of taxes deemed paid under
section 960(a)(3), equal to 15 percent of the $15 of
the taxes paid by CFC1 on the $115 PTI distribution
from CFC2, which was included in USP’s income under section 951(a)(1)(A). Under section 965(d)(1), no
credit or deduction is allowed for the remaining $8.50
of withholding tax, $14.78 of tax deemed paid under
section 960(a)(1), or $12.75 of tax deemed paid under section 960(a)(3), which represent the taxes paid
or deemed paid with respect to the 85 percent deductible portion of the $100 qualifying dividend. No
gross-up is required under section 78 for the $14.78
of tax deemed paid under section 960(a)(1) which
is not allowed as a credit or for any portion of the
taxes deemed paid under section 960(a)(3). CFC2’s
post-1986 undistributed earnings and post-1986 foreign income taxes, computed as of January 1, 2006,
are $1,035 ($1,150 - $115) and $180 ($200 - $20), respectively.
Example 6. Qualifying dividend under section
965(a)(2) attributable to dividend from third-tier
CFC, subpart F inclusion from second-tier CFC,
distribution through first-tier CFC to USP, and additional PTI distribution. (i) Facts. The facts are the
same as Example 5, except that CFC1 distributes an
additional $15 of PTI described in section 959(c)(2)
to USP in the election year, subject to Country X
withholding tax of $1.50. The additional $15 of
PTI is attributable to subpart F income of CFC1 that
was included in USP’s income in a year prior to the
election year.
(ii) Result. The additional $15 of PTI distributed
is a cash dividend that is eligible to be treated as a
qualifying dividend described in section 965(a)(2)

September 6, 2005

because during the election year USP included $115
in income under section 951(a)(1)(A) attributable
to the cash dividend paid from CFC3 to CFC2, and
CFC2 made cash distributions described in section 959(b) of $115 to CFC1. USP may identify
the additional $15 PTI distribution as a qualifying
dividend and claim an 85 percent DRD of $12.75
with respect to the remaining $15 of the subpart F
inclusion resulting from the dividend paid by CFC3
to CFC2. The amount of foreign taxes deemed paid
under section 960(a)(1) with respect to the $115 of
section 965(a)(2) dividends is $20 (($115/$115) x
$20), and the amount of foreign taxes deemed paid
under section 960(a)(3) with respect to the $115 of
PTI distributions is $15 ($15 of foreign taxes paid
by CFC1 with respect to the $115 distribution of PTI
from CFC2). Subject to other applicable limitations,
USP may claim a foreign tax credit or deduction
for $1.73 (15 percent of the $11.50 withholding tax
imposed on the $115 PTI distribution), and may
claim a credit for $3 (15 percent of the $20 of taxes
deemed paid under section 960(a)(1) with respect
to the $115 subpart F inclusion from CFC2), plus
$2.25 (15 percent of the $15 of tax deemed paid
under section 960(a)(3) with respect to the $115 PTI
distribution). If USP elects to credit foreign taxes in
2005, USP includes $3 in income under section 78.
Under section 965(d)(1), no credit or deduction is
allowed for the remaining $9.77 of withholding tax,
$17 of tax deemed paid under section 960(a)(1), or
$12.75 of tax deemed paid under section 960(a)(3),
which represent the taxes paid or deemed paid with
respect to the 85 percent deductible portion of the
$115 qualifying dividend. No gross-up is required
under section 78 for the $17 of tax deemed paid
under section 960(a)(1) which is not allowed as a
credit or for any portion of the taxes deemed paid
under section 960(a)(3). The adjustments to CFC2’s
post-1986 undistributed earnings and post-1986 foreign income taxes are the same as in Example 5.

SECTION 5. DISALLOWANCE
OF DEDUCTIONS FOR CERTAIN
EXPENSES RELATED TO
DEDUCTIBLE PORTION OF
QUALIFYING DIVIDENDS
.01 Expenses Incurred by Taxpayer
The disallowance of deductions for
expenses under section 965(d)(2) applies
only to expenses that are directly allocable to the deductible portion of qualifying
dividends. See section 9.01 of Notice
2005–38. Therefore, section 965(d)(2)
disallows a deduction for 85 percent of directly allocable expenses, which are those
expenses that relate directly to generating
qualifying dividends. These expenses are:
(a) Stewardship expenses described in
Treas. Reg. §1.861–8(e)(4) that are definitely related and allocable to qualifying
dividends;
(b) Legal, tax, accounting, consulting
and similar fees and expenses, including

478

expenses for employee compensation, for
the rendering of advice and the preparation of documents directly related to (i)
plans to repatriate earnings in the election
year, including the determination of the
potentially eligible amount of qualifying
dividends, the decision to repatriate earnings from particular CFCs, and the identification of particular distributions as cash
dividends, qualifying dividends, or other
amounts, (ii) the adoption and approval of
a domestic reinvestment plan, and (iii) the
declaration and payment of qualifying dividends;
(c) Fees and expenses related to tax accounting and reporting for qualifying dividends in the election year; and
(d) Wire transfer, currency exchange,
and similar fees incurred in connection
with the payment of qualifying dividends.
For purposes of this section 5.01, only
a pro rata portion of stewardship expenses
accrued in the election year with respect
to each CFC in which the taxpayer is a
U.S. shareholder is considered definitely
related and allocable to qualifying dividends. The pro rata portion is the amount
that bears the same ratio to the stewardship
expenses as the qualifying dividends paid
by a CFC bear to the total amount of dividends and subpart F inclusions included in
the U.S. shareholder’s income with respect
to that CFC and subpart F inclusions attributable to stock of any other CFCs held
indirectly by the U.S. shareholder in the
same chain of ownership described in section 958(a) in the election year. Deductions for other directly allocable expenses
described in the preceding paragraph are
subject to disallowance in the year paid or
accrued, whether that year is the election
year or a different taxable year.
Deductions for the allowable 15 percent portion of expenses that are directly
allocable to qualifying dividends are allocated and apportioned in accordance with
the generally applicable rules of sections
861 through 865 and the regulations thereunder. See section 6 of this notice.
The disallowance of deductions under
section 965(d)(2) does not extend to expenses that, while treated as definitely related to the production of income in a category that includes qualifying dividends, do
not relate directly to generating qualifying
dividends. Expenses described in the preceding sentence include interest expense,
research and experimental expenses, gen-

2005–36 I.R.B.

eral and administrative expenses, depreciation and amortization, sales and marketing expenses, state and local taxes, and any
other expenses not described in the first
paragraph of this section 5.01. In addition,
legal, tax, accounting, consulting, and similar fees and expenses related to the implementation of investments in the United
States contemplated by a domestic reinvestment plan are not considered directly
allocable to qualifying dividends.
.02 Expenses Incurred by CFCs
Deductions for expenses properly incurred by CFCs that are otherwise deductible in computing subpart F income
and earnings and profits are not limited by
section 965(d)(2).
SECTION 6. ALLOCATION AND
APPORTIONMENT OF EXPENSES
TO SEPARATE CATEGORIES WITH
QUALIFYING DIVIDENDS

any stock the dividends on which would
be so deductible. A qualifying dividend is
not exempt income, and the CFC stock on
which qualifying dividends are paid is not
an exempt asset, within the meaning of the
first sentence of section 864(e)(3). In addition, the similar rule in the second sentence of section 864(e)(3) does not apply to
qualifying dividends or the CFC stock on
which qualifying dividends are paid, since
no deduction is allowed under section 243
or 245 for any dividend for which a deduction is allowed under section 965. Section
965(c)(4). Accordingly, gross income attributable to a qualifying dividend is not
considered exempt income, and no portion
of the stock of a CFC paying a qualifying
dividend is considered an exempt asset, for
purposes of allocating and apportioning interest and other expenses in the election
year.
.03 Expenses Allocated and Apportioned
to Separate Categories that Include
Qualifying Dividends

.01 No New Separate Category
Section 965 does not provide for qualifying dividends to be assigned to a special separate category or otherwise modify the generally applicable look-through
rules of section 904(d)(3) for determining
the separate category to which dividends
and subpart F inclusions from CFCs are
assigned. For purposes of allocating expenses on the basis of assets in the election year, stock of CFCs paying qualifying dividends is characterized under the
generally applicable rules of Treas. Reg.
§1.861–12T(c)(3).
.02 Treatment of CFC Stock and
Qualifying Dividends under Section
864(e)
The first sentence of section 864(e)(3)
(section 864(e)(3)(A) for transactions before January 1, 2005) provides that, for
purposes of allocating and apportioning
any deductible expense, any tax-exempt
asset (and any income from such an asset) shall not be taken into account. The
second sentence of section 864(e)(3) provides that a similar rule applies in the case
of the portion of certain dividends equal
to the deduction allowable under section
243 or 245(a) with respect to such dividend, and in the case of a like portion of

2005–36 I.R.B.

Section 965 does not modify the generally applicable rules of sections 861
through 865 and the regulations thereunder for allocating and apportioning
expenses and losses to separate categories
described in section 904(d)(1) and Treas.
Reg. §1.904–5(m) (separate categories)
that include nondeductible CFC dividends.
However, the amount of nondeductible
CFC dividends in a separate category must
be determined for purposes of applying
the limitations on the allowable foreign
tax credit for the election year under section 904 and section 965(e)(1) and related
computations under sections 53 and 55.
See sections 7, 8, and 9 of this notice. For
this purpose, expenses that are allocated
and apportioned to a separate category
that includes qualifying dividends will be
considered to reduce other foreign source
gross income in the separate category
before reducing foreign source income
attributable to nondeductible CFC dividends. Except as provided in section 7.01
of this notice (relating to the taxable income limitation of section 965(e)(2)(A)),
if expenses and other deductions properly allocated and apportioned to foreign
source gross income in a separate category exceed the amount of foreign source
gross income exclusive of nondeductible
CFC dividends in that separate category,

479

such excess will reduce foreign source
income attributable to nondeductible CFC
dividends in the separate category to the
extent thereof, and any excess deductions
will constitute a separate limitation loss
described in section 904(f)(5). See section 8 of this notice for rules relating to
the allocation and recapture of separate
limitation losses in the election year and
subsequent years.
The amount of qualifying dividends
eligible for the DRD, the amount of nondeductible CFC dividends described in
section 965(e)(3), and the amount of
taxable income for the election year are
determined without regard to the manner in which deductible expenses are
allocated and apportioned in the election
year. Therefore, the amount of the section
965(a) DRD, the amount of foreign taxes
and expenses for which credit or deduction is disallowed under section 965(d),
the amount of taxable income determined
under section 965(e)(2)(A), and the allowable NOL deduction determined under
section 965(e)(2)(B) are not affected if
nondeductible CFC dividends in a separate category are reduced or eliminated
by reason of the allocation and apportionment of expenses pursuant to sections 861
through 865 and the regulations thereunder and this section 6.
.04 Examples
The following examples illustrate the
application of this section 6. Expenses described in the examples do not include any
expenses for which a deduction is disallowed under section 965(d)(2) or any other
applicable Code provision.
Example 1. Separate limitation income exceeds
nondeductible CFC dividends. (i) Facts. USP has the
following items of gross income and expense for the
election year: $1,200 of foreign source general limitation gross income, including $1,000 of qualifying
dividends, $1,000 of expenses allocated and apportioned to general limitation income (including the 85
percent DRD of $850, which pursuant to section 3.03
of this notice is allocated to reduce general limitation
income), $300 of U.S. source gross income, and $100
of expenses allocated and apportioned to U.S. source
income. Accordingly, USP has $400 of taxable income and $150 of nondeductible CFC dividends in
the election year, and the taxable income limitation
of section 965(e)(2)(A) does not apply.
(ii) Result. Under section 6.03 of this notice,
general limitation expenses are considered to reduce
other general limitation income before reducing
nondeductible CFC dividends. Accordingly, USP
has $200 of foreign source general limitation taxable

