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

2016

Department of the Treasury
Internal Revenue Service

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

Net Income (Loss) Reconciliation for Foreign Corporations with Reportable Assets
of $10 Million or More
Section references are to the Internal Revenue
Code unless otherwise noted.

Future Developments

For the latest information about
developments related to Schedule M-3
(Form 1120-F) and its instructions, such
as legislation enacted after they were
published, go to www.irs.gov/
form1120f.

General Instructions
Purpose of Schedule

Schedule M-3, Part I, determines the
adjusted financial net income (loss) of
the non-consolidated (see
Non-consolidated financial statement,
later, for the definition) foreign
corporation filing Form 1120-F, U.S.
Income Tax Return of a Foreign
Corporation. Schedule M-3, Parts II and
III, reconcile this financial result with the
corporation's taxable income before the
NOL deduction and special deductions
on Form 1120-F, Section II, line 29.
For purposes of this reconciliation,
Part I, line 1, provides rules for
determining the financial statement(s)
the taxpayer must use in reporting the
net income (loss) to be reported on Part
I, line 4. Part I, lines 5 through 10 then
provide adjustments to include or
exclude financial results to reconcile the
financial statement results reportable on
Part I, line 4, to the foreign corporation's
adjusted financial net income (loss)
reportable on Part I, line 11.
For foreign corporations other than
foreign banks (see definition in the
instructions for Part I, line 1, later), Part
I, line 11 includes the worldwide
financial net income (loss) of the
non-consolidated foreign corporation,
adjusted for the results of non-includible
entities and includible disregarded
entities (see definition later under Entity
Considerations for Schedule M-3). For
foreign banks, Part I, line 11, is
generally limited to the financial income
(loss) derived from the same set(s) of

Nov 09, 2016

books that are reported on Form
1120-F, Schedule L. Foreign banks are
foreign corporations described in
Regulations section 1.882-5(c)(4).

Who Must File

Any foreign corporation required to file
Form 1120-F, that reports on
Schedule L, line 17, column (d), of Form
1120-F, total assets at the end of the
corporation's tax year that equal or
exceed $10 million, must complete and
file Schedule M-3 in lieu of
Schedule M-1, Reconciliation of Income
(Loss) per Books With Income per
Return.
A foreign corporation filing Form
1120-F that is not required to file
Schedule M-3 may voluntarily file
Schedule M-3.
Note. A foreign corporation that is
required to complete (or voluntarily
completes) Schedule M-3 is still
required to complete Schedule M-2,
Analysis of Unappropriated Retained
Earnings per Books.

When and Where To File

Attach Schedule M-3 (Form 1120-F) to
the foreign corporation's Form 1120-F
income tax return. Be sure to check the
box at the top of Form 1120-F, page 1,
indicating that Schedule M-3 is
attached.

Completion of
Schedule M-3

Form 1120-F filers that are required to
file Schedule M-3 (Form 1120-F) and
have at least $50 million total assets at
the end of the tax year must complete
Schedule M-3 (Form 1120-F) in its
entirety.
Form 1120-F filers that (a) are
required to file Schedule M-3 (Form
1120-F) and have less than $50 million
total assets at the end of the tax year or
(b) are not required to file Schedule M-3
(Form 1120-F) and voluntarily file
Schedule M-3 (Form 1120-F) must
Cat. No. 50152J

either (i) complete Schedule M-3 (Form
1120-F) in its entirety or (ii) complete
Schedule M-3 (Form 1120-F) through
Part I and complete Schedule M-1
instead of completing Parts II and III of
Schedule M-3 (Form 1120-F). If the filer
chooses to complete Schedule M-1
instead of completing Parts II and III of
Schedule M-3 (Form 1120-F), line 1 of
Schedule M-1 must equal line 11 of Part
I of Schedule M-3 (Form 1120-F).
Filers must answer all questions on
page 1 of the form. Furthermore, for any
part of Schedule M-3 (Form 1120-F)
that is completed, all columns must be
completed, all numerical data requested
must be provided, and any statement
required to support a line item must be
attached. All additional statements
specifically referenced in these
instructions must be completed and
attached to the Schedule M-3 when
filed. If Part III is completed, please note
that Part III requires that results from
Schedule I (Form 1120-F), Interest
Expense Allocation Under Regulations
Section 1.882-5, and Schedule H (Form
1120-F), Deductions Allocated To
Effectively Connected Income Under
Regulations Section 1.861-8, also be
included. See instructions for Part III,
lines 26b, 26c, and 31, later.

Other Form 1120-F
Schedules Affected by
Schedule M-3
Requirements
Schedule L

Generally, the assets and liabilities
required to be reported on Schedule L
are the total assets and liabilities
reflected on the set(s) of books of the
foreign corporation that include assets
that give rise to U.S. effectively
connected income and U.S. booked
liabilities (as defined in Regulations
section 1.882-5(d)(2)). The total assets
and liabilities include the interbranch
assets and liabilities and the
noneffectively connected assets

reflected on such books. Such books
will reflect the assets of the foreign
corporation located in the United States
and all other of its assets used in its
trade or business within the United
States (other than its assets giving rise
to effectively connected income under
sections 864(c)(6) or (7)). A foreign
corporation may instead elect to report
its worldwide assets and liabilities on
Schedule L under Regulations section
1.6012-2(g)(1)(iii). If a foreign
corporation (including a foreign bank)
elects worldwide reporting on
Schedule L, the same set(s) of books
must be used to report the adjusted
worldwide net income (loss) results in
Part I, line 11.
If the foreign corporation has more
than one set of books and records
relating to assets located in the United
States or used in a trade or business
conducted in the United States, it must
report the combined amounts shown on
all such books and records on
Schedule L, as adjusted to eliminate
transactions recorded between the
reportable books. However, amounts
recorded for transactions between the
set(s) of books and other divisions of
the foreign corporation or includible
disregarded entities (see definition later
under Entity Considerations for
Schedule M-3) reportable on
Schedule M-3, Part I, line 5, are not
eliminated for Schedule L purposes
(except for certain transactions with
disregarded entities that are also
reportable on Schedule L), unless the
taxpayer elects worldwide reporting
under Regulations section 1.6012-2(g)
(1)(iii).
Adaptation of Form 1120-F,
Schedule L for treaty-based
reporting. The set(s) of books that
must be reported on Form 1120-F,
Schedule L are those of the U.S.
permanent establishment. These books
will generally be the same set(s) of
books reported on Schedule L as
described above. However, certain
books that give rise to effectively
connected income might not necessarily
give rise to treaty-based reporting. For
example, the assets on a set of books
could still be attributed to a U.S. office
for effectively connected income
reporting purposes even when
considered transferred from the U.S.
permanent establishment for treaty
reporting purposes (see, for example,
Regulations section 1.864-4(c)(5)(iii)) if
under the facts and circumstances,
such assets also constitute a set of
books that give rise to U.S. booked

liabilities under Regulations section
1.882-5(d)(2). Under such
circumstances, the set of books would
remain reportable on Schedule L for
Code-based reporting purposes, but for
treaty-based reporting purposes, such
transfer may effect attribution to another
part of the corporate enterprise under a
functional and factual analysis and no
longer be reportable on Schedule L as
part of the U.S. permanent
establishment after the transfer.
Additionally, a set of books having no
effectively connected income or U.S.
booked liabilities under Regulations
section 1.882-5(d)(2) might still
constitute a set of books of the U.S.
permanent establishment because the
items recorded thereon are primarily
attributable to the U.S. permanent
establishment under the application by
analogy of the OECD Transfer Pricing
Guidelines as expressly authorized by
or pursuant to a U.S. income tax treaty
and accompanying documents.

Schedule M-2

If the foreign corporation is a bank (and
checked the “Yes” box on Part I, line 1
of Schedule M-3), the amount shown on
Schedule M-2, line 2 (Net income (loss)
per books) must equal the amount
shown on Schedule M-3, Part I, line 11.
Both the foreign bank's Form 1120-F,
Schedule L reporting and Schedule M-3
(Form 1120-F) reporting are based on
the same set(s) of Schedule L books
which are generally determined on the
basis of Regulations section 1.882-5(d)
(2)(iii). If, however, the foreign bank
elects to complete its Form 1120-F,
Schedule L on the basis of its worldwide
books, then the bank will be required to
report its net income (loss) on
Schedule M-2 and Schedule M-3 from
the same worldwide set(s) of books
used for Form 1120-F, Schedule L
purposes.
If the foreign corporation is not a
bank (and therefore checked the “No”
box on Part I, line 1), the amount shown
on Schedule M-2, line 2 (Net income
(loss) per books) should reflect the net
income (loss) associated with the
Schedule L books. This amount will
equal the amount shown on
Schedule M-3, Part I, line 11 only if the
corporation voluntarily chooses to
complete Form 1120-F, Schedule L on
the basis of the corporation's worldwide
set(s) of books under Regulations
section 1.6012-2(g)(1)(iii), or, if the
Schedule L books determined under the
facts and circumstances constitute the
same results as worldwide income
reporting under Regulations section
-2-

1.882-5(d)(2)(ii). However, the
Schedule M-3 reporting on Part I, line 11
must always reflect the worldwide
profits and losses of the foreign
corporation filing the Form 1120-F even
if the Schedule L books determined
under Regulations section 1.882-5(d)(2)
(ii) gives rise to less than worldwide
reporting under the facts and
circumstances.

Entity Considerations for
Schedule M-3

For purposes of Schedule M-3,
references to the classification of an
entity (for example, as a corporation, a
partnership, or a trust) are to the
classification of the entity for U.S.
federal income tax purposes.
For a foreign corporation other than a
bank, the financial results of an entity
that is disregarded as separate from the
foreign corporation filing Form 1120-F
for federal income tax purposes
(“disregarded entity”) are reported on
Schedule M-3, Part I, line 4, if the
foreign corporation's applicable income
statement includes the net income of
such disregarded entity. Otherwise, the
results of the disregarded entity are
separately reported on Part I, line 5. On
Parts II and III, any item of income, gain,
loss or deduction of a disregarded entity
must be reported as an item of the
foreign corporation, and is not reported
on Part II, line 9, 10, or 11, as from a
partnership or pass-through entity. The
applicable financial statement may
include a disregarded entity only if it is
owned directly or indirectly by the
foreign corporation. An applicable
financial statement may not include a
disregarded entity that is the direct or
indirect owner of the foreign corporation
filing Form 1120-F.
Foreign bank disregarded entity
books – reporting for lines 4 and 5.
For foreign banks, the net income (loss)
of certain disregarded entities are not
combined with other U.S.-based sets of
books reported on line 4. The set(s) of
books with respect to disregarded
entities are included on Part I, line 5, if
the set(s) of books of such disregarded
entities give rise to U.S. booked
liabilities under Regulations section
1.882-5(d)(2)(iii). Transactions between
the set(s) of books reported on line 4
and line 5 are eliminated on line 8.
However, a U.S. LLC that is a
disregarded entity whose set(s) of
books do not give rise to U.S. booked
liabilities of the foreign bank under
Regulations section 1.882-5(d)(2)(iii),
are not included in line 4 or line 5.

Transactions between such disregarded
entities and set(s) of books reported on
line 4 are not eliminated.

Related Filing Requirements –
Reportable Entity Partner
Reporting Responsibilities
Reportable entity partner. For
purposes of these instructions, a
reportable entity partner with respect to
a partnership filing Form 1065, U.S.
Return of Partnership Income, is an
entity that (1) owns or is deemed to
own, directly or indirectly, under these
instructions a 50% or greater interest in
the income, loss, or capital of the
partnership on any day of the tax year
and (2) was required to file
Schedule M-3 on its most recently filed
U.S. federal income tax return or return
of income filed prior to that day.
For purposes of these instructions, (1)
the owner of a disregarded entity is
deemed to own all corporate and
partnership interests owned or deemed
to be owned under these instructions by
the disregarded entity; (2) the owner of
50% or more of a corporation by vote on
any day of the corporation's tax year is
deemed to own all corporate and
partnership interests owned or deemed
to be owned under these instructions by
the corporation during the corporation's
tax year; (3) the owner of 50% or more
of partnership income, loss, or capital
on any day of the partnership tax year is
deemed to own all corporate and
partnership interests owned or deemed
to be owned under these instructions by
the partnership during the partnership
tax year; and (4) the beneficial owner of
50% or more of the beneficial interest of
a trust or nominee arrangement on any
day of the trust or nominee arrangement
tax year is deemed to own all corporate
and partnership interests owned or
deemed to be owned under these
instructions by the trust or nominee
arrangement.
Reporting requirements of
reportable entity partner. A
reportable entity partner with respect to
a partnership (as defined above) must
report the following to the partnership
within 30 days of first becoming a
reportable entity partner and, after first
reporting to the partnership under these
instructions, thereafter within 30 days of
the date of any change in the interest it
owns or is deemed to own, directly or
indirectly, under these instructions, in
the partnership: (1) its name, (2) its
mailing address, (3) its taxpayer
identification number (TIN or EIN), if
applicable, (4) its entity or organization

type, (5) the state or country in which it
is organized, (6) the date on which it first
became a reportable entity partner, (7)
the date with respect to which it is
reporting a change in its ownership
interest in the partnership, if applicable,
(8) the interest in the partnership it owns
or is deemed to own in the partnership,
directly or indirectly (as defined under
these instructions), as of the date with
respect to which it is reporting, and (9)
any change in that interest as of the
date with respect to which it is reporting.
The reportable entity partner must
retain a copy of each required report it
makes to each partnership under these
instructions. Each partnership must
retain copies of the required reports it
receives under these instructions from
reportable entity partners.
Example 1. A, an LLC filing a Form
1065 for 2016 is owned 50% by Z, a
foreign corporation engaged in a trade
or business within the United States. A
owns 50% of each of B, C, D, and E,
each of which is also an LLC filing a
Form 1065 for calendar year 2016. Z
was first required to file Schedule M-3
(Form 1120-F) for its corporate tax year
ended December 31, 2015, and filed its
Form 1120-F with Schedule M-3 for
2015 on September 15, 2016. As of
September 16, 2016, Z was a reportable
entity partner with respect to A and,
through A, with respect to B, C, D, and
E. On October 5, 2016, Z reports to A,
B, C, D, and E, as it is required to do
within 30 days of September 16, that Z
is a reportable entity partner directly
owning (with respect to A) or deemed to
own indirectly (with respect to B, C, D,
and E) a 50% interest. Therefore,
because Z was a reportable entity
partner for 2016, each of A, B, C, D, and
E is required to file Schedule M-3 (Form
1065) for 2016, regardless of whether
they would otherwise be required to file
Schedule M-3 for that year. Z must
retain a copy of each of the required
reports it makes to A, B, C, D, and E
under these instructions, including the
reports it makes on October 5, 2016.

Part I – Financial
Information and Net
Income (Loss)
Reconciliation
When To Complete Part I

Part I must be completed for any tax
year for which the foreign corporation
files Schedule M-3.

