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SUPPLEMENTARY INFORMATION:

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9959]
RIN 1545–BP70

Guidance Related to the Foreign Tax
Credit; Clarification of Foreign-Derived
Intangible Income
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:

This document contains final
regulations relating to the foreign tax
credit, including the disallowance of a
credit or deduction for foreign income
taxes with respect to dividends eligible
for a dividends-received deduction; the
allocation and apportionment of interest
expense, foreign income tax expense,
and certain deductions of life insurance
companies; the definition of a foreign
income tax and a tax in lieu of an
income tax; the definition of foreign
branch category income; and the time at
which foreign taxes accrue and can be
claimed as a credit. This document also
contains final regulations clarifying
rules relating to foreign-derived
intangible income (FDII). The final
regulations affect taxpayers that claim
credits or deductions for foreign income
taxes, or that claim a deduction for FDII.
DATES:
Effective date: These regulations are
effective on March 7, 2022.
Applicability dates: For dates of
applicability, see §§ 1.164–2(i),
1.245A(d)–1(f), 1.336–5, 1.338–9(d)(4),
1.367(b)–7(h), 1.367(b)–10(e), 1.861–
3(e), 1.861–9(k), 1.861–10(h), 1.861–
14(k), 1.861–20(i), 1.901–1(j), 1.901–
2(h), 1.903–1(e), 1.904–6(g), 1.905–1(h),
1.905–3(d), 1.951A–7, and 1.960–7.
FOR FURTHER INFORMATION CONTACT:
Concerning §§ 1.245A(d)–1, 1.336–2,
1.338–9, 1.861–3, 1.861–20, 1.904–6,
1.960–1, and 1.960–2, Suzanne M.
Walsh, (202) 317–4908; concerning
§§ 1.250(b)–1, 1.861–8, 1.861–9, and
1.861–14, Jeffrey P. Cowan, (202) 317–
4924; concerning § 1.250(b)–5, Brad
McCormack, (202) 317–6911;
concerning §§ 1.164–2, 1.901–1, 1.901–
2, 1.903–1, 1.905–1, and 1.905–3,
Tianlin (Laura) Shi, (202) 317–6987;
concerning §§ 1.367(b)–3, 1.367(b)–4,
and 1.367(b)–10, Logan Kincheloe, (202)
317–6075; concerning §§ 1.367(b)–7,
1.861–10, and 1.904–4, Jeffrey L. Parry,
(202) 317–4916; concerning §§ 1.951A–
2 and 1.951A–7, Jorge M. Oben and
Larry Pounders, (202) 317–6934 (not
toll-free numbers).

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SUMMARY:

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Background
On December 7, 2018, the Treasury
Department and the IRS published
proposed regulations (REG–105600–18)
relating to foreign tax credits in the
Federal Register (83 FR 63200) (the
‘‘2018 FTC proposed regulations’’).
Those regulations addressed several
significant changes that the Tax Cuts
and Jobs Act (Pub. L. 115–97, 131 Stat.
2054 (2017)) (the ‘‘TCJA’’) made with
respect to the foreign tax credit rules
and related rules for allocating and
apportioning deductions in determining
the foreign tax credit limitation. Certain
portions of the 2018 FTC proposed
regulations were finalized as part of TD
9866, published in the Federal Register
(84 FR 29288) on June 21, 2019. The
remaining portions of the 2018 FTC
proposed regulations were finalized in
TD 9882, published in the Federal
Register on December 17, 2019 (84 FR
69022) (the ‘‘2019 FTC final
regulations’’). On the same date, new
proposed regulations (REG–105495–19)
addressing changes made by the TCJA
as well as other related foreign tax credit
rules were published in the Federal
Register (84 FR 69124) (the ‘‘2019 FTC
proposed regulations’’). Correcting
amendments to the 2019 FTC final
regulations and the 2019 FTC proposed
regulations were published in the
Federal Register on May 15, 2020. See
85 FR 29323 (2019 FTC final
regulations) and 85 FR 29368 (2019 FTC
proposed regulations). The 2019 FTC
proposed regulations were finalized as
part of TD 9922, published in the
Federal Register (85 FR 71998) on
November 12, 2020 (the ‘‘2020 FTC final
regulations’’). On the same date, the
Treasury Department and the IRS
published proposed regulations (REG–
101657–20) in the Federal Register (85
FR 72078) (the ‘‘2020 FTC proposed
regulations’’). The 2020 FTC proposed
regulations addressed changes made by
the TCJA and other foreign tax credit
issues. Correcting amendments to the
2020 FTC final regulations were
published in the Federal Register on
October 1, 2021. See 86 FR 54367. A
public hearing on the 2020 FTC
proposed regulations was held on April
7, 2021.
On July 15, 2020, the Treasury
Department and the IRS finalized
regulations under section 250 (the
‘‘section 250 regulations’’) in TD 9901,
published in the Federal Register (85
FR 43042). The 2020 FTC proposed
regulations also included revisions to
the section 250 regulations.
This document contains final
regulations (the ‘‘final regulations’’)

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addressing the following: (1) The
determination of foreign income taxes
subject to the credit and deduction
disallowance provisions of section
245A(d); (2) the determination of oil and
gas extraction income from domestic
and foreign sources and of electronically
supplied services under the section 250
regulations; (3) the impact of the repeal
of section 902 on certain regulations
issued under section 367(b); (4) the
sourcing of inclusions under sections
951, 951A, and 1293; (5) the allocation
and apportionment of interest
deductions of certain regulated utilities;
(6) a revision to the controlled foreign
corporation (‘‘CFC’’) netting rule; (7) the
allocation and apportionment of section
818(f)(1) items of life insurance
companies that are members of
consolidated groups; (8) the allocation
and apportionment of foreign income
taxes, including taxes imposed with
respect to disregarded payments; (9) the
definitions of a foreign income tax and
a tax in lieu of an income tax, including
changes to the net gain requirement, the
replacement of the jurisdictional nexus
rule with an attribution rule contained
in the net gain requirement, the
treatment of certain tax credits, the
treatment of foreign tax law elections for
purposes of the noncompulsory
payment rules, and the substitution
requirement under section 903; (10) the
allocation of the liability for foreign
income taxes in connection with certain
mid-year transfers or reorganizations;
(11) the foreign branch category rules in
§ 1.904–4(f); and (12) the time at which
credits for foreign income taxes can be
claimed pursuant to sections 901(a) and
905(a).
This rulemaking finalizes, without
substantive change, certain provisions
in the 2020 FTC proposed regulations
with respect to which the Treasury
Department and IRS did not receive any
comments. See §§ 1.164–2(d), 1.250(b)–
1(c), 1.250(b)–5, 1.336–2(g)(3), 1.338–
9(d), 1.367(b)–2, 1.367(b)–3, 1.367(b)–4,
1.367(b)–7, 1.367(b)–10, 1.461–1, 1.861–
3(d), 1.861–8(e)(4), 1.861–8(e)(8)(v),
1.861–9(g)(3), 1.861–10(e)(8)(v), 1.861–
10(f), 1.901–1, 1.901–2(e)(4), 1.901–2(f),
1.904–4(b), 1.904–4(c), 1.904–6, 1.905–
3, 1.954–1, 1.960–1, and 1.960–2. These
provisions are generally not discussed
in this preamble.
No comments were received with
respect to the transition rules contained
in the 2020 FTC proposed regulations to
account for the effect on loss accounts
of net operating loss carrybacks to pre2018 taxable years that are allowed
under the Coronavirus Aid, Relief, and
Economic Security Act, Public Law
116–136, 134 Stat. 281 (2020). Section
1.904(f)–12(j) was finalized without

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change in TD 9956, published in the
Federal Register (86 FR 52971) on
September 24, 2021.
Comments that do not pertain to the
2020 FTC proposed regulations, or that
are otherwise outside the scope of this
rulemaking, are generally not addressed
in this preamble but may be considered
in connection with future guidance
projects.
The rules contained in proposed
§ 1.861–9(k) (election to capitalize
certain expenses in determining tax
book value of assets), § 1.861–10(g)
(requiring the direct allocation of
interest expense in the case of certain
foreign banking branches), and
§§ 1.904–4(e)(1)(ii) and 1.904–5(b)(2)
(relating to the definition of financial
services income) are not finalized in this
document. The Treasury Department
and the IRS are continuing to study the
comments received in connection with
those provisions.

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Summary of Comments and
Explanation of Revisions
I. Disallowance of Foreign Tax Credit or
Deduction for Foreign Income Taxes
Under Section 245A(d)
Proposed § 1.245A(d)–1(a) generally
provided that neither a credit under
section 901 nor a deduction is allowed
for foreign income taxes (as defined in
§ 1.901–2(a)) paid or accrued by a
domestic or foreign corporation that are
attributable to a specified distribution or
specified earnings and profits of a
foreign corporation. The proposed rule
defined a specified distribution—in the
case of a distribution to a domestic
corporation—as the portion of a
dividend for which a deduction under
section 245A(a) is allowed, a hybrid
dividend, or a distribution of certain
previously taxed earnings (‘‘PTEP’’)
related to section 245A(d) (‘‘section
245A(d) PTEP’’). In the case of a
distribution to another foreign
corporation, a specified distribution
included the portion of the distribution
attributable to section 245A(d) PTEP, or
a tiered hybrid dividend that gives rise
to a U.S. shareholder inclusion by
reason of section 245A(e)(2) and
§ 1.245A(e)–1(c)(1). Specified earnings
and profits included the portion of the
earnings and profits of a foreign
corporation that would give rise to a
specified distribution if an amount
equal to the entire earnings and profits
of the foreign corporation were
distributed. Specified earnings and
profits also included an amount equal to
the portion of a U.S. return of capital
amount, as that term is defined in
§ 1.861–20(b), that is treated as arising
in a section 245A subgroup, after the

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application of the asset method in
§ 1.861–9. Proposed § 1.245A(d)–1(a)
relied upon the rules in § 1.861–20 to
associate gross income included in the
foreign tax base (‘‘foreign gross
income’’) with these amounts and to
allocate foreign income taxes to the
foreign gross income. The proposed
regulations also included an antiavoidance rule to, for example, prevent
taxpayers from using successive foreign
law distributions to inappropriately
associate withholding tax on the
distributions with PTEP arising from
inclusions under sections 951(a) and
951A(a). See proposed § 1.245A(d)–
1(b)(2). The Treasury Department and
the IRS requested comments on possible
revisions to § 1.861–20 to address these
concerns, including rules to require the
maintenance of separate accounts that
would reflect the effect of foreign law
transactions on the earnings and profits
of a foreign corporation. 85 FR at 72079.
A comment noted that proposed
§ 1.245A(d)–1(a) explicitly treated as
specified earnings and profits the
portion of a U.S. return of capital
amount that is deemed to arise pursuant
to § 1.861–20(d)(3)(i) in a section 245A
subgroup under the asset method of
§ 1.861–9, yet did not explicitly treat
any amount as specified earnings and
profits when the asset method of
§ 1.861–9 applies under proposed
§ 1.861–20(d)(3)(v) to characterize a
disregarded payment that is a
remittance as made from a section 245A
subgroup. The comment also expressed
concerns that proposed § 1.245A(d)–1
did not adequately clarify the treatment
of foreign tax imposed on a distribution
received by a domestic or foreign
corporation with respect to its interest
in a partnership, or on the proceeds of
a disposition of such an interest.
The comment also noted the
uncertainty in proposed § 1.245A(d)–
1(a) over the use of the asset method of
§ 1.861–9 to characterize foreign taxable
income of a CFC and apply the
disallowance rules of section 245A(d),
including when a CFC receives a
distribution that is a U.S. return of
capital amount. The comment stated
that, if the U.S. return of capital amount
is treated as made from earnings in a
section 245A subgroup of the
distributing CFC, the disallowance
under section 245A(d) of foreign taxes
associated with the portion of the
specified earnings and profits
attributable to tested income of the
recipient CFC not included by a United
States shareholder has the inappropriate
effect of double-counting the inclusion
percentage of section 960(d).
With respect to the anti-avoidance
rule of proposed § 1.245A(d)–1(b)(2), the

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comment acknowledged the need to
address successive foreign law
distributions and discussed three
alternative approaches. One approach
would revise § 1.861–20(d)(2)(ii)(A) to
treat a foreign law distribution as made
ratably out of all of a foreign
corporation’s earnings and profits,
including PTEP, if the amount of its
earnings and profits exceeds the foreign
gross income arising from the foreign
law distribution. The second approach
would maintain separate E&P accounts
to track the effect of foreign law
distributions; the comment viewed this
option as overly complex and
burdensome. The third approach would
maintain the anti-avoidance rule of
proposed § 1.245A(d)–1(b)(2) and make
no substantive changes to the operative
rules. The comment indicated that a
flexible, well-articulated anti-avoidance
rule could be more effective at policing
attempts to avoid section 245A(d) than
a series of potentially manipulable
mechanical rules.
The Treasury Department and the IRS
agree that proposed § 1.245A(d)–1 did
not clearly describe the income under
Federal income tax law to which foreign
gross income should be treated as
corresponding for purposes of allocating
and apportioning foreign income taxes
under § 1.860–20. This lack of clarity
resulted in uncertainty in determining
the extent to which foreign income taxes
on a U.S. return of capital amount,
which can arise in a variety of
transactions involving both stock and
partnership interests, should be treated
as attributable to income of a foreign
corporation that would give rise to a
deduction under section 245A(a) when
distributed.
In response to these comments,
§ 1.245A(d)–1(a) is revised to eliminate
references to specified distributions and
specified earnings and profits. Instead,
§ 1.245A(d)–1(a) of the final regulations
provides that no credit or deduction is
allowed for foreign income taxes
attributable to (1) ‘‘section 245A(d)
income’’ of a domestic corporation, a
successor of a domestic corporation, or
a foreign corporation (see § 1.245A(d)–
1(a)(1)(i)–(ii) and (a)(2)), or (2) ‘‘noninclusion income’’ of a foreign
corporation (see § 1.245A(d)–
1(a)(1)(iii)).
Section 245A(d) income means, in the
case of a domestic corporation,
dividends or inclusions for which a
deduction under section 245A(a) is
allowed, a distribution of section
245A(d) PTEP, and hybrid dividends
and inclusions related to tiered hybrid
dividends under section 245A(e). In the
case of a successor of a domestic
corporation, section 245A(d) income

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means a distribution of section 245A(d)
PTEP. In the case of a foreign
corporation, section 245A(d) income
means an item of subpart F income that
gives rise to an inclusion for which a
deduction under section 245A(a) is
allowed, a tiered hybrid dividend, and
a distribution of section 245A(d) PTEP.
Under § 1.245A(d)–1(b)(1), foreign
income taxes are attributable to section
245A(d) income if the taxes are
allocated and apportioned under
§ 1.861–20 to the statutory grouping
within each section 904 category (the
‘‘section 245A(d) income group’’) to
which section 245A(d) income is
assigned.
Accordingly, the disallowance under
§ 1.245A(d)–1(a) applies not only to
foreign income taxes that are paid or
accrued with respect to certain
distributions and inclusions, but also to
taxes paid or accrued by reason of the
receipt of a foreign law distribution with
respect to stock, a foreign law
disposition, ownership of a reverse
hybrid, a foreign law inclusion regime,
or the receipt of a disregarded payment
described in § 1.861–20(d)(3)(v)(B), to
the extent the foreign income taxes are
attributable to section 245A(d) income.
The disallowance also applies where a
foreign corporation pays or accrues
foreign income taxes that are
attributable to section 245A(d) income
of the foreign corporation, in which case
such taxes are not eligible to be deemed
paid under section 960 in any taxable
year. For example, the disallowance
applies to foreign income taxes paid or
accrued by reason of the receipt by the
foreign corporation of a tiered hybrid
dividend.
These revised rules ensure that
§ 1.861–20, including the rules of
§ 1.861–20(d)(2) for allocating and
apportioning foreign income tax to a
statutory or residual grouping in a year
in which there is no income for Federal
income tax purposes in the grouping,
apply consistently to allocate and
apportion foreign income taxes to the
section 245A(d) income group. The
rules of § 1.861–20(d)(3) apply to
determine the circumstances under
which foreign gross income included by
reason of a dividend or other
distribution with respect to stock, a
partnership distribution, a sale or
exchange of stock, or a sale or exchange
of a partnership interest is assigned to
the section 245A(d) income group.
Non-inclusion income is defined as
income other than subpart F income,
tested income, or income described in
section 245(a)(5), without regard to
section 245(a)(12), (items of income
constituting post-1986 undistributed
U.S. earnings) of a foreign corporation.

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Section 1.245A(d)–1(b)(2)(ii) attributes
foreign income taxes to non-inclusion
income of a foreign corporation to the
extent the foreign income taxes are
allocated and apportioned to the
domestic corporation’s section 245A
subgroup category of stock when
applying § 1.861–20 for purposes of
section 904 as the operative section. The
final rules also attribute foreign income
taxes to the non-inclusion income of a
reverse hybrid or foreign law CFC to the
extent that they are allocated and
apportioned to the non-inclusion
income group under § 1.861–20. See
§ 1.245A(d)–1(b)(2)(iii).
The disallowance under § 1.245A(d)–
1(a)(1)(iii) therefore applies to foreign
income taxes paid or accrued by a
domestic corporation that are
attributable to non-inclusion income of
a foreign corporation in which the
domestic corporation is a United States
shareholder. For example, paragraph
(a)(1)(iii) applies to foreign income taxes
that a domestic corporation that is a
United States shareholder of a foreign
corporation pays or accrues by reason of
its receipt from the foreign corporation
of a distribution that is a U.S. return of
capital amount to the extent the foreign
income taxes are attributable to noninclusion income of the foreign
corporation. The final regulations at
§ 1.245A(d)–1(b)(2)(ii) clarify that this
rule extends to foreign income taxes the
domestic corporation pays or accrues by
reason of a remittance, a distribution
that is a U.S. return of partnership basis
amount, or a disposition that gives rise
to a U.S. return of capital amount or a
U.S. return of partnership basis amount.
The disallowance under paragraph
(a)(1)(iii) also applies to foreign income
taxes that a domestic corporation that is
a United States shareholder pays or
accrues by reason of its ownership of a
reverse hybrid or foreign law CFC, to the
extent the foreign income taxes are
attributable to non-inclusion income of
the reverse hybrid or foreign law CFC
and not otherwise disallowed under
paragraph (a)(1)(i) or (ii).
The proposed anti-avoidance rule in
§ 1.245A(d)–1(b)(2) is finalized without
substantive change at § 1.245A(d)–
1(b)(3). While revising § 1.861–
20(d)(2)(ii)(A) to treat a foreign law
distribution as made ratably out of all of
a foreign corporation’s earnings and
profits would be a potentially feasible
alternative approach, the Treasury
Department and the IRS have
determined that on balance the antiavoidance rule provides an appropriate
framework and the necessary flexibility
to address section 245A(d) avoidance.
Finally, for the avoidance of doubt,
the final regulations clarify that section

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245A(d) operates to deny the credit or
deduction for foreign taxes paid or
accrued with respect to dividends for
which a domestic corporation could
claim a deduction under section 245A,
regardless of whether the corporation
claims the deduction on its return. See
§ 1.245A(d)–1(c)(19) and (21) (defining
section 245A(d) income and section
245A(d) PTEP). See also H.R. Rep. No.
115–466, at 600 (2017) (Conf. Rep.) (‘‘No
foreign tax credit or deduction is
allowed for any taxes paid or accrued
with respect to any portion of a
distribution treated as a dividend that
qualifies for the DRD.’’); id. at 598
(describing section 245A as ‘‘an
exemption for certain foreign income by
means of a 100-percent deduction’’).
II. Section 250 Regulations—Definition
of Electronically Supplied Service
Section 1.250(b)–5 provides rules for
determining whether a service is
provided to a person, or with respect to
property, located outside the United
States and therefore gives rise to foreignderived deduction eligible income
(‘‘FDDEI service’’). The rules identify
specific enumerated categories,
including a category for general services
provided to either consumers or
business recipients. For purposes of
determining whether such a general
service constitutes a FDDEI service, the
rules require the location of the
recipient to be identified.
The regulations contain special rules
in § 1.250(b)–5(d)(2) and § 1.250(b)–
5(e)(2)(iii) for determining the location
at which ‘‘electronically supplied
services’’ are provided. Section
1.250(b)–5(c)(5) defines the term
‘‘electronically supplied service’’ to
mean a general service (other than an
advertising service) that is delivered
primarily over the internet or an
electronic network, and provides that
such services include cloud computing
and digital streaming services. Proposed
§ 1.250(b)–5(c)(5) revised that definition
to clarify that, to qualify as an
electronically supplied service, the
value of the service to the end user must
be derived primarily from the service’s
automation and electronic delivery and
would not include, for example, legal,
accounting, medical or teaching services
‘‘delivered electronically and
synchronously.’’ No comments were
received on the proposed revised
definition of an electronically supplied
service.
By providing the example of
professional or teaching services
provided in real time (synchronously) as
not constituting electronically supplied
services, proposed § 1.250(b)–5(c)(5)
was intended to illustrate cases where

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the primary value of the service was not
in its automation and electronic
delivery. However, this example may
have implied that the temporal aspect of
when the service is rendered, relative to
when the end user accesses that service,
is a determinative factor in constituting
an ‘‘electronically supplied service.’’
The Treasury Department and the IRS
had intended that services accessed by
an end user outside of real time
(asynchronously) also will not
constitute an ‘‘electronically supplied
service’’ if, under all the facts and
circumstances, they primarily involve
human effort. Therefore, the final
regulations remove the reference to
‘‘and synchronously’’ from the fourth
sentence of § 1.250(b)–5(c)(5) to clarify
that the definition does not depend on
whether the services are rendered
synchronously or asynchronously but
rather depend on whether the services
primarily involve human effort.
III. Allocation and Apportionment of
Expenses Under Section 861
Regulations
A. Treatment of Section 818(f)(1) Items
for Consolidated Groups
Proposed § 1.861–14(h) provided that
certain items of life insurance
companies described in section 818(f)(1)
that are members of a consolidated
group are allocated and apportioned on
a life subgroup basis but provided a onetime election to allocate and apportion
these items on a separate company
basis. The one comment received
endorsed the approach in the 2020 FTC
proposed regulations, which are
finalized without change.