September 6, 2005

income, of which $150 is attributable to nondeductible CFC dividends, and $200 of U.S. source
taxable income.
Example 2. Nondeductible CFC dividends exceed
separate limitation income; nondeductible CFC dividends reduced. (i) Facts. The facts are the same as in
Example 1, except that USP has an additional $100
of deductible expenses allocated and apportioned to
general limitation income. Accordingly, USP has
$300 of taxable income and $150 of nondeductible
CFC dividends in the election year, and the taxable
income limitation of section 965(e)(2)(A) does not
apply.
(ii) Result. Under section 6.03 of this notice, general limitation expenses reduce nondeductible CFC
dividends after reducing other general limitation income. Accordingly, USP has $100 of foreign source
general limitation income, all attributable to nondeductible CFC dividends, and $200 of U.S. source taxable income.
Example 3. Nondeductible CFC dividends exceed separate limitation income; separate limitation
loss with U.S. source taxable income. (i) Facts. The
facts are the same as in Example 1, except that USP
has an additional $250 of deductible expenses allocated and apportioned to general limitation income.
Accordingly, USP has $150 of taxable income and
$150 of nondeductible CFC dividends in the election year, and the taxable income limitation of section
965(e)(2)(A) does not apply.
(ii) Result. Under section 6.03 of this notice, general limitation expenses reduce nondeductible CFC
dividends after reducing other general limitation income, and the excess deductions constitute a separate limitation loss. Accordingly, prior to the application of section 904(f) USP has a ($50) foreign source
general limitation separate limitation loss, no general
limitation nondeductible CFC dividends, and $200 of
U.S. source taxable income.
Example 4. Nondeductible CFC dividends exceed separate limitation income; separate limitation
loss with U.S. and foreign source taxable income. (i)
Facts. The facts are the same as in Example 3, except that instead of $300 of U.S. source gross income
USP has $200 of U.S. source gross income and $100
of foreign source passive gross income. Accordingly,
USP has $150 of taxable income and $150 of nondeductible CFC dividends in the election year, and
the taxable income limitation of section 965(e)(2)(A)
does not apply.
(ii) Result. Under section 6.03 of this notice, general limitation expenses reduce nondeductible CFC
dividends after reducing other general limitation income, and the excess deductions constitute a separate limitation loss. Accordingly, prior to the application of section 904(f) USP has a ($50) foreign source
general limitation separate limitation loss, no general limitation nondeductible CFC dividends, $100
of foreign source passive taxable income, no passive
limitation nondeductible CFC dividends, and $100 of
U.S. source taxable income.

September 6, 2005

SECTION 7. LIMITATION ON
REDUCTION IN TAXABLE
INCOME BELOW AMOUNT OF
NONDEDUCTIBLE CFC DIVIDENDS
PURSUANT TO SECTION 965(e)(2)
.01 In General
Under section 965(e)(2)(A), taxable
income for the election year cannot be less
than the amount of nondeductible CFC
dividends received during such year. In
addition, section 965(e)(2)(B)(i) provides
that nondeductible CFC dividends are not
taken into account under section 172 in determining the amount of any NOL for the
election year. Accordingly, if deductible
expenses and losses for the election year
(including the DRD allowed under section 965(a) but not including expenses
for which section 965(d)(2) disallows a
deduction) exceed the taxpayer’s gross
income exclusive of the amount of nondeductible CFC dividends, taxable income
will be equal to the amount of nondeductible CFC dividends, and the excess
deductions will constitute an NOL for the
taxable year. If, determined without regard
to section 965(e)(2)(A), taxable income
for the election year would be less than the
amount of nondeductible CFC dividends
received during such year, the excess of
the deductions allocated and apportioned
to a separate category over the amount
of gross income in the separate category
exclusive of the nondeductible CFC dividends will constitute a separate limitation
loss with respect to that separate category
for the election year. Such separate limitation loss is allocated in accordance with
section 904(f) and section 8 of this notice.
Section 965(e)(2)(B)(ii) provides that
nondeductible CFC dividends are not
taken into account in determining taxable
income for the election year for purposes of the second sentence of section
172(b)(2), which applies in determining
the allowable NOL carryover or carryback
to other years. Therefore, the amount
of the allowable NOL deduction that is
absorbed in the election year is limited
to the excess of taxable income over the
amount of nondeductible CFC dividends.
However, taxable income attributable to
nondeductible CFC dividends is taken into
account in determining the source and
allocation of NOL deductions taken into

480

account in the election year under paragraph 1 of Notice 89–3, 1989–1 C.B. 623.
.02 Examples
The following examples illustrate the
application of section 965(e)(2) and this
section 7.
Example 1. Taxable income limitation; one income category. (i) Facts. USP has the following
items of gross income and expense for the election
year: $1,000 of foreign source general limitation
gross income, including $100 of qualifying dividends, and $1,000 of deductible expenses allocated
and apportioned to general limitation income (computed after the disallowance of expenses directly
allocable to the deductible portion of the qualifying
dividends), including the $85 DRD allowed under
section 965(a) and $20 of expenses relating to nondeductible CFC dividends.
(ii) Result. Under section 965(e)(2)(A), USP’s
taxable income for the election year cannot be
less than $15, the amount of nondeductible CFC
dividends received during such year. Because taxable income computed without regard to section
965(e)(2)(A) ($0) is less than the amount of nondeductible CFC dividends ($15), under section 7.01 of
this notice the $1,000 of general limitation expenses
reduce general limitation income only to the extent of
$985 ($1,000 - $15), the excess of general limitation
gross income over general limitation nondeductible
CFC dividends. Accordingly, USP has $15 of general limitation taxable income, all attributable to
nondeductible CFC dividends.
Under section 965(e)(2)(B)(i), the amount of
USP’s NOL for the election year is computed
without regard to the $15 of nondeductible CFC
dividends. Accordingly, USP has general limitation
taxable income of $15 and a general limitation loss
of ($15) that constitutes a net operating loss of ($15)
for the election year.
Example 2. Taxable income limitation; U.S. and
foreign source income. (i) Facts. The facts are the
same as in Example 1, except that USP has $1,500
rather than $1,000 of deductible expenses allocated
and apportioned to general limitation income, and
also has $1,000 of U.S. source gross income and $500
of deductible expenses allocated and apportioned to
U.S. source income.
(ii) Result. Under section 965(e)(2)(A), USP’s
taxable income for the election year cannot be
less than $15, the amount of nondeductible CFC
dividends received during such year. Because taxable income computed without regard to section
965(e)(2)(A) ($0) is less than the amount of nondeductible CFC dividends ($15), under section 7.01 of
this notice the $1,500 of general limitation expenses
reduce general limitation income only to the extent of
$985 ($1,000 - $15), the excess of general limitation
gross income over general limitation nondeductible
CFC dividends, and the $515 ($1,500 - $985) excess
of general limitation deductions over that amount
constitutes a separate limitation loss. Accordingly,
prior to the application of section 904(f) USP has $15
of general limitation taxable income, all attributable
to nondeductible CFC dividends, a general limitation
separate limitation loss of ($515), and U.S. source
taxable income of $500 ($1,000 - $500).

2005–36 I.R.B.

Under section 965(e)(2)(B)(i), the amount of
USP’s NOL for the election year is computed without
regard to the $15 of nondeductible CFC dividends.
Accordingly, USP has taxable income of $15 and a
net operating loss of ($15) for the election year.
Example 3. Taxable income limitation; U.S. loss
and foreign source income. (i) Facts. The facts are
the same as in Example 2, except that instead of
$1,000 of U.S. source gross income USP has $400 of
U.S. source gross income and $600 of foreign source
passive gross income.
(ii) Result. Under section 965(e)(2)(A), USP’s
taxable income for the election year cannot be
less than $15, the amount of nondeductible CFC
dividends received during such year. Because taxable income computed without regard to section
965(e)(2)(A) ($0) is less than the amount of nondeductible CFC dividends ($15), under section 7.01 of
this notice the $1,500 of general limitation expenses
reduce general limitation income only to the extent of
$985 ($1,000 - $15), the excess of general limitation
gross income over general limitation nondeductible
CFC dividends, and the $515 ($1,500 - $985) excess
of general limitation deductions over that amount
constitutes a separate limitation loss. Accordingly,
prior to the application of section 904(f) USP has $15
of general limitation taxable income, all attributable
to nondeductible CFC dividends, a general limitation
separate limitation loss of ($515), foreign source
passive income of $600, and U.S. source loss of
($100) ($400 - $500).
Under section 965(e)(2)(B)(i), the amount of
USP’s NOL for the election year is computed without
regard to the $15 of nondeductible CFC dividends.
Accordingly, USP has taxable income of $15 and a
net operating loss of ($15) for the election year.
Example 4. Net operating loss absorption. (i)
Facts. Before taking into account the NOL deduction
or applying section 904(f) in the election year, USP
has $100 of general limitation taxable income, all attributable to nondeductible CFC dividends, $200 of
passive limitation taxable income, and a $100 NOL
from prior years, all attributable to general limitation
income.
(ii) Result. Because USP’s available NOL ($100)
does not exceed the amount of taxable income exclusive of nondeductible CFC dividends for the election year ($200), the taxable income limitation of
section 965(e)(2)(A) does not apply to limit USP’s
NOL deduction for the election year. Under section
965(e)(2)(B)(ii) and section 7.01 of this notice, USP’s
$100 of nondeductible CFC dividends is not taken
into account in determining the amount of USP’s allowable NOL deduction absorbed in the election year,
but is taken into account in determining the source
and allocation of NOL deductions absorbed in the
election year. Accordingly, under paragraph (1)(b)(ii)
of Notice 89–3, the $100 general limitation NOL deduction reduces USP’s $100 of general limitation income to zero. After allocation of the NOL deduction but before application of section 904(f), USP
has $200 of passive limitation taxable income and no
general limitation or passive limitation nondeductible
CFC dividends in the election year.
Example 5. Net operating loss limitation. (i)
Facts. Before taking into account the NOL deduction
or applying section 904(f), USP has $500 of general
limitation foreign source taxable income, including
$15 of nondeductible CFC dividends, $500 of passive

2005–36 I.R.B.

limitation foreign source taxable income, and $1,000
of U.S. source taxable income for the election year.
USP also has a net operating loss carryover of $2,000,
consisting of $1,000 of U.S. loss, $600 of general limitation loss, and $400 of passive limitation loss.
(ii) Result. Under section 965(e)(2)(A), the
amount of USP’s NOL deduction absorbed in the
election year is limited to $1,985, the amount of
USP’s taxable income exclusive of nondeductible
CFC dividends. Under paragraph (1)(b)(i) of Notice
89–3, the $1,000 U.S. loss component of the NOL
carryover is absorbed first, and $985 of the NOL carryover is available to offset foreign source income.
Under paragraph (1)(b)(ii) of Notice 89–3, separate
limitation losses that are part of the NOL carryover
are tentatively carried over to the extent of separate
limitation income in the same category. Pursuant to
section 965(e)(2)(B)(ii) and section 7.01 of this notice, the $15 of nondeductible CFC dividends is not
taken into account in determining the amount of the
allowable NOL deduction absorbed in the election
year, but is taken into account in determining the
amount of general limitation income available to be
absorbed by the allowable NOL. Accordingly, $500
of the $600 general limitation component of the NOL
and $400 of the passive limitation component of the
NOL are tentatively carried over to the election year,
eliminating the $500 of general limitation income
(including the $15 of nondeductible CFC dividends)
and $400 of the $500 of passive income.
Under paragraph (1)(b)(iii) of Notice 89–3, a proportionate part of the remaining loss from each separate limitation category is next carried over, to the extent of the remaining NOL carryover amount of $85,
and allocated in accordance with section 904(f)(5).
Accordingly, an additional $85 of the general limitation component of the NOL is carried over to the
election year and allocated to passive income in accordance with section 904(f)(5). At the conclusion
of these steps, USP has $15 of passive income in the
election year and a remaining NOL carryover to other
years of ($15), all attributable to general limitation
loss.