Question A. Treaty position taken on
Form 1120-F, Section II, for taxable
-3-

income. If a foreign corporation is a
resident in a country having an income
tax treaty with the United States, answer
“Yes” if the corporation reports income
under the treaty method in lieu of the
effectively connected income rules
under sections 864(c) and 882. For
reporting under this method in Parts II
and III, see Treatment of Items Under an
Eligible Treaty-Based Return Position to
Attribute Business Profits to a U.S.
Permanent Establishment, later.
Questions B through D. For
Schedule M-3, Part I, questions B
through D, use only the financial
statements of the foreign corporation
filing Form 1120-F. If the foreign
corporation prepares its own financial
statements but is controlled by another
corporation (U.S. or foreign) that
prepares financial statements that
include the foreign corporation, the
foreign corporation must use for its
Schedule M-3, Part I, its own financial
statements rather than the financial
statements of the controlling
corporation. These financial statements
are used for completing line 4.
Non-consolidated financial
statement. A foreign corporation's
“non-consolidated” financial statement
may include a financial statement which
reports a consolidation of entities or
subsidiaries that the foreign corporation
owns. In such a case, the net income or
(loss) of such entities or subsidiaries
would be included in the amount
reported on line 4 and, except for
disregarded entities, would be
eliminated by reporting these amounts
on line 7 (see line 7, later). Any
adjustments associated with removing
such amounts would be reported on
line 8.
Example 2. FC1 is a foreign
corporation other than a bank, resident
in Country X, and engaged in a trade or
business in the United States. FC1 is
required to file Form 1120-F. FC1
reports on Schedule L more than $10
million in assets and therefore, is
required to file Schedule M-3. FC1 is
owned 100% by FC, its non-banking
parent corporation also resident in
Country X. FC1's net income (loss)
results are included in a certified
audited consolidated financial
statement of FC. FC1 also has an
unconsolidated financial statement that
is not certified. In answering questions B
through D, FC1 may not use FC's
consolidated financial statement. FC1's
“non-consolidated financial statement”
is its own unconsolidated, worldwide
financial statement which is a statement

described in question C. If FC was also
engaged in a trade or business within
the United States with reportable assets
over $10 million, then FC would be
required to file its own Schedule M-3
and would be required to use its
certified audited financial statement
described in question B. In such
circumstances, FC1 would continue to
use its own non-consolidated statement
described in question C.
Example 3. Same facts as
Example 2, except FC1 is a disregarded
entity. Under U.S. tax principles, FC is
the taxpayer treated as directly engaged
in trade or business within the United
States and is required to file Form
1120-F and Schedule M-3. FC's
“non-consolidated” financial statement
is its consolidated certified audited
financial statement, described in
question B, because it is the financial
statement of the company engaged in a
trade or business within the United
States that is required to file Form
1120-F and Schedule M-3. FC's
consolidated entities (other than any
disregarded entities) are eliminated as
“non-includible” entities on Part I, line 7.

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

Line 2. Questions Regarding
Income Statement Period and
Restatements
Enter the beginning and ending dates
on line 2a for the corporation's annual
income statement period ending with or
within the current tax year.
Part I, lines 2b and 2c, regarding
restatements of income statements,

refer to the income statement issued by
the corporation filing the U.S. income
tax return. Answer “Yes” on lines 2b
and/or 2c if the corporation's annual
income statement has been restated for
any reason. Attach a statement
providing a short explanation of the
reason for the restatement for each
applicable period, including the original
amount and restated amount of each
annual statement period's net income.

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

Line 4. Net Income (Loss) from the
Income Statement Identified in
Part I, Line 1
Part I, line 4, reports the net income
(loss) from the applicable income
statement identified in Part I, line 1.
Foreign banks. If the foreign bank
has the type of non-consolidated,
worldwide financial statement described
in question B or C, the foreign bank
should check the “Yes” box for the
applicable question B or C. However, do
not report these results on Part I, line 4
unless the foreign bank also chooses
worldwide reporting of the set(s) of
books on Form 1120-F, Schedule L
under Regulations section 1.6012-2(g)
(1)(iii). If the foreign bank has certified
audited financial statements from which
the balance sheet reported on Form
1120-F, Schedule L is derived (as
described in question D), the net
income (loss) from such statements is
used to complete line 4, except that any
disregarded entities whose results are
reportable on Schedule L are excluded
from line 4 unless they are included in
the corporation's financial consolidation
-4-

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

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

Line 5. Net Income (Loss) from
Includible Disregarded Entities
(“Includible Entities”)
Include the net income (loss) of any
disregarded entity that is not included in
the income reported on Part I, line 4, but
should be included in Part I, line 11. The
financial results of disregarded foreign
entities are reported on lines 5a
(income) and 5b (loss), and the financial
results of disregarded U.S. entities are
reported on lines 5c (income) and 5d
(loss). The applicable financial
statement of the disregarded entity to be
used is determined first under question
B if available, then under question C.
However, a foreign bank should only
use the set(s) of books from the
disregarded entity that are reportable on
Schedule L.
Foreign banks. A foreign bank
should include on line 5 each
disregarded entity that meets the
following two conditions.
1. The disregarded entity is either
itself engaged in a trade or business
within the United States and has
generated income effectively connected
with it or, it is not engaged itself in a
trade or business within the United
States but has income effectively
connected with a trade or business
within the United States of the foreign
bank; and
2. The net income (loss) of the entity
would be includible on Part I, line 4, if
the assets and liabilities of such entity
were held directly by the foreign bank
rather than by the disregarded entity.
If the income of the includible
disregarded entity is effectively
connected with a trade or business
within the United States but would not
have been includible on Part I, line 4, if
the assets giving rise to such income
were held directly by the foreign
corporation rather than by the includible
entity, then any effectively connected
income of the includible entity is
reported on Part II, line 23, columns (b)
through (e), instead of Part I, line 5.
Foreign corporations other than a
bank. If the foreign corporation is not a
bank, include on line 5, all disregarded
entities not included on Part I, line 4.
When a foreign corporation reports
income (loss) from a financial statement
identified in question B or C, net income
(loss) of a disregarded entity may or
may not be included on line 4,
depending on the foreign corporation's
accounting principles. However,
inclusion of disregarded entities will be
-5-

necessary on line 5 when a taxpayer
has reported on Part I, line 4, amounts
from financial statements described in
question D or similar unaudited
statements.
Adjustments for intercompany
transactions between the foreign
corporation and includible disregarded
entities may be required. See the
instructions for Part I, line 8, later.
All foreign corporations. Attach a
supporting statement that lists for each
includible disregarded entity reported on
lines 5a through 5d the name, EIN (if
applicable), and net income (loss) per
the financial statement of that includible
disregarded entity.

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

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

Line 8. Adjustments to
Intercompany Transactions
Include on Part I, line 8: (i) adjustments
to consolidation entries and elimination
entries that are contained in the amount
reported on Part I, line 4 (see line 4
instructions) required as a result of
adding amounts on Part I, lines 5 and 6;
and (ii) amounts of any additional
consolidation entries and elimination
entries that are required as a result of
removing amounts on Part I, line 7.
Foreign banks. For foreign banks,
adjustments are necessary to account
for the elimination of certain
transactions between the Schedule L
books reported on line 4 and for
transactions between the foreign bank
and each disregarded entity reported on
Part I, line 5. For example, adjustments
must be reported on line 8 to eliminate

any intercompany dividends received by
the foreign corporation from any
disregarded entity whose results are
included on Part I, line 5. However, if a
disregarded entity is not reportable in
Part I (e.g., because it does not give rise
to U.S. booked liabilities under
Regulations section 1.882-5(d)(2)(iii)),
the dividend received by the foreign
bank is not eliminated on Part I, line 8.
Instead, the dividend is eliminated as an
interbranch transaction on Part II, line 3,
column (c).
Foreign corporations other than
banks. For foreign corporations other
than a bank, adjustments are necessary
in order to ensure that the consolidation
entries and intercompany elimination
entries included in the amount reported
on Part I, line 11, are only those
applicable to worldwide income of the
non-consolidated foreign corporation.
Adjustments on line 8 may be with
respect to transactions between the
foreign corporation and either a
disregarded entity reported on Part I,
line 5, or a nonincludible entity reported
on Part I, line 7. Adjustments for
transactions with nonincludible entities
are required only when the foreign
corporation reports worldwide income
on Part I, line 4, from a financial
statement described in Part I, questions
B or C. For example, adjustments must
be reported on line 8 to remove minority
interests and to reverse the elimination
of intercompany dividends included on
Part I, line 4, that relate to the net
income of entities removed on Part I,
line 7, because the income to which the
consolidation or elimination entries
relate has been removed. In addition,
consolidation or elimination entries must
be reported on line 8 to eliminate any
intercompany dividends received by the
foreign corporation from any
disregarded entity whose results are
included on Part I, line 5.
Special treatment of equity
method inclusions for a foreign
corporation other than a bank. If a
foreign corporation other than a bank
reports worldwide income on Part I,
line 4, and is an owner of an interest in
another entity that (1) is accounted for in
the foreign corporation's separate
general ledger on the equity method,
and (2) is fully consolidated in the
foreign corporation's worldwide financial
statements (thus eliminating the equity
inclusion) and, if that entity is also
reported on Part I, line 7, as a
nonincludible entity, then an adjustment
on Part I, line 8, must be made. The
foreign corporation must restore on
-6-

Schedule M-3, Part I, line 8, the equity
income inclusion from that entity. If the
foreign corporation does not account for
the entity on the equity method on its
own general ledger, it will not have
eliminated the equity income for
non-consolidated, worldwide financial
statement purposes, and therefore will
have no elimination of equity income to
reverse.
The attached supporting statement
for Part I, line 8, must identify the type
(e.g., minority interest, intercompany
dividends, etc.) and amount of
consolidation or elimination entries
reported, as well as the names of the
entities to which they pertain. It is not
necessary to report intercompany
eliminations that net to zero on Part I,
line 8, such as intercompany interest
income and expense. For instance, if
the foreign corporation reports interest
income on Part I, line 4, from
transactions with a disregarded entity
included on Part I, line 5, it is not
necessary to report the offsetting gross
interest income and gross interest
expense on Part I, line 8.
Example 4. F is a foreign
corporation other than a bank and has a
fiscal financial and tax year end. F files
Form 1120-F because it engaged in a
trade or business within the United
States and is required to file
Schedule M-3. F owns two U.S.
subsidiaries, S1 and S2, and has made
a check the box election for S1 to be
treated as a disregarded entity. Both S1
and S2 have the same fiscal year end
as F. In addition, F's home country
accounting rules require the inclusion of
S2's income and expenses in F's
non-consolidated, worldwide, certified
audited financial statements. However,
S1's income and expenses are not
included in F's non-consolidated,
worldwide, certified audited financial
statements.
On Schedule M-3, F must check
“Yes” to question B. F must report its net
income (loss) from its non-consolidated,
worldwide, certified audited financial
statements on Part I, line 4. On Part I,
line 5, F must include the net income
(line 5c) or loss (line 5d) generated by
S1, the disregarded U.S. entity.
Because S2 is included in the
non-consolidated, worldwide, certified
audited financial statements, it is not
reported on Part I, line 5, since it is
already included on Part I, line 4.
Any adjustments necessary to
remove intercompany transactions
between F and S1 must be reported on
Part I, line 8.

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

Line 10. Other Adjustments to
Reconcile to Amount on Line 11
Include on line 10 any other
adjustments, not reportable on lines 5
through 9, to reconcile net income (loss)
on Part I, line 4, with net income (loss)
on Part I, line 11.
For any adjustments reported on Part
I, line 10, attach a supporting statement
that provides, for each entity to which an
adjustment relates: the name and EIN (if
applicable) of the entity, the nature of
the adjustment, the amount of net
income (loss) included in Part I before
any adjustments on line 10, and the
amount of net income (loss) included on
Part I, line 11.

Line 11. Adjusted Financial Net
Income (Loss) of the
Non-Consolidated Foreign
Corporation
The sum of lines 4 through 10
constitutes the adjusted financial net
income (loss) of the non-consolidated
foreign corporation that is to be
reconciled in Parts II and III with the
foreign corporation's taxable income
reported on Form 1120-F, Section II,
line 29.
Example 5. Foreign corporations
other than a bank. FC is a non-bank
foreign corporation engaged in trade or
business within the United States and
required to file Form 1120-F and
Schedule M-3. FC does not have
income statements that report its
non-consolidated, worldwide income,
but FC does have unaudited income
statements for the set(s) of books it
reports on Schedule L with respect to its
trade or business within the United
States. Included in these results are
foreign disregarded entity FDE1 with net
income of $20,000 and foreign
disregarded entity FDE2 with net loss of
($5,000). FDE1 and FDE2 do not have
any effectively connected income and
do not have books that give rise to U.S.
booked liabilities under Regulations

section 1.882-5(d)(2)(ii). FC reports net
income on these financial statements of
$50,000. In addition, FC has foreign
locations that are not included in such
income statements. These locations do
not have effectively connected income
on set(s) of books that give rise to U.S.
booked liabilities. The financial net
income of such foreign locations is
$25,000.
FC must answer “No” to questions B
through D in Part I. FC must report on
Part I, line 4, $35,000 (total income
reported of $50,000, excluding the
results of FDE1 and FDE2). On Part I,
line 5a, FC will include the $20,000 of
net income of FDE1 and will include on
Part I, line 5b, the ($5,000) net loss of
FDE2. The net income of $25,000 from
foreign locations must be included on
Part I, line 6, such that $75,000 is the
net income reportable on line 11.
Example 6. Foreign corporations
other than a bank. FC is a non-bank
foreign corporation engaged in trade or
business within the United States and is
required to file Form 1120-F and
Schedule M-3. FC owns NI, a C
corporation for federal income tax
purposes. FC has certified audited
income statements that report its
worldwide income and that of NI. FC
reports net income on these statements
of $120,000. Included in these results
are foreign disregarded entity FDE1 with
net income of $30,000, foreign
disregarded entity FDE2 with net loss of
($5,000), and NI's net income of
$40,000. FDE1 and FDE2 both have
effectively connected income that give
rise to U.S. booked liabilities. Interest
income of $5,000 received by FC from
NI is eliminated in the preparation of
these statements.
FC must answer “Yes” to question B.
FC must report on Part I, line 4,
$120,000. The results of FDE1 and
FDE2 are not reported on Part I, line 5,
since their results are already included
on Part I, line 4. NI's income of $40,000
is reported on Part I, line 7, because NI
is a nonincludible entity. The $5,000 of
interest income is reported on Part I,
line 8. Assuming no other adjustments
are required on Part I, lines 9 and 10,
the total income reported on Part I,
line 11 is $85,000 ($120,000 – $40,000
+ $5,000).
Example 7. Foreign bank. FC is a
foreign corporation that is a bank
engaged in trade or business within the
United States and required to file Form
1120-F and Schedule M-3. FC has
certified audited income statements that
report its non-consolidated, worldwide
-7-

net income and unaudited income
statements for the set(s) of books it
reports on Schedule L for its trade or
business within the United States. FC
reports net income on the set(s) of
books of its trade or business within the
United States of $50,000, which
includes the results of U.S. disregarded
entity USDE1 with net income of
$15,000 and U.S. disregarded entity
USDE2 with a net loss of ($5,000).
Although FC must answer “Yes” to
question B, FC must not report on Part I,
line 4, the results of these
non-consolidated, worldwide, certified
audited income statements. FC must
also answer “No” to question D. FC
must report on Part I, line 4, the amount
from the unaudited income statements
for the set(s) of books it reports on
Schedule L of $40,000 (total income
reported of $50,000, excluding the
results of USDE1 and USDE2 which
also give rise to effectively connected
income and are set(s) of books included
in Form 1120-F, Schedule L). On Part I,
line 5c, FC will include the $15,000 of
net income of USDE1 and will include
on Part I, line 5d, the ($5,000) net loss
of USDE2. Assuming no other
adjustments are required on Part I, lines
8 through 10, the net income reported
on Part I, line 4, is $40,000, and the net
income reported on line 11 is $50,000.