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B. Allocation and Apportionment of
Foreign Income Taxes
1. In General
The 2020 FTC proposed regulations
provided more detailed and
comprehensive guidance regarding the
assignment of foreign gross income, and
the allocation and apportionment of the
associated foreign income taxes, to the
statutory and residual groupings in
certain cases. This guidance included
rules for dispositions of stock and
partnership interests, and rules for
transactions that are distributions with
respect to a partnership interest, under
Federal income tax law. It also included
new rules addressing the allocation and
apportionment of foreign income taxes
imposed by reason of disregarded
payments.
2. Dispositions of Stock
Proposed § 1.861–20(d)(3)(i)(D)
provided that the foreign gross income
arising from a transaction that is treated

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as a sale, exchange, or other disposition
of stock for Federal income tax purposes
is assigned first to the statutory and
residual groupings to which any U.S.
dividend amount is assigned under
Federal income tax law, to the extent
thereof. Foreign gross income is next
assigned to the grouping to which the
U.S. capital gain amount is assigned, to
the extent thereof. Any excess of the
foreign gross income over the sum of the
U.S. dividend amount and the U.S.
capital gain amount is assigned to the
statutory and residual groupings in the
same proportions in which the tax book
value of the stock is (or would be if the
taxpayer were a United States person)
assigned to the groupings under the
rules of § 1.861–9(g) in the U.S. taxable
year in which the disposition occurs.
A comment recommended that, to the
extent of any basis in the stock
attributable to a previous increase under
section 961, foreign gross income in
excess of the U.S. dividend amount be
assigned to the same statutory grouping
as the PTEP that gave rise to the basis
increase. The comment noted that
assigning foreign gross income in excess
of the U.S. dividend amount to the
grouping that produced the underlying
PTEP would better conform the tax
attribution consequences of a
disposition of stock with the tax
attribution consequences of a pre-sale
distribution with respect to the stock.
Under § 1.861–20(d)(1), Federal
income tax law applies to characterize
the transaction that gives rise to foreign
gross income. The sale of stock may
result in a U.S. dividend amount, a U.S.
return of capital amount, and a U.S.
capital gain amount for U.S. tax
purposes. As noted in the preamble to
the 2020 FTC proposed regulations,
when a controlled foreign corporation
has retained PTEP, the usual
consequence will be to increase the
portion of the amount realized on the
sale of the corporation’s stock that is
treated as a return of capital for U.S. tax
purposes, as a result of the basis
adjustments under section 961.
Accordingly, it is reasonable to conceive
of foreign gross income in the amount
of the basis attributable to retained
PTEP as a timing difference associated
with the earnings represented by the
PTEP, just as an amount of foreign gross
income equal to a section 1248 amount
that is included in the U.S. dividend
amount is treated as a timing difference
associated with those non-previously
taxed earnings.
However, the approach suggested in
the comment would create an additional
compliance burden for taxpayers and
administrative burdens for the IRS by
requiring the separate tracking of basis

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in the stock attributable to a previous
increase under section 961, which is not
otherwise required for U.S. tax
purposes. Additional rules would be
required to associate PTEP with the
particular shares of stock being sold,
such as in the case of a taxpayer with
PTEP in different statutory groupings
who sells one class of stock but retains
a different class of stock. The Treasury
Department and the IRS have
determined that the groupings to which
the tax book value of the stock is
assigned is an administrable and
reasonably accurate surrogate for both
the PTEP and the future, unrealized
earnings of the corporation with which
the foreign gross income is properly
associated when foreign tax is imposed
on a U.S. return of capital amount. For
these reasons, the final regulations
retain the rule in proposed § 1.861–
20(d)(3)(i)(D).
3. Partnership Transactions
Proposed § 1.861–20(d)(3)(ii)(B)
assigned foreign gross income arising
from a partnership distribution in
excess of the U.S. capital gain amount
by reference to the asset apportionment
percentages of the tax book value of the
partner’s distributive share of the
partnership’s assets (or, in the case of a
limited partner with less than a 10
percent interest, the tax book value of
the partnership interest), which are a
surrogate for the partner’s distributive
share of earnings of the partnership that
are not recognized in the year in which
the distribution is made for U.S. tax
purposes. This approach is based on
principles similar to those underlying
the rule in proposed § 1.861–
20(d)(3)(i)(D) for allocating and
apportioning foreign tax imposed on an
amount that is a return of capital with
respect to stock for Federal income tax
purposes. Similarly, the 2020 FTC
proposed regulations associated foreign
gross income from the disposition of a
partnership interest in excess of the U.S.
capital gain amount with a hypothetical
distributive share that is determined by
reference to the tax book value of the
partnership’s assets (or, in the case of a
limited partner with less than a 10
percent interest, the tax book value of
the partnership interest). See proposed
§ 1.861–20(d)(3)(ii)(C).
A comment recommended that, in the
case of either a distribution with respect
to a partnership or a disposition of a
partnership interest, foreign gross
income in excess of the U.S. capital gain
amount be characterized instead by
reference to the statutory and residual
groupings of amounts maintained in
partner-level accounts that track the
partners’ distributive shares of

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partnership earnings in prior years.
According to the comment, the tax book
value method potentially distorts the
allocation of tax to U.S. income items in
cases in which the amount of income
produced by the asset is
disproportionate to its basis. For this
reason, the comment recommended
tracing foreign gross income to amounts
in the partner’s cumulative distributive
share account in order to provide for
more accurate matching of foreign gross
income to partners’ distributive shares
of partnership income for the current
and prior years. The comment
recommended that these new partnerlevel accounts be increased as a partner
includes a distributive share of
partnership income and decreased as
the partnership makes distributions.
Under this multi-year account approach,
foreign gross income arising from
partnership distributions would be
characterized by reference to the
earnings in the account out of which the
distribution is made, and foreign gross
income arising from a disposition of a
partnership interest would be
characterized by reference to the
earnings in the account at the time of
disposition. In either case, additional
rules (such as providing for the use of
a pro rata, last-in-first-out, or other
approach) would be required to
determine the earnings in the account
out of which a distribution is
considered to be made, and for cases in
which the amount in the partner-level
account exceeds the foreign gross
income arising from a disposition of that
partner’s partnership interest.
Recognizing the additional recordkeeping requirements and complexity
required by this approach, the comment
suggested in the alternative that foreign
gross income in excess of a U.S. capital
gain amount recognized by reason of a
partnership distribution or disposition
of a partnership interest be
characterized based on the partner’s
distributive share of the partnership’s
current year income, to the extent
thereof, with any excess assigned based
on the tax book value method provided
for in the 2020 FTC proposed
regulations.
The final regulations retain the
approach from the 2020 FTC proposed
regulations for characterizing foreign
gross income arising from a partnership
distribution or disposition. The
Treasury Department and the IRS do not
agree that it is appropriate to treat a
partnership distribution as made out of
a partner’s distributive share of
partnership income. Contrary to the
ordering rules that apply to
distributions by a corporation, under
Federal income tax law partnership

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distributions are not sourced from
current or accumulated partnership
income. Similarly, under Federal
income tax law, a partnership
distribution reduces a partner’s basis in
its partnership interest without
differentiating between basis from
capital contributions and basis from a
partner’s distributive share of
partnership income.
A common principle of the rules in
§ 1.861–20 is that Federal income tax
law applies to characterize foreign gross
income. To the extent a partnership
distribution or disposition is treated as
a return of basis for Federal income tax
purposes, § 1.861–20(d)(3)(ii)(B) and (C)
appropriately reflect this principle by
allocating and apportioning any foreign
tax imposed on the partnership
distribution in the same manner as
foreign tax on a return of capital with
respect to stock. Furthermore, this
approach to characterizing foreign gross
income arising from a partnership
distribution is consistent with the
approach in § 1.861–20(d)(3)(v)(C)(1)
that applies to a distribution that is a
remittance by a taxable unit.
As acknowledged by the comment,
characterizing foreign gross income by
reference to a partner’s distributive
share of partnership income in prior
years would require creating new
partner-level accounts to track the
partner’s aggregate distributive share of
unremitted partnership income. That
type of partner-level account is not
otherwise required to be maintained to
characterize partnership distributions
for Federal income tax purposes and
would be unduly burdensome for both
taxpayers and the IRS, as well as being
generally inconsistent with the Federal
income tax rules for characterizing
partnership distributions. In addition,
the Treasury Department and the IRS
have determined that the suggested
alternative approach of characterizing
foreign gross income by reference to a
partner’s distributive share of current
year partnership income would be
susceptible to manipulation by timing
partnership distributions to maximize
foreign tax credit benefits. Therefore,
the comment is not adopted.
4. Disregarded Payments
The 2020 FTC proposed regulations
addressed the allocation and
apportionment of foreign income taxes
that are imposed by reason of a
disregarded payment between taxable
units. In the case of foreign income
taxes paid or accrued by an individual
or domestic corporation, the rules
defined a taxable unit as a foreign
branch, foreign branch owner, or nonbranch taxable unit as defined in

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proposed § 1.904–6(b)(2)(i)(B). In the
case of foreign income taxes paid by a
foreign corporation, the rules defined a
taxable unit by reference to the tested
unit definition in proposed § 1.954–
1(d)(2), as contained in proposed
regulations (REG–127732–19)
addressing the high-tax exception under
section 954(b)(4), published in the
Federal Register (85 FR 44650) on July
23, 2020 (the ‘‘2020 HTE proposed
regulations’’). See proposed § 1.861–
20(d)(3)(v)(E)(9).
In general, the 2020 FTC proposed
regulations characterized a disregarded
payment as either a payment out of the
current income attributable to a taxable
unit (a ‘‘reattribution payment’’), a
contribution to a taxable unit, or a
remittance out of accumulated earnings
of a taxable unit. See proposed § 1.861–
20(d)(3)(v). The rules assigned foreign
gross income arising from a reattribution
payment to the statutory and residual
groupings of the recipient taxable unit
based on the groupings to which the
current income out of which the
reattribution payment was made is
assigned. See proposed § 1.861–
20(d)(3)(v)(B). The rules assigned
foreign gross income arising from a
contribution received by a taxable unit
to the residual grouping, and assigned
foreign gross income arising from a
remittance by reference to the statutory
and residual groupings to which the
assets of the payor taxable unit were
assigned for purposes of apportioning
interest expense, which served as a
proxy for the accumulated earnings of
the payor taxable unit. See proposed
§ 1.861–20(d)(3)(v)(C). For this purpose,
the assets of a payor taxable unit were
determined under the rules of § 1.987–
6(b), modified to include in a taxable
unit’s assets any stock that it owned,
and in certain circumstances
reattributed another taxable unit’s assets
to the taxable unit or reattributed the
taxable unit’s assets to another taxable
unit. See proposed § 1.861–
20(d)(3)(v)(C)(1)(ii).
Comments criticized the tax book
value method as an inaccurate surrogate
for accumulated earnings of a taxable
unit in the case of an asset with a basis
that is disproportionate to the income
produced by the asset and requested
that foreign gross income arising from a
remittance be assigned to the statutory
and residual groupings based on the
current earnings of a taxable unit. In
addition, comments requested that,
rather than trace foreign gross income
arising from disregarded payments to
current or accumulated earnings of a
taxable unit, the definition of which
generally includes disregarded entities,
the rules should only trace such foreign

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gross income to current or accumulated
income of a qualified business unit
(‘‘QBU’’) to reduce the complexity and
compliance burden of the rules. Finally,
a comment suggested that the
modifications to the rules of § 1.987–
6(b) for purposes of determining the
assets of a taxable unit should be
expanded to include not only stock, but
any interest of a taxable unit in another
taxable unit, including a partnership.
The Treasury Department and the IRS
do not agree that current earnings of a
taxable unit, rather than the tax book
value of its assets, should be the basis
for characterizing foreign gross income
included by reason of a remittance. The
Treasury Department and the IRS have
determined that, although the tax book
value of the assets of a taxable unit may
not be a perfect surrogate for the
accumulated earnings of that taxable
unit, it is a better surrogate than currentyear earnings of the taxable unit. The
use of current-year earnings is rejected
because the current-year earnings may
already have been accounted for
through reattribution payments, may not
reflect all of a taxable unit’s assets, and
could be subject to manipulation
through the timing of disregarded
payments, depending on the character
of the earnings attributed to a taxable
unit for a particular taxable year.
Although a more accurate matching of
foreign gross income to accumulated
income for Federal income tax purposes
could be achieved through the
maintenance of multi-year accounts
tracking accumulated earnings of a
taxable unit, characterizing the
accumulated earnings of a taxable unit
by reference to the tax book value of its
assets appropriately balances concerns
about administrability, compliance
burdens, manipulability, and accuracy.
The Treasury Department and the IRS
do not agree that foreign gross income
should be traced to income only when
disregarded payments are made by a
QBU, rather than a taxable unit. The
purpose of this rule in the 2020 FTC
proposed regulations was to implement
a tracing regime for foreign income tax
imposed on disregarded payments that
more accurately distinguished payments
made out of current income from those
made out of accumulated income, rather
than treating all disregarded payments
as either remittances or contributions.
Tracing cannot achieve the policy goal
of improved accuracy in matching
disregarded payments to the current or
accumulated earnings out of which the
payment is made if it does not fully
account for all disregarded payments.
Accordingly, this recommendation is
not adopted.

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The Treasury Department and the IRS
agree that for purposes of § 1.861–20 the
assets of a taxable unit should include
not only stock that it owns, but also its
interests in other taxable units. Asset tax
book values serve as a surrogate for the
accumulated earnings from which a
taxable unit made a remittance;
including a taxable unit’s interests in all
other taxable units appropriately reflects
all of the income-producing assets of a
taxable unit that could produce
earnings. Accordingly, § 1.861–
20(d)(3)(v)(C)(1)(ii) of the final
regulations provides that a taxable unit’s
assets include its pro rata share of the
assets of another taxable unit in which
it owns an interest.
The definitions of the terms
‘‘contribution’’ and ‘‘remittance’’ in
§ 1.861–20(d)(3)(v)(E) of the final
regulations are revised so that, together,
they describe all payments that are not
reattribution payments. The proposed
regulations defined a ‘‘contribution’’ as
a transfer of property to a taxable unit
that would be treated as a contribution
to capital described in section 118 or a
transfer described in section 351 if the
taxable unit were a corporation under
Federal income tax law, or the excess of
a disregarded payment made by a
taxable unit to another taxable unit that
the first taxable unit owns over the
portion of the disregarded payment that
is a reattribution payment. The
proposed regulations defined a
‘‘remittance’’ as a transfer of property
that would be treated as a distribution
by a corporation to a shareholder with
respect to its stock if the taxable unit
were a corporation for Federal income
tax law, or the excess of a disregarded
payment made by a taxable unit to a
second taxable unit over the portion of
the disregarded payment that is a
reattribution payment, other than an
amount treated as a contribution. The
proposed definition of ‘‘contribution’’
did not encompass a disregarded
payment that is neither a reattribution
payment nor a transfer that would be
described in section 351, such as, in
some circumstances, disregarded
interest payments. To fill this gap,
§ 1.861–20(d)(3)(v)(E) of the final
regulations defines a ‘‘contribution’’ as
the excess of a disregarded payment
made by a taxable unit to another
taxable unit that the first taxable unit
owns over the portion of the disregarded
payment, if any, that is a reattribution
payment. This definition encompasses a
transfer of property to a taxable unit that
would be treated as a contribution to
capital described in section 118 or a
transfer described in section 351 if the
taxable unit were a corporation. In

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281

addition, § 1.861–20(d)(3)(v)(E) of the
final regulations defines a ‘‘remittance’’
as a disregarded payment that is neither
a contribution nor a reattribution
payment. This definition encompasses a
transfer of property that would be
treated as a distribution by a corporation
to a shareholder with respect to its stock
if the taxable unit were a corporation.
These changes ensure that the final
regulations provide rules for allocating
foreign income taxes attributable to all
disregarded payments.
In addition, the final regulations
define a ‘‘taxable unit’’ by reference to
the tested unit definition in § 1.951A–
2(c)(7)(iv)(A), a final regulation, instead
of by reference to the definition of a
taxable unit in proposed § 1.954–1(d)(2).
See § 1.861–20(d)(3)(v)(E)(9).
The final regulations provide a special
rule at § 1.861–20(d)(3)(vi) for allocating
and apportioning foreign income tax on
foreign gross income included by a
taxpayer by reason of its ownership of
a U.S. equity hybrid instrument (defined
in § 1.861–20(b)(22) as an instrument
that is stock or a partnership interest
under Federal income tax law but that
is debt or otherwise gives rise to the
accrual of income that is not treated as
a dividend or a distributive share of
partnership income under foreign law).
This special rule, which generally
allocates foreign income tax on foreign
gross interest income with respect to a
U.S. equity hybrid instrument to the
grouping to which distributions with
respect to the instrument are assigned,
clarifies how section 245A(d) and
§ 1.245A(d)–1 apply to foreign income
tax that is attributable to a hybrid
dividend. As discussed in part I of this
Summary of Comments and Explanation
of Revisions, § 1.245A(d)–1 relies upon
the rules of § 1.861–20 to determine
whether foreign income tax is
attributable to income described in
section 245A, including a hybrid
dividend described in section 245A(e),
in which case a credit or deduction for
the foreign income tax is disallowed.
Section 1.861–20(d)(3)(vi)(A) treats
foreign gross income included by reason
of an accrual of income with respect to
a U.S. equity hybrid instrument as a
distribution. Accordingly, it assigns the
foreign gross income to the statutory
and residual groupings as though the
accrual were a foreign law distribution
that was made on the date of the
accrual. Section 1.861–20(d)(3)(vi)(B)
provides an identical rule for a payment
of interest under foreign law with
respect to the U.S. equity hybrid
instrument; therefore, withholding tax
on the payment is also attributed to
income (determined under Federal
income tax law) from the instrument.

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Finally, as part of finalizing the rules
in § 1.861–20(d)(3)(v), conforming
changes are made to § 1.951A–2(c)(7)
and (8). In particular, § 1.951A–
2(c)(7)(iii)(B) is deleted and Examples 1
and 3 in § 1.951A–2(c)(8)(iii)(A) and (C)
are revised accordingly while Example
2 in § 1.951A–2(c)(8)(iii)(B) is removed
as obsolete. Section 1.951A–
2(c)(7)(iii)(B) is removed from the final
regulations because the special rules in
that paragraph for allocating and
apportioning current year taxes imposed
by reason of a disregarded payment are
rendered obsolete by the final rules in
§ 1.861–20(d)(3)(v). Under § 1.951A–
2(c)(7)(iii)(A), deductible expenses
(including expenses for current year
taxes) are allocated and apportioned
under the principles of § 1.960–1(d)(3)
and the rules in § 1.861–20.
5. Applicability Date
Section 1.861–20 (other than § 1.861–
20(h)) applies to taxable years that begin
after December 31, 2019, and end on or
after November 2, 2020. Section 1.861–
20(h) applies to taxable years beginning
on or after December 28, 2021. In
addition, the revisions to § 1.951A–
2(c)(7) and (8) apply to taxable years
that begin after December 28, 2021;
however, taxpayers may choose to apply
the final rules to taxable years that begin
after December 31, 2019, and on or
before December 28, 2021, consistent
with the applicability date of § 1.861–
20(d)(3)(v).
Several comments asked the Treasury
Department and the IRS to provide a
delayed applicability date for § 1.861–
20. The rules in proposed § 1.861–20
revised the corresponding provisions in
the 2019 FTC proposed regulations,
which were not finalized with the 2020
FTC final regulations to provide an
additional opportunity for comment.
Because the regulations are finalized
substantially as proposed, with
primarily clarifying changes in response
to comments, the Treasury Department
and the IRS have determined that it is
not appropriate to modify the proposed
applicability date.
IV. Creditability of Foreign Taxes Under
Sections 901 and 903

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A. Jurisdictional Nexus Requirement
1. In General
The 2020 FTC proposed regulations
added a jurisdictional nexus
requirement for determining whether a
foreign tax qualifies as a foreign income
tax for purposes of section 901.
Proposed § 1.901–2(a)(3) and (c)
generally required that, for a foreign tax
to be a foreign income tax, the foreign
country imposing the tax must have

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sufficient nexus to the taxpayer’s
activities or investment of capital or
other assets that give rise to the income
base on which the foreign tax is
imposed. In the case of a foreign tax
imposed by a foreign country on
nonresident taxpayers, the 2020 FTC
proposed regulations provided that a
foreign tax satisfies the jurisdictional
nexus requirement if it meets one of
three nexus tests.
First, under proposed § 1.901–
2(c)(1)(i), a foreign tax meets the
jurisdictional nexus requirement if it is
imposed only on income that is
attributable, under reasonable
principles, to the nonresident’s
activities located in the foreign country
(for this purpose, the nonresident’s
activities include its functions, assets,
and risks) (‘‘activities-based nexus’’). To
meet the activities-based nexus test, the
allocation of a nonresident’s income to
the nonresident’s activities in the
foreign country cannot take into
account, as a significant factor, the
location of customers, users, or any
similar destination-based criterion.
Proposed § 1.901–2(c)(1)(i) further
provided that reasonable principles for
determining income attributable to a
nonresident’s activities include rules
similar to those for determining
effectively connected income under
section 864(c).
Second, under proposed § 1.901–
2(c)(1)(ii), a foreign tax imposed on the
nonresident’s income arising in the
foreign country meets the jurisdictional
nexus requirement only if the foreign
tax law sourcing rules are reasonably
similar to the sourcing rules that apply
for Federal income tax purposes
(‘‘source-based nexus’’).
Third, under proposed § 1.901–
2(c)(1)(iii), a foreign tax imposed on
income or gain from sales or other
dispositions of property that is subject
to tax in the foreign country on the basis
of the situs of real or movable property
meets the jurisdictional nexus
requirement only if it is imposed with
respect to income or gain from the
disposition of real property situated in
the foreign country or movable property
forming part of the business property of
a taxable presence in the foreign country
(or from interests in certain entities
holding such property) (‘‘property-based
nexus’’).
In the case of a foreign tax imposed
by a foreign country on its residents,
proposed § 1.901–2(c)(2) provided that
in determining whether the foreign tax
meets the jurisdictional nexus
requirement, any allocation of income,
gain, deduction or loss between a
resident taxpayer and a related or
controlled entity under the foreign

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country’s transfer pricing rules must
follow arm’s length principles, without
taking into account as a significant
factor the location of customers, users,
or any other similar destination-based
criterion.
Under the 2020 FTC proposed
regulations, the jurisdictional nexus
requirement also applied to determine
whether a foreign levy is a tax in lieu
of an income tax under section 903 (an
‘‘in lieu of tax’’). Specifically, the 2020
FTC proposed regulations modified the
substitution requirement to add
proposed § 1.903–1(c)(1)(iv), which
required that the generally-imposed net
income tax would either continue to
qualify as a net income tax under
proposed § 1.901–2(a)(3), or would itself
constitute a separate levy that is a net
income tax if it were to be imposed on
the excluded income that is covered by
the tested in lieu of tax. This
modification was intended to ensure
that a foreign tax can qualify as an in
lieu of tax only if the foreign country
imposing the tax could instead have
subjected the excluded income to a tax
on net gain that would satisfy the
jurisdictional nexus requirement in
proposed § 1.901–2(c). In addition,
proposed § 1.903–1(c)(2)(iii) provided
that, to satisfy the substitution
requirement, a withholding tax must
meet the source-based jurisdictional
nexus requirement in proposed § 1.901–
2(c)(1)(ii) to qualify as a ‘‘covered
withholding tax.’’ Comments regarding
the jurisdictional nexus test of the
substitution requirement are discussed
in this part IV.A of this Summary of
Comments and Explanation of
Revisions; other comments regarding
the proposed modifications to the in
lieu of tax provisions are discussed in
part IV.C of this Summary of Comments
and Explanation of Revisions.
2. Reasonableness of Jurisdictional
Nexus Requirement
i. Text and History of the Relevant
Statutory Provisions
a. Income Tax in the U.S. Sense
Comments questioned the validity of
the jurisdictional nexus requirement,
stating that the requirement is
inconsistent with the plain language,
structure, and legislative history of the
statutory foreign tax credit provisions.
Comments stated that the plain meaning
of ‘‘income tax’’ refers solely to whether
the base of the tax is net income and
does not require a justification (nexus)
for the imposition of the tax. Some
comments stated that the term ‘‘income
tax’’ should not be interpreted to
encompass U.S. rules or international
norms regarding jurisdiction to tax

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because, according to those comments,
when the foreign tax credit provisions
were first enacted there were limited
source rules in the Code and
international norms for determining the
source of income were still developing.
Other comments stated that the
inclusion of a jurisdictional nexus
requirement would require
Congressional action and noted that
other exceptions to creditability have
been enacted by Congress (see, for
example, section 901(f), (i) and (m)).
Some comments stated that the
Supreme Court in Biddle v. Comm’r,
302 U.S. 573 (1938), made only a
passing reference to ‘‘an income tax in
the U.S. sense,’’ and that neither Biddle
nor any other case has interpreted the
statute to include a jurisdictional nexus
requirement.
The Treasury Department and the IRS
have determined that the addition of a
jurisdictional nexus requirement is a
valid exercise of the government’s
rulemaking authority. The Treasury
Department and the IRS have
determined that it is reasonable and
appropriate to interpret the terms
‘‘income tax’’ and ‘‘tax in lieu of an
income tax’’ in sections 901 and 903,
respectively, to incorporate a
jurisdictional nexus requirement.
Judicial decisions and administrative
guidance over the past century have
interpreted the term ‘‘income, war
profits, and excess profits tax,’’ which is
not defined in section 901 or by the
limited initial explanation in the early
legislative history. These interpretations
have consistently followed the
principle, introduced by the Biddle
court, that the determination of whether
a foreign tax is creditable under section
901 is made by evaluating whether such
tax, if enacted in the United States,
would be an income tax (in other words,
whether the foreign tax is ‘‘an income
tax in the U.S. sense’’). See PPL Corp.
v. Comm’r, 569 U.S. 329, 335 (2013).
See also Inland Steel Co. v. United
States, 230 Ct. Cl. 314, 325 (1982)
(‘‘Whether a foreign tax is an income tax
under I.R.C. § 901(b)(1) is to be decided
under criteria established by United
States revenue laws and court
decisions.’’). It is well-settled that U.S.
tax provisions should generally be
interpreted with reference to domestic
tax concepts absent a clear
Congressional expression that foreign
concepts control. United States v.
Goodyear Tire & Rubber Co., 493 U.S.
132, 145 (1989). The jurisdictional
nexus requirement is consistent with
the principle that U.S. tax principles,
not varying foreign tax law policies,
should control the determination of

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whether a foreign tax is an income tax
(or a tax in lieu of an income tax) that
is eligible for a U.S. foreign tax credit.
U.S. tax law has long incorporated a
jurisdictional nexus limitation in taxing
income of foreign persons. For example,
the United States only taxes income of
foreign persons that have income that is
effectively connected with a U.S. trade
or business or attributable to U.S. real
property, or have income that is fixed or
determinable, annual or periodic
(FDAP) income sourced in the United
States. See sections 871, 881, 882, and
897. In addition, U.S. foreign tax credit
rules reflect international norms of
taxing jurisdiction that assign the
primary right to tax to the source
country, the secondary right to tax to the
country where the taxpayer is a resident
or engaged in a trade or business, and
the residual right to tax to the country
of citizenship or place of incorporation.
See sections 904(a) (limiting foreign tax
credits to U.S. tax on foreign source
income) and 906(b)(1) (limiting foreign
tax credits allowed to foreign persons
engaged in a U.S. trade or business to
foreign taxes on foreign source
effectively connected income). In
keeping with these traditional U.S.
taxing rules, international taxing norms
(such as provisions included in the
OECD Model Tax Convention), and the
longstanding approach of the courts to
apply U.S. tax principles in determining
whether a foreign tax is an income tax
in the U.S. sense, it is appropriate for
the definition of a creditable tax to
incorporate the concept of jurisdictional
nexus from the U.S. tax law. The fact
that U.S. tax rules have changed since
the foreign tax credit provisions were
first enacted does not preclude an
interpretation of the term ‘‘income tax’’
to reflect U.S. norms, because the
principle of ‘‘an income tax in the U.S.
sense’’ incorporates an evolving
standard of what constitutes an income
tax in the U.S. sense.
In addition, the net gain requirement
in existing § 1.901–2(b), which
prescribes the elements of gross receipts
and costs that must comprise the base
of a foreign income tax, has historically
reflected jurisdictional norms in
limiting creditable taxes to those
imposed on net income. The
jurisdictional nexus requirement
clarifies the limits on the scope of the
items of gross receipts and costs that
may properly be taken into account in
computing the taxable base of a
creditable foreign income tax. Absent
this rule, U.S. tax on net income could
be reduced by credits for a foreign levy
whose taxable base was improperly
inflated by unreasonably assigning
income to a taxpayer, or by not

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appropriately taking into account
significant costs that are attributable to
gross receipts properly included in the
taxable base.
Existing § 1.901–2(b)(4)(i)(A) has long
contained a form of a nexus rule, by
requiring recovery of significant costs
and expenses that are ‘‘attributable,
under reasonable principles’’ to gross
receipts included in the foreign tax base.
A rule providing the extent to which
gross receipts and costs are within the
scope of a jurisdiction’s right to tax is
therefore necessary to determine which
items of gross receipts and costs a
foreign levy must include to satisfy the
net gain rules.
To better reflect the role of the
jurisdictional nexus rule as an element
of the net gain requirement, the rule in
proposed § 1.901–2(c) is incorporated in
the net gain requirement as new
paragraph § 1.901–2(b)(5). In addition,
the term ‘‘jurisdictional nexus
requirement’’ is replaced with
‘‘attribution requirement’’ to more
clearly reflect that the rule provides
limits on the scope of gross receipts and
costs that are attributable to a taxpayer’s
activities and thus appropriately
included in the foreign tax base for
purposes of applying the other
components of the net gain requirement.
b. Relationship to Foreign Tax Credit
Limitation
Some comments asserted that
Congress explicitly removed a
jurisdictional nexus requirement from
the predecessor to section 901 in 1921,
and since then, Congress has addressed
concerns regarding jurisdiction to tax
through the foreign tax credit limitation
under section 904 (and its predecessor
provisions). The comments pointed out
that the foreign tax credit provision,
when first enacted under the Revenue
Act of 1918, provided that U.S. tax was
‘‘credited with . . . the amount of any
income, war-profits and excess-profits
taxes paid during the taxable year to any
foreign country, upon income derived
from sources therein, or to any
possession of the United States.’’ Public
Law 65–254, § 222(a)(1) and 238(a), 40
Stat. 1057, 1073, 1080–81 (emphasis
added). The comments stated that the
phrase ‘‘upon income derived from
sources therein’’ served as a
jurisdictional nexus limit, which
Congress eliminated and replaced by
enacting the foreign tax credit limitation
in the Revenue Act of 1921. The
comments asserted that this legislative
history shows that Congress has rejected
including a jurisdictional nexus
requirement in section 901. The
comments also stated that the only
concern regarding jurisdiction to tax