.03 Other Deduction Limitations
For purposes of applying other Code
provisions that contain limitations based
on the amount of the taxpayer’s gross
income or taxable income for the taxable
year, gross income includes qualifying
dividends, and taxable income includes
nondeductible CFC dividends.
.04 Examples
The following examples illustrate the
application of section 7.03 of this notice.
Example 1. No taxable income limitation under
section 965(e)(2)(A). (i) Facts. Before calculating
its allowable charitable contribution deduction under section 170, USP has the following items of
gross income and expense for the election year:
$1,000 of foreign source general limitation gross income, including $200 of qualifying dividends, $500
of deductible expenses allocated and apportioned
to general limitation income (computed after the

481

disallowance of expenses directly allocable to the
deductible portion of the qualifying dividends), including the $170 DRD allowed under section 965(a)
and $20 of expenses relating to nondeductible CFC
dividends, $1,000 of U.S. source gross income, and
$500 of deductible expenses allocated and apportioned to U.S. source income. Under section 7.01 of
this notice, without regard to the charitable deduction
USP has $500 of general limitation taxable income,
including $30 of nondeductible CFC dividends, and
$500 of U.S. source taxable income for the election
year.
(ii) Result. Section 170(b)(2), which limits a
corporation’s charitable contribution deduction to 10
percent of taxable income computed without regard
to section 170 and certain other provisions not relevant on these facts, limits USP’s allowable deduction
to $100, 10 percent of USP’s taxable income of
$1,000 for the election year. If USP claims the $100
deduction, USP has $900 of taxable income for the
election year.
Example 2. Section 965(e)(2)(A) taxable income
limitation. (i) Facts. Before calculating its allowable
charitable contribution deduction under section 170,
USP has the following items of gross income and expense for the election year: $1,000 of foreign source
general limitation gross income, including $200
of qualifying dividends, and $1,000 of deductible
expenses allocated and apportioned to general limitation income (computed after the disallowance of
expenses directly allocable to the deductible portion
of the qualifying dividends), including the $170
DRD allowed under section 965(a) and $20 of expenses relating to nondeductible CFC dividends.
Under section 965(e)(2)(A) and section 7.01 of this
notice, without regard to the charitable contribution
deduction, USP’s current year deductions are limited
to $970 and USP has $30 of general limitation taxable income, all attributable to nondeductible CFC
dividends. Under section 965(e)(2)(B)(i) and section
7.01 of this notice, USP has a general limitation loss
of $30 that constitutes a net operating loss of $30 for
the election year.
(ii) Result. Section 170(b)(2), which limits a
corporation’s charitable contribution deduction to 10
percent of taxable income computed without regard
to section 170 and certain other provisions not relevant on these facts, limits USP’s allowable deduction
to $3, 10 percent of USP’s taxable income of $30 for
the election year. If USP claims the $3 deduction,
USP has $30 of taxable income and a $33 NOL for
the election year.

.05 No Other Limits on Use of Deductions
to Reduce Taxable Income
Section 965(e)(2) limits the use of deductions to reduce taxable income below
the amount of nondeductible CFC dividends, but does not restrict the use of
deductions to offset income in excess of
the amount of nondeductible CFC dividends. Therefore, deductions may offset
income in excess of the amount of nondeductible CFC dividends, including income
attributable to the section 78 gross-up that
is required with respect to foreign taxes

September 6, 2005

deemed paid with respect to nondeductible
CFC dividends.
SECTION 8. OVERALL FOREIGN
LOSS AND SEPARATE LIMITATION
LOSS RULES
.01 In General
Section 965 does not modify the operation of the overall foreign loss and
separate limitation loss allocation and
recapture rules or the U.S. loss allocation rules of section 904(f). Accordingly,
except in situations where the taxable income limitation of section 965(e)(2)(A)
applies, as provided in paragraph .02 of
this section, section 904(f) may operate
to reduce amounts of foreign source income, which may include nondeductible
CFC dividends in a separate category, or
recharacterize such amount as U.S. source
income or foreign source income in a different separate category for purposes of
applying the limitations on the allowable
foreign tax credit under sections 904(d)
and 965(e)(1).
The amount of taxable income and
the amount of the allowable NOL deduction for the election year are determined
prior to the application of section 904(f).
Therefore, the amount of the section
965(a) DRD, the amount of foreign taxes
and expenses for which a credit or deduction is disallowed under section 965(d),
the amount of taxable income determined
under section 965(e)(2)(A), and the allowable NOL deduction determined under
section 965(e)(2)(B) are not affected if
nondeductible CFC dividends are reduced
or recharacterized as U.S. source income
or foreign source income in another separate category pursuant to section 904(f).
.02 Loss Allocation
To the extent a separate limitation loss
or U.S. loss is allocated under section
904(f)(5)(B) or 904(f)(5)(D) to reduce
foreign source taxable income in a separate category that includes nondeductible
CFC dividends, such loss will be considered first to reduce other foreign source
income in the separate category before
foreign source income attributable to
nondeductible CFC dividends is reduced.
Even if nondeductible CFC dividends are
reduced as a result of a separate limitation
loss or U.S. loss allocation, income in a

September 6, 2005

later year in the separate category that is
recharacterized under section 904(f)(5)(C)
or section 904(f)(1) as income in the loss
category or as U.S. source income, as the
case may be, will not be considered nondeductible CFC dividends.
If the taxable income limitation of section 965(e)(2)(A) applies in the election
year, taxable income equals the amount
of nondeductible CFC dividends. In this
case, after the allocation and apportionment of expenses and the determination
and allocation of the allowable NOL deduction for the election year described
in sections 6 and 7 of this notice, but
prior to the application of section 904(f),
a taxpayer may have separate limitation
income attributable to nondeductible CFC
dividends with or without a separate limitation loss in the same separate category,
and may have separate limitation income
or separate limitation losses in other separate categories as well as U.S. source
taxable income or loss. Because separate
limitation losses and U.S. losses in the aggregate may not reduce the sum of separate
limitation income and U.S. source income
below the amount of nondeductible CFC
dividends in the election year, the excess
of such losses over the amount of such
income exclusive of the amount of nondeductible CFC dividends will constitute a
net operating loss for the election year. For
purposes of determining which losses are
absorbed in the election year and which
losses make up the net operating loss in
the election year if the taxable income
limitation of section 965(e)(2)(A) applies,
separate limitation losses and U.S. losses
are allocated under section 904(f)(5)(B)
and (D) without regard to nondeductible
CFC dividends. See Examples 3 and 4 in
section 8.05 of this notice.
.03 Loss Recapture
After separate limitation losses for the
taxable year are allocated to reduce separate limitation income in other separate
categories, any remaining separate limitation income may be recharacterized as
income in another separate category or
as U.S. source income, if the taxpayer
had separate limitation losses in that same
separate category in a prior taxable year
that were allocated to reduce separate
limitation income in that other separate
category or U.S. source income. This

482

recharacterization of income operates to
recapture the prior year separate limitation
loss or overall foreign loss. See section
904(f)(1), section 904(f)(5)(C), and Notice 89–3. Separate limitation losses and
overall foreign losses may be recaptured
in the election year out of income in any
separate category with separate limitation
income, including income attributable to
nondeductible CFC dividends, whether or
not the taxable income limitation of section 965(e)(2)(A) applies in the election
year.
Separate limitation losses and overall
foreign losses with respect to a separate
category that includes nondeductible CFC
dividends will be considered recaptured
first out of other income in the separate
category before any income attributable to
nondeductible CFC dividends is recharacterized. See Example 5 in section 8.05
of this notice. If nondeductible CFC dividends are recharacterized as U.S. source
income or income in a different separate
category, the recharacterized income is not
treated as nondeductible CFC dividends.
See Examples 6 and 7 in section 8.05 of
this notice.
.04 Treatment of Foreign Taxes Imposed
with Respect to Nondeductible CFC
Dividends
The recharacterization of income under
the overall foreign loss or separate limitation loss recapture rules does not result
in the recharacterization of any tax. Section 904(f)(5)(C). Accordingly, foreign
tax attributable to nondeductible CFC dividends in a separate category remains in
that separate category even if the income
attributable to the nondeductible CFC
dividends is recharacterized. See section
9.02 of this notice for rules relating to the
application of section 965(e)(1) to foreign
taxes attributable to nondeductible CFC
dividends when a portion of nondeductible
CFC dividends is recharacterized under
section 904(f) and this section 8.
.05 Examples
The following examples illustrate the
application of the rules of section 904(f)
and this section 8.
Example 1. No taxable income limitation; allocation of separate limitation loss. (i) Facts. After
the allocation and apportionment of expenses but before the application of section 904(f), USP has the following items of taxable income for the election year:

2005–36 I.R.B.

$100 of general limitation income, all attributable to
nondeductible CFC dividends, ($100) of passive limitation loss, and $200 of U.S. source taxable income.
(ii) Result. Because USP’s taxable income in the
election year ($200) exceeds the amount of nondeductible CFC dividends ($100), the taxable income
limitation of section 965(e)(2)(A) does not apply.
Under section 904(f)(5)(B), paragraph (2) of Notice
89–3, and section 8.02 of this notice, USP’s $100
passive limitation loss is allocated to reduce the $100
of general limitation income to zero. After allocation
of the separate limitation loss, USP has no general
limitation or passive income, no general limitation
or passive limitation nondeductible CFC dividends,
and $200 of U.S. source taxable income. USP has
a passive limitation loss recapture account of $100
with respect to general limitation income.
Example 2. Taxable income limitation; allocation
of separate limitation loss. (i) Facts. The facts are
the same as in Example 1, except that USP has $40,
rather than $200, of U.S. source taxable income in the
election year.
(ii) Result. Because USP’s taxable income computed without regard to section 965(e)(2)(A) ($40)
is less than the amount of nondeductible CFC dividends ($100), the taxable income limitation of section 965(e)(2)(A) applies. Therefore, under section
8.02 of this notice the loss allocation rules of section 904(f)(5) and Notice 89–3 are applied without
regard to the nondeductible CFC dividends. Accordingly, under section 904(f)(5)(A) and section 8.02 of
this notice $40 of USP’s $100 passive limitation loss
is allocated to reduce U.S. source taxable income to
zero, and the remaining $60 passive loss constitutes
an NOL for the election year. After allocation of the
separate limitation loss, USP has $100 of general limitation income, all attributable to nondeductible CFC
dividends, a $60 passive limitation loss that constitutes an NOL, and no U.S. source taxable income.
USP has a $40 overall foreign loss account in the passive category.
Example 3. Taxable income limitation; allocation
of U.S. loss. (i) Facts. After the allocation and apportionment of expenses but before the application
of section 904(f), USP has the following items of
taxable income for the election year: $750 of general limitation income, of which $500 is attributable
to nondeductible CFC dividends, and $750 of U.S.
source loss.
(ii) Result. Because USP’s taxable income
computed without regard to section 965(e)(2)(A)
($0) is less than the amount of nondeductible CFC
dividends ($500), the taxable income limitation
of section 965(e)(2)(A) applies. Therefore, under
section 8.02 of this notice the loss allocation rules
of section 904(f)(5) and Notice 89–3 are applied
without regard to the nondeductible CFC dividends.
Accordingly, under section 904(f)(5)(D) and section
8.02 of this notice $250 of USP’s $750 U.S. loss is allocated to reduce general limitation income to $500,
and the remaining $500 U.S. loss constitutes an NOL
for the election year. After allocation of the U.S.
loss, USP has $500 of general limitation income, all
attributable to nondeductible CFC dividends, and a
$500 U.S. loss that constitutes an NOL.
Example 4. Taxable income limitation; allocation
of separate limitation loss and U.S. loss. (i) Facts.
After the allocation and apportionment of expenses
but before the application of section 904(f), USP has

2005–36 I.R.B.