Parts II and III
General Reporting Information
A statement may be attached to any line
even if none is required. For each line
item in Parts II and III, report in column
(a) the amount of the item included in
the net income (loss) reported on Part I,
line 11. For each line item, report in
column (e) the amount included in
determining taxable income (loss) on
Form 1120-F, Section II, line 29.

Columns (b), (c), and (d)
The temporary and permanent
differences reportable in columns (b)
and (c) are those book-to-tax
differences determined through a
comparison of the financial statement
and tax amounts, under the Code or an
applicable income tax treaty, for each of
the line items included in Part I, line 11
and shown on Parts II and III.
Column (b). Temporary
book-to-tax differences. In column
(b), report the book-to-tax difference for
each item expected to reverse in a
future year or which reverses a prior
year difference (whether or not so
reported on a prior year's

Schedule M-3). Temporary differences
that increase the amount shown in
column (a) are reported as a positive
number.
Column (c). Permanent
book-to-tax differences. In column
(c) report any book-to-tax difference not
expected to reverse in a future year, and
that also does not constitute a reversal
of a prior year difference. The
determination as to whether a difference
is temporary or permanent should be
based on the facts available at the time
the foreign corporation files its U.S. tax
return. If the foreign corporation is
unable to determine whether a
difference between column (a) and
column (e) for an item will reverse in a
future tax year or reverses a prior year
book-to-tax difference, report the
difference for that item in column (c).
Amounts that are permanent
differences that reduce the income or
expense amount shown in column (a)
are recorded as negative numbers. For
example, interbranch income and
expense amounts recorded on a foreign
bank's books reportable on Schedule L
(and therefore included in column (a))
that are disregarded under U.S. tax
principles are permanent differences
reportable as negative amounts in
column (c).
If interbranch amounts recorded on
Schedule L books are treated as
third-party amounts under Proposed
Regulations sections 1.863-3(h) and
1.475(g)-2 of the global dealing rules, or
recognition treatment is otherwise
provided under an Advance Pricing
Agreement or Mutual Agreement
Procedure, then such interbranch
amounts are treated as amounts subject
to apportionment between non-ECI and
ECI in columns (d) and (e) and not as
permanent differences in column (c).
Amounts that are apportionable to
non-ECI are generally reportable only in
column (d). However, some amounts
may be both permanent differences
under U.S. tax principles and also be
apportioned to non-ECI under section
864(c). In such cases, a permanent
difference may not be double-counted
by including it a second time in column
(d). In such circumstances, where an
amount includible in column (a) is both a
permanent difference and apportionable
to non-ECI, the amount is reported in
column (c) and not in column (d).
Accordingly, non-ECI tax-exempt
interest is reported in column (c) as a
permanent difference under U.S. tax
principles. No additional apportionment

is necessary in column (d) for such
amounts.
Special treatment may apply for
column (c) reporting on Part III, lines
26d (substitute interest payments), 26e
(interest equivalents), and 27 (substitute
dividend payments). See instructions for
those lines below.
Apportionments between
effectively and non-effectively
connected income (ECI and
non-ECI). The combination of columns
(a), (b), and (c) results in the gross
taxable income or deduction amount
under U.S. tax principles for each line
item in Parts II and III that is eligible for
allocation and apportionment between
ECI and non-ECI.
Column (d). Foreign bank.
Column (d) is used to report the portion
of the combined amount of columns (a),
(b), and (c) that is allocated and
apportioned to non-ECI. If an amount
apportioned to non-ECI is included in
column (a), then report such amount as
a negative number in column (d). If the
apportioned amount included in column
(a) is a loss, then include the
apportioned loss as a positive number in
column (d). Certain income may be
apportioned to ECI that is not reported
on the Schedule L books and is not
reportable in column (a). These
amounts include allocable global
dealing income in Part II, line 16 and
other income from non-Schedule L
books reportable in Part II, line 23. Such
income is apportioned to ECI and
reported in column (d) as a positive
number. For amounts reportable in Part
II, if the apportioned amount is a loss,
report such loss as a negative number
in column (d). In column (e), combine
the amounts in columns (a), (b), (c), and
(d), to determine the amount of each
line item apportioned to ECI. See
special reporting instructions for
reporting amounts in column (d) for
substitute dividends and substitute
interest income in Part II, lines 3c and
4b and for the allocation and
apportionment of interest expense in
Part III, line 26. Expenses allocable from
Schedule H, line 20, are reportable in
Part III, line 31 in columns (d) and (e) as
a positive number.
Column (d). Foreign corporations
other than banks. Foreign
corporations other than banks use
column (d) to report apportionments
only to non-ECI. In Part II, column (d)
report apportionments of income as a
negative amount and report losses as a
positive number. Combine columns (a),
-8-

(b), (c), and (d) to reconcile the amount
apportioned to ECI in column (e). For
Part III, except for lines 26 and 31,
report expenses that are apportioned to
non-ECI as a negative number in
column (d). See special instructions for
the reporting of interest expense on
line 26. Corporations other than banks
do not report the allocation of expenses
under Regulations section 1.861-8 from
Schedule H (Form 1120-F), line 20, on
Schedule M-3, Part III, line 31.
Part III, lines 26d, 26e, and 27. In
Part III, line 26d (substitute interest
payments), line 26e (interest
equivalents), and line 27 (substitute
dividend payments), amounts in these
categories paid by the foreign
corporation that are not included in
column (a) are reported in column (c) as
a positive number. Amounts described
in lines 26d, 26e, and 27 are reported in
column (c) whether or not any of the
amount is apportionable in whole or in
part to ECI in column (e). Column (d) is
used for these line items only to
apportion amounts to non-ECI.
Example 9. FC is a foreign bank
that is required to file Form 1120-F and
Schedule M-3. FC included on Part I,
line 11, $100 of interest income, of
which $60 is effectively connected
tax-exempt interest income and $40 is
noneffectively connected tax-exempt
interest income. In addition, FC included
on Part I, line 11, $300 of fee and
commission income that was
recognized for U.S. tax purposes in a
prior year. FC also included $400 of
meals and entertainment expenses of
which $200 is deductible under section
274. FC determines that 60% of its
deductions under U.S. tax principles are
allocable to noneffectively connected
income.
FC reports on Part II, line 4a, column
(a), the $100 of tax-exempt interest
income. FC reports ($100) of permanent
book-to-tax difference on line 4a,
column (c) to eliminate the tax-exempt
interest income. No amount is
reportable on line 4a, column (d) since
all of the income is a permanent
difference under U.S. tax principles
without regard to its allocation between
effectively and noneffectively connected
income. FC also includes on Part II,
line 7, column (a), the $300 of fee and
commission income. Since this amount
was already recognized in a prior year
for U.S. tax purposes, FC reports on
line 7, column (b), a temporary
difference of ($300). On Part III, line 10,
column (a), FC includes the $400 of
meals and entertainment expenses. FC

first computes its limitation under
section 274 before determining the
amount allocable to noneffectively
connected income for purposes of
column (d). Therefore, FC reports on
Part III, line 10, column (c), a permanent
difference of ($200). FC then
determines the 60% of remaining meals
and entertainment expense that is
allocable to noneffectively connected
income and reports this $120 on Part III,
line 10, column (d) as a negative
amount. FC combines columns (a), (b),
(c), and (d) and reports the $80
deductible amount in line 10, column
(e).
Example 10. The facts are the
same as in Example 9, except the $100
of tax-exempt interest is not included on
Part I, line 11, and is therefore excluded
from Part II, line 4, column (a). Because
the $100 of tax-exempt interest income
is allocable to both ECI and non-ECI, it
has significance in determining the
allocation of expenses under indirect
methods under Regulations section
1.861-8, and is therefore required to be
reported on Part II, line 23 as income
not included in the Schedule L books
that is allocable and apportionable to
ECI. Because no amount is includible in
column (a), the full $100 of tax-exempt
interest is reported in column (d) as a
positive number and in column (c) as a
negative number. As a result, there is no
amount reportable in column (e).

Treatment of Items Under an
Eligible Treaty-Based Return
Position to Attribute Business
Profits to a U.S. Permanent
Establishment

If a foreign corporation elects to use an
eligible treaty that provides a
permissible method other than the rules
of section 864(c) and 882 to determine
its business profits attributable to a U.S.
permanent establishment, the foreign
corporation must report on Form
1120-F, Section II, its business profits
attributable to its U.S. permanent
establishment under such income tax
treaty that applies the OECD Transfer
Pricing Guidelines in lieu of the
effectively connected income rules of
sections 864 and 882. In such a case,
the treatment of items in columns (c)
and (d) must be adapted to apply the
concepts of the applicable treaty.
Foreign bank treaty-based reporting.
For foreign banks, if any amounts are
not reported in Part II, column (a), as
part of the set(s) of books that constitute
the books of the U.S. permanent
establishment, but are attributable to the

U.S. permanent establishment under
application of the OECD Transfer
Pricing Guidelines, such amounts are
included as permanent differences in
columns (c) and (d). Report in column
(e) all amounts that are business profits
attributable to the U.S. permanent
establishment. When a treaty-based
position modifies the amount(s)
reportable for any of the line items
shown in Parts II and/or III of
Schedule M-3 from the amounts
otherwise reportable based on Code
principles, either (1) attach a separate
statement identifying each such line
item, or (2) on Part II or III as applicable,
include footnotes or similar references
for each such item to indicate that a
treaty-based position was claimed for
determining the amount reportable in
column (e). If no amount is reportable in
column (e), see Treaty-based reporting,
later.
Interbranch reporting. If the
foreign corporation is a foreign bank
electing to use an eligible treaty,
interbranch income and expense and
noneffectively connected income are
not treated as permanent differences to
the extent such items are attributable to
the U.S. permanent establishment and
are also included in the net income
(loss) reported on Part I, line 11. For any
item reported on Part I, line 11, that is
attributable to the foreign corporation's
U.S. permanent establishment, such
amounts may have temporary
differences under U.S. tax principles
(e.g., depreciation deductions includible
in column (a) may have temporary
book-to-tax differences reportable in
column (b)). For amounts reported in
Part II, column (a), do not report as
permanent differences, interbranch
interest or other interbranch income in
column (c) or noneffectively connected
income including foreign related party
interest, dividends or royalties that are
not effectively connected income under
section 864(c)(4)(D) in column (d) to the
extent such amounts are attributable to
the U.S. permanent establishment
under the OECD Transfer Pricing
Guidelines, applied by analogy. Report
on any such applicable lines in Part II or
III using either of the methods of
identification specified under Foreign
bank treaty-based reporting above,
indicating that the amount reported in
column (e) reflects interbranch income
or loss attributable to the U.S.
permanent establishment.
Treaty-based reporting for foreign
corporations other than banks.
Foreign corporations other than banks
-9-

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

income under sections 864(c) and 882.
The two books maintained in the United
States are primarily attributable to FC's
U.S. permanent establishment. The
third set of books that constitutes a set
of books for Regulations section
1.882-5(d)(2)(iii) purposes is not
attributable to FC's permanent
establishment in the year FC files its
Form 1120-F under the treaty-based
method.
On the two books that are
attributable to FC's U.S. permanent
establishment, FC records net book
income of $175. (FC has the following
income: $500 of interbranch interest
income, $200 of noneffectively
connected interest income, and $1,200
of effectively connected income under
Code-based principles. FC has $1,000
of third party interest expense and $400
of interbranch interest expense on the
books of its U.S. permanent
establishment that is priced at arm's
length with its home office. Each type of
interest expense is also attributable to
its U.S. permanent establishment. On
the two sets of books maintained in the
United States, FC has other third party
expenses of $325 attributable to the
permanent establishment.) FC also has
$100 of income attributable to its U.S.
permanent establishment that is
recorded in its home office on set(s) of
books that are predominantly not
attributable to FC's U.S. permanent
establishment. FC determines that $75
of its book interest expense must be
disallowed after equity capital is
allocated to the U.S. permanent
establishment under the OECD Transfer
Pricing Guidelines applicable to Article 7
(Business Profits) of the treaty.
FC reports $350 of treaty-based
profits attributable to its U.S. permanent
establishment as follows:
On Part II, line 4a, column (a), $1,900
of interest income is reported for the
total interest income of the set(s) of
books attributable to the U.S.
permanent establishment. In column (c),
$100 is reported as a permanent
difference for the income not included
on the set(s) of books reported on Form
1120-F, Schedule L. In column (e), the
total interest of $2,000 is reported as
income attributable to the U.S.
permanent establishment.
On Part III, line 26a, the U.S.
permanent establishment's book
interest expense of $1,400 is reported in
column (a). The total book amount is
reversed on line 26a in either column (b)
or (c). The $1,400 from column (a) is
reported in columns (b) and/or (c) as a

negative number. This includes the $75
portion of the $1,400 that constitutes
equity capital allocated to the U.S.
permanent establishment. On Part III,
line 26b, column (d), the $1,325 tax
amount of the interest expense (after
the $75 allocation of equity capital is
taken into account) is reported. This
$1,325 amount reported in column (d) is
carried to column (e) and constitutes the
amount from line 26a that is treated as
interest expense attributable to the
business profits of the U.S. permanent
establishment. A footnote should be
included indicating that interbranch
income was included in the column (e)
amount.
On Part III, the $325 of book
expenses attributable to the U.S.
permanent establishment are recorded
in columns (a) and (e) in their respective
categories. No adjustments are made in
this example in column (b) for temporary
differences or to business profits that
are not attributable to the U.S.
permanent establishment in column (d).
No additional expenses are attributable
to the U.S. permanent establishment
from the home office, which would have
been reportable in column (d). A
footnote should be referenced to this
line indicating that a treaty-based
position was used in determining the
interest expense.