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discussed in the legislative history to
the 1918 and 1921 Revenue Acts was
Congress’ desire to preserve U.S.
primary taxing rights over U.S. source
income.
The Treasury Department and the IRS
disagree with the comments’ conclusion
that Congress has expressly rejected a
jurisdictional nexus requirement for
creditable foreign taxes. Although
source-based taxing rights are an
appropriate element of jurisdictional
nexus, tax residence and conducting
business in a foreign country also
provide jurisdictional nexus. The
Treasury Department and the IRS view
the introduction of the foreign tax credit
limitation in 1921 as merely refining the
1918 Revenue Act’s limitation of credits
to tax imposed upon foreign source
income. The legislative history does not
explain why Congress removed the
phrase ‘‘upon income from sources
therein’’ in 1921, nor does it suggest that
Congress believed it was removing a
jurisdictional nexus requirement and
replacing it with a foreign tax credit
limitation.
The Treasury Department and the IRS
also disagree with the comments’
assertion that statutory policy regarding
jurisdiction to tax is confined to the
section 904 foreign tax credit limitation.
Congress has not explicitly addressed
jurisdictional nexus with respect to the
foreign tax credit. There is no statutory
provision that addresses whether the
foreign tax credit should be allowed for
taxes imposed outside of traditional
U.S. taxing norms. Section 904 does not
address the threshold question of
whether a foreign tax is an income tax
in the U.S. sense. It only limits the
allowable credit to the amount of precredit U.S. tax on particular categories
of foreign source income, as revised by
Congress from time to time. The foreign
tax credit limitation preserves residual
U.S. tax on foreign source income
subject to a foreign rate of tax that is
lower than the U.S. rate, but does not
ensure that the foreign tax has an
appropriate jurisdictional basis. The
statute is silent with respect to
jurisdictional nexus, and it is reasonable
and appropriate for regulations to apply
U.S. tax concepts in addressing the
creditability of extraterritorial foreign
levies that Congress could not have
anticipated when the foreign tax credit
provisions were first enacted.
c. Legislative Re-Enactment Doctrine
Some comments argued that the
addition of a jurisdictional nexus
requirement is precluded by the
legislative re-enactment doctrine. These
comments noted that the 1980
temporary and proposed section 901

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regulations, which contained similar
nexus requirements, drew numerous
adverse comments and were the subject
of Congressional hearings, and that the
Treasury Department and the IRS did
not finalize those provisions in TD 7918
(48 FR 46276) (‘‘the 1983 regulations’’).
These comments asserted that in
passing the Tax Reform Act of 1986,
Public Law 99–514, 100 Stat. 2085
(1986), and the Tax Cuts and Jobs Act,
Public Law 115–97, 131 Stat 2054
(2017) (‘‘TCJA’’), Congress was aware of
the 1983 regulations (which do not
contain a jurisdictional nexus
requirement) and did not amend the
statute to add one, with the result that
Congress implicitly endorsed the 1983
regulations and precluded the Treasury
Department and the IRS from modifying
them.
The Treasury Department and the IRS
disagree with these comments. The
legislative re-enactment doctrine does
not preclude an agency from changing
its regulatory interpretation of a statute
if Congress amends related provisions.
See Helvering v. Reynolds, 313 U.S. 428,
432 (1941) (‘‘[The doctrine of legislative
reenactment] does not mean that the
prior construction has become so
imbedded in the law that only Congress
can effect a change.’’). See also
Helvering v. Wilshire Oil Co., 308 U.S.
90, 100 (1939) (holding that the
legislative reenactment doctrine applies
where ‘‘it does not appear that the rule
or practice has been changed by the
administrative agency through exercise
of its continuing rule-making power’’);
McCoy v. U.S., 802 F.2d 762 (4th Cir.
1986); Interstate Drop Forge Co. v. Com.,
326 F2d 743 (7th Cir. 1964).
Additionally, while a purported
legislative re-enactment may indicate
that Congress was aware of, and
implicitly endorsed, the prior regulatory
interpretation, a regulation or
administrative ruling promulgated
under a re-enacted statute is not treated
as binding unless other evidence clearly
manifests such a purpose. See
Oklahoma Tax Com. v. Texas Co., 336
U.S. 342 (1949); Jones v. Liberty Glass
Co., 332 U.S. 524 (1947). There is no
indication that Congress intended to
preclude the amendment of the section
901 and 903 regulations to add a
jurisdictional nexus requirement. None
of the comments identified any aspect of
either the Tax Reform Act of 1986 or the
TCJA that suggests that Congress
intended to limit future regulations
addressing the definition of creditable
foreign taxes under sections 901 and
903. Therefore, the Treasury Department
and the IRS have determined that the
legislative re-enactment doctrine does
not preclude the adoption of

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prospective regulations that include a
jurisdictional nexus requirement.
ii. Policy and Purpose of the Statutory
Foreign Tax Credit Provisions
Comments stated that adding a
jurisdictional nexus requirement is
contrary to the policy of the foreign tax
credit, which is to mitigate double
taxation of foreign source income. These
comments asserted that double taxation
results when the United States imposes
tax on income that is taxed by another
country, regardless of whether the other
country had a proper jurisdictional basis
for imposing the tax, and unrelieved
double taxation could discourage
foreign investment. The comments
asserted that Congress enacted the
foreign tax credit to enhance the
competitiveness of American companies
operating abroad, and the jurisdictional
nexus requirement in the 2020 FTC
proposed regulations would impede this
competitiveness. The comments
asserted that the policy goal of sections
901 and 903 is not to influence
international norms or change the
behavior of foreign governments.
However, another comment stated
that the jurisdictional nexus
requirement may reasonably be viewed
as consistent with the underlying
principles and purposes of the foreign
tax credit regime. This comment
asserted that the allowance of a foreign
tax credit for a tax levied on amounts
that do not have a significant
connection to the foreign jurisdiction
taxing such income, particularly U.S.
source income, could effectively convert
the foreign tax credit regime into a
means of subsidizing foreign
jurisdictions at the expense of the U.S.
fisc. Similarly, one comment that
questioned the government’s authority
to include a jurisdictional nexus
requirement also acknowledged that
taxes that have no nexus whatsoever to
the taxing jurisdiction would not
properly be considered taxes.
The Treasury Department and the IRS
agree with the comment that the
jurisdictional nexus requirement is
consistent with the policy goals of the
foreign tax credit. The foreign tax credit
is not intended to subsidize foreign
jurisdictions at the expense of the U.S.
fisc. The legislative history to the
predecessor provisions to section 901,
as well as subsequent statutory
amendments, reflect Congress’
consistent concern that foreign tax
credits should not be allowed to offset
U.S. tax on income that does not have
a significant connection to the foreign
jurisdiction taxing such income. See, for
example, S. Rep. No. 67–275, at 17
(1921) (describing the need to avoid

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allowing a foreign tax credit to ‘‘wipe
out’’ tax properly attributable to U.S.
source income); Senate Comm. on
Finance, 98th Cong., 2d Sess., Deficit
Reduction Act of 1984, Explanation of
Provisions Approved by the Committee
on March 21, 1984, at 392 (Comm. Print
1984) (describing the need for separate
foreign tax credit limitation categories to
prevent the U.S. Treasury from
inappropriately ‘‘bear[ing] the burden’’
of foreign taxes).
The 2020 FTC proposed regulations
are also consistent with the statutory
purpose of the foreign tax credit to
relieve double taxation of income
through the United States ceding its
own taxing rights only where the foreign
country has the primary right to tax
income. See Bowring v. Comm’r, 27
B.T.A. 449, 459 (1932) (‘‘In the case of
the citizen and resident alien, the
United States recognizes the primary
right of the foreign government to tax
income from sources therein . . . and
accordingly, grants a credit.’’). To
ensure that the United States provides a
foreign tax credit only where the foreign
country appropriately asserts
jurisdiction to tax income, creditable
foreign levies must incorporate norms
similar to those in U.S. tax law that
limit the scope of income subject to the
tax.
Some comments asserted that double
taxation meriting relief exists in every
case in which a foreign tax is not
allowed as a foreign tax credit against
U.S. tax. However, that assertion is
inconsistent not only with the foreign
tax credit limitation in section 904, but
with the plain text of section 901.
Section 901 allows a credit only for
income, war profits, and excess profits
taxes, and not for all foreign taxes that
may be imposed by a foreign
jurisdiction (such as value added taxes
or sales taxes, which may qualify for a
deduction under section 164), or for
other levies such as tariffs. As explained
in part IV.A.2.i.a of this Summary of
Comments and Explanation of
Revisions, determining which items of
gross receipts and costs are properly
included in a foreign taxable base is
inherent to the determination of
whether the foreign tax is an income tax
in the U.S. sense.
As noted in the preamble to the 2020
FTC proposed regulations, the
fundamental purpose of the foreign tax
credit—to mitigate double taxation with
respect to taxes imposed on income—is
served most appropriately if there is
substantial conformity in the principles
used to calculate the base of the foreign
tax and the base of the U.S. income tax.
This conformity extends not just to
ascertaining whether the foreign tax

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base approximates U.S. taxable income
determined on the basis of realized
gross receipts reduced by allocable costs
and expenses, but also to whether there
is a sufficient nexus between the income
that is subject to tax and the foreign
jurisdiction imposing the tax. Therefore,
the final regulations retain the
requirement in the 2020 FTC proposed
regulations that for a foreign tax to
qualify as an income tax, the tax must
conform with established international
jurisdictional norms, reflected in the
Internal Revenue Code and related
guidance, for allocating profit between
associated enterprises, for allocating
business profits of nonresidents to a
taxable presence in the foreign country,
and for taxing cross-border income
based on source or the situs of property.
Recently, many foreign jurisdictions
have disregarded international taxing
norms to claim additional tax revenue,
resulting in the adoption of novel
extraterritorial taxes that diverge in
significant respects from U.S. tax rules
and traditional norms of international
taxing jurisdiction. These extraterritorial
assertions of taxing authority often
target digital services, where countries
seeking additional revenue have chosen
to abandon international norms to assert
taxing rights over digital service
providers.1
The Treasury Department and the IRS
have determined that it is necessary and
appropriate to adapt the regulations
under sections 901 and 903 to address
this change in circumstances, especially
in relation to the taxation of the digital
economy—a sector that did not exist
when the foreign tax credit provisions
were first enacted. Accordingly,
regulations are necessary and
appropriate to more clearly delineate
the circumstances in which a tax does
not qualify as an income tax in the U.S.
sense due to the foreign jurisdiction’s
unreasonable assertion of jurisdictional
taxing authority.
Some comments asserted that the
jurisdictional nexus requirement in the
2020 FTC proposed regulations is
inconsistent with Congressional policy
reflected in the repeal of the per-country
foreign tax credit limitation in favor of
1 See OECD Inclusive Framework on BEPS, Tax
Challenges Arising from Digitalisation—Report on
Pillar One Blueprint, at 10 (Oct. 14, 2020)
(‘‘Globalisation and digitalisation have challenged
fundamental features of the international income
tax system, such as the traditional notions of
permanent establishment and the arm’s length
principle (ALP), and brought to the fore the need
for higher levels of enhanced tax certainty through
more extensive multilateral tax co-operation. These
transformational developments have taken place
against a background of increasing public attention
on the taxation of highly digitalised global
businesses.’’).

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an overall foreign tax credit limitation.
These comments suggested that the
proposed jurisdictional nexus
requirement would effectively revert to
the more limited per-country limitation
and, more generally, that the repeal of
the per-country limitation reflects a
general policy favoring broader
availability of foreign tax credits. The
Treasury Department and the IRS
disagree with these comments. The
jurisdictional nexus requirement does
not prevent cross-crediting within a
particular separate category described in
section 904, which has been amended
numerous times by Congress. For
example, the nexus requirement does
not preclude a foreign tax credit against
U.S. tax on foreign source general
category income derived from one
country for a foreign tax imposed by
another country that is assigned to the
general category, whereas under the
former per-country limitation, such
cross-crediting would not be allowed.
Additionally, while comments frame
the per-country limitation as more
restrictive than the overall limitation,
the debate concerning the limitation
also highlighted circumstances in which
the overall limitation is in fact the more
restrictive of the two.2 In 1960, when
adding back the overall limitation, but
retaining the per-country limitation,
Congress explained that the overall
limitation may not be appropriate based
on the business model of a particular
taxpayer. See S. Rep. No. 86–1393, at
3773–74 (1960). Thus, the Treasury
Department and the IRS do not agree
with the comments’ assertion that
Congress’ choice in 1976 to retain only
the overall limitation supports the
broadest allowance of foreign tax
credits, because either the per-country
or overall limitation may more
significantly restrict the amount of
foreign tax credit, depending on the
circumstances of a particular taxpayer.
Similarly, the choice in 1976 to add
back the overall limitation and make it
the only limitation did not represent
Congress’s definitive choice to allow
unlimited cross-crediting of high-rate
foreign taxes against U.S. tax on foreign
source income subject to a lower rate of
foreign tax. S. Rep. No. 86–1393, at
3773–74. Rather, Congress has
continually amended and debated the
appropriate scope of the foreign tax
2 For example, both houses of Congress, in
retreating from the overall limitation in 1954,
explained that ‘‘[t]he effect of the [overall]
limitation is unfortunate because it discourages a
company operating profitably in one foreign
country from going into another country where it
may expect to operate at a loss for a few years.
Consequently your committee has removed the
overall limitation.’’ H.R. Rep. No. 83–1337, at 4103
(1954); see also S. Rep. No. 83–1622, at 4739 (1954).

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credit limitation since 1962. The
ongoing Congressional amendments to
the foreign tax credit limitation show
that Congress had not definitively
resolved the permissible scope of crosscrediting when it enacted the
predecessor provision to section 901.
In addition, Congress did not repeal
the per-country limitation in 1976
primarily as a policy choice to allow
cross-crediting. Rather, Congress
repealed the per-country limitation
because it allowed a taxpayer to reduce
U.S. tax on U.S. source income by
application of a foreign source loss, and
later to reduce U.S. tax on foreign
source income through a foreign tax
credit. See S. Rep. No. 94–938, at 236
(1976); H.R. Rep. No. 94–658, at 225
(1975); Joint Comm. on Taxation,
General Explanation of the Tax Reform
Act of 1976, at 236 (1976). In
conclusion, the comments’ claim that
the jurisdictional nexus requirement in
the 2020 FTC proposed regulations is
inconsistent with the Congressional
policy reflected in the repeal of the percountry limitation is not supported by
the legislative history and is
contradicted by subsequent
amendments to section 904.
Comments also stated that section
904(d)(2)(H)(i), which provides a rule
for assigning to a separate category
foreign tax imposed by a foreign country
on an amount that does not constitute
income under U.S. tax principles,
provides further support for the view
that foreign tax credit provisions should
be construed broadly, with limited
reference to U.S. rules. One comment
pointed to cases, including Schering
Corp. v. Comm’r, 69 T.C. 579 (1978) and
Helvering v. Campbell, 139 F.2d 865
(1944), in which courts allowed a credit
for foreign taxes on amounts that the
U.S. does not tax due to timing or base
differences, for example, as a result of
characterization differences.
The Treasury Department and the IRS
find these comments unpersuasive,
because the jurisdictional nexus
requirement in the 2020 FTC proposed
regulations would not preclude a credit
for foreign taxes imposed on an amount
of taxable income that exceeds taxable
income computed under U.S. tax law
rules due to base or timing differences.
The nexus rule requires that the activity
subject to the tax have sufficient
connection to the foreign country
imposing the tax. It does not require that
every item included in the foreign tax
base conform in timing or amount to
items included in U.S. taxable income.
Consistent with section 904(d)(2)(H)(i),
the jurisdictional nexus requirement in
the 2020 FTC proposed regulations does
not preclude a credit for foreign income

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taxes imposed on base difference
amounts.
3. Other Policy Considerations
Several comments questioned the
policy reasons discussed in the
preamble to the 2020 FTC proposed
regulations that motivated the Treasury
Department and the IRS to add the
jurisdictional nexus requirement.
Comments disagreed with the notion
that destination-based taxing rights lack
sufficient connection to a jurisdiction.
They noted that Congress’s deliberations
of alternative approaches to the U.S.
corporate income tax and the current
multilateral negotiations by the OECD/
G20 Inclusive Framework on Base
Erosion and Profit Shifting (‘‘Inclusive
Framework’’) with respect to
reallocating taxing rights under the
‘‘Pillar 1’’ proposal demonstrate that
there is a legitimate debate about claims
to destination-based taxing rights. This
ongoing debate, the comments stated,
indicates that market-based or
destination-based taxes are income
taxes. As such, some comments asserted
that the jurisdictional nexus rule in the
2020 FTC proposed regulations is
inconsistent with changes that have
occurred in how income can be
generated through technology and
changes that various taxing
jurisdictions, including U.S. states, have
made to their taxing regimes in response
to those changes. The comments
recommended that if the jurisdictional
nexus requirement is not eliminated in
the final regulations, the requirement
should be modified such that it is more
flexible and takes into account evolving
jurisdictional norms. One comment
asked that the requirement be expansive
enough to allow credits for taxes
imposed on income sourced to a
jurisdiction based on the situs of users
or customers, as well as taxes imposed
on a taxpayer that generates income
from customers in a jurisdiction without
having a physical presence in that
jurisdiction.
One comment pointed out that U.S.
income tax principles incorporate
destination-based taxing rights. As an
example, the comment noted that
proposed § 1.861–18(f)(2)(ii) provided
that when a copyrighted article is sold
and transferred through an electronic
medium, the sale is deemed to have
occurred at the location of download or
installation onto the end-user’s device.
As another example, the comment cited
§ 1.250(b)–4(d)(1)(ii)(D), which provides
that a sale of certain property that
primarily contains digital content is for
a foreign use if the end user downloads,
installs, receives, or accesses the
purchased digital content on the end

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user’s device outside the United States.
Another comment noted that Congress
considered imposing a destinationbased income tax as part of the 2017 tax
reform.
In addition, comments stated that
over half of U.S. states with a corporate
income tax determine the amount of a
taxpayer’s income subject to the state’s
corporate income tax by apportioning
the taxpayer’s federal taxable income
using sales as the single factor. The
comments stated that under the
proposed jurisdictional nexus
requirements, these state income taxes
would fail to be an ‘‘income tax’’ in the
U.S. sense even though the income
subject to the state corporate income
taxes is based in significant respects on
the taxpayer’s taxable income
determined under the Code. The
comments also questioned whether this
policy means that a foreign country can
deny a foreign tax credit for otherwise
eligible U.S. state corporate income
taxes simply because the states rely on
sales-based apportionment factors to
source income and a market-based
jurisdictional nexus standard.
In general, the Treasury Department
and the IRS disagree with these
comments. As explained in part IV.A.2
of this Summary of Comments and
Explanation of Revisions, whether a
foreign tax is creditable under section
901 depends on whether the tax is an
‘‘income tax in the U.S. sense.’’ Neither
prior unenacted legislative proposals
nor potential future (yet undetermined)
changes to the Code with respect to U.S.
jurisdictional limits are determinative of
what constitutes an income tax in the
U.S. sense under current law.
The Treasury Department and the IRS
acknowledged in the preamble to the
2020 FTC proposed regulations that
future changes in U.S. law may
necessitate rethinking the rules for
determining creditable foreign income
taxes. It is nevertheless important that
these final regulations be issued
promptly to address novel
extraterritorial taxes. Existing law is
unclear on the extent to which foreign
taxes that are inconsistent with existing
jurisdictional norms meet the definition
of an income tax under section 901, and
the Treasury Department and the IRS
had previously received comments
requesting guidance on this matter.3 In
addition, to the extent these novel
extraterritorial taxes, which many
foreign jurisdictions have already
adopted, are being paid by taxpayers
3 See New York State Bar Association Tax
Section, Report on Issues Relating to the Definition
of a Creditable tax for Purposes of Sections 901 and
903 of the Code, Rep’t No. 1332 (Nov. 24, 2015).

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and claimed as a foreign tax credit, this
would have an immediate and
detrimental impact on the U.S. fisc.
Therefore, the Treasury Department and
the IRS disagree with the suggestion in
comments that the potential for future
law changes necessitates a delay in the
issuance of these necessary and
appropriate regulations.
The Treasury Department and the IRS
also disagree that the manner in which
U.S. states determine the amount of
income that is taxable in a particular
state has any bearing on whether a
foreign tax is an income tax in the U.S.
sense. See, for example, Heiner v.
Mellon, 304 U.S. 271, 279 (1937) (‘‘It is
well settled that in the interpretation of
the words used in a federal revenue act,
local law is not controlling unless the
federal statute by express language or
necessary implication, makes its own
operation dependent upon state law.’’).
Nothing in the Code, legislative history,
or case law suggests that whether a tax
is an income tax in the U.S. sense
should be determined by reference to
state, as opposed to Federal, income tax
principles. Furthermore, it is immaterial
whether a foreign country would
provide a foreign tax credit under its
own law for U.S. state income taxes.
In addition, U.S. tax law imposing
U.S. tax on income of nonresidents is
not based on notions of destination or
customer location. See sections 864(c),
871, 881, and 882. Moreover, the
comment citing section 250 is
inapposite, as that provision merely
defines the scope of sales and services
that constitute income from export
activity that qualifies for a special U.S.
tax deduction; it does not operate to
assert taxing jurisdiction over income of
nonresidents. Similarly, while proposed
§ 1.861–18(f)(2)(ii) interprets the place
of sale as being the place of download
solely for the purpose of determining
the source of certain types of income
from the sale or exchange of digital
property in cases where the statutory
source rule looks to the place where the
sale occurs, this rule does not expand
the scope of U.S. tax on income derived
by nonresidents. U.S. law does not tax
income from the sale or exchange of
property by a nonresident unless the
nonresident conducts a trade or
business in the United States (if
applicable, through a U.S. permanent
establishment) or disposes of a United
States real property interest as provided
under section 897.
One comment stated that the
jurisdictional nexus requirement may be
reasonably viewed as consistent with
the policy of the foreign tax credit

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regime, which, as discussed in part
IV.A.2 of this Summary of Comments
and Explanation of Revisions, is not
intended to subsidize foreign
jurisdictions at the expense of the U.S.
fisc. However, the comment also
asserted that defining what are
acceptable standards of taxing
jurisdiction based upon U.S. principles
may be unduly restrictive and may
result in non-creditability of foreign
taxes even when the foreign tax law is
mostly aligned with U.S. principles. As
an example, the comment posited that if
a foreign country’s generally-imposed
net income tax on its residents could in
certain instances apply in a manner that
is inconsistent with traditional arm’s
length principles, that tax would be
non-creditable with respect to all
resident taxpayers, even for taxpayers to
which income would be allocated in a
manner consistent with arm’s length
principles.
Comments also pointed out that the
jurisdictional nexus requirement that
was included in the 1980 temporary and
proposed regulations at § 4.901–2(a)(1)
(flush language) was a more flexible
standard because it required only that
the foreign tax follow reasonable rules
regarding source of income, residence,
or other bases for tax jurisdiction, and
did not require specific rules that are
similar to Federal income tax rules. In
addition, one comment noted that the
1980 temporary regulations also
provided that a foreign tax may satisfy
the definition of an income tax even if
the foreign tax law differs substantially
from the income tax provisions of the
Code. That comment recommended that
the final regulations should provide
flexibility to accommodate the
continued evolution of international tax
policy consensus, which may diverge
from the U.S. view of traditional taxing
norms.
Comments also asserted that certain
U.S. sourcing rules reflect domestic
policies other than jurisdiction to tax.
As an example, one comment noted that
the title passage rule for inventory in
sections 861(a)(6) and 862(a)(6) reflects
administrative simplification concerns,
and former section 863(b) served as an
incentive for certain activities. The
comments argued that foreign countries
that adopt a rule different from U.S.
source rules due to different choices
among competing policies should not
cause the foreign tax to be noncreditable. One comment argued that
diverging views of taxing rights,
especially as between developed and
developing countries, have long existed
outside the context of novel

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extraterritorial taxes. The comment
asserted that diverging views on taxing
rights is what makes relief from double
taxation necessary; it is not a reason to
deny creditability of a foreign tax.
The Treasury Department and the IRS
generally agree that different countries
may diverge in their approach to
asserting jurisdictional taxing rights,
just as countries may have different
approaches in determining the amounts
of realized gross receipts and
recoverable costs and expenses included
in the foreign taxable base. As a result,
the net gain requirement in existing
§ 1.901–2, as well as in these final
regulations, does not require strict
conformity between foreign and U.S. tax
law. However, the final regulations do
require that a foreign tax must be
consistent with the general principles of
income taxation reflected in the Code
for it to be an ‘‘income tax in the U.S.
sense.’’ These principles include not
only those related to determining
realization, gross receipts, and cost
recovery, but also principles related to
assertion of taxing rights. The purpose
of section 901 is not to provide double
tax relief in all cases in which foreign
tax is imposed on income of a U.S.
taxpayer, but rather, to relieve double
taxation only in the case of foreign taxes
that are ‘‘income, war profits, and excess
profits taxes’’. Accordingly, the purpose
of the regulations under section 901 is
to provide clarity and certainty as to
which income tax principles reflected in
the Code the foreign tax law must have
for a tax to be an income tax in the U.S.
sense within the meaning of section
901. However, the Treasury Department
and the IRS agree with the comments
asserting that certain aspects of the
source requirement can appropriately be
revised to be more flexible; these
changes are described in part IV.A.4 of
this Summary of Comments and
Explanation of Revisions.
Several comments recommended that
the Treasury Department and the IRS
address the policy concerns regarding
extraterritorial taxes through alternative
approaches. These comments
recommended that the Treasury
Department utilize international forums,
such as the Inclusive Framework and
bilateral treaty negotiations, to dissuade
foreign jurisdictions from enacting or
imposing these taxes. Comments argued
that the denial of foreign tax credits is
unlikely to prevent foreign jurisdictions
from imposing extraterritorial taxes and
will instead harm the U.S. taxpayers
operating in those foreign jurisdictions.