the following items of taxable income for the election
year: $100 of general limitation income attributable
to nondeductible CFC dividends, ($100) of general
limitation loss, $100 of passive income, and ($100)
of U.S. source loss.
(ii) Result. Because USP’s taxable income
computed without regard to section 965(e)(2)(A)
($0) is less than the amount of nondeductible CFC
dividends ($100), the taxable income limitation
of section 965(e)(2)(A) applies. Therefore, under
section 8.02 of this notice the loss allocation rules
of section 904(f)(5) and Notice 89–3 are applied
without regard to the nondeductible CFC dividends.
Accordingly, under section 904(f)(5)(B) and section
8.02 of this notice USP’s $100 general limitation loss
is allocated to reduce passive income to zero, and
the $100 U.S. loss constitutes an NOL for the election year. After allocation of the separate limitation
loss, USP has $100 of general limitation income, all
attributable to nondeductible CFC dividends, and a
$100 U.S. loss that constitutes an NOL. USP has a
$100 general limitation loss recapture account with
respect to passive income.
Example 5. OFL recapture from other income.
(i) Facts. After the allocation and apportionment of
expenses but before the application of section 904(f),
USP has the following items of taxable income for the
election year: $150 of general limitation income attributable to nondeductible CFC dividends and $190
of other general limitation income. USP has a pre2005 general limitation OFL account of $400.
(ii) Result. Under section 904(f)(1), 50 percent or
$170 of USP’s general limitation income is recharacterized as U.S. source income. Since the recapture amount does not exceed USP’s foreign source
general limitation income exclusive of nondeductible
CFC dividends, after OFL recapture USP has $150
of nondeductible CFC dividends and $20 of other income in the general limitation category, and $170 of
U.S. source income. USP’s general limitation OFL
recapture account is reduced by $170.
Example 6. OFL recapture from nondeductible
CFC dividends. (i) Facts. After the allocation and
apportionment of expenses but before the application
of section 904(f), USP has the following items of taxable income for the election year: $150 of general
limitation income, all attributable to nondeductible
CFC dividends. USP has a pre-2005 general limitation OFL account of $200.
(ii) Result. Under section 904(f)(1), unless USP
elects to recapture a larger percentage of the OFL account, 50 percent or $75 of USP’s general limitation
income is recharacterized as U.S. source income. After OFL recapture USP has $75 of nondeductible CFC
dividends in the general limitation category, and $75
of U.S. source income. USP’s OFL recapture account
is reduced by $75.
Example 7. Separate limitation loss recapture
from nondeductible CFC dividends. (i) Facts. After
the allocation and apportionment of expenses but before the application of section 904(f), USP has the following items of taxable income for the election year:
$240 of general limitation income, of which $150 is
attributable to nondeductible CFC dividends. USP
has a general limitation separate limitation loss recapture account with respect to passive income of $200.
(ii) Result. Since the $200 recapture amount exceeds $90, USP’s foreign source general limitation
income exclusive of nondeductible CFC dividends

483

($240 - $150), a portion of the nondeductible CFC
dividends is recaptured after all other general limitation income is recaptured under section 904(f)(5)(C).
Accordingly, $200 of USP’s general limitation income, equal to $90 of other income plus $110 of
nondeductible CFC dividends, is recharacterized as
passive income. After recapture of the separate limitation loss, USP has $40 of general limitation income,
all attributable to nondeductible CFC dividends, and
$200 of passive income. USP’s general limitation
separate limitation loss recapture account with respect to passive income is reduced by $200 to 0.

SECTION 9. RESTRICTION ON
USE OF CREDITS TO OFFSET
TAX ON NONDEDUCTIBLE CFC
DIVIDENDS AND COMPUTATION
OF ALTERNATIVE MINIMUM TAX
PURSUANT TO SECTION 965(e)(1)
.01 In General
Section 965(e)(1) provides that tax
on nondeductible CFC dividends is not
treated as a tax when determining the
amount of any allowable credit or the
amount of alternative minimum tax imposed by section 55. However, this rule
does not apply to the credit under section 53 for prior year minimum tax, or to
the credit under section 27(a) for foreign
taxes attributable to nondeductible CFC
dividends. Therefore, the portion of the
pre-credit U.S. tax that is attributable to
the nondeductible CFC dividends may not
be offset by any credit other than prior
year minimum tax credits and a foreign
tax credit for foreign taxes attributable to
the nondeductible CFC dividends.
.02 Additional Limitation on Foreign Tax
Credits
(a) In general. The limitation under section 965(e) on the use of foreign
tax credits against the U.S. tax on nondeductible CFC dividends (the section
965(e) limitation) is implemented through
an additional foreign tax credit limitation
for each separate category that includes
nondeductible CFC dividends. Section
965 does not provide for a distinct separate
category for qualifying dividends. Instead,
qualifying dividends are characterized as
income in separate categories under the
generally applicable look-through rules of
sections 904(d)(3)(B) and 904(d)(3)(D).
See sections 3.02 and 6.01 of this notice.
The section 965(e) limitation is applied
after gross income and deductible expenses, including the NOL deduction, are

September 6, 2005

allocated and apportioned to determine
U.S. source taxable income and foreign
source taxable income in the separate categories, as described in sections 6 and
7 of this notice, after the allocation of
separate limitation losses, overall foreign
losses, and U.S. losses and the recapture
of overall foreign losses and separate limitation losses pursuant to section 904(f), as
described in section 8 of this notice, and
after computing the regular section 904
limitation for each separate category that
contains nondeductible CFC dividends.
The section 965(e) limitation for any
separate category equals the sum of (i) the
creditable foreign taxes paid or accrued
with respect to the nondeductible CFC dividends in the separate category and (ii) the
modified section 904 limitation for that
separate category. The modified section
904 limitation for a separate category is
calculated by subtracting the amount of
nondeductible CFC dividends in the separate category from both the numerator
and denominator of the regular section 904
limitation fraction and subtracting the precredit U.S. tax attributable to the nondeductible CFC dividends in the separate category from the pre-credit U.S. tax used in
the regular section 904 limitation calculation. See Examples 1 through 4 of section
9.02(c) of this notice. For this purpose, the
pre-credit U.S. tax attributable to the nondeductible CFC dividends in the separate
category equals 35 percent (20 percent for
alternative minimum tax purposes) of the
amount of nondeductible CFC dividends
in the separate category.
For purposes of applying the section
965(e) limitation to a separate category
that included nondeductible CFC dividends that were reduced by deductions
or recharacterized as U.S. source income
or income in a different separate category pursuant to sections 6 and 8 of this
notice and section 904(f), the amount of
nondeductible CFC dividends in the separate category is the portion, if any, of the
nondeductible CFC dividends that was not
reduced by deductions or recharacterized,
and the amount of foreign tax attributable
to the nondeductible CFC dividends is the
portion of the foreign taxes paid with respect to nondeductible CFC dividends that
are attributable to such reduced amount.
The applicable foreign tax credit limitation for each separate category is the
smaller of the regular section 904 limita-

September 6, 2005

tion or the section 965(e) limitation, and
the allowable foreign tax credit for each
separate category is the smaller of the foreign taxes in the separate category or the
applicable foreign tax credit limitation.
In effect, the section 965(e) limitation
will reduce the otherwise allowable foreign tax credit only if nondeductible CFC
dividends are considered to bear a lower
effective rate of foreign tax than other
income in the same separate category and
the other income is effectively taxed in
excess of the U.S. rate. In this situation,
section 965(e)(1) is intended to prevent
the excess credits associated with the other
income from reducing the U.S. tax on the
nondeductible CFC dividends. See Example 4 in section 9.02(c) of this notice.
(b) No Limitation on Use of Foreign Tax
Credits against U.S. Tax on Income Other
than Nondeductible CFC Dividends. Section 965(e)(1) does not restrict the use of
foreign tax credits, including credits for
foreign taxes paid or deemed paid with respect to nondeductible CFC dividends, to
reduce the U.S. tax on income other than
nondeductible CFC dividends. Therefore,
to the extent otherwise allowable, foreign
tax credits for foreign taxes paid with respect to nondeductible CFC dividends or
other income may reduce the U.S. tax on
other foreign source taxable income, including income attributable to the section
78 gross-up for foreign taxes deemed paid
with respect to nondeductible CFC dividends.
(c) Examples. The following examples illustrate the application of section
965(e)(1) and this section 9.02.
Example 1. All Low-Taxed Income. (i) Facts.
USP wholly owns CFC1 and CFC2 and elects to
apply section 965 to its 2005 calendar tax year. As
of the close of 2005, CFC1 has post-1986 undistributed earnings and post-1986 foreign income
taxes of $1,000x and $100x, respectively, and CFC2
has post-1986 undistributed earnings and post-1986
foreign income taxes of $1,000x and $200x, respectively. All post-1986 undistributed earnings of CFC1
and CFC2 are general limitation earnings and profits,
and neither CFC1 nor CFC2 has any previously-taxed
earnings and profits described in sections 959(c)(1)
or 959(c)(2). USP’s base period amount is $100x,
and the requirements of section 965 are met for the
election year. CFC1 distributes a cash dividend of
$1,000x resulting in deemed-paid taxes of $100x
(($1,000x/$1,000x) x $100x), CFC2 distributes a
cash dividend of $100x resulting in deemed-paid
taxes of $20x (($100x/$1,000x) x $200x), and USP
accrues no other items of income or expense in the
election year. USP identifies the lower-taxed cash
dividend from CFC1 as the qualifying dividend.

484

(ii) Result. Step 1. Determine creditable foreign
taxes. USP is entitled to an $850x DRD under section 965(a) with respect to the $1,000x qualifying dividend from CFC1, and has $150x of nondeductible
CFC dividends. Under section 965(d)(1) and section
4.01 of this notice, USP may claim a credit for $15x
(.15 x $100x) of deemed-paid foreign tax attributable
to the nondeductible CFC dividend. Because no section 965 DRD is allowed with respect to the $100x
dividend from CFC2, all $100x is taxed, and all $20x
of deemed-paid tax attributable to the CFC2 dividend
is creditable. Thus, USP’s creditable foreign taxes,
prior to the application of the limitation rules, are
$35x ($15x + $20x), and USP includes $35x in income under section 78.
Step 2. Determine regular section 904 limitation.
Total foreign source taxable income (FSTI) equals
$285x ($1,000x CFC1 dividend - $850x DRD +
$100x CFC2 dividend + $35x gross-up). Because
USP has no other income, worldwide taxable income
(WWTI) is also $285x. USP’s pre-credit U.S. tax
is $99.75x (.35 x $285x). The regular section 904
limitation is $99.75x (($285x FSTI/$285x WWTI) x
$99.75x). Thus, all $35 of foreign taxes are eligible
for the credit under the regular section 904 limitation.
Step 3. Determine section 965(e) limitation.
Pursuant to this section 9.02, the section 965(e)
limitation is the sum of the creditable foreign taxes
paid or accrued with respect to the nondeductible
CFC dividends and the modified section 904 limitation that results from subtracting the amount of the
nondeductible CFC dividends from the numerator
and denominator of the regular section 904 limitation
fraction and subtracting the pre-credit U.S. tax on
the nondeductible CFC dividends from the pre-credit
U.S. tax in the regular section 904 limitation. The
foreign taxes on the $150x of nondeductible CFC
dividends are $15x. Subtracting the $150x of nondeductible CFC dividends from the numerator and
denominator of the regular section 904 limitation
fraction, USP has $135x of other FSTI and WWTI
($100x CFC2 dividend plus $35x of gross-up income) and a pre-credit U.S. tax on this amount
of $47.25x ($99.75x - (.35 x $150x)). The modified section 904 limitation equals $47.25x (($135x
FSTI/$135x WWTI) x $47.25x). The section 965(e)
limitation equals $62.25x ($15x + $47.25x). Because the total amount of creditable foreign taxes is
less than both the section 965(e) limitation and the
regular section 904 limitation, USP may credit all
$35x of foreign tax in the election year.
Example 2. All High-Taxed Income. (i) Facts.
The facts are the same as in Example 1, except
that CFC1 has post-1986 undistributed earnings
and post-1986 foreign income taxes of $1,000x and
$600x, respectively, and CFC2 has post-1986 undistributed earnings and post-1986 foreign income taxes
of $1,000x and $750x, respectively. Accordingly,
the $1,000x dividend from CFC1 results in foreign
taxes deemed paid of $600x (($1,000x/$1,000x) x
$600x), and the $100x dividend from CFC2 results in
foreign taxes deemed paid of $75x (($100x/$1,000x)
x $750x).
(ii) Result. Step 1. Determine creditable foreign
taxes. USP is entitled to an $850x DRD under section
965(a) with respect to the $1,000x qualifying dividend from CFC1, and has $150 of nondeductible CFC
dividends. Under section 965(d)(1) and section 4.01
of this notice, USP may claim a credit for $90x (.15

2005–36 I.R.B.