Schedule M-3 Reporting
Requirements for Regulations
Section 1.6011-4(b) Reportable
Transactions

If an amount is attributable to a
reportable transaction described in
Regulations section 1.6011-4(b), the
amount must be reported in columns
(a), (b), (c), (d), and (e), as applicable,
of Part II, line 12 (items relating to
reportable transactions), regardless of
whether the amount would otherwise be
reported on another line in Part II or Part
III of Schedule M-3. Thus, if a taxpayer
files Form 8886, Reportable Transaction
Disclosure Statement, the amounts
attributable to that reportable
transaction must be reported on Part II,
line 12.
A corporation is required to report in
column (a) of Parts II and III the amount
of every item specifically listed on
Schedule M-3 that is in any manner
included in the foreign corporation's
current year income statement net
income (loss) or in an income or
expense account maintained in the
corporation's books and records, even if
there is no difference between that
amount and the amount included in
-10-

taxable income. However, this reporting
is not required in cases where (a) these
instructions provide otherwise, or (b) the
amount is attributable to a reportable
transaction described in Regulations
section 1.6011-4(b) and is therefore
reported on Part II, line 12.
For example, with the exception of
interest income reflected on a
Schedule K-1 received by a foreign
corporation as a result of the
corporation's investment in a
partnership or other pass-through entity,
and interest equivalents, all interest
income included on Part I, line 11,
whether from unconsolidated affiliated
companies, third parties, banks, or other
entities, whether from foreign or
domestic sources, whether taxable or
exempt from tax, and whether classified
as some other type of income for U.S.
income tax purposes (such as
dividends), must be included on Part II,
line 4a, column (a). For the exceptions,
look for the specific line in Part II.
Similarly, all fines and penalties
included in Part I, line 11, paid to a
government or other authority for the
violation of any law for which fines or
penalties are assessed, must be
included on Part III, line 11, column (a),
regardless of the authority that imposed
the fines or penalties, regardless of
whether the fines or penalties are civil or
criminal, regardless of the classification,
nomenclature, or terminology attached
to the fines or penalties by the imposing
authority in its actions or documents.
If a foreign corporation would be
required to report in column (a) of Parts
II and III the amount of an item
specifically listed on Schedule M-3 in
accordance with the preceding
paragraphs, except for the fact that the
corporation has capitalized the item of
income or expense and reports the
amount in its financial statement
balance sheet or in asset and liability
accounts maintained in the
corporation's books and records instead
of in its income statement, the foreign
corporation must report the proper tax
treatment of the item in columns (b), (c),
(d), and (e), as applicable.
Furthermore, in applying the
preceding paragraphs, a foreign
corporation is required to report in
column (a) of Parts II and III the amount
of any item specifically listed on
Schedule M-3 that is included on Part I,
line 11, regardless of the nomenclature
associated with that item in the income
statements or books and records.
Accurate completion of Schedule M-3
requires reporting amounts according to

the substantive nature of the specific
line items included in Schedule M-3 and
consistent reporting of all transactions
of like substantive nature that occurred
during the tax year.

and the item is not described or
included in Part II, lines 1 through 24, or
Part III, lines 1 through 32, report the
entire amount of the item in columns (a)
and (e) of Part II, line 27.

For example, all expense amounts
that are included in the income
statements or exist in the books and
records that represent some form of
“Bad debt expense” must be reported
on Part III, line 24, column (a),
regardless of whether the amounts are
recorded or stated under different
nomenclature in the income statements
or the books and records such as:
“Provision for doubtful accounts,”
“Allowance for uncollectible notes
receivable,” or “Impairment of trade
accounts receivable.” Likewise, as
stated above, all fines and penalties
must be included on Part III, line 11,
column (a), regardless of the
terminology or nomenclature attached
to them by the corporation in its books
and records or income statements.
Similarly, if the fine and penalty, for
example, is included in another item, the
amount of the fine or penalty should be
segregated and included on Part III,
line 11.

Separately stated and adequately
disclosed. Each difference reported in
Parts II and III must be separately stated
and adequately disclosed. In general, a
difference is adequately disclosed if the
difference is labeled in a manner that
clearly identifies the item or transaction
from which the difference arises. For
further guidance about adequate
disclosure, see Regulations section
1.6662-4(f), Rev. Proc. 2004-45,
2004-31 I.R.B. 140, and Rev. Proc.
2005-75, 2005-50 I.R.B. 1137. If a
specific item of income, gain, loss,
expense, allocation, or deduction is
described on Part II, lines 1 through 24,
or Part III, lines 1 through 32, and the
line does not indicate to “attach a
statement,” and the specific instructions
for the line do not call for an attachment
of a statement, then the item is
considered separately stated and
adequately disclosed if the item is
reported on the applicable line and the
amount(s) of the item(s) are reported in
the applicable columns of the applicable
line.

With limited exceptions, Part II
includes lines for specific items of
income, gain, or loss (“income items”). If
an income item is described in Part II,
lines 1 through 23, report the amount of
the item on the applicable line,
regardless of whether or not there is any
difference for the item. If there is a
difference for the income item, or only a
portion of the income item has a
difference and a portion of the item does
not have a difference, and the item is
not described in Part II, lines 1 through
23, report and describe the entire
amount of the item on Part II, line 24.
With limited exceptions, Part III
includes lines for specific items of
expense, allocation, or deduction
(“expense items”). If an expense item is
described on Part III, lines 1 through 31,
report the amount of the item on the
applicable line, regardless of whether or
not there is a difference for the item. If
there is a difference for the expense
item, or only a portion of the expense
item has a difference and a portion of
the item does not have a difference and
the item is not described in Part III, lines
1 through 31, report and describe the
entire amount of the item on Part III,
line 32.
If there is no difference between the
financial accounting amount and the
taxable amount of an entire item of
income, loss, expense, or deduction

Note. A statement or explanation may
be attached to any line even if none is
required.
Except as otherwise provided,
differences for the same item must be
combined or netted together and
reported as one amount on the
applicable line of Schedule M-3.
However, differences for separate items
must not be combined or netted
together. Each item (and corresponding
amount attributable to that item) must
be separately stated and adequately
disclosed on the applicable line of
Schedule M-3, or any statement
required to be attached, even if the
amounts are below a certain dollar
amount.
Required statements for Part II,
line 24, and Part III, line 32. A
separate statement must be attached to
Schedule M-3 (Form 1120-F) that
includes a detailed description of each
item and adjustment entered on Part II,
line 24, and Part III, line 32.
The description for each amount
entered in column (a) must be readily
identifiable to the name of the account
in the financial statements or books and
records of the taxpayer, under which the
amount in column (a) of the statement
was recorded in the accounting records.
-11-

Also, the description for each amount
entered in column (a) must include
detailed information supporting each
adjustment reported in columns (b), (c),
and (d), including how the adjustment is
identified in the accounting records. The
entire description is considered the tax
description for the amount reported in
column (e) for each item reported on
Part II, line 24, or Part III, line 32.
Each description should adequately
describe all five columns of Part II,
line 24, or Part III, line 32. If additional
information is required to provide an
acceptable description, provide a
supporting statement.
Example 12. Temporary
differences. Foreign corporation FC
has been filing a Form 1120-F from its
2000 tax year through the present. The
income statement year is identical to the
tax year. FC placed in service ten
depreciable, fixed, U.S. assets during its
2000 tax year. FC is required to file
Schedule M-3 for the current tax year.
FC's total depreciation expense for its
2016 tax year for five of the assets is
$50,000 for income statement purposes
and $70,000 for U.S. income tax
purposes. FC's total annual
depreciation expense for its 2016 tax
year for the other five assets is $40,000
for income statement purposes and
$30,000 for U.S. income tax purposes.
In its income statements, FC treats the
differences between income statement
and U.S. income tax depreciation
expense as giving rise to temporary
differences that will reverse in future
years. FC must combine all of its
depreciation adjustments. Accordingly,
for its 2016 tax year, FC must report on
Part III, line 23 depreciation expense as
shown on its income statement of
$90,000 in column (a), a temporary
difference of $10,000 in column (b), and
U.S. income tax depreciation expense
of $100,000 apportionable between
non-ECI and ECI in column (d) and
column (e).
Example 13. Bad debt and
warranty reserves. Foreign
Corporation D files and completes
Schedule M-3 for its 2015 and 2016 tax
years. The income statement year is
identical to the tax year. On the last day
of its 2016 tax year, D establishes two
reserve accounts in the amount of
$100,000 for each account. One
reserve account is an allowance for
accounts receivable that are estimated
to be uncollectible. The second reserve
is an estimate of future warranty
expenses. Both reserves are only for
assets that give rise to effectively

connected income. In its income
statements, D treats the two reserve
accounts as giving rise to temporary
differences that will reverse in future
years. The two reserves are expenses
for D's 2016 income statements but are
not deductions for U.S. income tax
purposes in 2016. D must not combine
the Schedule M-3 differences for the
two reserve accounts. D must report the
amounts attributable to the allowance
for uncollectible accounts receivable on
Part III, line 24, Bad debt expense, and
must separately state and adequately
disclose the amounts attributable to the
other reserve, for warranty costs, on a
required attached statement that
supports the amounts on Part III, line 32.
D must also provide a description for
each reserve that meets the
requirements for Part III, line 32,
discussed earlier under Required
statements for Part II, line 24, and Part
III, line 32. In this example, an
acceptable description would be “Future
Warranty Expense Reserve.”
Note. There is no need to add the title
of the reserve account to the description
if the account name for the amount in
column (a) is already part of the
adjustment description.
Example 14. Non-ECI and ECI
apportionment of temporary
differences. Corporation E files and
completes Schedule M-3 for its 2015
and 2016 tax years. The income
statement year is identical to the tax
year. At the beginning of the 2016 tax
year, E establishes an allowance for
uncollectible accounts receivable (bad
debt reserve) of $100,000, all of which
is related to assets that give rise to
effectively connected income. During
2016, E increased the reserve by
$250,000 for additional accounts
receivable that may become
uncollectible, of which $150,000 is
related to assets that give rise to
effectively connected income.
Additionally, during 2016, E decreases
the reserve by $75,000 for accounts
receivable that were discharged in
bankruptcy during 2016, of which
$50,000 is related to assets that give
rise to effectively connected income.
The balance in the reserve account on
the last day of the 2016 tax year, is
$275,000, of which $200,000 relates to
assets that give rise to effectively
connected income. The $100,000
amount to establish the reserve account
and the $250,000 to increase the
reserve account are expenses on E's
2016 income statements, but are not
deductible for U.S. income tax purposes

in 2016. However, of the $75,000
decrease to the reserve, only $50,000,
which is attributable to assets that give
rise to effectively connected income, is
deductible for U.S. income tax purposes
in 2016.
In its income statements, E treats the
reserve account as giving rise to a
temporary difference that will reverse in
future tax years. For its 2016 tax year, E
must report its income statement bad
debt expense of $350,000 in Part III,
line 24, column (a). The temporary
difference of ($275,000) is determined
under U.S. tax principles and reported in
column (b) without regard to its
effectively or noneffectively connected
character. The amounts allocable to
noneffectively connected income are
then determined and reported in column
(d). E must report the ($25,000)
allocable to noneffectively connected
income in column (d) and U.S. income
tax bad debt expense of $50,000 in
column (e).

Part II. Reconciliation of
Net Income (Loss) per
Income Statement of
Non-Consolidated Foreign
Corporations With Taxable
Income per Return

Note. Foreign corporations report, on
lines 1 through 17, 19 through 21a, 24,
and 27 in column (a), the income (loss)
items included in the financial net
income (loss) reported on Part I, line 11.
See the instructions for Part I, line 11 for
reporting differences between foreign
banks and foreign corporations other
than a bank.

Tiebreaker rules. There are tiebreaker
rules described in detail below under
each applicable line instruction for Part
II. For example, for foreign corporations
that report income from their U.S. trade
or business associated with global
dealing activities in securities or
financial instruments, global dealing
income is prioritized on line 16 even
though some income or loss amounts in
the global dealing book might otherwise
appear to be reportable on another line
(e.g., dividends on line 3a or b, or
hedges on line 13).

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

currency gains and losses from other
section 988 transactions (line 15), or
receipts or sales of securities from
global securities dealings (line 16).

Line 2. Cost of Goods Sold

Report on line 2 any amounts deducted
as part of cost of goods sold during the
tax year, regardless of whether the
amounts would otherwise be reported
elsewhere in Part II or Part III. However,
do not report the items mentioned in the
next paragraph on this line 2. Examples
of amounts that must be included on
line 2 are amounts attributable to
inventory valuation, such as amounts
attributable to cost-flow assumptions,
additional costs required to be
capitalized (including depreciation) such
as section 263A costs, inventory
shrinkage accruals, inventory
obsolescence reserves, and lower of
cost or market (LCM) write-downs.
Attach a statement separately stating
each item included on this line and the
amount for each column.
Do not report the following on this
line 2:
Amounts reportable on Part II, line 12;
Any gain or loss from inventory
hedging transactions reportable on Part
II, line 13;
Mark-to-market income or (loss)
under section 475 reportable on Part II,
line 14;
Global dealing income reportable on
Part II, line 16;
Section 481(a) adjustments related to
cost of goods sold or inventory valuation
reportable on Part II, line 18;
Original issue discount, imputed
interest, and phantom income
reportable on Part II, line 20;
Fines and penalties reportable on
Part III, line 11;
Judgments, damages, awards, and
similar costs, reportable on Part III,
line 12;
Amounts reported on Part II, line 17,
Sales versus lease; and
Amounts reported on Part III, line 25,
Purchase versus lease.

Lines 3a and 3b. Dividends

Report on lines 3a through 3b, column
(a), the amount of dividends included in
Part I, line 11 from foreign and U.S.
entities. Report on lines 3a through 3b,
column (e), the amount of any dividends
included in taxable income on Form
1120-F, Section II, line 4. Do not include
on lines 3a through 3b dividends from
global securities dealings which are
reportable on Part II, line 16b, or
dividends reported elsewhere (e.g.,
substitute dividends reportable on

line 3c and reportable transactions
reportable on line 12). Any effectively
connected dividends from corporations
reported by the foreign corporation
under the equity method are reported in
columns (c) and (e) of this line, as
described in the instructions for Part II,
line 8.

Line 3c. Substitute Dividend
Payments Received

Report on line 3c, the gross substitute
dividend payments received with
respect to securities loans under section
1058 or substantially similar
transactions, or from sale repurchase
transactions, as described in
Regulations sections 1.861-3(a)(6),
1.864-5(b)(2)(ii), and 1.881-2(b)(2). Do
not net substitute dividend payments
received against any substitute dividend
payments made by the foreign
corporation to another securities lender.