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One comment asserted that the foreign
tax credit regulations should not be
used as a tool to further U.S. foreign
policy goals. Another comment
recommended that, instead of adopting
the jurisdictional nexus requirement,
the Treasury Department and the IRS
consider an alternative approach for
defining what exceeds appropriate
taxing jurisdiction by reference to the
criteria that the U.S. Trade
Representative has used to evaluate
whether these taxes are discriminatory
and burden U.S. commerce. Finally, one
comment asserted that the jurisdictional
nexus requirement would
disproportionately disallow credits for
taxes imposed by developing countries,
which are more likely to assert taxing
rights in a manner that is inconsistent
with international norms, as compared
to taxes imposed by developed
countries.
The Treasury Department and the IRS
agree that international forums can be
an effective way of discouraging foreign
jurisdictions from enacting
extraterritorial taxes; indeed, the
Treasury Department is actively engaged
in and supporting negotiations under
the auspices of the Inclusive Framework
that would result in their elimination.4
However, contrary to the comments’
assertion, the Treasury Department and
the IRS’s determination that regulations
are necessary and appropriate to ensure
that the U.S. fisc does not bear the costs
of such taxes derives from the text,
purpose, and policy of section 901, and
not from any foreign policy goals. The
Treasury Department and the IRS have
concluded that these novel
extraterritorial taxes (some of which are
currently in force and being levied on
U.S. taxpayers) are contrary to the text
and purpose of section 901 and
therefore must be addressed now.
Furthermore, nothing in the text,
structure, or history of section 901
suggests that the Treasury Department
or the IRS should consider the level of
economic development of a country in
determining whether a foreign tax
imposed by that country meets the
standards in section 901. Lastly, the
Treasury Department and the IRS have
considered the recommendation to use
the criteria used by the U.S. Trade
Representative but have determined that
those criteria are designed for a different
4 See OECD/G20 Base Erosion and Profit Shifting
Project, Statement on a Two-Pillar Solution to
Address the Tax Challenges Arising from the
Digitalisation of the Economy (October 8, 2021)
(describing agreement reached by 136 countries to
‘‘remove all Digital Services Taxes and other
relevant similar measures with respect to all
companies, and to commit not to introduce such
measures in the future.’’).

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purpose (that of evaluating whether the
foreign tax is unreasonable or
discriminatory and burdens or restricts
U.S. commerce under U.S. trade laws),
and are not suitable for purposes of
defining whether a tax is an income tax
in the U.S. sense for purposes of U.S.
tax laws.
Finally, one comment recommended
that the Treasury Department and the
IRS develop a list of per se creditable
and non-creditable taxes to provide
taxpayers certainty and reduce
compliance burdens. A per se list of
creditable and non-creditable taxes
would require significant government
resources to analyze foreign taxes and
maintain such a list, which would need
to be updated every time foreign tax
laws change. Therefore, the final
regulations do not adopt this comment.
4. Modifications to the Source-Based
Nexus Requirement
Comments argued that the
determination of whether foreign
sourcing rules are reasonably similar to
U.S. sourcing rules would be complex
and result in significant uncertainty
because U.S. sourcing rules are not
sufficiently well-defined. Comments
pointed out that the preamble to the
2020 FTC proposed regulations
acknowledged that the U.S. rules for
determining income effectively
connected with a U.S. trade or business
have been developed through case law,
are not strictly delineated, and thus
were not used as the standard for the
activities-based nexus requirement. The
comments suggested that the U.S.
sourcing rules for royalties and services
are similarly addressed only in case law
and not well-developed. They
contended that it would be difficult to
apply the sparse and inconsistent U.S.
case law on royalty sourcing to
determine if a foreign tax law’s sourcing
rules for royalties are reasonably similar
to U.S. rules. In addition, comments
asserted that the U.S. sourcing rules are
designed to distinguish between U.S.
and foreign source income, and are not
well-suited for determining, for
example, whether a royalty paid from
one CFC to another is specifically
sourced to the payor CFC’s jurisdiction
of residence. With respect to services
income, one comment noted that it is
unclear whether services should be
sourced solely based on the source of
the labor or by also taking into account
the location of capital, especially when
significant intangible property is
involved. Another comment asked for
clarification on how to evaluate whether
a foreign withholding tax that is
imposed both on services performed in
the country imposing the tax and on

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technical service fees paid by a resident
of such foreign country (regardless of
where the services are performed) meets
the source-based nexus requirement;
this comment asked whether the
determination of ‘‘reasonably similar’’
would depend on how important
technical services are relative to that
foreign country’s economy.
In response to these comments, the
final regulations modify the sourcebased nexus requirement to provide
additional flexibility and clarity.
Section 1.901–2(b)(5)(i)(B) continues to
require that the foreign sourcing rules
must be reasonably similar to the
sourcing rules under the Code.
However, in recognition that the Code
does not provide detailed sourcing rules
addressing every category of income, or
every type of income within that
category, and that the interpretation and
application of the Code sourcing rules
are sometimes addressed only in case
law and sub-regulatory guidance,
§ 1.901–2(b)(5)(i)(B) also provides that
the foreign tax law’s application of
sourcing rules need not conform in all
respects to the interpretation that
applies for Federal income tax purposes.
Thus, for example, the final regulations
require that in the case of gross income
arising from gross receipts from
royalties, the foreign tax law must
impose tax on such royalties based on
the place of use of, or the right to use,
the intangible property. However, the
final regulations do not require that the
foreign law, in determining the place of
use of an intangible in a particular
transaction or fact pattern, reach the
same conclusion as the IRS in a
particular revenue ruling or a U.S. court
in a particular case.
The final regulations provide
additional certainty by specifying the
source principles that foreign tax law
must apply to be considered reasonably
similar to U.S. source rules. With
respect to income from services,
§ 1.901–2(b)(5)(i)(B)(1) provides that
gross income arising from services must
be sourced based on where the services
are performed, as determined under
reasonable principles, which do not
include determining the place of
performance based on the location of
the service recipient. Thus, a
withholding tax that is imposed on
payments for services performed in the
country imposing the tax would meet
the source-based nexus requirement, but
a withholding tax on fees for technical
services performed outside of that
country would not meet the sourcebased nexus requirement. In addition,
the separate levy rules at § 1.901–
2(d)(1)(iii) are modified to provide that
withholding taxes that apply different

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sourcing rules to subsets of a single
class of gross income of nonresidents
are treated as separate levies. Therefore,
a withholding tax that applies a
nonqualifying source rule to a subset of
service income would not be creditable,
but because it is treated as a separate
levy the nonqualifying source rule
would not prevent a withholding tax on
other services that satisfies the sourcebased nexus requirement from
qualifying as a creditable tax.
Several comments also pointed out
that the United States and the foreign
jurisdiction may disagree on how to
characterize the income from a
particular transaction, making it more
difficult to determine whether the
foreign tax meets the jurisdictional
nexus requirement. The comments
noted that issues of characterization are
particularly prevalent with respect to
cross border payments for digital goods.
The comments stated that in respect of
software transactions that are treated as
sales of copyrighted articles under
§ 1.861–18, some foreign countries
regard some or all payments by their
resident taxpayers for software copies as
royalties, and accordingly, impose a
royalty withholding tax on those
payments. The comments also asserted
that even in cases where a foreign
country may not consider the payment
subject to royalty withholding tax, the
foreign country may nonetheless tax
other copyrighted article transactions as
royalties. As such, the comments
argued, cross border payments for
digital goods should be excepted from
the jurisdictional nexus requirement.
Another comment noted that similar
characterization questions may arise
when distinguishing between technical
service fees and royalties; the comment
queried whether a foreign withholding
tax imposed on royalties that the United
States would view as a payment for
services would be determined to be noncreditable or would require an
evaluation of the magnitude of the
services relative to the royalty.
Comments also argued that the United
States lacks guidance on the
classification and sourcing of income
from cloud computing transactions,
noting that the Treasury Department
and the IRS have not yet finalized the
proposed cloud computing regulations
that were issued in 2019. The comments
asserted that given the evolving U.S.
guidance on the character and source of
cloud computing transactions, the
creditability of a foreign tax imposed on
such transactions should not depend on
whether foreign law is reasonably
similar to U.S. law.
In response to these comments, the
final regulations provide that, in

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general, foreign tax law applies for
purposes of determining the character of
the gross income or gross receipts that
arise from a transaction. See § 1.901–
2(b)(5)(i)(B). The determination of
whether the foreign law source rule is
reasonably similar to the source rules
under the Code will follow from the
foreign law characterization of that
income. If there is no statutory source
rule in the Code for a particular amount
that is subject to foreign tax, then the
foreign law source rule will satisfy the
source-based nexus requirement if it is
reasonably similar to the U.S. source
rule that applies by closest analogy.
However, the final regulations also
clarify that in the case of copyrighted
articles, to satisfy the source-based
nexus requirement, the foreign tax law
must treat a transaction that is
considered the sale of a copyrighted
article under § 1.861–18 (where the
acquirer receives only the right to use a
copyrighted article and not, for
example, the right to duplicate and
publicly distribute, or the right to
publicly display the article) as a sale of
tangible property and not as a license.
See § 1.901–2(b)(5)(i)(B)(3). This rule is
consistent with established U.S. law and
international norms. See § 1.861–18(c);
see also OECD Model Tax Convention
(2017), commentary to art. 12. The
Treasury Department and the IRS have
determined that this rule is necessary to
ensure that foreign jurisdictions cannot
reclassify income from sales of
copyrighted articles as royalties to assert
taxing rights that are extraterritorial in
nature and outside the scope of what is
an income tax in the U.S. sense.
Comments recommended that, if the
jurisdictional nexus requirement is not
withdrawn entirely in the final
regulations, then payments for services
and payments for digital goods should
be excepted from the source-based
nexus requirement. With respect to
payment for services, the comments
argued that the U.S. source rule for
services is not the international norm;
many countries impose withholding tax
on payment for services made by a
resident in the country (or by a
nonresident with a permanent
establishment in the country).
Comments noted that the UN Model Tax
Convention allows contracting states to
impose withholding taxes on a variety
of services fees, and that the United
States has income tax treaties with
foreign jurisdictions that allow the
foreign country to withhold tax on
payments for services not performed in
that country. Several comments also
asserted that withholding taxes on
payments for services are not novel

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taxes, but rather are long-standing taxes
that are also creditable under existing
§ 1.903–1. Specifically, comments
pointed to Example 3 of existing
§ 1.903–1(b)(3), which concludes that a
gross basis tax imposed on a
nonresident for technical services
performed outside the country imposing
the tax are creditable. As such, the
comments stated, these withholding
taxes are consistent with international
norms and the final regulations should
continue to allow these taxes to be
creditable.
In addition, comments expressed
concern about the increased incidence
of unrelieved double taxation in respect
of cross-border payments for digital
services. The comments suggested that
under proposed § 1.861–19, essentially
all cloud transactions, as defined in
those proposed regulations, will be
classified as services for Federal income
tax purposes. As such, foreign
withholding taxes imposed on payments
for those services, if not imposed on the
basis that the services are performed in
the country, would be non-creditable
under the proposed source-based nexus
requirement. Comments also pointed
out that the effect of the source-based
nexus requirement in the 2020 FTC
proposed regulations is to create
disparate treatment for software
suppliers based on the approach a
supplier adopts to commercializing the
software. As an example, comments
pointed out that a software supplier that
makes software available through
limited time subscription is treated
under Federal income tax rules as
receiving payments of service fees,
whereas a software supplier that
provides software to users through
downloads under limited-time licenses
is treated as receiving payments of rents.
If a foreign country imposes
withholding taxes on both payments,
the withholding tax paid by the first
software supplier would not be
creditable (because the U.S. source rules
would not permit the service payment
to be sourced based on the location of
the user) whereas the taxes paid by the
second supplier would be creditable
(because U.S. source rules would permit
the rental payment to be sourced based
on where the user installs the software
copy). The comments argued that there
is no policy justification for such
disparate results.
The Treasury Department and the IRS
have determined that it is necessary and
appropriate to narrow the circumstances
under existing law (for example, as
illustrated in Example 3 of § 1.901–
1(b)(3)) in which withholding taxes on
payment for services are creditable. The
taxation of services performed by

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nonresidents, under U.S. tax law, is
clearly limited to cases in which the
services are performed in the United
States. Nothing in the Code, legislative
history, or case law indicates that a
different approach is appropriate for
technical or digital services. The
Treasury Department and the IRS have
determined that the assertion of foreign
withholding taxes on income from
services that are not performed within
the foreign jurisdiction is not consistent
with an income tax in the U.S. sense
and therefore should not qualify for a
credit under section 901.
Furthermore, the Code provides for
disparate treatment of classes of income
depending on whether the transaction
that gives rise to the income is
characterized as a service, license, sale,
or something else. This different
treatment is also reflected in existing
international norms, including the
OECD Model Tax Convention. Seeking
to conform the treatment of digital
transactions under the Code, or to
anticipate possible future changes to the
treatment or classification of digital
transactions, is beyond the scope of
these regulations. Instead, the Treasury
Department and the IRS have
determined that analyzing whether a
foreign tax is an income tax based on
how such income is characterized under
foreign law and comparing the foreign
tax law sourcing rule to U.S. tax
principles, provides adequate flexibility
to account for differences between U.S.
and foreign law, while adhering to the
requirement that a foreign tax be an
income tax in the U.S. sense to be
creditable. Thus, the final regulations do
not adopt the recommendation to except
digital services from the jurisdictional
nexus requirement.
One comment noted that the 2020
FTC proposed regulations could create
different results for sales of software,
depending on whether the software is
delivered on tangible media or delivered
by way of digital download because
there are different U.S. source rules for
such transactions. As an example, the
comment explained that a sale of a
software copy that is delivered on
tangible media is sourced, under U.S.
income tax principles, based on title
passage, whereas the sale of a
copyrighted article delivered through an
electronic medium is deemed to occur,
under proposed § 1.861–18(f)(2)(ii), at
the location of download or installation.
The comment further noted that if
proposed § 1.861–18(f)(2)(ii) is not
finalized, and the title passage rule
continues to apply to digital deliveries,
then for U.S. income tax purposes, the
source of the income would be
determined based upon where the

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servers from which the software copy is
made available is located. The comment
argued that these distinctions should
not be the basis for causing the supplier
of the software to be eligible or
ineligible for a foreign tax credit.
The Treasury Department and the IRS
have determined that it is unnecessary
to require a foreign tax law’s sourcing
rule for income derived from the sale or
other disposition of property to conform
with U.S. source rules. This is because
under the Code, the United States
imposes tax on such income of a
nonresident only if the nonresident
conducts a U.S. trade or business (if
applicable, through a U.S. permanent
establishment) or the income is derived
from real or movable property situated
in the United States. Thus, the final
regulations provide that, with respect to
foreign tax imposed on income derived
from the sale or other disposition of
property, including copyrighted articles
sold through an electronic medium, the
tax meets the attribution requirement
only if the inclusion of the income in
the foreign tax base meets the activitiesbased nexus requirement in § 1.901–
2(b)(5)(i)(A) or the property-based nexus
requirement in 1.901–2(b)(5)(i)(C).
5. Activities-Based Nexus Requirement
One comment stated that the physical
presence and permanent establishment
standard is not an inherent part of the
U.S. tax system; rather, it is a political
invention in the 1920s that was the
result of bargaining between the United
States and its treaty partners. The
comment stated that by adopting this
standard in the 2020 FTC proposed
regulations, the Treasury Department
and the IRS ignored the economic
realities of digital economies and lacked
reasoned decision-making. The
comment recommended that the final
regulations provide that the
jurisdictional nexus requirement is
satisfied when consumers of a service
rendered by a foreign corporation are
located in the taxing jurisdiction.
The Treasury Department and the IRS
disagree with the comment’s assertion
that the physical presence and
permanent establishment standard is
not an appropriate measure for nexus.
The permanent establishment standard
is a critical part of the U.S. Model
Income Tax Convention, existing U.S.
bilateral tax treaties, and the OECD
Model Tax Convention. Furthermore, a
physical presence standard is consistent
with the nexus rules in section 864,
which provide that only income
effectively connected with a trade or
business that a foreign resident
conducts in the United States is subject
to U.S. tax. Contrary to the comment’s

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contention, the 2020 FTC proposed
regulations did not ignore the economic
realities of digital economies; rather,
they adopted a standard based on the
existing Code and traditional
international taxing norms. The
Treasury Department and the IRS have
determined that the income tax
principles in the Code do not allow for
the assertion of taxing rights based
solely on the existence of consumers in
a jurisdiction.
One comment asserted that, where the
foreign law includes elements in
common with the effectively connected
income standard under section 864(c), a
broader standard for attributing income
to nonresidents on the basis of the
nonresidents’ activities as well as
activities of the nonresident’s related
parties should satisfy the activitiesbased nexus requirement of the 2020
FTC proposed regulations. The Treasury
Department and the IRS disagree with
this comment. Taking into account
activities of the nonresident’s related
parties would be inconsistent with the
principles reflected in the U.S. Model
Income Tax Convention, and the OECD
Model Tax Convention, as well as in
section 864 (unless the other party is
acting on behalf of the nonresident).
Accordingly, the final regulations at
§ 1.901–2(b)(5)(i)(A) clarify that the
activities-based attribution requirement
is not met when the nonresident is
deemed to have a trade or business in
the taxing jurisdiction by reason of
activities conducted by another person,
or when the foreign tax law attributes
profits to the nonresident based upon
the activities of another person, other
than in the case of a party acting on
behalf of the nonresident or in the case
of a pass-through entity of which the
nonresident is an owner. In addition,
the final regulations clarify in § 1.901–
2(b)(5)(i)(A) that foreign tax law that
attributes income to a nonresident by
taking into account as a significant
factor the mere location of persons from
which a nonresident makes purchases
does not meet the activities-based nexus
requirement.
Comments requested that taxes paid
to Puerto Rico be exempted from the
application of the jurisdictional nexus
requirement because, as a U.S. territory,
its taxes should not be treated in the
same manner as taxes imposed by a
foreign country. For Federal income tax
purposes, a credit is allowed for income
taxes paid or accrued to any foreign
country or United States territory. See
section 901(b)(1); see also section 903.
As no distinction is made between taxes
imposed by foreign countries and those
imposed by U.S. territories, the final
regulations follow the 2020 FTC

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proposed regulations in applying the
same standards in defining what is a
creditable income tax regardless of
whether the tax is imposed by a foreign
country or a U.S. territory. However, as
described in more detail in part IV.F.2
of this Summary of Comments and
Explanation of Revisions, a special
transition rule applies to defer for one
year the applicability date of the final
regulations under section 903 with
respect to certain taxes paid to Puerto
Rico.
Another comment recommended that
the example in proposed § 1.901–2(c)(3)
(§ 1.901–2(b)(5)(iii) of the final
regulations) be expanded to illustrate
the application of the attribution
requirement in the case where a
nonresident taxpayer is earning income
from electronically supplied services in
a country that imposes tax on such
services (ESS tax) and the taxpayer
either (1) maintains its own branch in
the foreign country imposing the tax,
with employees of the branch
conducting routine sales, marketing,
and customer support functions or (2)
uses a related party disregarded entity
resident in that country to perform local
marketing, customer support, and other
routine functions. With respect to the
second scenario, the comment noted
that where the ESS tax is imposed on
the resident disregarded entity, if the
entity’s tax base is determined under
arm’s length principles, without taking
into account as a significant factor the
location of customers, users, or any
other similar destination-based
criterion, then the ESS tax would meet
the residence-based nexus requirement
and would be creditable. The comment
suggested that in the first scenario,
although the ESS tax is not imposed on
the basis of a nonresident’s activities
located in the country, the portion of the
ESS tax that corresponds to the portion
of a separate nonresident corporate
income tax imposed on the branch’s
effectively-connected income that
would meet the activities-based
requirement (based on the actual
activities performed by the branch)
should be considered to meet the
activities-based nexus requirement if the
country does not impose the tax on the
branch’s effectively-connected income.
The Treasury Department and the IRS
agree with the comment’s analysis and
conclusion in the second scenario but
disagree with the analysis and
conclusion in the first scenario.
Whether a foreign tax meets the
requirements of § 1.901–2(b), including
the attribution requirement, is
determined based solely on the terms of
the foreign tax law, and not on a
taxpayer’s specific facts. Thus, the fact

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that a separate levy that the foreign
country could have imposed on
nonresident taxpayers with respect to
their branch operations in the foreign
country could meet the attribution
requirement in a particular factual
circumstance does not mean that a
different tax that is an ESS tax, or any
portion of an ESS tax, would be deemed
to meet the attribution requirement.
6. Property-Based Nexus Requirement
One comment requested clarification
on whether a foreign tax law similar to
the U.S. Foreign Investment in Real
Property Tax Act (FIRPTA) regime
under section 897 would satisfy the
proposed property-based nexus
requirement. It noted that under the
2020 FTC proposed regulations, a
foreign tax law identical to FIRPTA may
not meet the proposed property-based
nexus rule if (consistent with section
897) it included in the tax base a portion
of the gain from the sale of shares in a
foreign real property holding
corporation (within the meaning of
section 897(c)(2)) that does not
correspond to foreign real property
interests. The comment further noted
that a foreign levy imposed on a
nonresident’s gain from the sale of
shares of a corporation attributable to
real property in the taxing jurisdiction
would be creditable under the proposed
property-based nexus rule, even if
(inconsistent with section 897) the
corporation is not a resident of the
taxing jurisdiction.
In response to this comment, the final
regulations at § 1.901–2(b)(5)(i)(C)
clarify that a foreign tax may include in
its base gross receipts that are
attributable to the sale or disposition of
real property situated in the foreign
country, or to the disposition of an
interest in a corporation or other entity
that is a resident of the foreign country
that owns real property situated in the
foreign country, under rules reasonably
similar to those in section 897. In
addition, a foreign tax imposed on the
basis of the situs of property may
include in its base gains derived from
the sale or other disposition of property
forming part of the business property of
a taxable presence in the foreign country
as well as gains from the disposition of
an interest in a partnership or other
passthrough entity that has a taxable
presence in the foreign country to the
extent the gains are attributable to the
entity’s business property in that foreign
country, under rules that are reasonably
similar to those in section 864(c). A
foreign tax on any other gains of a
nonresident will not satisfy the
property-based attribution requirement.

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7. Interaction With Income Tax Treaties
The preamble to the 2020 FTC
proposed regulations confirmed that the
proposed regulations in §§ 1.901–2 and
1.903–1, when finalized, would not
affect the application of existing income
tax treaties to which the United States
is a party with respect to covered taxes
(including any specifically identified
taxes) that are creditable under the
treaty.
One comment recommended that the
final regulations expressly provide that
the regulations will not affect the
creditability of foreign taxes covered by
an existing income tax treaty. The
comment also argued, however, that
relying on the U.S. treaty network as the
sole mechanism for relieving double tax
for companies operating in foreign
countries with source or other
jurisdictional taxing norms that differ
from U.S. taxing norms is not equitable.
It noted that the United States only has
income tax treaties with 68 countries,
and that the United States has few
treaties with countries in South America
and Africa. The comment stated that the
treaty negotiation process is laborious
and that the Treasury Department
considers the level of trade and
investment between the countries in
determining with which countries it
engages in treaty negotiations, with the
result being that the United States has
historically declined to negotiate
treaties with countries that have smaller
economies, including developing
countries.
Another comment requested that the
Treasury Department and the IRS
specifically address the interaction of
the jurisdictional nexus requirement
with U.S. income tax treaties that have
allowed the treaty partner to impose a
capital gains tax on a nonresident
taxpayer on the sale of stock of a
corporation resident in the treaty
country regardless of whether the shares
constitute a real property interest or are
attributable to a permanent
establishment in the treaty country. The
comment noted that, despite the
statement in the preamble to the 2020
FTC proposed regulations, it is unclear
how the double taxation articles of U.S.
income tax treaties, which often provide
that the United States agrees to allow a
foreign tax credit subject to the
limitations of U.S. law, would be
interpreted in light of these regulations.
The comment recommended that the
Treasury Department and the IRS
modify the jurisdictional nexus
requirement such that foreign taxes
imposed on gains from the disposition
of stock of a corporation sourced on the

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basis of residence of the corporation
continue to be creditable.
Comments also asked for clarification
regarding the effect the final regulations
would have on a foreign tax that is a
covered tax under an existing U.S.
income tax treaty if the foreign tax is
paid by a CFC, which is not eligible for
the benefits given to U.S. residents
under the treaty. One comment noted
that because CFCs are not U.S.
residents, taxes paid by the CFC on a
foreign-to-foreign payment would not be
creditable under the U.S. income tax
treaty with the source country. The
comment questioned whether this
means that a foreign tax would not be
creditable when paid or accrued by a
CFC even though it would be creditable
if paid or accrued directly by a U.S.
taxpayer.5 The comment pointed out
that in this case, the United States has
already acknowledged the legitimacy of
the treaty partner’s claim to taxing
rights, even if it conflicts with U.S.
principles; thus, the tax should be
creditable even if paid by a CFC.
Another comment similarly noted that,
in respect of foreign taxes imposed on
gains from the disposition of stock of a
resident corporation that are creditable
under certain U.S. treaties, such treaties
would ensure creditability of those taxes
only when paid by U.S. persons, and
not, for example, when paid by an
upper-tier CFC upon the disposition of
lower-tier CFC stock.
In response to these comments, the
final regulations clarify in § 1.901–
2(a)(1)(iii) that a foreign tax that is
treated as an income tax under the relief
from double taxation article of an
income tax treaty that the United States
has entered into with the country
imposing the tax meets the definition of
a foreign income tax as to U.S. citizens
and residents of the United States that
elect to claim benefits under that treaty.
However, as the comments noted, CFCs
are not treated as U.S. residents under
U.S. income tax treaties, so CFCs
resident in a third country do not
qualify for benefits under U.S. income
tax treaties. Because U.S. income tax
treaties do not limit the application of
the treaty partner’s taxes imposed on
5 Another comment made a similar point in
connection with recommending that all proposed
revisions to the net gain requirement be withdrawn.
That comment noted that taxpayers that are
operating in a country with which the United States
has an income tax treaty may not be insulated from
uncertainty regarding the creditability of foreign
taxes because the treaties are unclear as to the
creditability of foreign taxes listed in the treaty that
are incurred by foreign subsidiaries and deemed
paid by U.S. taxpayers under section 960. That
comment is addressed in this part IV.A.7. of the
Summary of Comments and Explanation of
Revisions.