x $600x) of deemed-paid foreign tax attributable to
the nondeductible CFC dividend. Because no section
965 DRD is allowed with respect to the $100x dividend from CFC2, all $100x is taxed, and all $75x of
deemed-paid tax attributable to the CFC2 dividend
is creditable. Thus, USP’s creditable foreign taxes,
prior to the application of the limitation rules, are
$165x ($90x + $75x), and USP includes $165x in income under section 78.
Step 2. Determine regular section 904 limitation.
USP’s FSTI equals $415x ($1,000x qualifying dividend from CFC1 - $850x DRD + $100x dividend
from CFC2 + $165x gross-up). Because USP has no
other income, WWTI is also $415x. USP’s pre-credit
U.S. tax is $145.25x (.35 x $415x). Thus, the limitation equals $145.25x (($415x FSTI/$415x WWTI)
x $145.25x). Because the limitation is less than the
total creditable taxes of $165x, the regular section
904 limitation prevents the excess $19.75x from being credited in the current year.
Step 3. Determine section 965(e) limitation. The
foreign taxes on the $150x of nondeductible CFC dividends are $90x. Subtracting the $150x of nondeductible CFC dividends from the numerator and denominator of the regular section 904 limitation fraction, USP has $265x of other FSTI and WWTI ($415x
- $150x) and a pre-credit U.S. tax on this amount
of $92.75x ($145.25x - (.35 x $150x)). The modified section 904 limitation equals $92.75x (($265x
FSTI/$265x WWTI) x $92.75x). The section 965(e)
limitation equals $182.75x ($90x + $92.75x). Because the section 965(e) limitation is higher than the
regular section 904 limitation, the total amount of
creditable foreign taxes are subject to the regular section 904 limitation of $145.25x.
Example 3. High-Taxed Nondeductible CFC
Dividend/Low-Taxed Other Income. (i) Facts. The
facts are the same as in Example 1, except that CFC1
has post-1986 undistributed earnings and post-1986
foreign income taxes of $1,000x and $400x, respectively, CFC2 does not pay a dividend in the election
year, and USP has an additional $100x of general limitation income subject to no foreign tax. Accordingly,
the $1,000x dividend from CFC1 results in foreign
taxes deemed paid of $400x (($1,000x/$1,000x) x
$400x), and no foreign taxes of CFC2 are deemed
paid in the election year.
(ii) Result. Step 1. Determine creditable foreign
taxes. USP is entitled to an $850x DRD under section 965(a) with respect to the $1,000x qualifying dividend from CFC1, and has $150x of nondeductible
CFC dividends. Under section 965(d)(1) and section
4.01 of this notice, USP may claim a credit for $60x
(.15 x $400x) of deemed-paid foreign tax attributable
to the nondeductible CFC dividend. Thus, USP’s
creditable foreign taxes, prior to the application of the
limitation rules, are $60x, and USP includes $60x in
income under section 78.
Step 2. Determine regular section 904 limitation.
USP’s FSTI equals $310x ($1,000x qualifying dividend from CFC1 - $850x DRD + $60x gross-up +
$100x of other income). Because USP has no other
income, WWTI is also $310x. USP’s pre-credit
U.S. tax is $108.50x (.35 x $310x). Thus, the regular section 904 limitation equals $108.50x (($310x
FSTI/$310x WWTI) x $108.50x). All $60x of foreign tax would be creditable, because the foreign
taxes paid in excess of the U.S. tax on the nondeductible CFC dividend can reduce the U.S. tax on

2005–36 I.R.B.

the gross-up income and the other foreign source
income.
Step 3. Determine section 965(e) limitation. The
foreign taxes on the $150x of nondeductible CFC dividends are $60x. Subtracting the $150x of nondeductible CFC dividends from the numerator and denominator of the regular section 904 limitation fraction, USP has $160x of other FSTI and WWTI ($310x
- $150x) and a pre-credit U.S. tax on this amount of
$56x ($108.50x - (.35 x $150x)). The modified section 904 limitation equals $56x (($160x FSTI/$160x
WWTI) x $56x). The section 965(e) limitation equals
$116x ($60x + $56x). Because the section 965(e)
limitation is higher than the regular section 904 limitation, the $60x total amount of creditable foreign
taxes are subject to the regular section 904 limitation
of $108.50x, and the excess foreign taxes on the nondeductible CFC dividend can reduce the U.S. tax on
USP’s other foreign source income.
Example 4. Low-Taxed Nondeductible CFC
Dividend/High-Taxed Other Income. (i) Facts. The
facts are the same as in Example 1, except that CFC2
has post-1986 undistributed earnings and post-1986
foreign income taxes of $1,000x and $750x, respectively. Accordingly, the $1,000x dividend from
CFC1 results in foreign taxes deemed paid of $100x
(($1,000x/$1,000x) x $100x), and the $100x dividend from CFC2 results in foreign taxes deemed paid
of $75x (($100x/$1,000x) x $750x).
(ii) Result. Step 1. Determine creditable foreign
taxes. USP is entitled to an $850x DRD under section 965(a) with respect to the $1,000x qualifying dividend from CFC1, and has $150x of nondeductible
CFC dividends. Under section 965(d)(1) and section
4.01 of this notice, USP may claim a credit for $15x
(.15 x $100x) of deemed-paid foreign tax attributable
to the nondeductible CFC dividend. Because no section 965 DRD is allowed with respect to the $100x
dividend from CFC2, all $100x is taxed, and all $75x
of deemed-paid tax attributable to the CFC2 dividend
is creditable. Thus, USP’s creditable foreign taxes,
prior to the application of the limitation rules, are
$90x ($15x + $75x), and USP includes $90x in income under section 78.
Step 2. Determine regular section 904 limitation.
USP’s FSTI equals $340x ($1,000x qualifying dividend from CFC1 - $850x DRD + $100x dividend
from CFC2 + $90x gross-up). Because USP has no
other income, WWTI is also $340x. USP’s pre-credit
U.S. tax is $119x (.35 x $340x). Thus, the regular section 904 limitation equals $119x (($340x FSTI/$340x
WWTI) x $119x). The regular section 904 limitation
would allow all $90x of foreign tax to be credited,
because the foreign taxes paid in excess of the U.S.
tax on the CFC2 dividend could reduce the U.S. tax
on the low-taxed nondeductible CFC dividend from
CFC1.
Step 3. Determine section 965(e) limitation.
The foreign taxes on the $150x of nondeductible
CFC dividends are $15x. Subtracting the $150x of
nondeductible CFC dividends from the numerator
and denominator of the regular section 904 limitation fraction, USP has $190x of other FSTI and
WWTI ($340x - $150x) and a pre-credit U.S. tax
on this amount of $66.50x ($119x - (.35 x $150x)).
The modified section 904 limitation equals $66.50x
(($160x FSTI/$160x WWTI) x $66.50x). The section
965(e) limitation equals $81.50x ($15x + $66.50x).
Because the section 965(e) limitation is less than the

485

regular section 904 limitation of $119x, the section
965(e) limitation applies and prevents USP from
crediting $8.50x of the $90x of potentially creditable
taxes. The $8.50x of tax which is not creditable
under the section 965(e) limitation equals the excess
foreign taxes on the other foreign source income that
would have been creditable against the U.S. tax on
the nondeductible CFC dividend under the regular
section 904 limitation (i.e., the excess of the $75x of
foreign tax on the CFC2 dividend over $66.50x, the
pre-credit U.S. tax on $190x of other foreign source
income ($100x CFC2 dividend + $75x gross-up attributable to tax deemed paid on the CFC2 dividend
+ $15x gross-up attributable to the nondeductible
CFC dividend from CFC1)). The excess taxes may
be carried over and used as a credit in other years to
the extent allowed under section 904(c).

.03 No Use of Credits Other than Credit
for Prior Year Minimum Tax to Offset U.S.
Tax on Nondeductible CFC Dividends
Section 965(e)(1) provides that no
credit other than a foreign tax credit for
foreign taxes attributable to nondeductible
CFC dividends and the credit for prior
year minimum tax under section 53 may
offset the U.S. tax on nondeductible CFC
dividends. However, section 965 does
not limit the application of credits against
the U.S. tax on income other than nondeductible CFC dividends. Because other
credits, including the possessions tax
credit allowed under sections 27(b) and
30A, the nonconventional source fuel
credit allowed under section 29, the qualified electric vehicle credit allowed under
section 30, and the general business credit
allowed under section 38, as well as the
credit for prior year minimum tax that
is allowed under section 53, are applied
after the foreign tax credit, taxpayers must
identify the portion of their pre-credit U.S.
tax and allowable foreign tax credit for the
election year that is attributable to nondeductible CFC dividends and the portion
that is attributable to other income in order to determine the amount of their other
allowable credits.
For purposes of this determination and
section 9.05 of this notice, the portion of
a taxpayer’s pre-credit U.S. tax that is attributable to nondeductible CFC dividends
equals the smaller of the taxpayer’s total
pre-credit U.S. tax or 35 percent of the
amount of nondeductible CFC dividends.
For this purpose, the amount of nondeductible CFC dividends is the amount determined under section 965(e)(3), without
regard to any reduction or recharacterization of nondeductible CFC dividends in

September 6, 2005

a separate category for purposes of determining the foreign tax credit limitation as
provided in sections 6 through 8 of this notice. The portion of the taxpayer’s precredit U.S. tax that is attributable to other
income equals the excess, if any, of the taxpayer’s total pre-credit U.S. tax over the
pre-credit U.S. tax attributable to nondeductible CFC dividends. To determine the
total allowable foreign tax credit for the
election year, the taxpayer must first compute the allowable credit for each separate category, applying the section 965(e)
limitation described in section 9.02 of this
notice. The portion of the taxpayer’s allowable foreign tax credit in each separate category that is attributable to nondeductible CFC dividends equals the smaller
of 35 percent of the amount of nondeductible CFC dividends in the separate category, determined after applying sections
6 through 8 of this notice, or the foreign
taxes paid or accrued with respect to the
nondeductible CFC dividends in that separate category, determined in accordance
with section 9.02(a) of this notice. The
portion of the allowable foreign tax credit
that is attributable to nondeductible CFC
dividends is the sum of the amounts determined under the preceding sentence in
all of the taxpayer’s separate categories.
The remainder, if any, of the allowable foreign tax credit is considered attributable to
other income.
The taxpayer’s residual U.S. tax on
nondeductible CFC dividends, as reduced
by the portion of the allowable foreign
tax credit that is attributable to that income, may not be reduced by any credit
other than the prior year minimum tax
credit. The taxpayer’s residual U.S. tax on
other income, as reduced by the balance
of the allowable foreign tax credit, may
be reduced by other credits in accordance
with the rules generally applicable to such
credits.
.04 Computation of Section 53 Credit in
Election Year
Under section 965(e)(1), the U.S. tax
on nondeductible CFC dividends is taken
into account in determining the allowable
amount of prior year minimum tax credits
under section 53 for the election year. Accordingly, for purposes of section 53 the
taxpayer’s regular tax and tentative minimum tax are computed taking into ac-

September 6, 2005

count the regular tax and tentative minimum tax on nondeductible CFC dividends,
as reduced by allowable foreign tax credits computed in accordance with section
965(e)(1) and section 9.02 of this notice.
As a result, credits for prior year minimum
tax may be allowed in the election year
to reduce the regular tax on nondeductible
CFC dividends and other income, subject
to the limitation of section 53(c), even if
the taxpayer’s entire taxable income is attributable to nondeductible CFC dividends
or if the taxpayer is subject to AMT on taxable income other than nondeductible CFC
dividends in the election year. See Examples 3 through 6 of section 9.06 of this notice.
.05 Computation of Alternative Minimum
Tax in Election Year
Section 965(e)(1) provides that the
U.S. tax on nondeductible CFC dividends
is not treated as tax imposed by chapter
1 for purposes of computing the AMT
imposed by section 55. For purposes of
computing AMT for the election year, the
taxpayer’s regular tax described in section
55(c) does not include the portion of the
taxpayer’s pre-credit regular tax liability
that is attributable to nondeductible CFC
dividends, and the foreign tax credit taken
into account does not include the portion
of the taxpayer’s allowable foreign tax
credit that is attributable to nondeductible
CFC dividends. Similarly, the taxpayer’s
tentative minimum tax determined under
section 55(b)(1)(B) does not include the
portion of the taxpayer’s tentative minimum tax or alternative minimum tax
foreign tax credit that is attributable to
nondeductible CFC dividends. In addition, the deductible portion of qualifying
dividends is not treated as a preference
item in computing alternative minimum
taxable income. Accordingly, the additional tax owed by the taxpayer by reason
of the AMT in the election year is the
same that would be owed if the qualifying
dividends were not paid. See Examples 1,
2, 4 and 5 of section 9.06 of this notice.
.06 Examples
The following examples illustrate the
application of section 965(e)(1) and sections 9.04 and 9.05 of this notice.
Example 1. Calculation of AMT with no foreign
tax credit. (i) Facts. For the election year USP’s tax-