Foreign banks – worldwide reporting. Foreign banks must also report in
column (c) all U.S. source substitute
dividend payments received as
beneficial owner to the extent they are
not already included in Part I, line 11
and without regard to whether such
payments received are effectively
connected income. For example,
substitute dividends received by a
foreign bank that are not reported on
Form 1120-F, Schedule L, must be
reported as U.S. source payments
received in column (c) and reversed to
the extent of the non-ECI portion of the
payments in column (c) as a negative
number in column (d). Reporting in
columns (c) and (d) for substitute
dividends is required even if no amount
would be reported in columns (a) and
(e). Any U.S. source substitute
dividends that are effectively connected
with the foreign corporation’s trade or
business within the United States are
reportable in column (e). Do not report
on any line, substitute dividend
payments received in custody for
another owner of the substitute payment
or such payments reportable on
line 16b.
Example 15. FC, a foreign bank
resident in Country X, is engaged in a
banking trade or business within the
United States through a U.S. permanent
establishment. FC has an income tax
treaty with the United States that
imposes a 15% tax on gross portfolio
dividends received by the corporation
that are not attributable to a U.S.
permanent establishment. FC records
securities lending transactions with
respect to U.S. and foreign stocks on its

home office set(s) of books. These
set(s) of books do not give rise to U.S.
booked liabilities under Regulations
section 1.882-5(d)(2)(iii) and are not
reportable on Form 1120-F, Schedule L.
FC receives $200 of substitute
dividends from transactions described
in section 1058, all of which are not
effectively connected with FC's trade or
business within the United States and
are not attributable to FC's U.S.
permanent establishment. Under
Regulations sections 1.861-3(a)(6) and
1.881-2(b)(2), the substitute dividends
are sourced and characterized as U.S.
source dividends. Under FC's treaty
with the United States, the dividends are
subject to a 15% gross basis tax.
The substitute payments are not
reportable on Part I, line 11, or Part II,
line 3c, column (a). FC must report $200
of dividends on line 3c, column (c) as a
positive number. On line 3d, column (d),
the $200 is reported as a negative
number. FC enters zero in column (e).
On Form 1120-F, Section I, FC must
report the substitute dividends received
that are not properly withheld upon and
reported by the withholding agent on
Form 1042-S.

Line 4a. Interest Income
Excluding Interest Equivalents

Report on Part II, line 4a, column (a), the
total amount of interest income included
in Part I, line 11, and report on Part II,
line 4a, column (e), the total amount of
interest income included on Form
1120-F, Section II, line 5, that is not
required to be reported elsewhere in
Part II. In column (b) or (c), as
applicable, adjust for amounts treated
for U.S. income tax purposes as interest
income that are treated as some other
character of income in the income
statements, or vice versa. All
interbranch interest income included on
Part I, line 11, that is excluded from
taxable income is reported as a
permanent difference in column (c). For
foreign corporations other than banks,
see the instructions for Part I, line 8,
regarding eliminations of interbranch
transactions.
Do not report on this line 4a, in any
column, amounts reported in
accordance with instructions for Part II,
lines 4b, 4c, 9 through 13, 16a, 20, and
23.
Example 16. FC is a foreign bank
that is required to file Form 1120-F and
Schedule M-3 for the current tax year.
FC included on Part I, line 11, the
following interest income items totaling
$2,000: $600 of interbranch interest
-13-

income; $100 of tax-exempt interest,
$60 of which is effectively connected;
$300 of interest income with respect to
securities described in Regulations
section 1.864-4(c)(5)(ii)(b)(3) (“10% rule
securities”), $150 of which is allocable
to noneffectively connected income
under the rule of that paragraph; and
$1,000 of other effectively connected
interest income.
FC reports on Part II, line 4a, column
(a) all $2,000 of this interest income. FC
reports ($700) as a permanent
difference on line 4a, column (c), to
eliminate all $100 of the tax-exempt
interest income (including the
noneffectively connected portion) and
all $600 of the interbranch interest
income. FC must also report ($150) of
noneffectively connected interest
income from its “10% rule securities” in
column (d) as a negative amount. FC
combines columns (a), (b), (c), and (d)
and reports $1,150 of effectively
connected interest income in column
(e).

Line 4b. Substitute Interest
Payments Received

Report on line 4b, the gross substitute
interest payments received with respect
to securities loans under section 1058,
sale repurchase transactions, or similar
transactions, as described in
Regulations sections 1.861-2(a)(7),
1.864-5(b)(2)(ii), and 1.881-2(b)(2). Do
not net substitute interest payments
received against substitute interest
payments made by the foreign
corporation with respect to any section
1058 sale repurchase transactions,
including payments made with respect
to “matched book” transactions, or any
similar transaction.

Foreign banks – worldwide reporting. Foreign banks must report all U.S.
source substitute interest payments
received as beneficial owner, whether
or not such payments are included in
Part I, line 11, and are effectively
connected income. All U.S. sourced
substitute interest received by a foreign
bank that is not reported on Form
1120-F, Schedule L, is reportable in
column (c) and the non-ECI portion is
reversed as a negative amount in
column (d). Both U.S. and foreign
source substitute interest that is
effectively connected with the foreign
corporation's trade or business within
the United States is reportable in
column (e).
Do not report on line 4b substitute
interest payments received in custody
for another owner of the substitute

payment or such payments reportable
on line 16a.

or vice-versa, are reportable on Part II,
line 17, instead of line 5.

Report all substitute interest
payments received on line 4b whether
or not such amounts are characterized
as interest or other income under the
Code.

Line 7. Fee and Commission
Income

Example 17. FC, a foreign bank,
receives $1,000 of gross U.S. source
substitute interest payments with
respect to sale repurchase agreements.
FC also has $200 of gross U.S. source
substitute interest with respect to
securities loans of municipal bonds in
transactions described in section 1058.
All of the substitute interest received
was included on FC's set(s) of books
reported on Form 1120-F, Schedule L
and is reportable on Part I, line 11.
FC must report all $1,200 of the
substitute interest in column (e) as
effectively connected income. The $200
of U.S. source ECI substitute interest
received from the municipal bond
securities loans is not characterized as
tax-exempt municipal bond interest, but
is U.S. source “other income” consistent
with the characterization provisions
applicable only to substitute interest
payments described in Regulations
section 1.881-2(a)(2). Accordingly, no
amount of the payment is reportable in
column (c) as a permanent difference.

Line 4c. Interest Equivalents
Other Than Substitute Interest
Reported on Line 4b

Report on line 4c, interest income
equivalents other than substitute
interest reportable on line 4b or other
interest equivalents reportable on other
lines in Part II. Interest equivalents
reportable on line 4c generally consist of
fees and commission income with
respect to certain financial transactions
that do not give rise to interest under
section 163 (e.g., financial guarantee
fees, and acceptance confirmation and
standby letter of credit fees). Do not
report periodic income with respect to
notional principal contracts on Part II,
line 4c.
Do not report on this line 4c, amounts
reported in accordance with instructions
for Part II, lines 4a, 4b, 9, 10, 11, 12, 13,
16a, 20, and 23.

Line 5. Gross Rental Income

Report on line 5, gross rental income
that is treated as rental income for both
the taxpayer's financial reporting
purposes and for U.S. income tax
purposes. Gross rents that are recorded
as a sale for financial purposes and as
rental income for federal tax purposes

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

Line 8. Income (Loss) From
Equity Method Corporations

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

Lines 9 and 10. Income (Loss)
from Partnerships

Note. The income (loss) reported in
column (e) must reconcile with the
effectively connected taxable income
reportable to the foreign corporation on
Schedule K-1 and by the foreign
corporation on Schedule P (Form
1120-F).
Except as provided below for certain
foreign partnership interests of
corporations other than a bank, report
amounts on Part II, line 9 or 10, as
described below:
1. Report in column (a), the sum of
the corporation's distributive shares of
all items of income, gain, deduction, and
loss from a U.S. or foreign partnership
that are included in Part I, line 11;
2. Report in column (b) or (c), as
applicable, except for amounts
described for column (e) below, the sum
of all differences, if any, attributable to
the corporation's distributive share of
income or loss from a U.S. or foreign
partnership. In column (c), the
corporation's distributive share of
interest expense from all of its
partnership interests reported in column
(a) must be reversed as a permanent
difference. Enter the amount of all such
interest expense as a negative number
in column (c). The amount of
partnership interest expense allowed as
a deduction against effectively
connected income is included in Part III,
-14-

lines 26b and 26c from Schedule I
(Form 1120-F), lines 23 and 24d.
Note. The amount of partnership
interest expense reported as a
permanent difference in column (c) on
lines 9 and 10 may not be the same
amount of total interest expense
reported on Schedule P, line 15a
(“Total” column), if the Schedule M-3
filing corporation reports its worldwide
non-consolidated financial statement
income in Part I, line 11, and for each
line item in Parts II and III;
3. Report in column (d), the total
amount of non-effectively connected
income that relates to the distributive
share of income or loss from a U.S. or
foreign partnership;
4. Report in column (e), except for
amounts described below, the sum of all
amounts attributable to the corporation's
distributive shares of income or loss
from a U.S. or foreign partnership that is
included in taxable income. The amount
reported on line 10, column (e) should
reconcile with the amount reported on
Schedule P, line 12 ("Total" column),
minus the sum of the amounts reported
on Schedule P, lines 5 and 10 ("Total"
column).
Do not report on Part II, line 9 or 10,
as applicable, any portion of a
corporation's deduction under section
199 (income attributable to domestic
production activities) attributable to a
partnership interest of the corporation. A
corporation must report this deduction
only on Part III, line 17.
Exclusion of certain foreign
partnership interests from line 10.
Foreign corporations other than banks
that have foreign partnership interests
with no effectively connected income for
the year need not separately report
those interests on this line. If, however,
the foreign corporation reports a
partnership interest on the equity
method in the income statement used
for Part I, line 4, it may report such
amounts in column (a) of this line. The
corporation should report effectively
connected amounts in column (e)
consistent with the reporting equity
method amounts in column (a). For
example, if the foreign corporation does
not report the partnership interest on
Part II, line 10, column (a), it should not
report any amounts in column (e) for the
partnership interest. It would instead
report the income and other items from
the partnership interest for column (e)
purposes based on the reporting for
each line included in the income
statement. However, if a foreign

corporation allocates interest expense
under the separate currency pools
method in Regulations section
1.882-5(e) or allocates excess interest
expense under Regulations section
1.882-5(d)(5), and interest expense
included in the foreign corporation's
distributive share of a foreign
partnership is included in such
allocation, see the instructions for Part
III, line 26a, for the required reporting.
Example 18. FC is a calendar year
taxpayer that is required to file
Schedule M-3 for the current tax year.
FC, which is not a foreign bank, is a
partner in foreign partnership FP. FC
prepares income statements in
accordance with home country GAAP.
In its income statements, FC treats the
difference between income statement
net income and taxable income from its
investment in FP as a permanent
difference. For its 2016 tax year, FC's
income statement includes $10,000 of
income attributable to its share of FP's
net income. FC's Schedule K-1 from FP
reports $5,000 of ordinary income,
$7,000 of long-term capital gains,
$4,000 of charitable contributions, and
$200 of section 179 expense. It has
been determined that all of these
amounts are effectively connected to
FC's trade or business within the United
States. Consequently, FC must enter
the following amounts on Part II, line 10:
$10,000 in column (a), a ($200)
temporary difference in column (b) for
the section 179 deduction that is
effectively connected with FC's trade or
business, a permanent difference of
($2,000) in column (c), and $7,800 in
column (e). The ($2,000) permanent
difference reported in column (c) is
determined as the aggregate difference
between column (a) and column (e)
after temporary differences in column
(b).
Example 19. Same facts as
Example 18 except that FC's charitable
contribution deduction is wholly
attributable to its partnership interest in
FP and is limited to $90 pursuant to
section 170(b)(2) due to other
investment losses incurred by FC. In its
income statements, FC treated this
limitation as a temporary difference. FC
must not report the charitable
contribution limitation of $3,910
($4,000 - $90) on Part II, line 9. FC must
report the limitation on Part III, line 16,
and report the disallowed charitable
contributions of ($3,910) in columns (b)
and (e).

Line 11. Income (Loss) from
Other Pass-Through Entities

For any interest in a pass-through entity
(other than an interest in a partnership
reportable on Part II, line 9 or 10, as
applicable) owned by the corporation,
report the following on line 11:
1. Report in column (a), the sum of
the corporation's distributive share of
income or loss from the pass-through
entity that is included in Part I, line 11;
2. Report in column (b) or (c), as
applicable, the sum of all differences, if
any, attributable to the pass-through
entity. In column (c), the corporation's
distributive share of interest expense
from all of its pass-through entities
reported in column (a), must be
reversed as a permanent difference.
Enter the amount of all such interest
expense as a negative number in
column (c). The amount of pass-through
interest expense allowed as a deduction
against effectively connected income is
included on Part III, lines 26b and 26c,
from Schedule I (Form 1120-F), lines 23
and 24d;
3. Report in column (d), the total
amount of noneffectively connected
income related to the distributive share
of income or loss from the pass-through
entity;
4. Report in column (e), the sum of
all taxable amounts of income, gain,
loss, or deduction reportable on the
corporation's Schedules K-1 received
from the pass-through entity (if
applicable).
Do not report on Part II, line 11, any
portion of a corporation's deduction
under section 199 (income attributable
to domestic production activities) even if
some or all of the corporation's
deduction under section 199 is
attributable to an interest in a
pass-through entity held by the
corporation. A corporation must report
its deduction under section 199 only on
Part III, line 17.
Foreign corporations other than
banks that have interests in foreign
pass-through entities with no effectively
connected income for the year need not
separately report those interests on this
line. If, however, the foreign corporation
reports a pass-through interest on the
equity method in the income statement
used for Part I, line 4, it may report such
amounts in column (a) of this line. The
corporation should report effectively
connected amounts in column (e)
consistent with the reporting equity
method amounts in column (a). For
example, if the foreign corporation does
-15-

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

Line 12. Items Relating to
Reportable Transactions

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

for Part II, line 12, columns (a) through
(e).
In lieu of the requirements of the
preceding paragraph, a corporation will
be considered to have separately stated
and adequately disclosed a reportable
transaction if the corporation attaches a
supporting statement that provides the
following for each reportable
transaction:
1. A description of the reportable
transaction disclosed on Form 8886 for
which amounts are reported on Part II,
line 12;
2. The name and tax shelter
registration number, if applicable, as
reported on lines 1a and 1c,
respectively, of Form 8886; and
3. The type of reportable transaction
(i.e., listed transaction, confidential
transaction, transaction with contractual
protection, etc.) as reported on line 2 of
Form 8886.
If a transaction is a listed transaction
described in Regulations section
1.6011-4(b)(2), the supporting
statement also must include the
information requested on line 3 of Form
8886. In addition, if the reportable
transaction involves an investment in
the transaction through another entity
such as a partnership, the supporting
statement must include the name and
EIN (if applicable) of that entity as
reported on line 5 of Form 8886.
Example 20. Corporation J is a
calendar year taxpayer that is required
to file Schedule M-3 for the current tax
year. J incurred seven different
abandonment losses during its 2016 tax
year. One loss of $12 million results
from a reportable transaction described
in Regulations section 1.6011-4(b)(5),
another loss of $5 million results from a
reportable transaction described in
Regulations section 1.6011-4(b)(4), and
the remaining five abandonment losses
are not reportable transactions. J
discloses the reportable transactions
giving rise to the $12 million and $5
million losses on separate Forms 8886
and sequentially numbers them X1 and
X2, respectively. J must separately state
and adequately disclose the $12 million
and $5 million losses on Part II, line 12.
The $12 million loss and the $5 million
loss will be adequately disclosed if J
attaches a supporting statement for
line 12 that lists each of the sequentially
numbered forms, Form 8886-X1 and
Form 8886-X2, and with respect to each
reportable transaction reports the
appropriate amounts required for Part II,
line 12, columns (a) through (e).