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third-country CFCs, the final regulations
clarify that taxes paid to a U.S. treaty
partner by a third-country CFC are
treated as a separate levy that must
independently satisfy the requirements
of section 901 or 903 to be creditable.
However, the final regulations clarify
that any limitations that a foreign
country has agreed to under its treaties
with other jurisdictions that apply to
nonresident CFCs would be taken into
account in determining whether such
levy meets the requirements of § 1.901–
2(b) or § 1.903–1(b) when paid by the
CFC. See § 1.901–2(a)(1)(iii). Thus, for
example, in determining whether a
foreign country’s nonresident corporate
income tax meets the activities-based
jurisdictional requirement of § 1.901–
2(b)(5)(i)(A), when the tax is paid by a
CFC that is resident in a third country,
any limitations or modifications that the
first foreign country has agreed to under
the permanent establishment and
business profits articles of an income
tax treaty with the third country are
taken into account. The final regulations
make corresponding modifications to
the separate levy rules to provide that a
foreign levy that is modified by a
particular treaty is treated as a separate
levy. See § 1.901–2(d)(1)(iv).
B. Net Gain Requirement
1. In General
The 2020 FTC proposed regulations
modified the net gain requirement to
limit the role of the predominant
character analysis in determining
whether a tax meets each of the
components of the net gain
requirement—the realization
requirement, the gross receipts
requirement, and the net income
requirement (which under the 2020 FTC
proposed regulations is referred to as
the cost recovery requirement). The
2020 FTC proposed regulations also
limited the prevalence of the empirical
analysis required by the existing
regulations, which asks whether a
foreign tax is likely to reach net gain in
the ‘‘normal circumstances’’ in which it
applies. Instead, the 2020 FTC proposed
regulations generally provided that the
determination of whether a tax satisfies
each of the realization, gross receipts,
and cost recovery requirements under
the net gain requirement is based on the
terms of the foreign tax law governing
the computation of the tax base. See
proposed § 1.901–2(a)(3). The preamble
to the 2020 FTC proposed regulations
explained that reduced reliance on
empirical analysis would allow
taxpayers and the IRS to evaluate the
nature of the foreign tax based on
objective and readily available

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information and would lead to more
consistent and predictable outcomes.
Several comments recommended that
instead of finalizing the proposed
modifications to the net gain
requirement, the Treasury Department
and the IRS should either retain the
predominant character test of the
existing regulations or propose less
extensive changes to the net gain
requirement and provide transition
rules. Some of these comments stated
that the proposed rules would create too
rigid a standard that would lead to
increased instances of double taxation,
putting U.S. companies at a competitive
disadvantage. One comment stated that
under the proposed standard, a credit
may not be allowed for a foreign tax that
is an income tax in the U.S. sense based
on the actual operation of the foreign
tax. Another comment asserted that the
proposed standard would place U.S.
multinationals operating in developing
countries at a significant competitive
disadvantage compared with foreign
competitors operating in the same
developing countries that do not face
the same risk of double taxation because
they are subject to a participation
exemption or a less restrictive foreign
tax credit regime.
Comments stated that the
predominant character and facts and
circumstances analysis of the existing
regulations is a better approach because
there is a lack of uniformity in the
income tax systems across different
jurisdictions and because a particular
country’s tax system can regularly
change over time. Comments stated that
the existing regulations provide the
necessary flexibility to allow a credit to
be claimed for foreign taxes that are
calculated with variations from U.S. tax
principles. In addition, several
comments questioned whether
administrative difficulties with applying
the predominant character test of the
existing regulations was a legitimate or
sufficient justification for removing the
test, noting that the controversies over
creditability of foreign taxes have not
been pervasive or unresolved enough to
justify the new more objective
standard.6 Several comments stated that
instead of reducing administrative
burdens the proposed changes add
complexity and reduce certainty
6 One comment made this assertion specifically
with respect to the removal of the alternative gross
receipts test of the existing regulation, noting that
there have been only three court cases involving the
gross receipts test over the past four decades. That
comment is addressed in this part IV.B.1 of the
Summary of Comments and Explanation of
Revisions; other comments regarding the gross
receipts requirement are discussed in part IV.B.2 of
the Summary of Comments and Explanation of
Revisions.

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because they require taxpayers to
compare foreign and U.S. tax law,
including statutes, regulations, case law,
rulings, and pronouncements, with any
subsequent changes to either foreign or
U.S. law requiring re-evaluation of
whether there is sufficient conformity.
Comments also asserted that it is not
realistic for the Treasury Department
and the IRS to expect foreign tax law to
conform substantially to U.S. tax law.
These comments noted that different
jurisdictions use different means to
protect their tax base and that some
countries may have a relatively simple
tax regime and choose to protect their
base through disallowance of
deductions. Comments suggested that a
foreign tax should not have to strictly
conform to U.S. rules; it should be
creditable if it has the essential elements
of an income tax in the U.S. sense.
Comments also asserted that the Code
definition of gross income and
allowable deductions reflect evolving
priorities of Congress and should not
serve as the determinative standard of a
model income tax that other countries
should follow. Finally, another
comment stated that the significant
changes made by the 2020 FTC
proposed regulations would
fundamentally change existing U.S. tax
laws and policies to a degree that only
Congress can implement through
legislation.
As explained in part IV.A.2 of this
Summary of Comments and Explanation
of Revisions, Congress did not prescribe
a fixed definition of the term ‘‘income
tax’’ for purposes of section 901 or 903.
As a result, the meaning of the term has
been developed and refined through
administrative guidance and case law
since 1919. This body of law has
followed the guiding principle that the
determination of whether a foreign tax
is an income tax for purposes of sections
901 and 903 is made by reference to
U.S. tax law. The 1983 final regulations
followed this principle and, influenced
by court opinions decided in the years
preceding those regulations, adopted an
approach that required a foreign tax to
be examined in the normal
circumstances in which the tax is
applied to determine whether the
predominant character of the tax is that
of an income tax in the U.S. sense. As
explained in the preamble to the 2020
FTC proposed regulations, the IRS’s
experience over the past 40 years has
highlighted the significant
administrative difficulties with applying
the predominant character test, the
ambiguities inherent in the empirical
analysis required to apply the test, and
the inconsistent outcomes that may
result from applying the predominant

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character test. See 85 FR 72089–72092.
In addition, the courts that applied the
1983 regulations further brought into
focus the type of quantitative empirical
evidence, such as private financial data
on the extent of disallowed expenses,
that the IRS and the taxpayer may need
to obtain and analyze to determine
whether a foreign tax is an income tax
under the empirical tests of the existing
regulations. See, for example, Texasgulf
Inc. v. Comm’r, 172 F.3d 209, 216 (2d
Cir. 1999) (court examined statistics for
claimed processing allowances and for
nonrecoverable expenses across a 13year period derived from a study
conducted by taxpayer’s expert to
determine if alternative allowance
provided under the Ontario Mining Tax
effectively compensated for nonrecovery
of significant expenses); Exxon Corp. v.
Comm’r, 113 T.C. 338 (1999) (both
parties relied heavily on expert
witnesses from the petroleum industry,
the U.K. government, and from legal,
tax, accounting, and economic
professions).
The comments that recommended
against the approach in the 2020 FTC
proposed regulations did not suggest
any alternative approaches that would
not require the empirical analysis
necessitated by the existing regulations.
Due to the difficulty that taxpayers and
the IRS face in properly applying the
existing regulations, the Treasury
Department and the IRS have
determined that it is necessary and
appropriate to finalize the rule in the
2020 FTC proposed regulations that the
determination of whether a foreign tax
meets the net gain requirement is
primarily based on the terms of the
foreign tax law governing the
computation of the tax base. This
approach allows taxpayers and the IRS
to evaluate the nature of the foreign tax
based on more objective and readily
available information.
The Treasury Department and the IRS
disagree with the comments that
suggested that the existing regulations
entail minimal administrative burdens
or that the rules in the 2020 FTC
proposed regulations will increase
administrative burdens. Although the
final regulations require a comparison of
foreign law to U.S. law, that comparison
is generally done by examining the
terms of the foreign tax law, which
taxpayers must do in any case in order
to compute their foreign tax liability,
rather than by examining difficult-toobtain foreign tax return and private
financial data to determine the effect of
the tax (as is required under the existing
regulations).
In addition, the Treasury Department
and the IRS disagree that the final

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regulations will add complexity or
create more disputes. The fact that
relatively few court cases have
addressed the definition of an income
tax under § 1.901–2 does not suggest
that the existing regulations are clear
and easy to apply, but rather that they
are challenging for the IRS to
administer. It is unclear whether
taxpayers are correctly applying the
existing requirements in § 1.901–2 by
performing the empirical analysis
required by the regulations. Because the
existing regulations are difficult for
taxpayers to apply and for the IRS to
administer, there is potential for the
requirements in existing § 1.901–2 to be
applied incorrectly, a result that is
detrimental to sound tax administration.
The Treasury Department and the IRS
have determined that the changes made
in the final regulations will increase
certainty and will prevent the need for
the IRS to gather and evaluate data that
are not readily available in order to
ensure that taxpayers are appropriately
applying the relevant empirical
analysis—particularly in the case of
novel extraterritorial taxes that are
generally imposed on a gross basis (such
as digital services taxes) and that would
meet the requirements of the existing
regulations only if the nonrecoverable
costs and expenses attributable to that
gross income, together with the tax paid
by all persons subject to the tax, can
empirically be proven almost never to
result in a loss. The Treasury
Department and the IRS disagree with
comments that suggest that
administrative concerns are not a
sufficient reason for revising the
regulations. Having clear, administrable
rules that can be consistently applied is
critical to sound tax administration.
The Treasury Department and the IRS
also disagree with the comments
suggesting that the 2020 FTC proposed
regulations reflect a fundamental change
to existing foreign tax credit policies or
that the existing regulations do not
require taxpayers to compare foreign
and U.S. tax law (including statutes,
regulations, case law, rulings, and
pronouncements) to determine whether
a tax is creditable. In fact, for a foreign
taxable base that deviates from the U.S.
computational norm of realized gross
receipts reduced by significant costs and
expenses, the predominant character
test by its terms requires taxpayers to
perform an empirical analysis every
year to determine whether a tax is
creditable, such that changes in the
empirical impact of a foreign tax
(despite no change in the terms of the
tax) could impact the creditability
analysis. The final regulations will
simplify the determination of whether a

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foreign levy is an income tax in the U.S.
sense by eliminating this burdensome
inquiry.
Furthermore, the Treasury
Department and the IRS disagree that
the final regulations will result in
additional double taxation in a manner
that is inconsistent with the statute, or
that they inappropriately place U.S.
multinationals at a competitive
disadvantage compared to foreign
competitors from a country with a
participation exemption regime or a
less-restrictive foreign tax credit system.
Section 901 allows credits only for
foreign taxes that are income taxes in
the U.S. sense, and this standard is met
only if there is substantial conformity in
the principles used to calculate the
foreign tax base and the U.S. tax base.
Absent such conformity, no credit is
appropriate under section 901. Finally,
the manner in which foreign countries
relieve double taxation for its resident
taxpayers does not have any bearing on
the appropriate interpretation of section
901, which provides a credit only for
foreign income taxes, not all foreign
taxes.
In addition, some comments stated
that the proposed rules, which focus on
the terms of the foreign law in
determining whether the net gain
requirement is met, inappropriately
shift the analysis from the substance to
the form of a foreign levy. In particular,
some comments asserted that this is
inconsistent with court cases, including
PPL Corp. v. Comm’r, 569 U.S. 329
(2013), in which courts have stated that
the substantive effects of a tax should be
considered when determining whether a
tax constitutes a foreign income tax.
Other comments stated that the
predominant character analysis of the
existing regulations better reflects the
guidance from cases such as Biddle and
Keasbey & Mattison Co. v. Rothensies,
133 F.2d 894 (3rd Cir. 1943), which
confirm that whether a foreign tax is
creditable should be determined on the
basis of its substantive resemblance to
an income tax in the U.S. sense.
The Treasury Department and the IRS
disagree with comments suggesting that
the approach adopted in the 2020 FTC
proposed regulations to minimize the
role of empirical analysis is inconsistent
with the principles applied by the
courts in PPL, Biddle, or Keasbey to
determine whether a foreign tax is an
income tax in the U.S. sense. The
Supreme Court in Biddle established
that statutory terms such as ‘‘income
tax’’ are properly interpreted to have the
meaning understood under U.S. tax law;
the Keasbey court, citing Biddle, stated
that ‘‘a tax paid [to] a foreign country is
not an income tax within the meaning

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of [section 901] unless it conf[o]rms in
its substantive elements to the criteria
established under our revenue laws.’’
Keasbey, 133 F.2d at 897. The Supreme
Court in PPL determined the
creditability of the U.K. windfall tax by
applying the predominant character test
of the existing regulations, which
evaluates the substantive effect of the
tax by resort to empirical analysis of the
effect of alternative methods of
determining gross receipts and
deductible expenses. Citing Biddle, the
Supreme Court stated that ‘‘instead of
the foreign government’s
characterization of the tax, the crucial
inquiry is the tax’s economic effect. In
other words, foreign tax creditability
depends on whether the tax, if enacted
in the U.S., would be an income, war
profits, or excess profits tax.’’ PPL, 569
U.S. at 335.
Consistent with the guiding principle
that a creditable tax must be an income
tax in the U.S. sense, the 2020 FTC
proposed regulations required a
comparison of the foreign tax law to the
U.S. tax law to determine whether the
provisions for computing the base on
which the foreign tax is imposed
conforms with U.S. criteria for an
income tax (that is, a tax imposed on
realized gross receipts reduced by
allocable costs and expenses). Under the
2020 FTC proposed regulations, the
foreign government’s characterization of
the tax or the name given to the tax do
not control the determination of
creditability; rather, the determination
involves an examination of the
substantive provisions of the foreign tax
law that govern the computation of the
income that is subject to tax. The
Supreme Court in PPL was applying the
predominant character test in the
existing regulations and was not
interpreting the statute. Because the
final regulations modify the standard for
determining whether a foreign levy is an
income tax in the U.S. sense, the final
regulations do not conflict with the PPL
decision. Thus, the Treasury
Department and the IRS disagree with
the comments’ contentions that the 2020
FTC proposed regulations have
inappropriately shifted the inquiry away
from the substance, or the substantive
economic effect, of the foreign tax.
2. Alternative Gross Receipts Test
The 2020 FTC proposed regulations
removed the ‘‘alternative gross receipts
test’’ in existing § 1.901–2(b)(3), which
provided that a foreign tax meets the
gross receipts requirement if it is
computed under a method that is likely
to produce an amount that is not greater
than the fair market value of actual
arm’s length gross receipts. Under

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proposed § 1.901–2(b)(3)(i), a foreign tax
meets the gross receipts tests only if the
tax is imposed on actual gross receipts,
or is imposed on deemed gross receipts
arising from pre-realization timing
difference events (for example, a markto-market regime, tax on the physical
transfer, processing, or export of readily
marketable property, or a deemed
distribution or inclusion), or is imposed
on the basis of gross receipts from an
insignificant non-realization event. In
addition, proposed § 1.901–2(b)(3)(i)
provided that, for purposes of the gross
receipts test, amounts that are properly
allocated to a taxpayer under the
jurisdictional nexus rules in proposed
§ 1.901–2(c), such as pursuant to
transfer pricing rules that properly
allocate income to a taxpayer on the
basis of costs incurred by that entity, are
treated as the taxpayer’s actual gross
receipts.
Several comments criticized the
removal of the alternative gross receipts
test and asked that it be retained.
Comments stated that eliminating the
alternative gross receipts test creates an
overly restrictive gross receipts
requirement that can cause foreign taxes
to not qualify as income taxes due to
small or formalistic differences in how
foreign law measures gross receipts as
compared to U.S. law. One comment
noted that it is not unusual for taxing
jurisdictions to provide alternate
measures of gross receipts to avoid
compliance difficulties. The comment
also noted that U.S. tax law uses
alternative gross receipts, such as using
the applicable Federal rate (determined
by the IRS) to determine interest
deemed to be received by certain
lenders. Other comments noted that the
U.S. standards for measuring gross
receipts and gross income have changed
over time, and there is no static view of
gross receipts against which to measure
foreign law. One such comment pointed
to realized cash receipts, the accrual
method, financial statement income,
and in limited instances mark-to-market
as examples of varying ways to compute
gross receipts. Another comment
pointed to the changes to the rules for
determining the taxable year for income
inclusions under section 451 from 2012
to 2018.
One comment asserted that the
proposed regulation’s treatment of
alternative measures of gross receipts
determined by applying a markup to
costs (which does not meet the gross
receipts requirement) is irreconcilable
with the rule in proposed § 1.901–
2(b)(3)(i) that treated allocations of gross
income under transfer pricing methods
to a taxpayer as actual gross receipts.
The comment contended that there is no

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logical reason for treating a foreign law
that allows taxpayers to use a cost-plus
transfer pricing methodology as meeting
the gross receipts test, but not a foreign
law that uses a measurement of gross
receipts based on costs, and that the
2020 FTC proposed regulations will
result in significant controversy in
distinguishing the two situations. The
comment recommended that the
Treasury Department and the IRS
continue to treat foreign income taxes
based on alternative measurements of
gross receipts as meeting the gross
receipts test, so long as the taxpayer can
show that the alternative is likely to
produce an amount not greater than fair
market value.
One comment requested clarification
on how the proposed rules would apply
in situations where the foreign
jurisdiction imposes a levy on a
combination of actual gross receipts and
receipts computed based on some other
method.
In addition, comments pointed out
that the Treasury Department and the
IRS previously proposed to eliminate
the alternative gross receipts test in the
1980 proposed and temporary
regulations under sections 901 and 903,
but after extensive consideration
decided to retain it in the 1983 final
regulations. The comments asked the
Treasury Department and the IRS to
justify the reconsideration of the
elimination of the alternative gross
receipts test, given that such elimination
was previously rejected.
The Treasury Department and the IRS
have determined that it is necessary and
appropriate to remove the alternative
gross receipts test because, in general, a
tax that is imposed on an amount
greater than actual realized gross
receipts, or greater than the value of
property, is not an income tax in the
U.S. sense. In addition, the decision to
provide an alternative gross receipts test
in the 1983 final regulations, even if
made in response to comments, does not
preclude the Treasury Department and
the IRS from later re-evaluating and
removing the rule. The IRS’ experience
with applying the alternative gross
receipts test has shown that the test is
vague and unduly burdensome to
administer because of the empirical
evaluation needed to determine whether
the alternative method is likely to
produce an amount that is not greater
than fair market value.
However, in response to comments
received, the final regulations provide
that deemed gross receipts resulting
from deemed realization events or
insignificant non-realization events that
meet the realization requirement in
§ 1.901–2(b)(2) will meet the gross

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receipts requirement if the deemed gross
receipts are reasonably calculated to
produce an amount that is not greater
than fair market value. For example,
deemed gross receipts resulting from a
mark-to-market regime or foreign tax
law that imputes interest income under
a provision similar to section 7872
would satisfy the gross receipts
requirement.
The Treasury Department and the IRS
disagree with the comment that seems
to conflate a situation when actual gross
receipts arise from a transaction
between related parties that is priced
under a cost-plus transfer pricing
methodology with the transactions
contemplated in the 2020 FTC proposed
regulations. Such a related-party
transaction is distinct from a foreign
levy that imposes tax on deemed gross
receipts that are determined based upon
a markup of costs rather than the actual
gross receipts from the transaction
among unrelated parties. The former
involves using a transfer pricing
methodology to determine the
appropriate payment (that is, the actual
gross receipts as reported or adjusted for
tax purposes) that a taxpayer in a
transaction with a related party should
receive based upon arm’s length
principles. In contrast, in the context of
transactions between unrelated parties,
using a measure of deemed gross
receipts based on costs may have no
relationship to the actual gross receipts.
However, the Treasury Department
and the IRS have determined that the
reference in proposed § 1.901–2(b)(3)(i)
to gross receipts that are properly
allocated to a taxpayer under a foreign
tax meeting the jurisdictional nexus
requirement was potentially confusing
and unnecessary, because such a related
party transfer pricing methodology
would result in actual gross receipts,
either by means of an actual payment or
a constructive payment resulting from a
receivable recorded on the taxpayer’s
books and records. Accordingly, the
reference to gross receipts determined
under a transfer pricing methodology is
removed from the final regulations, and
an example is added to the final
regulations at § 1.901–2(b)(3)(ii)(B) to
illustrate the intended application of the
rule.
3. Cost Recovery Requirement
The 2020 FTC proposed regulations
modified various aspects of the net
income test of the existing regulations
(referred to as the ‘‘cost recovery
requirement’’ under the 2020 FTC
proposed regulations) to ensure that a
foreign tax is a creditable tax only if the
determination of the foreign tax base
conforms in essential respects to the

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determination of taxable income under
the Code.
Several comments recommended
against adopting the proposed changes
to the cost recovery requirement out of
concern that the proposed changes will
result in more instances of unrelieved
double taxation. One comment asserted
that the effect of the revisions to the cost
recovery requirement would be to limit
creditability of foreign levies that have
been traditionally characterized as
income taxes based solely on minor
deviations between U.S. tax principles
and the foreign law. The comment
asserted that the revised standard is
stricter than the standard traditionally
applied by the courts, and unreasonably
narrows the standard since the term
‘‘foreign income, war profits, and excess
profits taxes’’ in the statute has not been
changed.
In general, the Treasury Department
and the IRS disagree with comments
that the revised cost recovery standard
will result in additional unrelieved
double taxation in a manner that is
inconsistent with the policies
underlying section 901. This is because
double taxation that merits relief under
section 901 occurs only if there is
substantial conformity in the principles
used to calculate the foreign tax base
and the U.S. tax base. However, the final
regulations modify certain aspects of the
cost recovery requirement in order to
provide additional flexibility and to
reduce instances where minor
deviations between U.S. principles and
foreign tax law could cause a foreign
levy to be non-creditable; these changes
are described in part IV.B.3.ii and iii of
this Summary of Comments and
Explanation of Revisions.
i. Gross Basis Taxes
The 2020 FTC proposed regulations
removed the nonconfiscatory gross basis
tax rule of the existing regulations. That
rule provided that a foreign levy whose
base is gross receipts is treated as
meeting the cost recovery requirement if
the foreign levy is almost certain to
reach net gain in the normal
circumstances in which it applies
because costs and expenses will almost
never be so high as to offset gross
receipts or gross income, and the rate of
the tax is such that after the tax is paid
persons subject to the tax are almost
certain to have net gain. Instead,
proposed § 1.901–2(b)(4)(i)(A) provided
that a foreign levy must permit recovery
of the significant costs and expenses
attributable to such gross receipts, or
permit recovery of an alternative
amount that by its terms may be greater,
but will never be less, than the actual
amounts of such significant costs and

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expenses. Proposed § 1.901–2(b)(4)(i)(A)
further provided that a foreign tax that
is imposed on gross receipts or gross
income and that does not permit
recovery of any costs or expenses does
not meet the cost recovery requirement,
even if in practice there are no or few
costs and expenses attributable to all or
particular types of gross receipts
included in the foreign tax base.
One comment stated that the removal
of the nonconfiscatory gross basis tax
rule is inconsistent with court decisions
that predate the 1983 regulations and
that have concluded that a tax on gross
receipts may qualify as a creditable
income tax so long as it reaches net
income. The comment specifically cited
Seatrain Lines, Inc. v. Comm’r, 46
B.T.A. 1076 (1942), Santa Eulalia
Mining Co. v. Comm’r, 2 T.C. 24 (1943),
and Bank of America Nat. Trust & Sav.
Ass’n v. U. S., 459 F.2d 513 (Ct. Cl.
1972). The comment stated that in
determining whether a foreign levy is an
income tax, the courts focus on the
nature of the income that is the subject
of the tax and whether that type of
income is likely to involve significant
expenses that could result in a net loss
being realized from the activity being
taxed. The comment further contended
that digital services taxes would qualify
as creditable income taxes under this
analysis, because the amounts of costs
and expenses associated with the type
of gross receipts subject to the digital
services taxes are never so high as to
cause businesses subject to the tax to
incur a loss after payment of the tax. No
explanation or evidence (whether
empirical or anecdotal) was provided to
support this assertion.
The comment further asserted that the
explanation for the proposed change in
the preamble to the 2020 FTC proposed
regulations is unpersuasive. It
contended that the court decisions
involving the net gain requirement have
not reflected any administrative
difficulties. As such, the comment
stated that the removal of the
nonconfiscatory gross basis tax rule in
the 2020 FTC proposed regulations is
unjustified and recommended that the
existing rule be retained.
The Treasury Department and the IRS
have determined that foreign taxes that
do not permit recovery of significant
costs and expenses are not income taxes
in the U.S. sense. Although some cases
preceding the 1983 regulations, such as
those cited in the comment, determined
that a gross basis tax could be an income
tax in the U.S. sense, other cases
reached a different conclusion. See
C.I.R. v. American Metal Co., 221 F.2d
134 (1955) (a Mexican Production Tax
was not creditable because it applied

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regardless of whether miners made a
profit or sales); Keasbey, 133 F.2d 894
(tax imposed under the Quebec Mining
Act was not an income tax in the U.S.
sense because the levy permitted
deductions only for costs incurred in
the mining operation, and not for
expenses incident to the general
conduct of the business); Bank of
America, 459 F.2d 513 (gross basis tax
on income of banks did not qualify as
an income tax under section 901). The
Treasury Department and the IRS do not
agree that a tax is properly considered
a tax on net income so long as empirical
evidence demonstrates that the
nonrecoverable costs and expenses
attributable to the gross receipts or gross
income are almost never so high as to
eliminate any profit after the tax is paid.
It is unlikely, as a practical matter, that
the data required to make such an
empirical showing of the amounts of
disallowed expenses of all taxpayers
subject to the tax will be available to
either taxpayers or the IRS other than in
the context of a targeted tax of narrow
application such as the levies
considered in Texasgulf or Exxon. In
any event, such a gross basis tax is so
dissimilar to the U.S. income tax against
which the foreign tax credit is allowed
that the Treasury Department and the
IRS have determined it should not
qualify as an income tax in the U.S.
sense. With respect to the comment that
asserted that gross basis digital services
taxes never result in a loss to affected
companies, the fact that the comment
failed to provide any evidence may be
indicative of the difficulty of making
this empirical showing. Furthermore,
comments made by the affected
industries have made clear that gross
basis taxes are inconsistent with the
fundamental nature of an income tax,
and could in fact result in taxation of
companies that are in a loss position.7
Accordingly, the final regulations

largely maintain the approach of the
2020 FTC proposed regulations in
eliminating the nonconfiscatory gross
basis tax rule.
However, upon consideration of the
comments, the Treasury Department
and the IRS agree that a gross basis tax
may meet the cost recovery requirement
if in fact there are no significant costs
and expenses attributable to the gross
receipts included in the taxable base.
Accordingly, the final regulations at
§ 1.901–2(b)(4)(i)(A) remove the rule in
the 2020 FTC proposed regulations that
provided that a gross basis tax could
never meet the cost recovery
requirement, even if in practice there
are no significant costs and expenses
attributable to the gross receipts
included in the foreign tax base. Instead,
§ 1.901–2(b)(4)(i)(A) provides that a
gross basis tax satisfies the cost recovery
requirement if there are no significant
costs and expenses attributable to the
gross receipts included in the foreign
tax base that must be recovered under
the rules of § 1.901–2(b)(4)(i)(C)(1). In
addition, the Treasury Department and
the IRS recognize that the Code contains
various limitations on the recovery of
non-business expenses that have been
modified from time to time. For
example, miscellaneous itemized
deductions, including unreimbursed
employee expenses, are generally not
deductible. Thus, the final regulations
provide in § 1.901–2(b)(4)(i)(C)(2) that a
foreign tax law that does not permit
recovery of costs and expenses
attributable to wages and investment
income not derived from a trade or
business satisfies the cost recovery
requirement. Furthermore, the final
regulations clarify in § 1.901–
2(b)(4)(i)(A) that a foreign tax need not
permit recovery of costs and expenses,
such as certain personal expenses, that
are not attributable, under reasonable
principles, to gross receipts included in
the foreign taxable base.