486

able income consists of $200x of foreign source general limitation nondeductible CFC dividends subject
to no foreign tax and $400x of U.S. source income.
USP’s pre-credit regular tax liability is $210x (.35 x
$600x). USP has $600x of U.S. source preference
items.
(ii) Result. Taking into account the adjustments
required by section 965(e)(1)(B) for purposes of
computing USP’s alternative minimum tax under
section 55 in the election year, USP’s taxable income computed without regard to the $200x of nondeductible CFC dividends is $400x, which would
result in a pre-credit regular tax liability of $140x
(.35 x $400x). USP’s alternative minimum taxable
income computed without regard to the $200x of
nondeductible CFC dividends is increased by $600x
of preference items from $400x to $1,000x. USP’s
tentative minimum tax, computed without regard to
the nondeductible CFC dividends, is $200x (.20 x
$1,000x). The excess of USP’s adjusted tentative
minimum tax of $200x over its adjusted regular
tax of $140x results in alternative minimum tax of
$60x. USP’s pre-credit tax for the election year is
$270x ($210x of regular tax plus $60x of alternative minimum tax). This amount is equivalent to
20 percent of $1,000x, USP’s alternative minimum
taxable income exclusive of the nondeductible CFC
dividends, plus 35 percent of $200x of nondeductible
CFC dividends.
Example 2. Alternative minimum tax foreign tax
credit. (i) Facts. The facts are the same as in Example 1, except that instead of $400x of U.S. source
income, USP has $200x of U.S. source income and
$200x of other foreign source general limitation income, and USP’s foreign taxes paid or deemed paid
with respect to general limitation income are $100x,
including $20x of foreign tax paid or accrued with respect to the $200x of nondeductible CFC dividends.
(ii) Result. As in Example 1, USP’s pre-credit
regular tax on $400x of taxable income in excess of
the $200x of nondeductible CFC dividends is $140x
and its pre-credit tentative minimum tax on $1,000x
of alternative minimum taxable income in excess of
the nondeductible CFC dividends ($400x plus $600x
of preference items) is $200x. USP’s allowable
foreign tax credit computed for regular tax purposes
is $90x, the lesser of $100x, the foreign taxes paid,
$140x, the regular section 904 limitation (($400x
FSTI/$600x WWTI) x $210x pre-credit U.S. tax),
or $90x, the section 965(e) limitation ($20x foreign
tax on nondeductible CFC dividends + $70x, the
limitation on other income of ($200x FSTI/$400x
WWTI) x $140x). The portion of the allowable
regular foreign tax credit that is attributable to the
nondeductible CFC dividends is $20x, the smaller
of the $70x pre-credit U.S. tax on the nondeductible
CFC dividends (.35 x $200x) or $20x, the foreign
taxes paid or accrued with respect to the nondeductible CFC dividends. The remaining $70x of the
allowable regular foreign tax credit is the amount
attributable to USP’s other foreign source income.
Accordingly, USP’s regular tax described in section
55(c), computed without regard to the tax on nondeductible CFC dividends, is $70x ($140x regular tax
- $70x foreign tax credit).
Computed without regard to section 965(e)(1)(B),
USP’s alternative minimum tax foreign tax credit
is $60x, the lesser of $100x, the foreign taxes paid,
$80x, the regular alternative minimum tax for-

2005–36 I.R.B.

eign tax credit limitation (($400x FSAMTI/$1200x
WWAMTI) x $240x), or $60x, the section 965(e) limitation ($20x + ($200x FSAMTI/ $1000x WWAMTI)
x $200x). The portion of the alternative minimum
tax foreign tax credit that is attributable to nondeductible CFC dividends is $20x, the lesser of $40x,
the pre-credit U.S. alternative minimum tax on the
nondeductible CFC dividends (.20 x $200x) or $20x,
the foreign taxes paid or accrued with respect to the
nondeductible CFC dividends. The $40x balance
of the alternative minimum tax foreign tax credit is
attributable to USP’s other foreign source income.
Accordingly, USP’s tentative minimum tax described in section 55(b)(1)(B), computed without regard to the tax on nondeductible CFC dividends, is
$160x ($200x - $40x). Under section 55 as modified by section 965(e)(1)(B), USP’s alternative minimum tax is $90x, the excess of its tentative minimum
tax over its regular tax ($160x - $70x). Accordingly,
USP’s tax for the election year is $210x ($210x regular tax on $600x of taxable income - $90x regular foreign tax credit + $90x alternative minimum tax). This
amount is equivalent to 20 percent of USP’s $1,000x
of alternative minimum taxable income exclusive of
the nondeductible CFC dividends less the $40x alternative minimum tax foreign tax credit on that amount
($200x - $40x), plus 35 percent of $200x of nondeductible CFC dividends less the $20x regular foreign
tax credit on that amount ($70x - $20x).
Example 3. No AMT; prior year minimum tax
credit. (i) Facts. For the election year USP’s taxable income consists of $200x of foreign source nondeductible CFC dividends subject to no foreign tax.
USP’s pre-credit regular tax liability is $70x (.35 x
$200x). USP has no preference items.
(ii) Result. Taking into account the adjustments
required by section 965(e)(1)(B) for purposes of computing USP’s alternative minimum tax under section
55 in the election year, USP’s taxable income computed without regard to the $200x of nondeductible
CFC dividends is $0, which would result in a precredit regular tax liability of $0. USP’s alternative
minimum taxable income computed without regard to
the $200x of nondeductible CFC dividends is also $0,
so its tentative minimum tax, computed without regard to the nondeductible CFC dividends, is $0. The
excess of USP’s adjusted tentative minimum tax of $0
over its adjusted regular tax of $0 results in alternative minimum tax of $0. USP’s pre-credit tax for the
election year is $70x ($70x of regular tax plus $0 alternative minimum tax), equal to 35 percent of $200x
of nondeductible CFC dividends.
For purposes of computing USP’s prior year
minimum tax credit under section 53 for the election
year, the modifications to section 55 that are required
under section 965(e)(1)(B) do not apply. Accordingly, for purposes of computing the limitation of
section 53(c), USP’s regular tax liability is $70x (.35
x $200x of taxable income including nondeductible
CFC dividends), its tentative minimum tax is $40x
(.20 x $200x of alternative minimum taxable income
including nondeductible CFC dividends), and the
excess of the regular tax liability over the tentative
minimum tax for the election year is $30x ($70x $40x). USP may claim a credit under section 53(a) in
the election year for the excess (if any) of its adjusted
net minimum tax imposed for all post-1986 taxable
years prior to the election year over the amount allowable as a credit under section 53(a) for such prior

2005–36 I.R.B.

taxable years, up to the $30x limitation computed
under section 53(c).
Example 4. AMT with no foreign tax credit and
prior year minimum tax credit. (i) Facts. For the election year USP’s taxable income consists of $200x of
foreign source general limitation nondeductible CFC
dividends subject to no foreign tax and $400x of U.S.
source income. USP’s pre-credit regular tax liability
is $210x (.35 x $600x). USP has $350x of U.S. source
preference items described in section 57(a)(5).
(ii) Result. Taking into account the adjustments
required by section 965(e)(1)(B) for purposes of
computing USP’s alternative minimum tax under
section 55 in the election year, USP’s taxable income
computed without regard to the $200x of nondeductible CFC dividends is $400x, which would result
in a pre-credit U.S. regular tax liability of $140x
(.35 x $400x). USP’s alternative minimum taxable
income computed without regard to the $200x of
nondeductible CFC dividends is $750x, taxable income of $400x increased by $350x of preference
items. USP’s tentative minimum tax, computed
without regard to the nondeductible CFC dividends,
is $150x (.20 x $750x). The excess of USP’s adjusted
tentative minimum tax of $150x over its adjusted
regular tax of $140x results in alternative minimum
tax of $10x. USP’s pre-credit tax for the election
year is $220x ($210x of regular tax plus $10x of
alternative minimum tax). This amount is equivalent
to $150x (20 percent of $750x, USP’s alternative
minimum taxable income exclusive of the nondeductible CFC dividends), plus $70x (35 percent of
$200x of nondeductible CFC dividends).
For purposes of computing USP’s prior year
minimum tax credit under section 53 for the election year, the modifications to section 55 that are
required under section 965(e)(1)(B) do not apply.
Accordingly, for purposes of computing the limitation of section 53(c), USP’s regular tax liability is
$210x (.35 x $600x of regular taxable income including nondeductible CFC dividends), its tentative
minimum tax is $190x (.20 x $950x of alternative
minimum taxable income including nondeductible
CFC dividends), and the excess of the regular tax
liability over the tentative minimum tax for the election year is $20x ($210x - $190x). USP may claim
a credit under section 53(a) in the election year for
the excess (if any) of its adjusted net minimum tax
imposed for all post-1986 taxable years prior to the
election year over the amount allowable as a credit
under section 53(a) for such prior taxable years, up
to the $20x limitation computed under section 53(c).
Example 5. AMT with foreign tax credit and prior
year minimum tax credit. (i) Facts. The facts are the
same as in Example 2, except that USP has $200x
rather than $600x of U.S. source preference items.
(ii) Result. Taking into account the adjustments
required by section 965(e)(1)(B) for purposes of
computing USP’s alternative minimum tax under
section 55 in the election year, USP’s taxable income
computed without regard to the $200x of nondeductible CFC dividends is $400x, which would result
in a pre-credit U.S. regular tax liability of $140x (.35
x $400x). USP’s pre-credit tentative minimum tax,
computed without regard to the nondeductible CFC
dividends, is $120x (.20 x $600x).
USP’s allowable foreign tax credit computed for
regular tax purposes is $90x, the lesser of $100x, the
foreign taxes paid, $140x, the regular section 904

487

limitation (($400x FSTI/$600x WWTI) x $210x precredit U.S. tax), or $90x, the section 965(e) limitation
($20x foreign tax on nondeductible CFC dividends
+ $70x, the limitation on other income of (($200x
FSTI/$400x WWTI) x $140x). The portion of the
allowable regular foreign tax credit that is attributable to the nondeductible CFC dividends is $20x, the
smaller of the $70x pre-credit U.S. tax on the nondeductible CFC dividends (.35 x $200x) or $20x, the
foreign taxes paid or accrued with respect to the nondeductible CFC dividends. The remaining $70x of
the allowable regular foreign tax credit is the amount
attributable to USP’s other foreign source income.
Accordingly, USP’s regular tax described in section
55(c), computed without regard to the tax on nondeductible CFC dividends, is $70x ($140x regular tax $70x foreign tax credit).
Computed without regard to section 965(e)(1)(B),
USP’s alternative minimum tax foreign tax credit
is $60x, the lesser of $100x, the foreign taxes paid,
$80x, the regular alternative minimum tax foreign tax credit limitation (($400x FSAMTI/$800x
WWAMTI) x $160x), or $60x, the section 965(e) limitation ($20x + ($200x FSAMTI/ $600x WWAMTI)
x $120x). The portion of the alternative minimum
tax foreign tax credit that is attributable to nondeductible CFC dividends is $20x, the lesser of $40x,
the pre-credit tentative minimum tax on the nondeductible CFC dividends (.20 x $200x) or $20x, the
foreign taxes paid or accrued with respect to the
nondeductible CFC dividends. The $40x balance
of the alternative minimum tax foreign tax credit is
attributable to USP’s other foreign source income.
Accordingly, USP’s tentative minimum tax described
in section 55(b)(1)(B), computed without regard to
the tax on nondeductible CFC dividends, is $80x
($120x - $40x). Under section 55 as modified by
section 965(e)(1)(B), the excess of USP’s tentative
minimum tax over its regular tax is $10x ($80x $70x).
For purposes of computing USP’s prior year minimum tax credit under section 53 for the election year,
the modifications to section 55 that are required under
section 965(e)(1)(B) do not apply. Accordingly, for
purposes of computing the limitation of section 53(c),
USP’s pre-credit regular tax liability is $210x (.35
x $600x of taxable income including nondeductible
CFC dividends) and its pre-credit tentative minimum
tax liability is $160x (.20 x $800x of alternative minimum taxable income including nondeductible CFC
dividends). As described above, USP’s regular and
AMT foreign tax credits are limited under section
965(e) to $90x and $60x, respectively. Therefore, for
purposes of section 53(c) USP’s regular tax liability
is $120x ($210x - $90x foreign tax credit), its tentative minimum tax is $100x ($160x - $60x alternative minimum tax foreign tax credit), and the excess
of its regular tax over its tentative minimum tax is
$20x ($120x - $100x). USP may claim a credit under section 53(a) in the election year for the excess (if
any) of its adjusted net minimum tax imposed for all
post-1986 taxable years prior to the election year over
the amount allowable as a credit under section 53(a)
for such prior taxable years, up to $20x, the limitation
computed under section 53(c).
Example 6. Minimum tax credit after OFL recapture. (i) Facts. The facts are the same as in Example
5, except that USP has a pre-2005 general limitation
OFL account of $500x.