Alternatively, J's disclosures will be
adequate if the description provided for
each loss on the supporting statement
includes the names and tax shelter
registration numbers, if any, disclosed
on the applicable Form 8886, identifies
the type of reportable transaction for the
loss, and reports the appropriate
amounts required for Part II, line 12,
columns (a) through (e). J must report
the losses attributable to the other five
abandonment losses on Part II, line 21e,
regardless of whether a difference
exists for any or all of those
abandonment losses.

Hedging transactions of securities
dealer property (other than a global
dealing operation) that is
marked-to-market under section 475(a)
(see instructions for line 14a);
Hedging transactions entered into by
a commodities dealer that makes a
mark-to-market election under section
475(e) (see instructions for line 14c);
and
Hedging transactions entered into by
a securities or commodities trader that
makes a mark-to-market election under
section 475(f) (see instructions for
line 14d).

Example 21. Corporation K is a
calendar year taxpayer that is required
to file Schedule M-3 for the current tax
year. K enters into a transaction with
contractual protection that is a
reportable transaction described in
Regulations section 1.6011-4(b)(4).
This reportable transaction is the only
reportable transaction for K's 2016 tax
year and results in a $7 million capital
loss for both financial statement
purposes and U.S. income tax
purposes. It was determined that the
entire amount is attributable to
effectively connected income. Although
the transaction does not result in a
difference, K is required to report on
Part II, line 12, the following amounts:
($7 million) in column (a), zero in
columns (b) and (c), and ($7 million) in
column (e). The transaction will be
adequately disclosed if K attaches a
supporting statement for line 12 that (a)
sequentially numbers the Form 8886
and refers to the sequentially-numbered
Form 8886-X1 and (b) reports the
applicable amounts required for line 12,
columns (a) through (e). Alternatively,
the transaction will be adequately
disclosed if the supporting statement for
line 12 includes a description of the
transaction, the name and tax shelter
registration number, if any, and the type
of reportable transaction disclosed on
Form 8886.

Do not report the income from the
hedged item(s) on line 13. For hedging
transactions reportable on line 13,
report in column (e) the amount of
taxable income from hedging
transactions as defined in section
1221(b)(2). Use columns (b) and (c) to
report all differences caused by treating
hedging transactions differently for
financial accounting purposes and for
U.S. income tax purposes. For example,
if a portion of a hedge is considered
ineffective under GAAP but still is a valid
hedge under section 1221(b)(2), the
difference must be reported on line 13.
The hedge of a capital asset, which is
not a valid hedge for U.S. income tax
purposes, must also be reported here if
it is considered a hedge under the
corporation's method of accounting. For
instance, transactions that would
constitute a valid hedge for U.S. income
tax purposes but constitute hedges of
capital assets solely because the asset
gives rise to noneffectively connected
income and is not eligible for ordinary
treatment under section 582(c), are also
reported on line 13.

Line 13. Hedging Transactions

Report on line 13, column (a), the net
gain or loss from hedging transactions
(including hedges of inventory) included
in the amount reported on Part I, line 11,
other than:
Hedging transactions entered into by
a global dealing operation (see line 16
instructions);
Qualified integrated foreign currency
hedging transactions under Regulations
section 1.988-5(a) (report these
transactions on either Part II, line 4, or in
Part III, line 26a, column (a) as
applicable);
-16-

Report on Part II, line 16c, hedging
transactions entered into by a global
dealing operation including those that
are “risk transfer agreements” defined in
Proposed Regulations section
1.475(g)-2. However, income with
respect to a risk transfer agreement that
is held by the foreign corporation's
non-global dealing operations is, unless
reported elsewhere in Part II, reported
on line 13 to the extent it is reported on
Part I, line 11. If a foreign bank does not
so report a risk transfer agreement held
by a non-global dealing operation on
Part I, line 11, any ECI from such risk
transfer agreement earned by the
non-global dealing operation must be
reported on Part II, line 23, column (d).
Report on this line 13, hedging gains
and losses with respect to non-dealer
transactions that are determined under
the mark-to-market method of

accounting on the income statement
(other than those that are subject to
mark-to-market treatment under a valid
election under sections 475(e) or (f)).
Example 22. FC is a foreign bank
that enters into a U.S. dollar interest rate
notional principal contract to hedge a
portfolio of securities held for
investment on its U.S. set(s) of books
that are reportable on Form 1120-F,
Schedule L. The hedged portfolio
consists of four securities of equal
amounts, only two of which give rise to
effectively connected income. For
financial statement purposes, the
notional principal contract is treated as a
hedging transaction. For U.S. tax
purposes, the two securities that give
rise to noneffectively connected income
are capital assets that are not eligible for
ordinary treatment on disposition under
section 582(c). Consequently, the
notional principal contract does not
constitute a hedging transaction under
section 1221(b)(2). Regardless, the
income gain or loss with respect to the
notional principal contract (including any
mark-to-market income from the hedge)
is reportable as a hedging transaction
on line 13 and is not reported on line 4b
or 14b.

Lines 14a through 14d.
Mark-to-Market Income (Loss)

Except for global dealing operations
reportable on line 16 and for certain
hedging transactions reported on
line 13, report on lines 14a through 14d,
column (a) any amount that is subject to
mark-to-market treatment under section
475. Report on line 14a, income or
(loss) from securities held by a dealer in
securities, in its capacity as a dealer
under section 475(a). On line 14b,
report the mark-to-market treatment of
securities held by a dealer other than in
its capacity as a dealer that is subject to
the characterization provisions of
section 475(d)(3)(B). Report on
line 14c, the mark-to-market income of a
dealer in commodities having made a
valid election under section 475(e), and
on line 14d, report the mark-to-market
income of a trader in securities or
commodities having made a valid
election under section 475(f).
“Securities” for these purposes are
securities described in section 475(c)(2)
and commodities described in section
475(e)(2). “Securities” do not include
any items specifically excluded from
sections 475(c)(2) and 475(e)(2), such
as certain contracts to which section
1256(a) applies (which may be
reportable on line 13 as hedges).

Report hedging gains and losses
from transactions held in investment
capacity or trader capacity not subject
to a securities or commodities trading
election, but which are determined
under the mark-to-market method of
accounting, on Part II, line 13 (hedging
transactions), and not on line 14.
Traders in securities and commodities. For a trader in securities or
commodities that made a valid election
under section 475(f) to use the
mark-to-market method to account for
securities or commodities held in
connection with a trading business that
files Form 4797, any Schedule M-3
entries required as a result of marking to
market these securities or commodities
are reported as follows: (a)
mark-to-market gains and losses from
Form 4797, line 10, are included on Part
II, line 14d, of Schedule M-3 (Form
1120-F); (b) any other Schedule M-3
entries required based on other results
(non-mark-to-market gains and losses)
included in the total reported on Form
4797, line 17, should be reported on
Part II, line 21d, of Schedule M-3 (Form
1120-F), unless the instructions for
Schedule M-3 require the amounts to be
reported on another line.
Example 23. Foreign corporation
FC, a broker-dealer that is not a foreign
bank, is a dealer in securities under
section 475(a) and conducts its entire
securities dealing operation within the
United States. All of the income is
recorded on set(s) of books reported on
Form 1120-F, Schedule L; is effectively
connected with FC's trade or business
within the United States; and constitutes
income of a securities dealer as defined
in Regulations section 1.864-2(c)(2)(iv)
only, and not of a global dealing
operation. The income of this securities
dealing operation is reportable on Part
II, line 14. If FC engaged in a global
securities dealing operation, however,
the income generated from that activity
would be reportable on line 16, columns
(d) and (e) as sourced and allocated
under Proposed Regulations section
1.863-3(h) between non-ECI and ECI. If
the global dealing operation is of a
foreign bank and is not includible in
column (a), the apportionment of the
global dealing operation's results would
be reportable in column (d) for the
amount of income or loss that is
allocable to ECI. Income would be
reportable as a positive number and
losses would be reportable as a
negative number. If the global dealing
set(s) of books are reportable in column
(a), either because like FC, it is a broker
-17-

dealer and not a foreign bank, or it is a
foreign bank whose global dealing
operation is reportable on Form 1120-F,
Schedule L, the apportionment of the
global dealing operation's results would
be reportable in column (d) for the
portion that needs to be allocated to
noneffectively connected income. In
such instance, the amount of income
allocable to non-ECI would be
reportable as a negative amount and
the amount of loss would be reportable
as a positive number in column (d). For
all filers, columns (a), (b), (c), and (d)
are combined to determine the ECI
amount reportable in column (e).

Line 15. Gains (Losses) from
Certain Section 988
Transactions

Report on line 15 gains or (losses) from
certain section 988 transactions. These
are only those section 988 transactions
that are not reportable with respect to
hedging transactions, mark-to-market
gains (losses), or global securities
dealing operations on Part II, lines 13,
14, and 16. Section 988 gains (losses)
reportable on line 15 will generally be
those recognized with respect to foreign
currency denominated instruments that
are acquired and normally held for
investment or otherwise not held by a
global securities dealer. Foreign
currency transactions entered into by a
global securities dealing operation are
reportable exclusively on line 16c. Do
not report on line 15 qualified integrated
foreign currency hedging transactions
as defined in Regulations section
1.988-5(a) (see line 13 instructions).
Example 24. FC is a foreign
corporation that is not a dealer or trader
in securities or commodities. FC
acquires foreign interest-bearing bonds
issued by a corporation resident in
Country X. The bonds are denominated
in a functional currency other than FC's
currency and other than the U.S. dollar.
FC holds the bonds in connection with
its trade or business within the United
States and the bonds give rise to
effectively connected income, gain or
(loss). FC accrues interest income on its
set(s) of books in U.S. dollars and
accounts for currency gains (losses)
with respect to each accrual period.
When FC receives coupon interest
payments, it records section 988
transaction foreign currency gains
(losses). These gains (losses) are
reportable on line 15.
If FC is a foreign bank and subject to
section 475, generally, these gains
(losses) are still reportable on line 15

and not on line 14 if the bank acquires
and properly identifies the securities as
held for investment or if the securities
are held for proprietary trading that is
not subject to a section 475 trader
election under section 475(f).

Lines 16a and 16b. Interest
Income and Dividends from
Global Securities Dealing

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

Line 16c. Gains (Losses) and
Other Fixed and Determinable,
Annual, or Periodic Income
from Global Securities Dealing

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

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

Line 17. Sale Versus Lease (for
Sellers and/or Lessors)
Note. See the instructions for Part III,
line 25, later, for purchasers and/or
lessees.
Asset transfer transactions with
periodic payments characterized for
financial accounting purposes as either
a sale or a lease may, under some
circumstances, be characterized as the
opposite for tax purposes. If the
transaction is treated as a lease, the
seller/lessor reports the periodic
payments as gross rental income and
also reports depreciation expense or
deduction. If the transaction is treated
as a sale, the seller/lessor reports gross
profit (sale price less cost of goods sold)
from the sale of assets and reports the
periodic payments as payments of
principal and interest income.
On Part II, line 17, column (a), report
the gross profit or gross rental income
for financial statement purposes for all
sale or lease transactions that must be
given the opposite characterization for
tax purposes. On Part II, line 17, column
(e), report the gross profit or gross rental
income for federal income tax purposes.
Interest income amounts for such
transactions must be reported on Part II,
line 4a (interest income excluding
interest equivalents), in columns (a) and
(e), as applicable. Depreciation
expense for such transactions must be
reported on Part III, line 23
(depreciation), in columns (a) and (e),
as applicable. Use columns (b), (c), and
(d) of Part II, lines 4a and 17, and Part
III, line 23, as applicable, to report the
differences between column (a) and (e).

Example 27. Corporation M sells
and leases property to customers. M is
a calendar year taxpayer that was
required to file Schedule M-3 for its
2015 tax year and is required to file
Schedule M-3 for its 2016 tax year. For
financial accounting purposes, M
accounts for each transaction as a sale.
For U.S. income tax purposes, each of
M's transactions must be treated as a
lease. In its income statements, M treats
the difference in the financial accounting
and the U.S. income tax treatment of
these transactions as temporary. During
2016, M reports on its income
statements $1,000 of sales and $700 of
cost of goods sold with respect to 2016
lease transactions. M receives periodic
payments of $500 in 2016 with respect
to these 2016 transactions and similar
transactions from prior years and treats
$400 as principal and $100 as interest
income. For financial income purposes,
M reports gross profit of $300 ($1,000 $700) and interest income of $100 from
these transactions. For U.S. income tax
purposes, M reports $500 of gross
rental income (the periodic payments)
and (based on other facts) $200 of
depreciation deduction on the property.
It was determined that the entire amount
of these items is effectively connected
income/expense. On its 2016
Schedule M-3, M must report on Part II,
line 4a (interest income), $100 in
column (a), ($100) in column (b), and
zero in column (e). In addition, M must
report on Part II, line 17, $300 of gross
profit in column (a), $200 in column (b),
and $500 of gross rental income in
column (e). Lastly, M must enter $200 in
each of columns (b) and (e) on Part III,
line 23.

Line 18. Section 481(a)
Adjustments

With the exception of a section 481(a)
adjustment that is required to be
reported on Part II, line 12, for
reportable transactions, any difference
between an income or expense item
attributable to an authorized (or
unauthorized) change in method of
accounting made for U.S. income tax
purposes that results in a section 481(a)
adjustment must be reported on Part II,
line 18, regardless of whether a
separate line for that income or expense
item exists in Part II or Part III.
Example 28. Corporation N is a
calendar year taxpayer that was
required to file Schedule M-3 for its
2015 tax year and is required to file
Schedule M-3 for its 2016 tax year. N
was depreciating certain fixed assets
over an erroneous recovery period and,

effective for its 2016 tax year, N
receives IRS consent to change its
method of accounting for the
depreciable fixed assets and begins
using the proper recovery period. The
change in method of accounting results
in a positive section 481(a) adjustment
of $100,000 that is required to be
spread over four tax years, beginning
with the 2016 tax year. It has been
determined that the entire amount is
attributable to effectively connected
income. In its income statements, N
treats the section 481(a) adjustment as
a temporary difference. N must report
on Part II, line 18, $25,000 in columns
(b) and (e) for its 2016 tax year and
each of the subsequent three tax years
(unless N is otherwise required to
recognize the remainder of the section
481(a) adjustment earlier). N must not
report the section 481(a) adjustment on
Part III, line 23.
If the section 481(a) adjustment was
not effectively connected to N's trade or
business within the United States and is
not includible in column (a), the amount
would be reportable for each year in
column (b) as a temporary difference
(for U.S. tax principles) and then
reversed as an apportionment to
non-ECI in column (d). If N were a
foreign bank, the amount would only be
so reportable if the section 481(a)
adjustment was with respect to
transactions recorded on set(s) of
books reportable on Form 1120-F,
Schedule L.