7 United States Trade Representative, Section 301
Investigation, Report on France’s Digital Services
Tax at 57–58 (Dec. 2, 2019), available at https://
ustr.gov/sites/default/files/Report_On_
France%27s_Digital_Services_Tax.pdf (quoting
numerous comments from digital companies and
industry groups attesting that the digital service
taxes’ application to revenue rather than income is
inconsistent with prevailing principles of
international taxation). In particular, a member
from National Foreign Trade Council stated that a
‘‘tax imposed on gross revenue has no relationship
to net income or profits, which are the only proper
bases for a corporate income tax.’’ Id. at 57. Another
industry representative stated that a ‘‘tax on
ordinary business profits, imposed on gross
revenue, has no relationship to net income. . . .
Gross revenue has no relationship to net income,
and therefore such taxes are not limited to taxing
the gains of an enterprise, and will drive companies
into deeper losses if they are not profitable. Thus,
such a tax is likely to harm growing
companies. . . .’’). Id. at 58.

ii. Significant Costs
Proposed § 1.901–2(b)(4)(i)(A)
provided that the cost recovery
requirement is satisfied if the foreign tax
law permits recovery of significant costs
and expenses attributable to the gross
receipts included in the foreign tax base.
The significance of the cost is
determined based on whether, for all
taxpayers in the aggregate to which the
foreign tax applies, the item of cost or
expense constitutes a significant portion
of the taxpayers’ total costs and
expenses. See proposed § 1.901–
2(b)(4)(i)(B)(2). In addition, proposed
§ 1.901–2(b)(4)(i)(B)(2) specified that
certain costs—such as costs or expenses
related to capital expenditures, interest,

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rents, royalties, services, and research
and experimentation—are always
treated as significant, and thus, must be
recoverable.
The 2020 FTC proposed regulations
also addressed foreign expense
disallowance provisions. Proposed
§ 1.901–2(b)(4)(i)(B)(2) provided that a
foreign levy that disallows recovery of
all or a portion of a significant cost or
expense meets the cost recovery
requirement if such disallowance is
consistent with the types of
disallowances reflected in the Code.
Several comments recommended that
the Treasury Department and the IRS
retain the standard in the existing
regulations and withdraw the list of
‘‘per se’’ significant costs and expenses
in proposed § 1.901–2(b)(4)(i)(B)(2).
Although some comments
acknowledged the rationale for adding
the list of expenses that are always
treated as significant and thus must be
recoverable, they also asserted that this
rule would create complexities because
it would require continued evaluation
and re-evaluation of U.S. and foreign tax
rules. One comment noted that there
could be changes to either the foreign
tax law or the U.S. tax law that could
cause a foreign tax to be no longer
creditable. It suggested, as an example,
that a foreign tax that includes rules
identical to current section 163(j),
which took effect in 2018, would have
likely failed the cost recovery
requirement in 2017 but would have
met the cost recovery requirement in
2018.
One comment recommended that if
the per se list of recoverable expenses is
retained, it should apply only to
taxpayers that in fact incur a significant
amount of such cost or expense, for
example, amounts in excess of a certain
percentage of the particular taxpayer’s
gross receipts. The comment recognized
that its recommendation conflicts with
the rule in the existing and proposed
regulations that a foreign tax either
satisfies or does not satisfy the
definition of a foreign income tax in its
entirety, for all persons subject to the
foreign tax, but asserted that such a
deviation is appropriate because a
taxpayer should not be denied a credit
for a foreign tax because the foreign law
does not permit or limits recovery of an
expense if the particular taxpayer does
not incur a significant amount of that
expense.
One comment questioned why the
Treasury Department and the IRS
retained the empirical analysis in the
definition of significance, noting that it
is contrary to the stated overall purpose
of the proposed modifications of the net

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gain requirement to minimize reliance
on empirical evidence.
Comments also disagreed with the
policy of the 2020 FTC proposed
regulations of requiring foreign expense
disallowance rules to be consistent with
U.S. disallowances. Comments noted
that foreign countries have different
ways of structuring deduction
disallowances and different policy goals
that they want to achieve through
deduction disallowances. One comment
pointed to interest deduction
disallowance rules as an example,
noting that the U.S. rules have a myriad
of restrictions on interest deductions,
including because in certain
circumstances interest payments may
reflect a return on capital. The comment
stated that if a foreign jurisdiction
prohibits deductions for interest
payments in some or most
circumstances because it views interest
as a return on capital, that could cause
the foreign tax to be no longer
creditable. The comment asserted that a
foreign levy should not be noncreditable simply because the foreign
jurisdiction has more restrictive
limitations on interest deductibility.
Comments also pointed to deduction
disallowances for related-party interest
payments, noting that foreign
governments may significantly restrict
deductions for interest incurred on
related party debt. The comments
contended that such limitations would
not be unreasonable, but that it is
unclear whether a foreign levy with
such restrictions would be creditable
under the 2020 FTC proposed
regulations. One comment further
asserted that it is unfair to disallow
foreign tax credits when a foreign
country adopts disallowance provisions
different from U.S. rules, because denial
of the credit results in double taxation
of U.S. taxpayers that have no control
over the foreign country’s policy
decisions. Another comment stated that
the statute does not require strict
conformity with U.S. tax principles for
a foreign tax to be creditable. Thus,
foreign tax law deviations from U.S. tax
law should not cause a foreign levy to
be non-creditable unless the foreign law
expense disallowances are so pervasive
as to make the foreign base not related
to net income.
Comments also stated that the
requirement that foreign cost
disallowances must be consistent with
the types of disallowances in the Code
will lead to additional administrative
burdens for the IRS and compliance
burdens for taxpayers because the 2020
FTC proposed regulations provide
insufficient guidance on the application
of the rule. Comments noted it is

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unclear the degree to which the foreign
tax disallowance rule must be similar to
U.S. disallowance rules. The comment
also asked how temporary changes to
the U.S. tax rules that are intended to
ameliorate shorter-term economic or
policy concerns, such as the changes to
section 163(j) under the Coronavirus
Aid, Relief, and Economic Security Act,
Public Law 116–136, 134 Stat. 281
(2020), are intended to affect the
application of the rule. Similarly,
another comment noted that foreign
countries may have a similar policy goal
as the United States but may adopt
limitations, for example as part of the
BEPS initiative, on a different timeline
than the United States.
Other comments noted that it is
unclear if foreign expense disallowance
provisions that are not similar to
disallowances under the Code but that
are necessitated by sound tax policy
would cause a foreign levy to be noncreditable under the 2020 FTC proposed
regulations. For example, one comment
asked whether a foreign country that
permits full expensing of capital
expenditures but disallows any
deduction for interest expense (which
the comment asserts only avoids
economically duplicative deductions in
the case of debt-financed investments)
would run afoul of the proposed rules
because it is not consistent with the
disallowances in section 162 of the
Code. A comment queried whether
disallowance of deductions under an
alternative minimum tax regime similar
to section 55 or section 59A would be
deemed consistent with Federal income
tax principles for purposes of the cost
recovery requirement. Comments
recommended that if the proposed
modifications to the cost recovery
requirement are finalized, the Treasury
Department and the IRS should provide
additional examples illustrating the
application of the rule, including
examples of permissible disallowances
as well as examples of disallowances
that are not identical to Federal income
tax rules but are considered consistent
with U.S. tax principles.
After consideration of the comments,
the Treasury Department and the IRS
have determined that the final
regulations should generally maintain
the approach of the 2020 FTC proposed
regulations, which reflects the
appropriate balance between accuracy
and administrability in determining
whether the foreign tax law permits
recovery of the significant costs and
expenses attributable to the gross
receipts included in the foreign taxable
base. The costs and expenses that are
deemed significant under the 2020 FTC
proposed regulations are those costs and

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expenses that represent substantial
deductions claimed by U.S. taxpayers in
computing the base of the U.S. income
tax. Therefore, it is reasonable to
presume that those enumerated costs
also reflect substantial costs and
expenses of taxpayers operating abroad.
The Treasury Department and the IRS
have determined that it would be
impossible, as a practical matter, for
either taxpayers or the IRS to obtain
both the private financial data and tax
return data, for all taxpayers subject to
a generally-imposed foreign tax, that
would be needed to apply the empirical
test of the existing regulations to
determine whether in fact all such
taxpayers in the aggregate incurred
substantial costs and expenses for
which deductions were not allowed in
determining the foreign taxable base.
Accordingly, the final regulations at
§ 1.901–2(b)(4)(i)(C)(1) retain the
requirement that the foreign tax law by
its terms must allow recovery of
significant costs and expenses,
including recovery of costs and
expenses related to capital
expenditures, interest, rents, royalties,
wages or other payments for services,
and research and experimentation. In
addition, § 1.901–2(b)(4)(i)(C)(1)
clarifies that the foreign tax law applies
to determine the character of a
particular deduction. For example, if a
foreign country denies a deduction for
a payment made on an instrument that
is treated as equity for foreign tax
purposes, the cost recovery requirement
is met even if the instrument is treated
as debt for U.S. tax purposes. In
response to comments, § 1.901–
2(b)(4)(i)(C)(1) also clarifies that foreign
tax law that does not permit recovery of
a significant cost or expense (such as
interest expense) is not considered to
allow recovery of such significant cost
or expense by reason of the time value
of money attributable to the acceleration
of a tax benefit for a different expense
(such as current expensing of capital
expenditures).
However, the Treasury Department
and the IRS agree that the final
regulations should clarify the scope of
permissible foreign tax law expense
disallowance rules. Accordingly, the
final regulations include additional
rules and examples at § 1.901–
2(b)(4)(i)(C)(1) and § 1.901–2(b)(4)(iv),
respectively, illustrating that foreign tax
law rules need not mirror U.S. expense
disallowance rules, but need only be
consistent with the principles reflected
in U.S. tax law. For example, § 1.901–
2(b)(4)(i)(C)(1) provides that a rule
limiting interest deductions to 10
percent of a reasonable measure of

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taxable income (determined either
before or after deductions for
depreciation and amortization) based on
principles similar to those underlying
section 163(j) would qualify.
iii. Alternative Allowance Rule
Under the ‘‘alternative allowance
rule’’ in § 1.901–2(b)(4) of the existing
regulations, a foreign tax that does not
permit recovery of one or more
significant costs or expenses, but that
provides allowances that effectively
compensate for nonrecovery of such
significant costs or expenses, is treated
as meeting the cost recovery
requirement. The 2020 FTC proposed
regulations modified the alternative
allowance rule to provide that an
alternative allowance meets the cost
recovery requirement only if the foreign
tax law, by its terms, permits recovery
of an amount that equals or exceeds the
actual amounts of such significant costs
and expenses. See proposed § 1.901–
2(b)(4)(i)(A).
Several comments criticized the
modification of the alternative
allowance rule and recommended that
the Treasury Department and the IRS
retain the standard of the existing
regulations. One comment asserted that
the proposed rules would cause a
foreign levy to be non-creditable even if
the foreign levy provides an allowance
that in fact equals or exceeds the
taxpayer’s actual expenses; the
comment contends that this is arguably
inconsistent with the language of the
statute. Some comments asserted that
foreign levies are unlikely to meet the
requirement that the foreign tax law
expressly guarantee that the alternative
allowance will equal or exceed actual
costs because alternative allowances are
generally designed to avoid compliance
burdens related to the determination of
actual costs. Thus, the comments stated,
the proposed rules could cause
alternative tax regimes that foreign
countries impose to be non-creditable,
even if those regimes allow equivalent
recovery of expenses in most if not all
circumstances.
Some comments disagreed with the
statement in the preamble of the 2020
FTC proposed regulations that
alternative allowances fundamentally
diverge from the approach to cost
recovery in the Code; the comments
pointed out that the Code also has
examples of alternative allowances
(citing to rules regarding travel expense
reimbursement, the return on intangible
income for global intangible low tax
income (‘‘GILTI’’) and foreign-derived
intangible income (‘‘FDII’’), the standard
deduction, and certain safe harbor
methods for determining home office

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deductions). Comments further stated
that U.S. tax rules have allowed the use
of estimates of expenses in certain
circumstances through, for example,
application of the ‘‘Cohan rule’’ (Cohan
v. Comm’r, 39 F.2d 540 (2d Cir. 1930)),
which permits courts to allow a tax
benefit, such as a deduction, if a
taxpayer proves entitlement to a tax
benefit but fails to substantiate the exact
amount of the benefit.
Some comments questioned the
preamble’s assertion that it is difficult in
practice for taxpayers and the IRS to
determine whether an alternative
allowance under foreign tax law
effectively compensates for the
nonrecovery of significant costs or
expenses, noting that the taxpayer was
able to do so in Texasgulf. One
comment asserted that many court
decisions show that a foreign levy that
provides alternative allowances for
deductions can still be an income tax in
the U.S. sense. The comment did not
cite any court decisions in support of
this assertion.
For the reasons explained in part
IV.B.1 of this Summary of Comments
and Explanation of Revisions, the
Treasury Department and the IRS
disagree with comments that the
alternative allowance rule of the
existing regulations is an appropriate or
administrable rule. In addition, the use
of percentages of the basis of certain
tangible property to compute income for
GILTI and FDII purposes is
distinguishable from providing an
alternative allowance in lieu of actual
costs and expenses to compute the
taxable base because these allowances
are in addition to, and not in
substitution for, provisions in the Code
that allow deductions for the actual
costs and expenses attributable to gross
receipts included in the U.S. tax base.
Moreover, nothing in the final
regulations precludes a foreign tax law
from allowing deductions in excess of
those needed to recover the actual,
significant costs and expenses of
earning taxable gross receipts. Finally,
the Cohan rule is a judicial doctrine that
permits approximating actual costs and
expenses in limited circumstances
where the taxpayer demonstrates that it
incurred a business expense but kept
inadequate records to substantiate the
exact amounts of such expense. Where
a taxpayer can substantiate the actual
amounts of its business expenses, the
Code allows those expenses as
deductions. Thus, the Cohan rule
establishes a substantiation standard,
but does not modify the Code rule
allowing actual costs and expenses to be
recovered. Accordingly, the final
regulations retain the rule that a foreign

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tax law must permit the recovery of
significant costs and expenses to be an
income tax in the U.S. sense.
However, the Treasury Department
and the IRS recognize that some foreign
jurisdictions, in order to relieve
administrative and compliance burdens
on certain small businesses, may
provide an alternative method for
determining deductible costs
attributable to gross receipts, either as
an optional alternative method or as the
sole method. As the comments noted,
the Code contains alternative
allowances or safe-harbor rules for
determining deductible business
expenses in limited circumstances. As a
result, the final regulations at § 1.901–
2(b)(4)(i)(B)(1) provide that the cost
recovery requirement is satisfied if the
foreign tax law allows the taxpayer to
choose between deducting actual costs
or expenses or an optional allowance in
lieu of actual costs and expenses. In
addition, the Treasury Department and
the IRS have determined that additional
flexibility is warranted to accommodate
alternative allowances in lieu of actual
cost recovery, if the alternative
measures are designed to minimize
administrative or compliance burdens
with respect to small taxpayers.
Accordingly, the final regulations at
§ 1.901–2(b)(4)(i)(B)(2) provide an
exception for these types of alternative
allowances.
C. Tax in Lieu of Income Tax
1. In General

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Section 903 provides that the term
‘‘income, war profits, and excess profits
taxes’’ includes a tax paid in lieu of a
tax on income, war profits, or excess
profits that is otherwise generally
imposed by any foreign country. Under
the 2020 FTC proposed regulations, a
foreign levy is a tax in lieu of an income
tax only if (i) it is a foreign tax, and (ii)
it satisfies the substitution requirement.
See proposed § 1.903–1(b)(2). A foreign
tax (the ‘‘tested foreign tax’’) satisfies
the substitution requirement, if based on
the foreign tax law, it meets the four
requirements in proposed § 1.903–
1(c)(1): The generally-imposed net
income tax requirement, the nonduplication requirement, the close
connection requirement, and the
jurisdiction-to-tax requirement.
2. Generally-Imposed Net Income Tax
Requirement
To meet the generally-imposed net
income tax requirement, a separate levy
that is a net income tax (as defined in
proposed § 1.901–2(a)(3)) must be
generally imposed by the same foreign
country (the ‘‘generally-imposed net

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income tax’’) that imposed the tested
foreign tax. Comments stated that the
2020 FTC proposed regulations would
unduly limit a foreign levy’s
qualification as a creditable ‘‘in lieu of
tax’’ by requiring the generally-imposed
net income tax to satisfy proposed
§ 1.901–2, particularly as it has been
revised to require more similarity to
U.S. tax principles. One comment
further explained that a tested foreign
tax would not satisfy the generallyimposed net income tax requirement
with respect to a foreign jurisdiction
that limits the deductibility of interest
under rules that are inconsistent with
the Code. Because these comments
request relaxation of the rules in
proposed § 1.901–2, as opposed to
changes to proposed § 1.903–1, the
responses to these comments are
addressed above at part IV.A of this
Summary of Comments and Explanation
of Revisions, with respect to the
jurisdictional nexus requirement, and at
part IV.B, with respect to the net gain
requirement.
3. Non-Duplication Requirement
Under the non-duplication
requirement, neither the generallyimposed net income tax nor any other
net income tax imposed by the foreign
country may be imposed with respect to
any portion of the income to which the
amounts that form the base of the tested
foreign tax relate (the ‘‘excluded
income’’). A tested foreign tax does not
meet this requirement if a net income
tax imposed by the same country
applies to the excluded income of any
persons that are subject to the tested
foreign tax, even if not all persons
subject to the tested foreign tax are
subject to the net income tax.
Comments asserted that the nonduplication requirement is inconsistent
with the interpretation of the
substitution requirement in
Metropolitan Life Ins. Co. v. United
States, 375 F. 2d 835 (Ct. Cl. 1967),
which held that the Canadian premiums
tax was ‘‘in lieu of’’ the income tax for
mutual life insurance companies, which
were only subject to the premiums tax,
even though other types of insurance
businesses were subject to both the
Canadian premiums tax and the
generally-imposed net income tax. As
such, comments recommended that the
non-duplication requirement apply on a
taxpayer-by-taxpayer basis, and any loss
of creditability of taxes paid should be
limited to income that is actually
subject to both the generally-imposed
net income tax and the tested foreign
tax.
Under the existing regulations, a
foreign levy is either creditable or not

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299

creditable for all taxpayers subject to the
levy. This ‘‘all or nothing rule’’ applies
under existing § 1.903–1 to the
determination of whether a foreign tax
is an in lieu of tax. The 2020 FTC
proposed regulations similarly provided
as part of the non-duplication
requirement that a foreign levy that is
imposed in addition to the generallyimposed net income tax with respect to
some taxpayers is not a tax that is
imposed in substitution for, or in lieu
of, a generally-imposed net income tax.
The Treasury Department and the IRS
have determined that analyzing each
tested foreign tax based on how it
applies to each taxpayer (instead of
analyzing the tax as a whole) would
significantly increase compliance and
administrative burdens for taxpayers
and the IRS. Moreover, allowing a tested
foreign tax to qualify as an in lieu of tax
for any taxpayer when some taxpayers
pay both the tested foreign tax and the
generally-imposed income tax on
income from the same activity is
inconsistent with the notion that the
foreign country made a deliberate
choice to create and impose a separate
levy instead of imposing the generallyimposed net income tax on the excluded
income. Accordingly, the final
regulations retain the ‘‘all or nothing’’
rule in the non-duplication requirement.
Comments stated that it would be
difficult for both the IRS and taxpayers
to determine how a tested foreign tax
would apply to all taxpayers subject to
the levy, given that the tax can be
applied on a basis other than income.
The 2020 FTC proposed regulations
apply based on the terms of the foreign
tax law, not how the tax applies in
practice. To determine whether a tested
foreign tax is creditable, the taxpayer is
not required to analyze how the tested
foreign tax applies on a taxpayer-bytaxpayer basis in practice, but instead is
required only to analyze the foreign tax
law. Therefore, the provision is
finalized without change.
4. Close Connection Requirement
The close connection requirement in
the 2020 FTC proposed regulations
requires that, but for the existence of the
tested foreign tax, the generally-imposed
net income tax would otherwise have
been imposed on the excluded income.
The requirement is met only if the
imposition of the tested foreign tax
bears a close connection to the failure to
impose the generally-imposed net
income tax on the excluded income. A
close connection exists if the generallyimposed net income tax would apply by
its terms to the income, but for the fact
that the excluded income is expressly
excluded. Otherwise, a close connection

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must be established with proof that the
foreign country made a cognizant and
deliberate choice to impose the tested
foreign tax instead of the generallyimposed net income tax. This proof
must be based on foreign tax law, or the
legislative history of either the tested
foreign tax or the generally-imposed net
income tax.
One comment suggested that the close
connection requirement can be read to
be met only if the tested foreign tax
applies to activities that were initially
subject to the generally-imposed net
income tax and then expressly excluded
from its scope, and not if the activities
subject to the tested foreign tax were
never within the scope of the generallyimposed net income tax. The Treasury
Department and the IRS did not intend
for the regulations to apply in this
manner. Therefore, the final regulations
at § 1.903–1(c)(1)(iii) clarify that a close
connection also exists if the generallyimposed net income tax by its terms
does not apply to the excluded income,
and the tested foreign tax is enacted
contemporaneously with the generallyimposed net income tax.
Comments asserted that the close
connection requirement goes beyond the
language of section 903, which
comments maintained requires only that
the tested foreign tax be imposed in
place of the generally-imposed net
income tax; not that the generallyimposed net income tax would
otherwise apply to the taxpayer.
Comments also asserted that the close
connection requirement should be
removed because the non-duplication
requirement is sufficient for ensuring
that the tested foreign tax does not
duplicate the tax base of the generallyimposed net income tax. Some
comments also stated that the
requirement that the taxpayer provide
proof that the generally-imposed net
income tax ‘‘would be imposed’’ absent
the tested foreign tax contradicts the
court’s finding in Metropolitan Life.
The Treasury Department and the IRS
have determined that the close
connection requirement is consistent
with a reasonable construction of the
term ‘‘in lieu of’’ in section 903.
According to Black’s Law Dictionary,
‘‘in lieu of’’ means ‘‘to be instead of’’
which implies a connection between the
imposition of the tested foreign tax and
the absence of a generally-imposed net
income tax. Otherwise, the statute
would have provided that a credit
would be allowed for any tax paid by
persons not subject to a generallyimposed net income tax. The mere fact
that two taxes may be mutually
exclusive with respect to some subset of

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taxpayers does not demonstrate that one
is ‘‘in lieu’’ of the other.
Furthermore, the requirement that
taxpayers demonstrate a close
connection is consistent with the text of
section 903 as well as court decisions
interpreting section 903. The Treasury
Department and the IRS disagree that
the close connection requirement
contradicts the court’s finding in
Metropolitan Life. Rather, the ‘‘close
connection’’ requirement is taken
directly from Metropolitan Life, 375
F.2d at 839–40 (‘‘We have found ‘a very
close connection between the
imposition of the Canadian premiums
taxes involved here and the failure to
impose income taxes.’ . . . The
Canadian jurisdictions, we also found,
made ‘a cognizant and deliberate choice
. . . between the application of
premiums taxes or income taxes for
mutual life insurance companies.’’).
Therefore, the comments are not
adopted.
Other comments stated that the close
connection requirement would result in
significant administrative burdens and
uncertainties because jurisdictions with
less sophisticated legislative processes
and tax regimes may lack specific
statutory language or legislative
histories to determine whether there
was a close connection between the
tested foreign tax and the generallyimposed net income tax.
In response to the comments, the final
regulations at § 1.903–1(c)(1)(iii) clarify
that a close connection also exists if the
generally-imposed net income tax by its
terms does not apply to the excluded
income, and the tested foreign tax is
enacted contemporaneously with the
generally-imposed net income tax.
Therefore, legislative history is not
always required to establish that the
tested foreign tax satisfies the close
connection requirement.
5. Jurisdiction-to-Tax Requirement
The jurisdiction-to-tax requirement
provides that if the generally-imposed
net income tax were applied to the
excluded income, the generally-imposed
net income tax would either continue to
qualify as a net income tax under
proposed § 1.901–2(a)(3), or would
constitute a separate levy from the
generally-imposed net income tax that
would itself be a net income tax under
proposed § 1.901–2(a)(3). One comment
noted that the reference to proposed
§ 1.901–2(a)(3) incorporates both the
jurisdictional nexus requirement and
the net gain requirement. The comment
questioned how a taxpayer can
determine whether a hypothetical
generally-imposed net income tax
would reach net gain.