September 6, 2005

(ii) Result. Under section 904(f)(1), unless USP
elects to recapture a larger percentage of the OFL account, 50 percent or $250x of USP’s $400x of foreign
source general limitation income is recharacterized as
U.S. source income. After OFL recapture USP has
$150x of foreign source general limitation income,
all attributable to nondeductible CFC dividends. See
section 8.03 of this notice. Pursuant to section 9.02
of this notice, $15x (($150x/$200x) x $20x) of foreign tax is paid or accrued with respect to the $150x
of nondeductible CFC dividends.
Pursuant to sections 9.03 and 9.05 of this notice,
for purposes of computing USP’s alternative minimum tax under section 55 in the election year, USP’s
pre-credit regular tax and pre-credit tentative minimum tax are computed without regard to the $200x
of nondeductible CFC dividends, as determined under section 965(e)(3) without regard to the recharacterization of $50x of nondeductible CFC dividends
as U.S. source income pursuant to the recapture of
USP’s general limitation OFL account under section
904(f) and section 8.03 of this notice. As in Example
5, USP’s pre-credit regular tax and pre-credit tentative minimum tax, computed without regard to nondeductible CFC dividends, are $140x and $120x, respectively.
USP’s allowable foreign tax credit computed for
regular tax purposes is $15x, the lesser of $100x,
the foreign taxes paid, $52.50x, the regular section
904 limitation (($150x FSTI/$600x WWTI) x $210x
pre-credit U.S. tax), or $15x, the section 965(e) limitation ($15x foreign tax on nondeductible CFC dividends + $0, the limitation on other income of ($0
FSTI/$400x WWTI) x $140x). Pursuant to section
9.03 of this notice, the portion of the allowable regular foreign tax credit that is attributable to the nondeductible CFC dividends is $15x, the smaller of the
$52.50x pre-credit U.S. tax on the reduced amount
of nondeductible CFC dividends (.35 x $150x) or
$15x, the foreign taxes paid or accrued with respect
to the reduced amount of nondeductible CFC dividends. Therefore, no foreign tax credit is attributable
to USP’s other foreign source income. Accordingly,
USP’s regular tax described in section 55(c), computed without regard to the tax on nondeductible CFC
dividends, is $140x ($140x regular tax - $0 foreign
tax credit).
Computed without regard to section 965(e)(1)(B),
USP’s alternative minimum tax foreign tax credit
is $15x, the lesser of $100x, the foreign taxes paid,
$30x, the regular alternative minimum tax foreign tax credit limitation (($150x FSAMTI/$800x
WWAMTI) x $160x) or $15x, the section 965(e)
limitation ($15x + ($0 FSAMTI/ $600x WWAMTI)
x $120x). Pursuant to section 9.03 of this notice,
the portion of the alternative minimum tax foreign
tax credit that is attributable to nondeductible CFC
dividends is $15x, the lesser of $30x, the pre-credit
tentative minimum tax on the nondeductible CFC
dividends (.20 x $150x) or $15x, the foreign taxes
paid or accrued with respect to the nondeductible
CFC dividends. Accordingly, none of the alternative minimum tax foreign tax credit is attributable
to USP’s other foreign source income. Therefore,
USP’s tentative minimum tax described in section
55(b)(1)(B), computed without regard to the tax
on nondeductible CFC dividends, is $120x ($120x
tentative minimum tax - $0 alternative minimum tax
foreign tax credit). Under section 55 as modified by

September 6, 2005

section 965(e)(1)(B), USP’s regular tax of $140x exceeds its tentative minimum tax of $120x. Therefore,
USP does not owe AMT for the election year.
For purposes of computing USP’s prior year minimum tax credit under section 53 for the election year,
the modifications to section 55 that are required under
section 965(e)(1)(B) do not apply. Accordingly, for
purposes of computing the limitation of section 53(c),
USP’s pre-credit regular tax is $210x (.35 x $600x
of taxable income including nondeductible CFC dividends) and its pre-credit tentative minimum tax is
$160x (.20 x $800x of alternative minimum taxable
income including nondeductible CFC dividends). As
described above, USP’s regular and AMT foreign tax
credits are limited under section 965(e) to $15x, all
attributable to nondeductible CFC dividends. Therefore, for purposes of section 53(c) USP’s regular tax
liability is $195x ($210x - $15x foreign tax credit), its
tentative minimum tax is $145x ($160x - $15x alternative minimum tax foreign tax credit), and the excess of its regular tax over its tentative minimum tax
is $50x ($195x - $145x). USP may claim a credit under section 53(a) in the election year for the excess (if
any) of its adjusted net minimum tax imposed for all
post-1986 taxable years prior to the election year over
the amount allowable as a credit under section 53(a)
for such prior taxable years, up to $50x, the limitation
computed under section 53(c).

SECTION 10. OTHER GUIDANCE
.01 Application of General Tax Law
Principles
Unless otherwise specifically provided,
general tax law principles, including the
circular cash flow, step-transaction, and
substance-over-form doctrines, apply for
purposes of determining the federal income tax consequences of transactions undertaken in connection with section 965.
For example, assume USP, a domestic corporation, wholly owns CFC1 which, in
turn, wholly owns CFC2. If CFC2 declares a dividend and CFC1 declares a dividend of the same amount, and, at the direction of CFC1, CFC2 pays the amount
of its dividend in cash directly to USP,
then under applicable Code provisions, including section 965, such payment shall be
treated as a distribution of cash from CFC2
to CFC1, followed by a distribution of cash
from CFC1 to USP. See, e.g., Rev. Rul.
80–292, 1980–2 C.B. 104.
.02 Base Period Inclusions under Section
965(b)(2)(B)
In computing a taxpayer’s base period
amount, section 965(b)(2)(B)(i) includes
dividends described in section 965(c)(3)
that were received during each base period
year from CFCs, section 965(b)(2)(B)(ii)

488

includes amounts includible in gross income for each base period year under section 951(a)(1)(B) with respect to CFCs,
and section 965(b)(2)(B)(iii) includes
amounts that would have been included
for each base period year but for section
959(a). For this purpose, dividends received from CFCs by a disregarded entity
or a partnership owned by a U.S. shareholder during a base period year shall be
treated as received by such U.S. shareholder to the extent the dividend was
included in income shown on the U.S.
shareholder’s return described in section
965(b)(2) for the base period year, regardless of whether cash or property in
the amount of the dividend was received
by the shareholder in the base period
year. In addition, for purposes of section
965(b)(2)(B), amounts includible under
section 951(a)(1)(B) (or that would have
been so included but for section 959(a))
in gross income of a domestic partnership
that was owned by a U.S. shareholder
during a base period year shall be treated
as includible in the U.S. shareholder’s
income under section 951(a)(1)(B), or excluded under section 959(a), to the extent
the includible amount was (i) allocated
to the U.S. shareholder-partner under the
rules of sections 702 and 704 and the regulations thereunder in a base period year;
and (ii) separately stated to the partner
under Treas. Reg. §1.702–1(a)(8)(ii).
.03 Allocation of $500 Million
Limitation—Clarification of Section
4.05 of Notice 2005–38
Section 4.05 of Notice 2005–38 provides that the $500 million limitation on
qualifying dividends described in section
965(b)(1)(A) is allocated among the qualified members of a section 52(a) group
in proportion to the aggregate amount of
total current and accumulated non-previously-taxed earnings and profits of all
CFCs owned (within the meaning of section 958(a)) by such qualified members,
determined with reference to the earnings and profits appropriately reported on
Schedule J of the last Form 5471 filed on
or before the apportionment date. For this
purpose, the amount of non-PTI earnings
and profits of a CFC taken into account
by a qualified member is that member’s
pro rata share of the CFC’s earnings and
profits, determined in accordance with

2005–36 I.R.B.

section 951(a)(2) for the year for which
Form 5471 was filed.
.04 Effect of Restatement of Certified
Financial Statement
A restatement of a previously filed and
certified financial statement described in
section 965(c)(1) that occurs after June
30, 2003, does not alter the statement’s
status as having been filed and certified
on or before June 30, 2003. In such a
case, the limitations described in section
965(b)(1)(B) and (C) are the amount of
earnings permanently reinvested outside
the United States, and a specific amount
of tax liability, respectively, that are shown
on the statement as originally filed, not the
amounts shown on the restatement.
.05 Definition of United States
For purposes of section 965, the term
“United States” includes the 50 states, the
District of Columbia, the territorial waters of the United States, and the seabed
and subsoil of those submarine areas that
are adjacent to the territorial waters of the
United States and over which the United
States has exclusive rights, in accordance
with international law, with respect to the
exploration and exploitation of natural resources. The term “United States” does
not include possessions and territories of
the United States or the airspace over the
United States and these areas.
.06 Treatment of Accounts Payable
Resulting from Section 482 Adjustments
Accounts payable established under
Rev. Proc. 99–32, 1999–2 C.B. 296, in
connection with section 482 adjustments
are treated as indebtedness for purposes of
section 965(b)(3).
.07 Exceptions to Related Party
Indebtedness for Certain Ordinary Course
Transactions of Banks and Dealers in
Securities—Addition to Section 7.02 of
Notice 2005–38
For purposes of section 965(b)(3), the
term “indebtedness” does not include
indebtedness of a CFC arising in the ordinary course of business as a bank or
as a dealer in securities that would not
be treated as U.S. property under section 956(c)(2)(A)(i), (J), (K), or (L) were
it an obligation of a United States per-

2005–36 I.R.B.

son (and not of the CFC). For purposes
of applying the exception under section
956(c)(2)(A)(i), a “bank” is a CFC that
meets the definition of a bank in section
585(a)(2)(B), without regard to the second sentence thereof, and without regard
to whether the CFC is engaged in a U.S.
trade or business, provided that the CFC
operates under the laws of the foreign jurisdiction where it is engaged in business
and is subject to supervision and examination by an authority having supervision
over banking institutions in that jurisdiction (in lieu of supervision by a Federal or
State supervisory authority).
.08 Intercompany Trade
Payables—Modification of Section
7.02 of Notice 2005–38
For purposes of section 965(b)(3), in
addition to the exceptions described in section 7.02 of Notice 2005–38 and section
10.07 of this notice, the term “indebtedness” does not include indebtedness of a
CFC arising in the ordinary course of a
business from licenses, provided that such
indebtedness is actually paid within 183
days.
.09 Distributions to Intermediary
Partnerships—Clarification of Section
3.02 of Notice 2005–10 and Section 9.06
of Notice 2005–38
Section 3.02 of Notice 2005–10 provides that for purposes of section 965(a),
a cash dividend paid by a CFC to a passthrough entity that is owned by a U.S.
shareholder is treated as received by such
U.S. shareholder only if and to the extent
that such shareholder receives a cash distribution in the amount of the CFC dividend during the election year. Section
9.06 of Notice 2005–38 provides a limited exception to the general cash distribution requirement with respect to cash dividends paid to a disregarded entity. This
limited exception does not apply to cash
dividends paid to a partnership. Therefore, a cash dividend paid by a CFC to a
partnership that is owned by a U.S. shareholder is treated as received by such U.S.
shareholder only if and to the extent the
partnership distributes cash to the shareholder-partner in the election year. For this
purpose, a distribution of cash does not include a guaranteed payment, as defined in
section 707(c), or a payment made to the