Line 19. Unearned/Deferred
Revenue

Report on line 19, column (a), amounts
of revenues included in Part I, line 11,
which were deferred from a prior
financial accounting year. Report on
line 19, column (e), revenues
recognizable for federal income tax
purposes that are recognized for
financial accounting purposes in a
different year. Also, report on line 19,
column (e), any amount of revenues
reported on line 19, column (a), that are
recognizable for U.S. income tax
purposes in the current tax year. Use
columns (b), (c), and (d) of line 19, as
applicable, to report the differences
between column (a) and column (e). If
the amounts are not includible on set(s)
of books reportable on Form 1120-F,
Schedule L, but are reportable in Part I,
line 11, for a foreign corporation other
than a bank, then report the entire
difference as temporary in column (b).
Any amount allocable to noneffectively
connected income should, to that
extent, be included in column (d) to
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reverse some or all of the amount
included in column (b).
Line 19 must not be used to report
income recognized from long-term
contracts. Instead, use line 24 (other
income (loss) items with differences).
Example 29. FC, a foreign
corporation other than a bank, has
prepaid commission income of $1,000
recognizable for U.S. income tax
purposes in the current tax year that is
recognized for financial accounting
purposes in a different year. FC treats
this difference as a temporary difference
on its income statements. Of this
amount, $600 is allocable to effectively
connected income. The amount
recognized for income statement
purposes in 2016 is $250. FC reports
this amount on Part II, line 19, column
(a). In column (b), FC reports $750 as a
temporary book-to-tax difference to
adjust to the amount recognized by the
foreign corporation in 2016 under U.S.
tax principles. In column (d), FC
reverses $400 as income allocable to
noneffectively connected income.
Finally, in column (e), FC reports $600,
the amount includible on FC's Form
1120-F as effectively connected income
in 2016.
In 2017, assuming no other
commission income is earned or
accrued for either financial or U.S. tax
purposes, FC would include $750 on
Part II, line 19, column (a), the amount
recognized currently for financial
purposes. FC would then reverse the
$750 in column (b) as a temporary
difference since this amount was
previously recognized for U.S. tax
purposes.

Line 20. Original Issue
Discount, Imputed Interest, and
Phantom Income

Report on line 20 any amounts of
original issue discount (OID), other
imputed interest, phantom income, or
OID includible on line 16a. The term
“original issue discount and other
imputed interest” includes, but is not
limited to:
1. The excess of a debt instrument's
stated redemption price at maturity over
its issue price, as determined under
section 1273;
2. Amounts that are imputed interest
on a deferred sales contract under
section 483;
3. Amounts treated as interest or
OID under the stripped bond rules under
section 1286;

4. Amounts treated as OID under
the below-market interest rate rules
under section 7872; and
5. Amounts recognized as phantom
income with respect to a noneconomic
residual interest in a Real Estate
Mortgage Investment Conduit (REMIC),
including inducement fees recognized
with respect to such interests.
Note. Phantom income is a term used
to describe taxable income that may be
derived from the holding of ownership
interests in an asset securitization
vehicle. The income is "phantom"
because it is not economic income (i.e.,
there is no cash or other property
actually received or available for
distribution to the equity holder). Income
with respect to a residual interest in
REMICs is referred to as excess
inclusion income and is subject to
special rules in the Code and
regulations. In a non-REMIC vehicle, it
may take the form of OID derived from
deep-discount debt held as collateral in
the asset securitization entity.
Foreign corporations that accrue
phantom income with respect to
residual interests in REMICs that are not
recognized under the foreign
corporation's accounting regime must
show all book-to-tax gross phantom
income differences as permanent
differences in column (c), whether or not
it is effectively connected with a trade or
business and whether or not the REMIC
interests are recorded on set(s) of
books that are reportable on Form
1120-F, Schedule L. Amounts that are
not effectively connected with the
foreign corporation's trade or business
must be reversed and shown as a
negative number in column (d).
Example 30. FC is a foreign bank
that acquires and holds noneconomic
residual interests in a REMIC on set(s)
of books that are reportable on Form
1120-F, Schedule L. Under the foreign
corporation's accounting system, the
amounts are not recognized for financial
income reporting purposes and are
treated as permanent differences. FC
reports no amounts on Part II, line 20,
column (a), for each year that phantom
income/deduction is recorded under
U.S. tax principles. In column (c), FC
records phantom income as a
permanent difference because such
amounts are not recognizable under the
foreign corporation's accounting regime.
The amounts are effectively connected
with FC's trade or business and
therefore, are also reported in column
(e).

Example 31. The facts are the
same as in Example 30, except that the
phantom income is treated as
noneffectively connected income by FC
and subject to tax under section 881(a).
FC must report the phantom income as
a permanent difference on Part II,
line 20, column (c) and then reverse the
amount in column (d) as noneffectively
connected income. No amount is
reported in column (e). The full amount
of phantom income recognized in
column (c) is reportable on Form
1120-F, Section I, line 10, as other fixed
or determinable, annual, or other
periodic income and subject to tax at
30%.
Example 32. The facts are the
same as in Example 30, except FC
recognizes $100 of residual excess
inclusion income on its set(s) of books
and records reportable on Form 1120-F,
Schedule L, for cash received, and an
additional $1,000 of phantom income
not recognized for financial accounting
purposes. FC treats $100 as effectively
connected income. FC reports on Part
II, line 20, $100 in column (a), $1,000 in
column (c), ($1,000) in column (d), and
$100 in column (e). The $1,000
reversed in column (d) is reportable on
Form 1120-F, Section I, line 10, as in
Example 31.

Line 21a. Income Statement
Gain/Loss on Sale, Exchange,
Abandonment, Worthlessness,
or Other Disposition of Assets
Other Than Inventory and
Pass-Through Entities

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

Line 21b. Gross Capital Gains
from Schedule D, Excluding
Amounts from Pass-Through
Entities

Report on line 21b, gross capital gains
reported on Schedule D (Form 1120),
Capital Gains and Losses, excluding
capital gains from pass-through entities
that are included on line 9, 10, or 11, as
applicable.

Line 21c. Gross Capital Losses
from Schedule D, Excluding
Amounts from Pass-Through
Entities, Abandonment Losses,
and Worthless Stock Losses

Report on line 21c, gross capital losses
reported on Schedule D (Form 1120),
excluding capital losses from (a)
pass-through entities that are included
on line 9, 10, or 11, as applicable; (b)
abandonment losses, which must be
reported on Part II, line 21e; and (c)
worthless stock losses, which must be
reported on Part II, line 21f. Do not
report on line 21c capital losses carried
over from a prior tax year and utilized in
the current tax year. See the instructions
for Part II, line 22, regarding the
reporting requirements for capital loss
carryovers utilized in the current tax
year.

Line 21d. Net Gain/Loss
Reported on Form 4797,
Line 17, Excluding Amounts
from Pass-Through Entities,
Abandonment Losses, and
Worthless Stock Losses

Report on line 21d the net gain or loss
reported on line 17 of Form 4797, Sales
of Business Property, excluding
amounts from (a) pass-through entities
included on line 9, 10, or 11, as
applicable; (b) abandonment losses,
which must be reported on Part II,
line 21e; and (c) worthless stock losses,
which must be reported on Part II,
line 21f.
Note. Traders in securities or
commodities that have made a valid
election under section 475(f) to use the
mark-to-market method to account for
securities or commodities, see the
instructions for Part II, lines 14a through
14d, earlier.

Line 21f. Worthless Stock
Losses

Report on line 21f any worthless stock
loss, regardless of whether the loss is
characterized as an ordinary loss or a
capital loss. See Regulations section

-20-

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

Line 21g. Other Gain/Loss on
Disposition of Assets Other
Than Inventory

Report on line 21g any gains or losses
from the sale or exchange of property
other than inventory and that are not
reported on lines 21b through 21f.

Line 22. Capital Loss Limitation
and Carryforward Used

Report as a positive amount on line 22,
column (b) or (c), as applicable, and
column (e) the excess of the net capital
losses over the net capital gains
reported on Schedule D (Form 1120) by
the corporation.
If the corporation utilizes a capital
loss carryforward on Schedule D (Form
1120) in the current tax year, report the
carryforward utilized as a negative
amount on Part II, line 22, columns (b)
or (c), as applicable, and column (e).

Line 23. Gross Effectively
Connected Income of Foreign
Banks from Books That Do Not
Give Rise to U.S. Booked
Liabilities

Line 23 applies only to foreign banks (as
described in Regulations section
1.882-5(c)(4)). Foreign banks report in
columns (d) and (e), the gross
effectively connected income or loss
(other than income or loss from a global
dealing operation) that is excluded from
the set(s) of books reportable on Form
1120-F, Schedule L, and excluded from
the net income shown on Part I, line 11.
Gross effectively connected income or
loss of this type is that which is
ordinarily recorded on books of
non-U.S. branches or locations that do

not ordinarily engage in effectively
connected income producing activities,
such as income from securities
recorded in a home office that are
attributable to a U.S. office under
Regulations section 1.864-4(c)(5)(iii).
Gross effectively connected income or
loss reportable on line 23 is also income
of a type that is recognized under
sections 864(c)(6) and 864(c)(7) with
respect to property that ceases to be
held in connection with a trade or
business within the United States (e.g.,
transferred securities of a non-banking,
financing or similar business or of a
former banking, financing or similar
business) or that is recognized under
the Code at a time subsequent to
cessation of the trade or business within
the United States. Amounts from a
global dealing operation that are
apportionable in whole or in part to
effectively connected income, are
reported on line 16 and not on this
line 23.
Example 33. FC, a foreign bank,
negotiates and solicits a portfolio of
loans and municipal bonds that are
attributable to its U.S. office under
Regulations section 1.864-4(c)(5)(iii).
FC also enters into a number of forward
contracts for customers through its U.S.
trade or business. These contracts are
not entered into in connection with a
global securities dealing operation. The
transactions are initially recorded on
FC's set(s) of books that are reported on
Form 1120-F, Schedule L. In a later
year, FC transfers several of the loans,
the forward contracts and the municipal
bonds to its home office in Country X to
be held other than in connection with a
global securities dealing operation.
These assets are recorded in FC's
home office on set(s) of books that do
not give rise to U.S. booked liabilities
under Regulations section 1.882-5(d)(2)
(iii). As a result, the transferred assets
are no longer reportable on Form
1120-F, Schedule L.
Report on Part II, line 23, column (c),
as a negative number, the amount of the
effectively connected municipal bond
interest. The municipal bond interest is
a permanent difference that must be
reversed in column (d) since it is no
longer taken into account in column (a)
on FC's set(s) of books reportable on
Schedule L.
Report on Part II, line 23, column (d),
the gross income, gains and (losses)
from the transferred loans and municipal
bond securities and forward contracts
that is effectively connected with the
foreign bank's trade or business within
-21-

the United States. Report the income
and gains as positive numbers and
losses as negative amounts.
Report on Part II, line 23, column (e),
the combined column (b), (c), and (d)
amounts to determine the aggregate
amount of effectively connected gross
income, gains (losses) from the
transferred loan securities and forward
contracts. The tax-exempt municipal
bond interest is netted to zero in column
(e).
Treaty-based reporting. If a
corporation excludes any amounts from
column (a) on the grounds that it is
reporting the books of a U.S. permanent
establishment (see Adaptation of Form
1120-F, Schedule L for treaty-based
reporting, earlier, in these instructions
for such reporting) and further excludes
from the same line any amounts from
column (e) that would otherwise be
reportable under Code principles, the
corporation should report the
Code-based amount in column (c) and
reverse the amount in column (d), with a
footnote reference explaining that
column (d) reports a treaty-based
exclusion, or attach a statement which
identifies the portion of such exclusion
reported in the total amount shown in
column (d).

Line 24. Other Income (Loss)
Items with Differences

Separately state and adequately
disclose on Part II, line 24, all items of
income (loss) with differences that are
not otherwise listed on Part II, lines 1
through 23. Attach a statement that
describes and itemizes the type of
income (loss) and the amount of each
item and provides a description that
states the income (loss) name for book
purposes for the amount recorded in
column (a) and describes the
adjustment being recorded in column
(b), (c), or (d). The entire description
completes the tax description for the
amount included in column (e) for each
item separately stated on this line.
The attached statement should have
six columns. The first column has the
description for the next five columns.
The second column is column (a),
income (loss) per income statement.
The third column is column (b),
temporary differences. The fourth
column is column (c), permanent
differences. The fifth column is column
(d), other permanent differences for
allocations to non-ECI and ECI. The
sixth column is column (e), income
(loss) per tax return. For each item listed
on the attached statement for line 24,

columns (a) through (d) when combined
must equal column (e). The amounts in
columns (a) through (e) for all items
must be totaled on the attached
statement and the total amounts must
be included on Part II, line 24.
If any “comprehensive income” as
defined by Statement of Financial
Accounting Standards (SFAS) No. 130
is reported on this line, describe the
item(s) in detail. Foreign corporations
may report on line 24 net income (loss)
from their distributive share of foreign
partnership interests that do not have
any U.S. source or effectively
connected income, that the foreign
corporation does not report on line 10.
The aggregate income from such
partnerships should be reported on
line 24, column (d), as a negative
number.

Line 26. Total Expense/
Deduction Items

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

Line 27. Other Items with No
Differences

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

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

Lines 1 Through 4. Income Tax
Expense

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

Line 5. Non-U.S. Withholding
Taxes

Report on line 5, column (a), the amount
of non-U.S. (foreign) withholding taxes
included in determining adjusted
financial net income on Part I, line 11. If
the corporation is deducting any foreign
withholding tax, use column (b), (c), or
(d), as applicable, to report any
difference between foreign withholding
tax included in financial accounting net
income and the amount of any foreign
withholding tax deduction reported in
column (e). If the corporation is crediting
foreign withholding taxes against its
U.S. income tax liability, no amount is
reported in column (e).

Line 6. Corporate Officer's
Compensation with Section
162(m) Limitation

Report on line 6, column (a), the total
amount of non-performance-based
current compensation expense
(“applicable employee remuneration”)
for corporate officers that are “covered
employees” under section 162(m)(3).
Report in column (b) or (c) as
applicable, the nondeductible amount of
current compensation in excess of $1
million ($500,000 if the corporation
-22-

receives or has received financial
assistance under the Treasury Troubled
Asset Relief Program (TARP)). Report
the noneffectively connected portion of
the deductible compensation in column
(d), and the deductible portion of the
compensation allocable to effectively
connected income in column (e). Do not
report the “applicable employee
remuneration” for “covered employees”
defined under section 162(m) on line 8,
9, or 15.

Line 7. Salaries and Other Base
Compensation

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

Line 8. Stock Option Expense

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

Line 9. Other Equity-Based
Compensation

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

Line 10. Meals and
Entertainment

Report on line 10, column (a), any
amounts paid or accrued by the
corporation during the tax year for
meals, beverages, and entertainment
that are accounted for in financial
accounting income, regardless of the
classification, nomenclature, or
terminology used for such amounts, and
regardless of how or where such
amounts are classified in the
corporation's financial income statement
or the income and expense accounts
maintained in the corporation's books

and records. Report only amounts not
otherwise reportable elsewhere on
Schedule M-3, Parts II and III (e.g., Part
II, line 2).