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In response to the comment, the final
regulations clarify that if the generallyimposed net income tax, or a
hypothetical new tax that is a separate
levy with respect to the generallyimposed net income tax, were applied
to the excluded income, such generallyimposed net income tax or separate levy
must meet the attribution requirement
in § 1.901–2(b)(5) but does not need to
meet the other net gain requirements
contained in § 1.901–2(b).
D. Separate Levy Determination
The 2020 FTC proposed regulations
retained the general rule of the existing
regulations, which provides that
whether a foreign levy is an income tax
for purposes of sections 901 and 903 is
determined independently for each
separate foreign levy, but modified the
rules to clarify the principles used to
determine whether one foreign levy is
separate from another foreign levy. See
proposed § 1.901–2(d)(1). Proposed
§ 1.901–2(d)(1)(ii) provided that
separate levies are imposed on
particular classes of taxpayers if the
taxable base is different for those
taxpayers.
One comment requested clarification
of the treatment of a foreign tax imposed
on a distribution that is, in part, a
dividend and, in part, gives rise to
capital gain. The comment noted that
§ 1.861–20(g)(5) includes an example
that treats the tax imposed on the
dividend amount as a separate levy from
the tax imposed on the capital gain
amount of the distribution, but it is
unclear whether the separate levy
determination results from the fact that
two different tax rates apply to the same
distribution, or because the taxes apply
to two different types of income. The
comment recommended that the final
rules clarify the analysis for identifying
separate levies in the case of different
taxable bases, or to elaborate on the
policy considerations underlying the
separate levy rules.
One comment recommended that the
Treasury Department and the IRS
further consider the application of the
separate levy rules to minimum tax
regimes to ensure they do not prevent
creditability of amounts that would
otherwise be treated as foreign income
taxes. The comment noted that if a
regime imposes an incremental
alternative minimum tax that would not
be creditable under section 901 or
section 903, creditability of the net
income tax could depend on whether
the two amounts are considered
separate levies.
Another comment stated that because
the 2020 FTC proposed regulations
require separate determinations of

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creditability for each class of taxpayers
for which the application of the foreign
levy results in a significantly different
tax base (rather than determining
whether a foreign levy applies to net
income in the normal instance), the
application of the separate levy rules
and the net gain requirements is
complex. It stated that the
determination of a separate levy is both
fact intensive and nuanced because all
deviations from the ‘‘pure’’ income tax
system of the Code will have to be
identified and some deviations will
create a separate class of taxpayers (and
therefore a separate levy) while other
deviations would simply have to be
weighed for significance.
The Treasury Department and the IRS
have determined that additional
clarification of the separate levy rules is
not needed in connection with the
example in § 1.861–20(g)(5), because the
rules for allocating and apportioning the
foreign income tax on the facts of the
example would be the same whether the
tax on the foreign law dividend and
capital gain amounts was imposed
pursuant to a single levy or separate
levies. However, in response to
comments, the final regulations at
§ 1.901–2(d)(3) provide additional
examples to illustrate the application of
the separate levy rules to minimum tax
regimes and other foreign tax regimes
involving separate levies that include
some common elements. In particular,
§ 1.901–2(d)(3)(ix) (Example 9)
illustrates that a foreign tax containing
a limitation on interest deductions that
applies only to one class of taxpayers
subject to the tax does not cause the tax
to be treated as a separate levy as to that
class of taxpayers.
E. Amount of Tax That Is Considered
Paid

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1. Refundable Credits
The 2020 FTC proposed regulations
modified § 1.901–2(e)(2)(ii) of the
existing regulations to provide explicit
rules regarding the effect of foreign law
tax credits in determining the amount of
tax a taxpayer is considered to pay or
accrue. Proposed § 1.901–2(e)(2)(ii)
provided that a tax credit allowed under
foreign law is considered to reduce the
amount of foreign income tax paid,
regardless of whether the amount of the
tax credit is refundable in cash to the
extent it exceeds the taxpayer’s liability
for foreign income tax. Proposed
§ 1.901–2(e)(2)(iii) provided an
exception to this rule for credits in
respect of overpayments of a different
tax liability that are refundable in cash
at the taxpayer’s option and applied to

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satisfy the taxpayer’s foreign income tax
liability.
While one comment agreed with the
rule in proposed § 1.901–2(e)(2), other
comments disagreed with the proposed
rule, including the example illustrating
these rules in proposed § 1.901–
2(e)(4)(ii)(A), asserting that refundable
tax credits should be treated as
government grants administered
through the foreign country’s tax
system. Under that view, refundable tax
credits should be treated as a
constructive payment of cash to the
taxpayer that the taxpayer uses to
constructively pay the amount of foreign
income tax liability that is offset or
satisfied by application of the tax credit.
These comments argue that refundable
tax credits provide an economic benefit
that is not tied to taxable income or tax
liability, which is similar to a
government grant and unlike nonrefundable tax credits or subsidies
described in section 901(i). They further
argue that accounting standards under
IFRS and GAAP, as well as OECD
commentary, treat refundable tax credits
as a government expenditure, and that
the IRS has issued guidance in the past
that suggests that refundable tax credits
may be deemed to satisfy, rather than
reduce, a foreign tax liability (TAM
200146001; Rev. Rul. 86–134, 1986–2
C.B. 104).
Comments also stated that the IRS’s
administrative concerns about the
difficulty of distinguishing between
refundable and non-refundable tax
credits could be addressed through
additional guidance, through data
collection, or by requiring that any
excess of a tax credit over a taxpayer’s
cumulative foreign income tax liability
cannot be indefinitely carried forward
but must be paid to the taxpayer in cash
after a certain period. Comments argued
that the proposed treatment of
refundable tax credits would increase
taxpayers’ worldwide tax costs by
reducing effective foreign tax rates of
taxpayers’ controlled foreign
corporations and thereby subjecting
more taxpayers to residual U.S. tax on
GILTI inclusions. Finally, one comment
requested guidance on the treatment of
transferable tax credits, which are tax
credits that are acquired by a taxpayer
from another taxpayer and used to
satisfy the acquiring taxpayer’s tax
liability. The comment suggested that
transferable tax credits should be treated
similarly to refundable tax credits.
The Treasury Department and the IRS
generally disagree that refundable tax
credits are appropriately treated as
offsetting constructive payments of cash
to the taxpayer followed by a
constructive payment of an (unreduced)

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301

foreign income tax liability. Refundable
tax credits that are payable in cash only
to the extent they exceed a taxpayer’s
foreign income tax liability, either in the
current year or over a period of years,
are not similar to unrestricted cash
grants. Tax revenue foregone by a
foreign taxing jurisdiction by means of
such a tax credit reflects a policy choice
to forego revenue, and that may be
viewed as a tax expenditure, but a tax
expenditure is distinct from a cash
outlay. Revenue foregone by granting a
tax credit that the taxpayer does not
have the option to receive in cash
reduces its tax liability in exactly the
same manner whether the credit is fully
nonrefundable or potentially refundable
only to the extent the credit exceeds the
taxpayer’s tax liability. In both cases,
the taxpayer does not have the option to
receive the applied amount of the credit
in cash. No comments suggested that a
nonrefundable credit should be treated
as constructively received in cash by the
taxpayer and used to pay an unreduced
tax liability. The Treasury Department
and the IRS have determined that it is
inappropriate to treat the nonrefundable
portion of a refundable credit differently
from a fully nonrefundable credit.
In addition, a rule that required the
IRS to obtain empirical data on the
refundability in practice of nominally
refundable tax credits would be too
difficult for taxpayers and the IRS to
apply. Because the foreign law rules
governing such credits often limit the
refundable portion to the amount by
which the credit exceeds the taxpayer’s
tax liability over a period of years,
taxpayers would have to make
speculative determinations, or post-hoc
adjustments based on whether the
excess portion of credits granted in one
year actually became refundable in later
years, in order to determine whether the
application of the credit could be
treated as a payment (rather than a
reduction) of foreign tax.
The Treasury Department and the IRS
generally agree with the comment that
transferable tax credits granted by a
foreign country, which presumably are
never fully refundable in cash at the
taxpayer’s option since that option
would eliminate the benefit taxpayers
derive from selling tax credits to other
taxpayers, should be analyzed under the
same rules as other foreign law tax
credits. The application of a purchased
tax credit to satisfy a foreign tax
liability, similar to other tax credits that
are not fully refundable in cash at the
taxpayer’s option, represents foregone
revenue that is not received or retained
by the foreign country. In order to
constitute an amount of foreign income
tax paid for purposes of section 901, an

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amount must be both owed and remitted
to the foreign country, and not used to
provide a benefit to the taxpayer, to a
related person, to any party to the
transaction, or to any party to a related
transaction. See section 901(i) and
§ 1.901–2(e)(3). Accordingly, § 1.901–
2(e)(2)(ii) of the final regulations
confirms that applying a foreign law tax
credit, including credits that are
refundable in cash only to the extent
they exceed tax liability and credits that
are transferred from another taxpayer, to
reduce a foreign income tax liability is
not considered a payment of foreign tax
that is eligible for a credit.
These regulations do not address
whether the use of a transferred tax
credit to satisfy a foreign (or other)
income tax liability may constitute the
payment of a liability for purposes of
other provisions of the Code, such as
section 164. However, section 275
generally disallows a deduction for
foreign income taxes paid or accrued in
a taxable year for which the taxpayer
claims to any extent the benefit of the
foreign tax credit.
However, the Treasury Department
and the IRS agree that refundable tax
credits may appropriately be treated as
a means of paying, rather than reducing,
a foreign income tax liability if the
taxpayer has the option to receive in
cash the full amount of the tax credit,
rather than just the portion that exceeds
the taxpayer’s foreign income tax
liability. Accordingly, the final
regulations expand the tax overpayment
exception in proposed § 1.901–
2(e)(2)(iii) to apply to any tax credit that
is fully refundable in cash at the
taxpayer’s option. The final regulations
also clarify that a tax credit will not be
considered not fully refundable solely
by reason of the fact that the amount of
the tax credit could be subject to seizure
or garnishment to satisfy a different,
pre-existing debt of the taxpayer to the
government or a third party.
2. Noncompulsory Payments
The 2020 FTC proposed regulations
clarified that the references to a ‘‘foreign
tax’’ in § 1.901–2(e)(5)(i) of the existing
final regulations, defining the amount of
tax paid for purposes of sections 901
and 903, are only to creditable foreign
income taxes (and in lieu of taxes). As
under the existing final regulations, the
2020 FTC proposed regulations
provided that an amount remitted is not
a compulsory payment, and so is not an
amount of foreign income tax paid, to
the extent the taxpayer failed to
minimize the amount of foreign income
tax due over time. Comments disagreed
with the clarification, arguing that when
taxpayers settle tax controversies with

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foreign tax authorities, a credit should
be allowed for foreign income taxes that
were paid in exchange for a greater
reduction in foreign non-income taxes.
A comment argued that foreign nonincome taxes should be treated like
litigation costs or any other costs of
pursuing a remedy in determining
whether a taxpayer has acted reasonably
to minimize its foreign income tax
liability.
The final regulations retain the
clarification that § 1.901–2(e)(5) requires
taxpayers to take reasonable steps to
minimize their liability for foreign
income taxes, including by exhausting
remedies that an economically rational
taxpayer would pursue whether or not
the amount at issue was eligible for the
foreign tax credit. However, the
Treasury Department and the IRS agree
that this requirement is met if the
reasonably expected, arm’s length costs
of reducing foreign income tax liability
would exceed the amount of the
potential reduction, and that reasonably
expected costs may include the cost of
a reasonably anticipated offsetting
foreign non-income tax liability. In
addition, the Treasury Department and
the IRS have determined that this
reasonable cost analysis should apply
not only in the exhaustion of remedies
context, but also in evaluating whether
a taxpayer has appropriately applied
foreign tax law to minimize its foreign
income tax liabilities even in the
absence of a foreign tax controversy.
The final regulations are modified to
reflect these changes. In addition, an
example is added to the final
regulations at § 1.901–2(e)(5)(vi)(G)
(Example 7) to illustrate that where a
taxpayer has a choice to claim or forgo
a deduction that would reduce its
foreign income tax liability but increase
its foreign non-income tax liability by a
greater amount, the taxpayer can choose
not to claim the income tax deduction
without violating the noncompulsory
payment requirement.
The 2020 FTC proposed regulations
added provisions clarifying the scope of
a taxpayer’s obligation under the
noncompulsory payment rules to take
advantage of foreign law options and
elections that may minimize the
taxpayer’s foreign income tax liability.
The final regulations clarify that a
taxpayer must take advantage of foreign
law options and elections that relate to
the computation of tax liability as
applied to the facts that affect the
taxpayer’s liability, but do not require
taxpayers to modify any other conduct
that may have tax consequences,
including, for example, choices relating
to business form or the maintenance of
books and records on which income is

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reported, or the terms of contracts or
other business arrangements.
The 2020 FTC proposed regulations
also exempted foreign law options or
elections relating to loss sharing and
entity classification from the
noncompulsory payment rules. One
comment suggested that the final
regulations should also include an
exception for options and elections that
have the effect of increasing the tax
liability of the taxpayer while also
reducing the tax liability of a related
person by a greater amount and
provided an example related to foreign
law anti-hybrid regimes. The Treasury
Department and the IRS have
determined that applying the
noncompulsory payment rule on a
group-wide basis would be too difficult
for taxpayers to comply with and for the
IRS to administer, due to the difficulty
of defining the related group in a way
that properly accounts for differences in
U.S. and foreign tax law and prevents
abuse. However, the final regulations at
§ 1.901–2(e)(5)(iv) include an additional
limited exception for certain
transactions that increase one person’s
foreign income tax liability but result in
a reduction in another person’s foreign
income tax liability through the
application of foreign law hybrid
mismatch rules, provided that such
reduction in the second person’s
liability is greater than the increase in
the first person’s liability.
F. Applicability Date
1. In General
Proposed § 1.901–2(h) provided that
the revised rules in proposed § 1.901–2
apply to foreign taxes paid or accrued in
taxable years beginning on or after the
date that the final regulations adopting
the rules are filed with the Federal
Register. Proposed § 1.903–1(e)
similarly provided that proposed
§ 1.903–1 applies to foreign taxes paid
or accrued in taxable years beginning on
or after the date that the final
regulations are filed with the Federal
Register.
One comment asked that the final
regulations include a delayed
applicability date. The comment stated
that, given the potentially significant
impact of the jurisdictional nexus
requirement discussed in part IV.A of
this Summary of Comments and
Explanation of Revisions on the
creditability of foreign levies and
uncertainty regarding whether the
proposed amendments to the section
901 and 903 regulations would be
finalized, it is unreasonable to expect
that taxpayers would modify their
business operations before the

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regulations are finalized. The comment
recommended that the final regulations
should delay the applicability date to
allow taxpayers ample time to assess the
impact of the regulations on their
business and to adjust their operations
accordingly. Another comment
recommended that the Treasury
Department and the IRS defer finalizing
the regulations and provide an
additional extended comment period.
The Treasury Department and the IRS
have determined that it is not
appropriate to delay the applicability
date of §§ 1.901–2 and 1.903–1 beyond
the date indicated in the 2020 FTC
proposed regulations. The Treasury
Department and the IRS recognized the
potentially significant impact of the
jurisdictional nexus requirement, and
thus, provided a fully prospective
applicability date in the 2020 FTC
proposed regulations. The 2020 FTC
proposed regulations provided ample
notice to taxpayers that extraterritorial
taxes that are not an income tax in the
U.S. sense would not be creditable, and
these final regulations largely adopt
§ 1.901–2 and § 1.903–1 as proposed.
The Treasury Department and the IRS
disagree with the comment’s assertion
that applicability dates of significant
final regulations should be deferred to
allow time for taxpayers to modify their
business operations to take into account
the new rules. The Treasury Department
and the IRS have also determined that
sufficient time has been afforded for
stakeholders to provide comments. Ten
comments were received in relation to
the jurisdictional nexus requirement, all
of which were carefully considered in
finalizing the regulations. In addition,
the Treasury Department and the IRS
have determined that it is essential to
finalize these regulations and to retain
the applicability date announced in the
2020 FTC proposed regulations to avoid
the detrimental impact to the U.S. fisc
if, due to ambiguities under existing
regulations, novel extraterritorial taxes
are inappropriately allowed as a foreign
tax credit against U.S. tax.
Comments asked for confirmation that
foreign taxes paid or accrued in a
taxable year before the regulations are
finalized but that are carried forward
and claimed as a credit (and thus
‘‘deemed’’ paid or accrued under
section 904(c)) in a taxable year after the
final regulations become applicable will
not be subject to the final regulations.
For the avoidance of doubt, the final
regulations clarify that the term ‘‘paid,’’
which for purposes of §§ 1.901–2 and
1.903–1 means ‘‘paid’’ or ‘‘accrued’’
depending on whether the taxpayer is
claiming a foreign tax credit on the cash
or accrual basis, does not refer to foreign

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taxes that are carried over and
‘‘deemed’’ paid or accrued under
section 904(c) or to taxes paid by CFCs
that are ‘‘deemed paid’’ by a U.S.
shareholder under section 960. See
§ 1.901–2(g)(5). The applicability date
provisions in §§ 1.901–2(h) and 1.903–
1(e) have been conformed to crossreference the revised definition of
‘‘paid’’ in § 1.901–2(g)(5). Because the
Treasury Department and the IRS view
the revised definition to be a
clarification, not a change, to existing
law, no inference is intended with
respect to the proper interpretation of
the applicability date of existing foreign
tax credit regulations that are not
modified by these final regulations.
2. Deferred Application to Certain
Puerto Rican Taxes
Notice 2011–29, 2011–16 IRB 663,
announced that the IRS and the
Treasury Department were evaluating
the novel issues raised by legislation
enacted by Puerto Rico on October 25,
2010. The legislation added new rules
(‘‘Expanded ECI Rules’’) to section 1123
of the Puerto Rico Internal Revenue
Code of 1994 (‘‘1994 PR IRC’’) that
characterize certain income of
nonresident corporations, partnerships,
and individuals as effectively connected
with the conduct of a trade or business
in Puerto Rico. The legislation also
added section 2101 to the 1994 PR IRC,
which imposes an excise tax (‘‘Puerto
Rico Excise Tax’’) on a controlled group
member’s acquisition from another
group member of certain personal
property manufactured or produced in
Puerto Rico and certain services
performed in Puerto Rico.8 Pending the
resolution of the novel issues involved
in the determination of the creditability
of the Puerto Rico Excise Tax, Notice
2011–29 announced that the IRS will
not challenge a taxpayer’s position that
the Puerto Rico Excise Tax is a tax in
lieu of an income tax under section 903,
and that any change in the foreign tax
credit treatment of the Puerto Rico
Excise Tax would be prospective.
Notwithstanding the general
applicability of §§ 1.901–2 and 1.903–1
to foreign taxes paid or accrued in
taxable years beginning on or after the
date these final regulations are filed
with the Federal Register, the final
regulations provide that § 1.901–2 will
apply to Puerto Rico income tax paid by
reason of the Expanded ECI Rules, and
§ 1.903–1 will apply to Puerto Rico
Excise Tax, paid or accrued in taxable
8 The provisions implementing the Expanded ECI
Rules and the Puerto Rico Excise Tax were
incorporated into sections 1035.05 and 3070.01,
respectively, of the Puerto Rico Internal Revenue
Code of 2011 (13 L.P.R.A §§ 30155, 31771).

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years beginning on or after January 1,
2023. The Treasury Department and the
IRS have determined that a delayed
applicability date is necessary and
appropriate in light of the status of
Puerto Rico as a territory of the United
States, the special treatment of the
Puerto Rico Excise Tax under Notice
2011–29 that has been in place since
2011, and with respect to the Expanded
ECI Rules, the interconnectedness
between such rules and the Puerto Rico
Excise Tax under Puerto Rico’s statutory
scheme. Notice 2011–29 will continue
to apply until the final regulations are
applicable with respect to the Puerto
Rico Excise Tax.
V. Definition of Foreign Branch Category
Income in Connection With
Intercompany Payments
Proposed § 1.904–4(f)(4)(xv) (Example
15) illustrated the application of the
matching rule in § 1.1502–13 to a
regarded intercompany payment
between one affiliated group member
and a foreign branch of a different
member. One comment noted that the
example does not illustrate how
§ 1.1502–13(b)(2) would apply to limit
the amount of an intercompany item
taken into account under § 1.1502–13(c).
The comment also suggested that
additional examples would help clarify
how intercompany payments for R&D
services required to be taken into
account under § 1.1502–13, or
disregarded payments for such services,
are accounted for in determining the
amount and source of foreign branch
category income.
The 2020 FTC proposed regulations
did not modify the application of
§ 1.1502–13(b) in the foreign branch
category context, and additional
examples illustrating the application of
the intercompany transaction
regulations, the R&E expense allocation
rules, and the foreign branch category
are beyond the scope of the issues
considered in the 2020 FTC proposed
regulations. Accordingly, the foreign
branch examples are finalized without
substantive change. However, the
Treasury Department and the IRS may
address these issues in a future
guidance project.
VI. Sections 901(a) and 905(a)—Rules
Regarding When the Foreign Tax Credit
Can Be Claimed
A. Timing of Foreign Tax Accruals
The 2020 FTC proposed regulations
provided rules regarding when a
taxpayer can claim a credit for foreign
income taxes paid or accrued,
depending on the taxpayer’s method of
accounting. For taxpayers that use the

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accrual method of accounting or that
have made an election under section
905(a) to claim foreign tax credits on the
accrual basis, proposed § 1.905–
1(d)(1)(i) provided that foreign income
taxes accrue and can be claimed as a
credit in the taxable year in which all
the events have occurred that establish
the fact of the liability and the amount
of the liability can be determined with
reasonable accuracy (that is, in the
taxable year when the all events test
under § 1.446–1(c)(1)(ii)(A) has been
met). Proposed § 1.905–1(d)(1)(i) further
provided that in the case of a foreign
income tax that is computed based on
items of income, deduction, and loss
that arise in a foreign taxable year
(‘‘foreign net income tax’’), the tax
accrues at the close of the foreign
taxable year and can be claimed as a
credit in the U.S. taxable year with or
within which the taxpayer’s foreign
taxable year ends. Foreign withholding
taxes that represent advance payments
of a foreign net income tax liability
determined on the basis of a foreign
taxable year accrue at the close of the
foreign taxable year. See proposed
§ 1.905–1(d)(1)(i). In contrast, foreign
withholding taxes that are imposed on
a payment giving rise to an item of gross
income accrue on the date the payment
from which the tax is withheld is made.
Id.
One comment argued that the rule in
proposed § 1.905–1(d)(1)(i) providing
that foreign net income tax accrues at
the close of the foreign taxable year is
an incorrect application of the all events
test in section 461. The comment
acknowledged that the proposed rule
incorporated the long-standing position
of the Treasury Department and the IRS
reflected in Revenue Ruling 61–93,
1961–1 C.B. 390, but argued that that
ruling reached the wrong conclusion
because it asserted that the liability
accrues when all events have occurred
to establish the fact of the liability and
the amount of the liability, whereas
section 461(h) only requires that the
amount of the liability can be
determined with reasonable accuracy.
The comment argued that in cases
where the foreign and U.S. taxable years
do not coincide, the fact of the liability
for foreign taxes on income earned
during the U.S. taxable year is
established, and, in normal
circumstances, the amount of the
liability should be determinable with
reasonable accuracy at the end of the
U.S. taxable year, because both the
amount of income and applicable
foreign tax rate will be known. The
comment further noted that in the case
of taxpayers employed in a foreign