489

shareholder other than in its capacity as a
member of the partnership.
.10 Domestic Reinvestment
Plans—Clarification of Section 4.01
of Notice 2005–10
Section 965(b)(4)(B) provides that section 965(a) shall not apply to any dividend
received by a U.S. shareholder unless the
amount of the dividend is invested in the
United States pursuant to a domestic reinvestment plan which provides for the reinvestment of such dividend in the United
States. Section 4.01 of Notice 2005–10
provides that a taxpayer may adopt separate domestic reinvestment plans to apply
to different cash dividends made during the
election year. A taxpayer may, but is not
required to, adopt a domestic reinvestment
plan that provides for the reinvestment of
cash dividends only from specified CFCs,
to the extent of the dollar amounts of anticipated investments that are specified in
the plan in accordance with section 4.03
of Notice 2005–10. In this situation, cash
dividends from other CFCs in the election
year that are not covered by another domestic reinvestment plan will not be subject to the section 965(a) DRD or to the disallowance of deductions and credits under
section 965(d), even if the dollar amount
of cash dividends from the specified CFCs
is less than the total dollar amount of anticipated investments specified in the plan
and if the taxpayer in fact expends the total dollar amount specified in the plan on
permitted investments. On the other hand,
a taxpayer may not choose to claim the
section 965(a) DRD with respect to less
than all of the qualifying dividends that
are covered by a domestic reinvestment
plan, assuming that all such amounts are
properly reinvested in accordance with the
plan and that all the other requirements under section 965 are satisfied. For example, assume that USP wholly owns CFC1
and CFC2. USP properly adopts a domestic reinvestment plan that provides for the
reinvestment of up to $10 million of qualifying dividends in the United States. During the election year CFC1 pays qualifying
dividends of $8 million, CFC2 pays qualifying dividends of $2 million, USP invests
at least $10 million in permitted investments, and all the other requirements of
section 965 are met. Unless the plan provides only for the reinvestment of qualify-

September 6, 2005

ing dividends from either CFC1 or CFC2,
the entire $10 million of qualifying dividends is subject to section 965.
.11 Qualified Plan Funding—Clarification
of Section 5.05(b) of Notice 2005–10
Section 5.05(b) of Notice 2005–10 provides, in part, that the satisfaction of an
obligation to fund a qualified plan ordinarily will contribute to the financial stabilization of the taxpayer. For this purpose, contributions to a qualified pension
plan that do not give rise to excise tax
under section 4972 (which imposes a tax
on certain nondeductible pension contributions) will be considered to satisfy an obligation to fund a qualified plan even if those
contributions are not currently deductible.
Contributions to a qualified profit sharing
or stock bonus plan also qualify for this
purpose if those contributions to the plan
are required under a fixed contribution formula provided under the terms of the plan.
Contributions to a qualified profit sharing
or stock bonus plan do not qualify if contributions to the plan are made on a discretionary basis.
SECTION 11. TRANSITION RULES
.01 Domestic Reinvestment Plans
Approved Prior to August 19, 2005
If a domestic reinvestment plan is approved prior to August 19, 2005, the taxpayer may modify such plan to take into
account the guidance herein not later than
October 19, 2005, even if the dividend to
which the domestic reinvestment plan relates has already been paid. Any plan that
is so modified must be subsequently approved by the taxpayer’s president, chief
executive officer, or comparable official
and by the taxpayer’s board of directors,
management committee, executive committee, or similar body.
.02 Tax Returns Filed Prior to August 19,
2005
If, prior to August 19, 2005, a taxpayer
has filed its tax return for the taxable year
to which it elects section 965 to apply, such
taxpayer may revise its computations or
annual reporting to conform to the guidance in this notice on an amended tax return that is filed by December 31, 2005.

September 6, 2005

SECTION 12. EFFECT ON OTHER
DOCUMENTS
Sections 10.09, 10.10, and 10.11 of
this notice clarify sections 3.02, 4.01, and
5.05(b), respectively, of Notice 2005–10.
Section 10.03 of this notice modifies section 4.05, section 10.09 clarifies section
9.06, and section 10.07 makes an addition to and section 10.08 modifies section
7.02, of Notice 2005–38. See also section
11 of this notice, pursuant to which domestic reinvestment plans approved prior
to August 19, 2005 (including domestic
reinvestment plans adopted or modified
pursuant to the guidance included in Notice 2005–10 and Notice 2005–38), may
be modified to take into account the guidance in this notice.
SECTION 13. EFFECTIVE DATE
This notice is effective for taxable years
ending on or after October 22, 2004.
SECTION 14. PAPERWORK
REDUCTION ACT
The collections of information contained in this notice have been reviewed
and approved by the Office of Management and Budget in accordance with the
Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)) under control number
1545–1957.
An agency may not conduct or sponsor,
and a person is not required to respond
to, a collection of information unless the
collection of information displays a valid
control number.
The collections of information are in
sections 3 and 11 of this notice. This information is required to provide the IRS sufficient information to determine whether a
taxpayer has properly elected to apply section 965 to a taxable year and whether the
taxpayer has properly calculated its taxable income and allowable credits with respect to qualifying dividends, taking into
account the limitations imposed by sections 965(d) and (e). The collections of information are required to obtain the benefit of section 965 for a taxable year. The
likely respondents are business corporations.
Estimated total annual reporting and/or
recordkeeping burden: 250,000 hours.

490

Estimated average annual burden hours
per respondent: 10 hours.
Estimated number of respondents:
25,000.
Estimated annual frequency of responses: once.
The collections of information contained in this notice have been submitted
to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3507(d)). Comments on the collections of
information should be received by October 19, 2005. Comments are specifically
requested concerning:
Whether the proposed collections of information are necessary for the proper performance of the functions of the Internal
Revenue Service, including whether the
information will have practical utility;
The accuracy of the estimated burden
associated with the proposed collections of
information (see below);
How the quality, utility, and clarity of
the information to be collected may be enhanced;
How the burden of complying with the
proposed collections of information may
be minimized, including through the application of automated collection techniques
or other forms of information technology;
and
Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of services to provide information.
Comments concerning the accuracy of
the burden estimate and suggestions for reducing the burden of the final or temporary regulations should be sent to the Office of Management and Budget, Attn:
Desk Officer for the Department of the
Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503,
with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington
DC 20224.
Books or records relating to a collection
of information must be retained as long
as their contents may become material in
the administration of any internal revenue
law. Generally, tax returns and tax return
information are confidential, as required
by 26 U.S.C. 6103.

2005–36 I.R.B.

SECTION 15. DRAFTING
INFORMATION
The principal author of this notice is
Barbara Allen Felker of the Office of Associate Chief Counsel (International). However, other personnel from the IRS and
the Treasury Department participated in its
development. For further information regarding this notice, contact Ms. Felker or
Michael Gilman at (202) 622–3850 (not a
toll-free call).
26 CFR 601.204: Changes in accounting periods
and methods of accounting.
(Also Part I, Sections 77, 381, 446, 455, 456, 461;
1.77–1, 1.381(c)(4)–1, 1.381(c)(5)–1, 1.446–1,
1.455–6, 1.456–6, 1.461–1.)

Rev. Proc. 2005–63
SECTION 1. PURPOSE
This revenue procedure supersedes Rev.
Proc.
83–77, 1983–2
C.B. 594, and the 90-day extension
of time granted therein for submitting
applications or requests for consent
to change a method of accounting
under § 1.77–1, 1.381(c)(4)–1(d)(2),
1.381(c)(5)–1(d)(2),
1.455–6(b),
1.456–6(b), or 1.461–1(c)(3)(ii) of
the Income Tax Regulations.
An application or request submitted in
accordance with this revenue procedure
for consent to change a method of accounting under § 1.77–1, 1.455–6(b),
1.456–6(b), or 1.461–1(c)(3)(ii) may
be submitted during the taxable year in
which the taxpayer desires to make the
change in method of accounting. An
application or request submitted in accordance with this revenue procedure
for consent to change a method of accounting under § 1.381(c)(4)–1(d)(2) or
1.381(c)(5)–1(d)(2) may be submitted by
the later of 1) the last day of the taxable
year in which the distribution or transfer
occurred, or 2) the earlier of a) the day that
is 180 days after the date of distribution
or transfer, or b) the day on which the taxpayer files its federal income tax return for
the taxable year in which the distribution
or transfer occurred.

2005–36 I.R.B.

SECTION 2. BACKGROUND
.01 Section 1.446–1(e) provides the
general rules for filing an application
to obtain the Commissioner’s consent
to change a method of accounting for
federal income tax purposes.
Under
§ 1.446–1(e)(3)(i), as amended by T.D.
8719, 1997–1 C.B. 100, an application
must be filed during the taxable year in
which the taxpayer desires to make the
change in method of accounting. Prior to
the amendment, § 1.446–1(e)(3)(i) provided that an application must be filed
within 180 days after the beginning of the
tax year in which the proposed change is
requested to be made.
.02 Notwithstanding the provisions of
§ 1.446–1(e)(3)(i), § 1.446–1(e)(3)(ii) authorizes the Commissioner to prescribe
administrative procedures setting forth the
terms and conditions under which taxpayers will be permitted to change their
method of accounting.
.03 The following regulations concerning a change in method of accounting each
contain a requirement that an application
or request for consent must be filed within
a 90-day period:
(1) Section 1.77–1 provides that a taxpayer who previously elected to include
the amount of loans from the Commodity Credit Corporation in gross income for
the taxable year in which the loans are received must obtain permission to change
to a different method of accounting for the
loans. An application for permission to
change to a different method of accounting must be submitted within 90 days after
the beginning of the taxable year in which
the taxpayer proposes to make the change.
(2) Section 1.381(c)(4)–1(d)(2) provides that, under § 1.381(c)(4)–1(d)(1),
an acquiring corporation may submit an
application for permission to use a method
of accounting, or a request for a determination of the method of accounting to be
used, not later than 90 days after the date
of distribution or transfer.
(3) Section 1.381(c)(5)–1(d)(2) provides that, under § 1.381(c)(5)–1(d)(1),
an acquiring corporation may submit an
application for permission to use a method
of taking inventories, or a request for a
determination of the method of taking in-

491

ventories to be used, not later than 90 days
after the date of distribution or transfer.
(4) Section 1.455–6(b) provides that,
with the consent of the Commissioner, a
taxpayer may elect to apply the provisions
of § 455 to any trade or business in which
the taxpayer receives prepaid subscription
income. The taxpayer must submit a written request for consent to make the election
within 90 days after the beginning of the
taxable year in which the election is first
applicable.
(5) Section 1.456–6(b) provides that,
with the consent of the Commissioner, a
taxpayer may elect to apply the provisions
of § 456 to any trade or business in which
the taxpayer receives prepaid dues income.
The taxpayer must submit a written request
for consent to make the election within 90
days after the beginning of the taxable year
in which the election is first applicable.
(6) Section 1.461–1(c)(3)(ii) provides
that, with the consent of the Commissioner, a taxpayer may elect to accrue real
property taxes ratably in accordance with
§§ 461(c) and 1.461–1(c). The taxpayer
must submit a written request for consent
to make the election within 90 days after
the beginning of the taxable year in which
the election is first applicable.
.04. In Rev. Proc. 83–77, the
Commissioner exercised discretionary
authority under former § 1.9100–1(a) to
grant automatic extensions of 90 days
to the 90-day periods for submitting
applications or requests for consent
to change methods of accounting under §§ 1.77–1, 1.381(c)(4)–1(d)(2),
1.381(c)(5)–1(d)(2),
1.455–6(b),
1.456–6(b),
and
1.461–1(c)(3)(ii).
Taxpayers that complied with the provisions of Rev. Proc. 83–77 obtained
automatic extensions of 90 days and
therefore had 180 days in which to submit
their applications or requests for consent,
as did taxpayers filing applications or
requests for consent under the general
rule of § 1.446–1(e)(3)(i) prior to the
amendment described in section 2.01 of
this revenue procedure.
.05. The changes in method of accounting described in §§ 1.77–1 and 1.455–6(b)
are included in the changes to which the
automatic change in method procedures of
Rev. Proc. 2002–9, 2002–1 C.B. 327

September 6, 2005