Line 11. Fines and Penalties

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

Line 12. Judgments, Damages,
Awards, and Similar Costs

Report on line 12, column (a), the
amount of any estimated or actual
judgments, damages, awards,
settlements, and similar costs, however
named or classified, included in
financial accounting income, regardless
of whether the amount deducted was
attributable to an estimate of future
anticipated payments or actual
payments. Also report on line 12,
column (a), the reversal of any
overaccrual of any amount described in
this paragraph.

Report on line 12, column (e), any
such amounts as are described in the
preceding paragraph that are includible
in taxable income, regardless of the
financial accounting period in which
such amounts were or are included in
financial accounting net income.
Complete columns (b), (c), and (d), as
appropriate.
Do not report on this line 12, amounts
required to be reported in accordance
with instructions for Part III, line 11.
Do not report on this line 12, amounts
recovered from insurers or any other
indemnitors for any judgments,
damages, awards, or similar costs
described above.

Line 13. Pension and
Profit-Sharing

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

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

Line 15. Deferred
Compensation

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

Line 16. Charitable
Contributions

Report on line 16 any charitable
contribution of tangible or intangible
property to a U.S. or foreign charity. For
example, include contributions of:
-23-

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

Line 17. Domestic Production
Activities Deduction

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

Line 18. Current Year
Acquisition or Reorganization
Investment Banking Fees,
Legal and Accounting Fees

Report on line 18 any investment
banking fees, and any legal and
accounting fees paid or incurred in
connection with a taxable or tax-free
acquisition of property (e.g., stock or
assets) or a tax-free reorganization.
Report on this line any investment
banking fees incurred at any stage of
the acquisition or reorganization
process including, for example, fees
paid or incurred to evaluate whether to
investigate an acquisition, fees to

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

Line 19. Current Year
Acquisition/Reorganization
Other Costs

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

Line 20. Amortization/
Impairment of Goodwill

Report on line 20 amortization of
goodwill or amounts attributable to the
impairment of goodwill.

Line 21. Amortization of
Acquisition, Reorganization,
and Start-Up Costs

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

Line 22. Other Amortization or
Impairment Write-Offs

Report on line 22 any amortization or
impairment write-offs not otherwise
includible on Schedule M-3.

Line 23. Depreciation

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

Line 24. Bad Debt Expense

Report on line 24, column (a), any
amounts attributable to an allowance for
uncollectible accounts receivable or
actual write-offs of accounts receivable
included in determining net income per
the income statement. Report in

columns (d) and (e) the respective
noneffectively connected and the
effectively connected portions of the
deductible amount of bad debt expense
determined under section 166 for
federal income tax purposes that is also
included in column (a). If a foreign bank
has an effectively connected bad debt
expense that is not reportable in column
(a), the ECI amount is included in
column (b) if it is a temporary difference
and in column (e) to report the ECI
treatment. If there is no temporary
difference between the foreign bank's
books and tax treatment, then such ECI
amount that is not included in column
(a) is apportioned in column (d), and its
total is reflected in column (e).

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

Note. See the instructions for Part II,
line 17, earlier, for sellers and/or
lessors.

Asset transfer transactions with periodic
payments characterized for financial
accounting purposes as either a
purchase or a lease may, under some
circumstances, be characterized as the
opposite for tax purposes.
If a transaction is treated as a lease,
the purchaser/lessee reports the
periodic payments as gross rental
expense. If the transaction is treated as
a purchase, the purchaser/lessee
reports the periodic payments as
payments of principal and interest and
also reports depreciation expense or
deduction with respect to the purchased
asset.
Report on line 25, column (a), gross
rent expense for a transaction treated
as a lease for income statement
purposes but as a sale for U.S. income
tax purposes. Report on line 25, column
(e), gross rental deductions for a
transaction treated as a lease for U.S.
income tax purposes but as a purchase
for income statement purposes. Report
interest expense for such transactions
on Part III, lines 26a through 26e,
columns (a) and (e), as applicable.
Report depreciation expense or
deductions for such transactions on Part
III, line 23 (depreciation), columns (a)
and (e), as applicable. Use columns (b),
(c), and (d) of Part III, lines 23, 25, and
26a through 26e, as applicable, to
report the differences between columns
(a) and (e) for such recharacterized
transactions.

-24-

Line 26a. Interest Expense Per
Books

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

Line 26b. Interest Expense
Allocable under Regulations
Section 1.882-5

The interest expense deduction under
Regulations section 1.882-5 is based on
a three-step formula required to be
reported on Schedule I (Form 1120-F).
Report the allocable amount of interest
expense from Schedule I, line 23, in
column (d) and in column (e) of line 26b.

Line 26c. Regulations Section
1.882-5 Allocation Amount
Subject to Deferral or
Disallowance

Enter in column (e) the amount reported
on Schedule I (Form 1120-F), line 24d.
This amount is generally entered in
column (e) as a negative number.
However, if the deferred interest

expense reportable on Schedule I,
line 24b, from prior years is deductible
in the current year in greater amount
than other current year disallowances
reportable on Schedule I, lines 24a and
24c, enter the net amount in column (e)
as a positive number.
Enter in column (b) the amount from
Schedule I, line 24b, as a positive or
negative number as the case may be for
the current year. In column (c), enter the
combined amounts from Schedule I,
lines 24a and 24c.

Line 26d. Substitute Interest
Payments

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

Line 26e. Interest Equivalents
(Guarantee Fees)

All foreign corporations, report on
line 26e the foreign corporation's
amounts with respect to deductions that
are not interest payments but are
sourced to the recipient in the manner of
interest (“interest equivalents”). These
amounts include fees expensed for
financial guarantee and confirmation,
acceptance and standby letter of credit
transactions. Foreign banks that record
U.S. source guarantee fees on set(s) of

books not reported on Form 1120-F,
Schedule L, and not reported in column
(a), must report the U.S. source fees as
a permanent difference on line 26e,
column (c), and allocate and apportion
the relevant amounts to noneffectively
connected income in column (d) even if
there is no amount to allocate to
effectively connected amounts in
column (e). Foreign corporations other
than banks must record all interest
equivalent payments in column (a).

column (c) are apportioned to
noneffectively connected income of the
foreign corporation in column (d) and
reported as a negative number.
Amounts included in column (a) that are
also apportioned to non-ECI, are also
reported in column (d) as a negative
number. The combined amounts of
columns (a), (b), (c), and (d) are
apportioned to effectively connected
income in column (e) as the case may
be.

Note. In using column (d) to apportion
amounts to non-ECI that are not
included in column (a), line 26e contains
an exception to the general instructions
for Schedule M-3 reporting by foreign
banks.

Note. In using column (d) to apportion
amounts to non-ECI that are not
included in column (a), line 27 contains
an exception to the general instructions
for Schedule M-3 reporting by foreign
banks.

Example 34. FC is a foreign bank,
resident in Country X, that files Form
1120-F and Schedule M-3. FC enters
into a guarantee arrangement with FC2,
a wholly owned subsidiary, resident in
Country Y, that guarantees the
transactions in FC's global dealing
operation. The set(s) of books in FC's
global dealing operation are booked in
FC's home office and are not reportable
on Form 1120-F, Schedule L. FC
allocates and apportions 40% of the
income and applicable expenses from
its global dealing operation to effectively
connected taxable income. FC's
guarantee fee expense paid to its
foreign-related party is allocated directly
to the income of the global dealing
operation and apportioned 40% to FC's
effectively connected income from such
operation. FC must report the guarantee
fee expense paid to FC2 in column (c).
The amount of expense reported in
column (c) is apportioned 60% to
noneffectively connected income in
column (d) and 40% to effectively
connected income in column (e).

Line 28. Fee and Commission
Expense

Line 27. Substitute Dividend
Payments

All foreign corporations report on line 27
the amount of U.S. source substitute
dividend payments with respect to
securities lending transactions
described in Regulations sections
1.861-3(a)(6) and 1.881-2(b)(2).
Foreign banks that record substitute
dividend payments on set(s) of books
that are not reported on Form 1120-F,
Schedule L, also might report foreign
source substitute dividend payments
whether or not they are allocable in
whole or in part to ECI. Foreign banks
report in column (c), U.S. source and
allocable foreign source substitute
dividends not already reflected in
column (a). The amounts reported in
-25-

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

Line 29. Rental Expense

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

Line 30. Royalty Expense

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

Line 31. Expenses Allocable
Under Regulations Section
1.861-8

Line 31 applies only to foreign banks.
For purposes of Schedule M-3, all of the
home office and other allocations to
U.S. effectively connected income that
are reportable on Schedule H (Form
1120-F) under Regulations section
1.861-8 (including amounts that are
subject to timing differences under U.S.
tax principles, such as home office
depreciation) are reportable as
apportionments to ECI in column (d).

Report in columns (d) and (e) the
amount from Schedule H, line 20.
Note. Foreign corporations other than
banks that are required to file Form
1120-F to report effectively connected
income in Section II of that form, are still
required to complete and attach
Schedule H to their U.S. income tax
return. The amounts from Schedule H,
line 20, are not reportable by a foreign
corporation other than a bank on this
line of Schedule M-3 because
worldwide expenses are already
includible in Part I, line 11, and in each
expense line item in Part III. Such
amounts are subject to individual
line-item apportionment to non-ECI in
column (d).

Line 32. Other Expense/
Deduction Items with
Differences and Reconciliation
to Eliminate Duplicate Amounts
on Line 31

Separately state and adequately
disclose on line 32, all items of expense/
deduction that are not otherwise listed
on Part III, lines 1 through 31. Amounts
included on line 31, column (e) from
Schedule H (Form 1120-F), line 20, that
are also included in this Schedule M-3,
Part III, lines 3, 5 through 23, 25, 26d,
26e, and 27, need to be reversed to
avoid duplicate allocation. The
combined amounts for these lines
reported in column (e) that is duplicative
of any amount included in line 31,
column (e), is reported and reversed on
line 32. Report such duplicative amount
as a negative amount includible in
line 32, column (c) and column (e).
Such negative amount will need to be
combined with other expense/deduction
items that have differences. Attach a
statement to show the duplicative items
that are being reversed.
Attach a statement that describes
and itemizes the type of expense/
deduction and the amount of each item,
and provides a description that states
the expense/deduction name for book
purposes for the amount recorded in
column (a) and describes the
adjustment being recorded in column
(b), (c), or (d). The entire description
completes the tax description for the
amount included in column (e) for each
item separately stated on this line.
The statement attached to the
Schedule M-3 for line 32 must
separately state and adequately
disclose the nature and amount of the
expense related to each reserve and/or
contingent liability. The appropriate level

of disclosure depends upon each
taxpayer’s operational activity and the
nature of its accounting records. For
example, if a corporation’s net income
amount reported in the income
statement includes anticipated
expenses for a discontinued operation
as a single amount, and its general
ledger or other books, records, and
workpapers provide details for the
anticipated expenses under more
explanatory and defined categories
such as employee termination costs,
lease cancellation costs, loss on sale of
equipment, etc., a supporting statement
that lists those categories of expenses
and their details will satisfy the
requirement to separately state and
adequately disclose. In order to
separately state and adequately
disclose the employee termination
costs, it is not required that an
anticipated termination cost amount be
listed for each employee, or that each
asset (or category of asset) be listed
along with the anticipated loss on
disposition.
The attached statement should have
six columns. The first column has the
description for the next five columns.
The second column is column (a),
expense per income statement. The
third column is column (b), temporary
differences. The fourth column is
column (c), permanent differences. The
fifth column is column (d), other
permanent differences for allocations to
non-ECI and ECI. The sixth column is
column (e), deduction per tax return. For
each item listed on the attached
statement for line 32, columns (a)
through (d) when combined must equal
column (e). The amounts in columns (a)
through (e) for all items must be totaled
on the attached statement and the total
amounts must be included on line 32 of
the face of the statement.
Comprehensive income. If any
“comprehensive income” as defined by
SFAS No. 130 is reported on this line,
describe the item(s) in detail.
Reserves and contingent liabilities.
Report on line 32 amounts related to the
change in each reserve or contingent
liability that is not required to be
reported elsewhere on Schedule M-3.
For example: (1) amounts relating to
changes in reserves for litigation must
be reported on Part III, line 12
(judgments, damages, awards, and
similar costs), and (2) amounts relating
to changes in reserves for uncollectible
accounts receivable must be reported
on Part III, line 24 (bad debt expense).
-26-

Report on line 32, the amortization of
various items of prepaid expense, such
as prepaid subscriptions and license
fees, prepaid insurance, etc.
Report on line 32, column (a),
expenses included in net income
reported on Part I, line 11, that are
related to reserves and contingent
liabilities. Report on line 32, column (e),
amounts related to liabilities for reserves
and contingent liabilities that are
deductible in the current tax year for
U.S. income tax purposes. Examples of
reserves that are allowed for book
purposes, but not for tax purposes,
include warranty reserves, restructuring
reserves, reserves for discontinued
operations, and reserves for
acquisitions and dispositions. Only
report on line 32 items that are not
required to be reported elsewhere on
Schedule M-3, Parts II and III.
Amounts incurred as fixed or
determinable or other periodic interest
rate or equity notional principal contract
expense that is not incurred in a
hedging transaction, securities dealing
or global securities dealing operation,
each of which is reportable on Part II,
are reportable on Part III, line 32.
Example 35. Corporation Q is a
calendar year taxpayer that is required
to file Schedule M-3 for the current tax
year. On July 1 of each year, Q has a
fixed liability for its annual insurance
premiums on its home office building
that provides a 12-month coverage
period beginning July 1 through June
30. In addition, Q historically prepays 12
months of advertising expense on July
1. On July 1, 2016, Q prepays its
insurance premium of $500,000 and
advertising expenses of $800,000. For
statutory accounting purposes, Q
capitalizes and amortizes the prepaid
insurance and advertising over 12
months. For U.S. income tax purposes,
Q deducts the insurance premium when
paid and amortizes the advertising over
the 12-month period. In its annual
statement, Q treats the differences
attributable to the annual statement
treatment and U.S. income tax
treatment of the prepaid insurance and
advertising as temporary differences.
Q also has a legal reserve where
$300,000 was expensed for financial
accounting purposes and a ($100,000)
temporary difference was calculated to
arrive at the income tax deduction of
$200,000. The statement attached to
Q’s return for Part III, line 32, must be
separately stated and adequately
disclosed as indicated in the table
below.

Line 33. Total Expense/
Deduction Items

Report on Part II, line 26, columns (a)
through (e), as applicable, the inverse of

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

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

Line 32—Example 35
Statement Concerning Other Expense/Deduction Items With Differences

Column (a)
Expense per
Income Statement

Column (b)
Temporary
Difference

Column (c)
Permanent
Difference

Column (d)
Other
Permanent
Differences for
Allocations to
non-ECI and ECI

Prepaid insurance
premium expensed not
capitalized

$250,000

$250,000

-0-

-0-

$500,000

Legal expense reserve

$300,000

($100,000)

-0-

-0-

$200,000

Total Line 32

$550,000

$150,000

-0-

-0-

$700,000

Description

-27-

Column (e)
Deduction per Tax
Return