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country, the employer will also
withhold and remit foreign tax on the
taxpayer’s salary to the foreign country
throughout the year. The comment
further argued that the proposed rule
would result in instances where the
taxpayer has to pay U.S. tax on foreign
source income in a U.S. taxable year
earlier than the year in which the
foreign taxable year ends and the credit
for foreign tax on the income may be
claimed, creating a mismatch that may
not be addressed by section 904(c)
carryback rules.
The Treasury Department and the IRS
disagree with the comment’s contention
that proposed § 1.905–1(d)(1)(i) is
inconsistent with the all events test in
section 461 and that the all events test
can be satisfied, in the case of a foreign
net income tax, before the close of the
foreign taxable year. First, the
comment’s contention that Revenue
Ruling 61–93 reached the wrong
conclusion because it misapplied the all
events test is incorrect. The revenue
ruling was issued before Congress
codified in section 461(h)(4) the all
events test that had developed through
case law. The ruling’s statement of the
all events test is consistent with the
Supreme Court’s description of the
standard in Dixie Pine Products Co. v.
Comm’r, 320 U.S. 516, 519 (1944) (‘‘all
the events must occur in that year
which fix the amount and the fact of the
taxpayer’s liability for items of
indebtedness deducted though not
paid.’’).
Second, the comment’s argument
regarding whether the all events test
requires the amount of the liability to be
fixed or only to be determinable with
reasonable accuracy is misplaced,
because in the case of a foreign net
income tax, neither the fact of the
liability nor the amount due can be
determined with reasonable accuracy
until the accounting period closes and
the amount of the taxpayer’s taxable
income for that period can be computed.
An estimate does not meet the standard
required by the all events test to accrue
a foreign tax expense; all events through
the close of the taxable year must have
occurred before the fact and amount of
the liability can be determined with
reasonable accuracy. See Rev. Rul. 72–
490, 1972–2 C.B. 100. Before the
accounting period closes, any number of
events, such as a large loss incurred late
in the foreign taxable year, could occur
that could affect the taxpayer’s taxable
income and resulting foreign income tax
liability for that period. Although
withholding taxes or estimated
payments made to satisfy a projected net
income tax liability are readily
determinable by a taxpayer, the basis for

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the calculation of the final foreign
income tax liability is not knowable
until the foreign taxable year ends. For
these reasons, the final regulations do
not adopt the comment and confirm that
foreign net income taxes accrue at the
end of the foreign taxable year and can
be claimed as a credit by an accrual
basis taxpayer only in the U.S. taxable
year with or within which the
taxpayer’s foreign taxable year ends.
B. Cash to Accrual Basis Election
Proposed § 1.905–1(e) provided rules
related to the election in section 905(a)
for a cash method taxpayer to claim
foreign tax credits on the accrual basis.
Proposed § 1.905–1(e)(1) provided that,
in general, the election must be made on
a timely-filed original return by
checking the appropriate box on Form
1116 (Foreign Tax Credit (Individual,
Estate, or Trust)) or Form 1118 (Foreign
Tax Credit—Corporations) indicating
the cash method taxpayer’s choice to
claim the foreign tax credit in the year
the foreign income taxes accrue.
However, the 2020 FTC proposed
regulations also provided an exception
in proposed § 1.905–1(e)(2), which
permitted a taxpayer who has never
previously claimed a foreign tax credit
to elect to claim the foreign tax credit on
an accrual basis, even if such initial
claim for credit is made on an amended
return.
One comment asserted that an
election to change from the cash to the
accrual method under section 905(a)
should be allowed to be made on an
amended return. In support of that
assertion, the comment argued that the
purpose of the election is to allow better
matching between the credit for the
foreign tax and the U.S. tax on the
foreign income. The comment further
argued that cases such as Dougherty v.
CIR, 60 T.C. 917 (1973), support the
principle that elections should be
allowed to be made on an amended
return when circumstances that are not
known at the time of the filing of the
initial return are material to the decision
for making the election. The comment
further argued that the case discussed in
the preamble of the 2020 FTC proposed
regulations in support of the rule not
allowing an election change to be made
on an amended return, Strong v.
Willcuts, 17 AFTR 1027 (D. Minn.
1935), did not hold that the election
cannot be made on an amended return,
and that the court’s discussion of the
issue was dictum and does not represent
legal authority.
The Treasury Department and the IRS
disagree with this comment. First,
section 905(a) requires that if a cash
basis taxpayer elects to claim foreign tax

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credits on the accrual basis, ‘‘the credits
for all subsequent years shall be taken
on the same basis.’’ This statutory
language plainly allows only a one-time
change from the cash to the accrual
method for determining the year in
which the credit is taken and precludes
a taxpayer from ever again changing that
choice. If the one-time choice to switch
from the cash to the accrual method
were permitted to be made retroactively
on an amended return, then the
taxpayer would have to file amended
returns for intervening years in which
credits had been originally claimed on
the cash basis to comply with the
statutory mandate and prevent
duplicative credits for foreign taxes that
accrued in one year and were paid (and
claimed as credits on the cash basis) in
a different year. Because the applicable
statutes of limitation for assessments
and refunds relating to foreign tax
credits may expire at different times, in
the absence of a foreign tax
redetermination any retroactive
revisions to the year in which foreign
tax credits are properly claimed could
result in time-barred U.S. tax
deficiencies. The Treasury Department
and the IRS have determined that the
compliance burdens and administrative
complexity that would follow from
deviating from the rule requiring the
election to be made prospectively
outweigh the benefits for taxpayers of
any flexibility that would follow from
allowing the accrual basis election to be
made on an amended return for a year
in which the taxpayer originally
claimed foreign tax credits on the cash
basis.
In addition, although the legislative
history indicates that Congress, in
enacting the predecessor to the section
905(a) election, was concerned with
better matching of U.S. and foreign taxes
on the same income, that does not mean
that Congress intended taxpayers to be
able to make the election on an
amended return. See S. Rep. No. 68–398
(1924); H.R. Rep. No. 68–179 (1924).
Cases from the 1940s examined whether
section 131(a), which between 1932 and
1942 provided that the election to claim
a foreign tax credit was made ‘‘[i]f the
taxpayer signifies in his return his
desire to have the benefits of this
section,’’ allowed taxpayers to change
their choice from deducting to crediting
foreign taxes after they filed their
original return. In one such case, the
Second Circuit noted that:
Section 131(a) was intended, we think, to
prevent a taxpayer, fully cognizant of the
facts when making its return, from
subsequently changing its position, but not to
hold a taxpayer to a choice made when
unaware that its choice had practical

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consequences. That such was the legislative
purpose is emphasized by Sec. 131(d) which
does preclude a shift of position by a
taxpayer, knowingly electing to claim a
credit, as to a cash or accrual basis.

W.K. Buckley, Inc., v. Comm’r, 158
F.2d 158, 162 (2d Cir. 1946) (emphasis
added). Congress amended section
131(a) in the Revenue Act of 1942 to
provide that the election to claim a
credit can be made or changed before
the expiration of the refund period. See
Revenue Act of 1942, Public Law 77–
753, 158, 56 Stat. 798, 857. Notably,
Congress has never amended section
905(a) to prescribe a time by which the
section 905(a) election must be made.
The Treasury Department and the IRS
also disagree with the comment’s
assertion that Strong v. Willcuts does
not support the position that the accrual
basis election cannot be made on an
amended return. In that case, the court
denied the taxpayer’s claim on two
bases. The first was that, in the court’s
view, the statute contemplates that the
election must be made when the return
is originally filed and that there is no
basis to assume that a taxpayer can shift
his position after the filing of his return.
Strong v. Willcuts, 17 AFTR 1027. The
court addressed ‘‘another and even more
formidable obstacle’’ to taxpayer’s
claim, but that did not mean that the
first issue was not relevant to the court’s
decision. Id.
In addition, although the Dougherty
court held that the taxpayer could make
a section 962 election on an amended
return, it acknowledged that there are
limits on when a taxpayer can make a
late election. The court reviewed prior
case law and concluded that ‘‘the
critical question involved in
determining the timeliness of a delayed
election is whether the original action
(or the failure to act) on the part of the
taxpayer did not amount to an election
against, and was not inconsistent with,
the position which the taxpayer
ultimately did adopt.’’ Dougherty, 60
T.C. at 940. In addition, the court noted
that it was significant that the granting
of a right of late election did not permit
the taxpayer, in effect, to play both ends
against the middle as the result of
hindsight. Id. Proposed § 1.905–1(e)(2)
already provided an exception that,
consistent with the above principles,
permitted a taxpayer who is claiming a
foreign tax credit for the first time to
make the election on an amended
return, because in that case, the
taxpayer has not taken an action
(claiming a foreign tax credit on the
cash basis) that is inconsistent with the
position the taxpayer seeks to adopt by
making a section 905(a) election
(claiming a foreign tax credit on the

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accrual basis). For the above reasons,
the final regulations do not adopt the
comment’s recommendation.
C. Provisional Credit for Contested
Taxes
1. In General
The 2020 FTC proposed regulations
provided that, in general, contested
foreign income taxes do not accrue and
cannot be claimed as a credit in the
relation-back year until the contest is
resolved, even if the taxpayer remits the
contested taxes to the foreign country in
an earlier year. See proposed § 1.905–
1(d)(3). Proposed § 1.905–1(d)(4),
however, provided an elective exception
for accrual basis taxpayers to claim a
provisional credit for the portion of the
contested taxes that the taxpayer has
paid, even though the contest has not
been resolved and the taxes have not yet
accrued. As a condition for making this
election, a taxpayer must agree to not
assert the statute of limitations as a
defense to the assessment of additional
taxes and interest if, after the contest
has been concluded, the IRS determines
that the tax was not a compulsory
payment. The taxpayer must also agree
to comply with annual reporting
requirements.
Proposed § 1.905–1(d)(4)(i) provided
that a taxpayer may make an election to
claim a foreign tax credit, but not a
deduction, for contested foreign income
taxes. One comment asked for
clarification on whether this limitation
on deducting a contested tax applies to
CFC-level deductions, or whether this
limitation was intended to apply only to
a U.S. taxpayer claiming a deduction,
rather than a foreign tax credit, for the
contested foreign taxes. The comment
recommended that the final regulations
address the application of the contested
tax liability rules to the deductions of
CFC taxpayers and argued that if a
provisional credit election is made, the
CFC should be allowed a deduction for
the relation-back year in advance of the
accrual. In response to this comment,
the final regulations clarify that the
provisional foreign tax credit can only
be made for contested foreign income
taxes that relate to a taxable year in
which the taxpayer has made the
election under section 901 to claim a
credit (instead of a deduction) for
foreign income taxes that accrue in such
year. See § 1.905–1(d)(4)(i). The final
regulations also clarify that if an
election is made by the U.S. taxpayer
with respect to a contested foreign
income tax liability incurred by a CFC,
the taxpayer may claim the deemed paid
credit in the relation-back year; in
addition, the CFC can take the

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deduction for the contested foreign
income tax into account in computing
its taxable income in the relation-back
year. Id.
2. Annual Reporting
Proposed § 1.905–1(d)(4)(iii) provided
annual reporting requirements
associated with the election to claim a
provisional foreign tax credit for
contested foreign income taxes.
Proposed § 1.905–1(d)(4)(v) provided
that a taxpayer that fails to comply with
those annual reporting requirements
will be treated as receiving a refund of
the amount of the contested foreign
income tax liability, resulting in a
redetermination of the taxpayer’s U.S.
tax liability pursuant to § 1.905–3(b).
Comments argued that an annual
reporting requirement is unnecessary
because taxpayers must waive the
assessment statute to make the election
and recommended instead that
taxpayers should be required to file an
amended return notifying the IRS when
the contest is resolved. Alternatively, if
the final regulations retain an annual
reporting requirement, comments
recommended that the deemed refund
consequence for failure to comply be
removed because it is overly harsh.
The Treasury Department and the IRS
have determined that annual reporting
is necessary and appropriate to ensure
that taxpayers and the IRS properly
track ongoing contests for which a
provisional foreign tax credit has been
allowed. However, the Treasury
Department and the IRS agree that an
inadvertent failure to timely report an
ongoing contest or the conclusion of a
contest need not result in a deemed
refund, because the government’s
interests are adequately protected by the
statute waiver required by the election.
The terms of the election guarantee the
IRS sufficient time after being notified
of the conclusion of the contest to
evaluate whether the taxpayer failed to
exhaust effective and practical remedies
to minimize its foreign income tax if it
fails to secure a refund of the contested
tax, and to assess any resulting
underpayment of U.S. tax. Accordingly,
the final regulations omit the deemed
refund rule.

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D. Creditable Foreign Tax Expenditures
of Partnerships and Other Pass-Through
Entities
1. Foreign Tax Redeterminations for
Cash Method Partners
Proposed § 1.905–1(f)(1) provided that
a partner that elects to claim a foreign
tax credit in a taxable year may claim
its distributive share of foreign income
taxes that the partnership paid or

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accrued (as determined under the
partnership’s method of accounting)
during the partnership’s taxable year
that ends with or within the partner’s
taxable year. Under this rule, a cash
method taxpayer may claim a credit for
its distributive share of an accrual
method partnership’s foreign income
taxes even if the partnership has not
paid (that is, remitted) the taxes to the
foreign country during the partner’s
taxable year with or within which the
partnership’s tax expense accrued.
However, proposed § 1.905–1(f)(1)
further provided that if additional
foreign taxes result from a
redetermination of the partnership’s
foreign tax liability for a prior taxable
year, a cash-method partner may only
take into account its distributive share
of such additional taxes for foreign tax
credit purposes in the partner’s taxable
year with or within which the taxable
year of the partnership in which it pays
the taxes ends.
One comment recommended that the
final regulations extend the application
of the principles of the relation-back
rule in proposed § 1.905–1(d)(1)(ii) to
partners of an accrual method
partnership by treating a cash method
partner’s distributive share of additional
tax paid by the partnership as a result
of a change in the foreign tax liability as
paid or accrued by the partner in its
taxable year with or within which the
partnership’s relation-back year ends.
The comment stated that this would be
more consistent with the principle
espoused in proposed § 1.905–1(f)(1)
that the partnership’s method of
accounting for foreign income taxes
generally controls for purposes of
determining the taxable year in which a
partner is considered to pay or accrue
its distributive share of those taxes.
The Treasury Department and the IRS
disagree with the comment’s suggestion
that proposed § 1.905–1(f)(1) should
essentially cause a partner’s method of
accounting to be the same as the
partnership’s method with regard to any
partnership items of foreign income tax.
The proposed regulation is consistent
with §§ 1.702–1(a)(6) and 1.703–
1(b)(2)(i), which provide that when a
partnership takes into account a
creditable foreign tax expenditure under
its method of accounting, the partner
takes its distributive share of the foreign
tax into account as if it was properly
taken into account under the partner’s
method of accounting in the partner’s
year with or within which the
partnership’s taxable year ends. These
rules do not change the partner’s
method of accounting to conform to the
partnership’s method of accounting
with respect to its distributive share of

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the partnership’s taxes. Thus, for
example, in the case of an accrual
method partnership and a cash method
partner, if the partnership accrues, but
has not yet paid, an amount of foreign
income tax, the cash method partner
takes into account its distributive share
of the foreign tax expense as if it had
been paid in the partner’s taxable year
with or within which the partnership’s
taxable year ends. Similarly, if the
partnership later accrues and pays an
additional amount of foreign income tax
with respect to the same taxable year
pursuant to a foreign tax
redetermination described in section
905(c)(2)(B), a cash method partner
takes its distributive share of the
additional amount of foreign tax into
account in its taxable year with or
within which ends the partnership’s
taxable year in which the foreign tax
redetermination occurs, because the
additional foreign tax is considered to
be paid by the partner in that year, not
in the former taxable year to which
additional foreign tax of the accrualbasis partnership relates. Therefore, the
final regulations do not adopt the
comment’s recommendation.
2. Provisional Credit for Cash Method
Taxpayers
Proposed § 1.905–1(f)(2) provided that
a partnership takes into account and
reports a contested foreign income tax to
its partners only when the contest
concludes and the finally determined
amount of the liability has been paid by
the partnership. However, proposed
§ 1.905–1(f)(2) allowed an accrual
method partner to elect to claim a
provisional foreign tax credit, in the
relation-back year, for its share of a
contested foreign income tax liability
that the partnership has remitted to the
foreign country, even though the
contested tax has not yet accrued. The
procedures for making this election
were set forth in proposed § 1.905–
1(d)(4).
One comment recommended the same
election be made available for cash
method partners. The Treasury
Department and the IRS agree that a
cash method partner should be allowed
to elect to claim a provisional foreign
tax credit for its share of a contested
foreign income tax liability that the
partnership has paid to the same extent
as an accrual basis partner, even though
under § 1.901–2(e)(2) a contested tax is
not a reasonable approximation of the
final tax liability to the foreign country
and so in the absence of the election is
not treated as an amount of tax paid.
The final regulations, at § 1.905–1(c)(3),
extend the election provided for in
proposed § 1.905–1(d)(4) to allow cash

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method taxpayers to claim a provisional
foreign tax credit for a contested foreign
income tax in the year the contested tax
is remitted. The election is available for
contested foreign income taxes paid
directly by the taxpayer or paid by a
partnership in which the taxpayer is a
partner. The procedure and
requirements for making this election
are the same as those that apply under
proposed § 1.905–1(d)(4), which is being
finalized with the modifications
discussed in part VI.D.1 of this
Summary of Comments and Explanation
of Revisions.
E. Correction of Improper Accrual
Proposed § 1.905–1(d)(5) provided
rules for accrual method taxpayers that
are changing from an improper method
to a proper method for accruing foreign
income taxes. Proposed § 1.905–
1(d)(5)(ii) provided a modified cutoff
approach under which taxpayers were
required to adjust the amount of foreign
income taxes that can be claimed as a
credit or deduction in the taxable year
of the method change (and, if
applicable, in subsequent years) to
prevent duplication or omission of any
amount of foreign income tax paid.
Specifically, proposed § 1.905–
1(d)(5)(ii) provided that the amount of
foreign income tax in a statutory or
residual grouping that properly accrues
in the taxable year of change is adjusted
either downward, but not below zero, by
the amount of foreign income tax in the
same grouping that the taxpayer
improperly accrued and deducted or
credited in a prior taxable year, or
conversely, adjusted upward by the
amount of foreign income tax that
properly accrued but that had not been
taken as a deduction or credit by the
taxpayer in a taxable year before the
year of change.
No comments were received regarding
the rules in proposed § 1.905–1(d)(5)
and they are generally finalized as
proposed. However, the Treasury
Department and the IRS have
determined that there are circumstances
in which a taxpayer may have both a
downward and an upward adjustment
to the properly accrued foreign income
taxes in a statutory or residual grouping
in the taxable year of change, and that
in those circumstances, proposed
§ 1.905–1(d)(5)(ii) was unclear whether
the rule provided that the downward
adjustment alone could not reduce the
properly accrued taxes below zero, or
that the downward adjustment, net of
the upward adjustment, could not
reduce the properly accrued taxes below
zero. Section 1.905–1(d)(5)(ii) has been
revised to clarify that, under the
modified cutoff approach, the amount of

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properly accrued foreign income tax in
each statutory and residual grouping is
first adjusted upward and then adjusted
downward (but not below zero), and
that any downward adjustment in
excess of the amount of properly
accrued foreign income tax in any
grouping, as increased by the upward
adjustment, is carried forward and
reduces the properly accrued foreign
income tax in the grouping in
subsequent years.
In addition, the Treasury Department
and the IRS determined that proposed
§ 1.905–1(d)(5)(ii) was unclear regarding
the treatment of foreign income taxes for
which a credit is never allowed under
section 901, but for which a deduction
under section 164(a)(3) is allowed
because section 275 does not apply. See,
for example, sections 901(j), (k), (l), and
(m). Accordingly, the final regulations
clarify that the modified cut-off
approach is applied separately with
respect to amounts of these foreign
income taxes. See § 1.905–1(d)(5)(ii).
Special Analyses
I. Regulatory Planning and Review
Executive Orders 13563 and 12866
direct agencies to assess costs and
benefits of available regulatory
alternatives and, if regulation is
necessary, to select regulatory
approaches that maximize net benefits
(including potential economic,
environmental, public health and safety
effects, distributive impacts, and
equity). Executive Order 13563
emphasizes the importance of
quantifying both costs and benefits,
reducing costs, harmonizing rules, and
promoting flexibility.
The final regulations have been
designated by the Office of Information
and Regulatory Affairs (OIRA) as subject
to review under Executive Order 12866
pursuant to the Memorandum of
Agreement (MOA, April 11, 2018)
between the Treasury Department and
the Office of Management and Budget
regarding review of tax regulations. The
Office of Information and Regulatory
Affairs has designated these regulations
as economically significant under
section 1(c) of the MOA. Accordingly,
the OMB has reviewed these
regulations.
A. Background and Need for the Final
Regulations
The U.S. foreign tax credit (FTC)
regime alleviates potential double
taxation by allowing a non-refundable
credit for foreign income taxes paid or
accrued that could be applied to reduce
the U.S. tax on foreign source income.
Although the Tax Cuts and Jobs Act

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(TCJA) eliminated the U.S. tax on some
foreign source income by enacting a
dividends received deduction, the
United States continues to tax other
foreign source income, and to provide
foreign tax credits against this U.S. tax.
The calculation of how foreign taxes can
be credited against U.S. tax operates by
defining different categories of foreign
source income (a ‘‘separate category’’)
based on the type of income.9 Foreign
taxes paid or accrued, as well as
deductions for expenses borne by U.S.
parents and domestic affiliates that
support foreign operations, are allocated
to the separate categories based on the
income to which such taxes or
deductions relate. These allocations of
deductions reduce foreign source
taxable income and therefore reduce the
allowable FTCs for the separate
category, since FTCs are limited to the
U.S. income tax on the foreign source
taxable income (that is, foreign source
gross income less allocated expenses) in
that separate category. Therefore, these
expense allocations help to determine
how much foreign tax credit is
allowable, and the taxpayer can then
use allowable foreign tax credits
allocated to each separate category
against the U.S. tax owed on income in
that category.
The Code and existing regulations
further provide definitions of the foreign
taxes that constitute creditable foreign
taxes. Section 901 allows a credit for
foreign income taxes, war profits taxes,
and excess profits taxes. The existing
regulations under section 901 define
these ‘‘foreign income taxes’’ such that
a foreign levy is an income tax if it is
a tax whose predominant character is
that of an income tax in the U.S. sense.
Under the existing regulations, this
requires that the foreign tax is likely to
reach net gain in the normal
circumstances in which it applies (the
‘‘net gain requirement’’), and that it is
not a so-called soak-up tax.
The ‘‘net gain requirement’’ of the
existing regulations is made up of the
realization, gross receipts, and net
income requirements. Generally, the
creditability of the foreign tax under the
existing regulations relies on the
definition of an income tax under U.S.
principles, and on several aggregate
empirical tests designed to determine if
in practice the tax base upon which the
tax is levied is an income tax base.
However, compliance and
administrative challenges faced by
taxpayers and the IRS in implementing
9 Before the TCJA, these categories were primarily
the passive income and general income categories.
The TCJA added new separate categories for global
intangible low-taxed income (the section 951A
category) and foreign branch income.

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the existing definition of an income tax
necessitate changes to the existing
structure. These final regulations set
forth such changes.
Additionally, as a dollar-for-dollar
credit against United States income tax,
the foreign tax credit is intended to
mitigate double taxation of foreign
source income. This fundamental
purpose is most appropriately served if
there is substantial conformity in the
principles used to calculate the base of
the foreign tax and the base of the U.S.
income tax, not only with respect to the
definition of the income tax base, but
also with respect to the jurisdictional
nexus upon which the tax is levied.
Further, countries, including the United
States, have traditionally adhered to
consensus-based norms governing
jurisdictional nexus for the imposition
of tax. However, the adoption or
potential adoption by foreign countries
of novel extraterritorial foreign taxes
that diverge in significant respects from
these norms of taxing jurisdiction now
suggests that further guidance is
appropriate to ensure that creditable
foreign taxes in fact have a predominant
character of ‘‘an income tax in the U.S.
sense.’’
Finally, these regulations are
necessary in order to respond to
outstanding comments raised with
respect to other regulations and in order
to address a variety of issues arising
from the interaction of provisions in
other regulations.
The Treasury Department and the IRS
in 2019 issued final regulations (84 FR
69022) (2019 FTC final regulations) and
proposed regulations (84 FR 69124)
(2019 FTC proposed regulations), which
were finalized in 2020 (85 FR 71998)
(2020 FTC final regulations). The
Treasury Department and the IRS
received comments with respect to the
2019 FTC proposed regulations, some of
which were addressed in proposed
regulations (85 FR 72078) published in
2020 (2020 FTC proposed regulations)
instead of in the 2020 FTC final
regulations in order to allow further
opportunity for notice and comment.
The 2020 FTC proposed regulations,
which also addressed additional issues,
are finalized in these final regulations.
The following analysis provides an
overview of the regulations, discussion
of the costs and benefits of these
regulations as compared with the
baseline, and a discussion of alternative
policy choices that were considered.
B. Overview of the Structure of and
Need for Final Regulations
These final regulations address a
variety of outstanding issues, most
importantly with respect to the existing

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definition of a foreign income tax.
Section 901 allows a credit for foreign
income taxes, and the existing
regulations define the conditions under
which foreign taxes will be considered
foreign income taxes. These final
regulations revise aspects of this
definition in light of challenges that
taxpayers and the IRS have faced in
applying the rules of the existing
regulations. In particular, the
requirements in the existing regulations
presuppose conclusions based on
country-level or other aggregated data
that can be difficult for taxpayers and
the IRS to obtain and analyze for
purposes of determining whether the
foreign tax is imposed on net gain,
causing both administrative and
compliance burdens and difficulties
resolving disputes. Therefore, the final
regulations revise the net gain
requirements such that, in cases where
data-driven conclusions have been
difficult to establish historically, the
requirements rely less on data of the
effects of the foreign tax, and instead
rely more on the terms of the foreign tax
law (See Part I.C.3.i. of this Special
Analyses for alternatives considered and
affected taxpayers). For example, a
foreign tax, to be creditable, must
generally be levied on realized gross
receipts (and certain deemed gross
receipts) net of deductions for expenses.
Under these final regulations, the use of
data to demonstrate that an alternative
base upon which the tax is levied is in
practice a gross receipts equivalent
cannot be used to satisfy the gross
receipts portion of the net gain
requirement.
In addition to these changes, the final
regulations adopt the jurisdictional
nexus requirement introduced by the
2020 FTC proposed regulations
(renamed the ‘‘attribution requirement’’
in the final regulations) for purposes of
determining whether a foreign tax is an
income tax in the U.S. sense. Under this
requirement, the foreign tax law must
require a sufficient nexus between the
foreign country and the taxpayer’s
activities or investment of capital or
other assets that give rise to the income
being taxed. Therefore, a tax imposed by
a foreign country on income that lacks
sufficient nexus to activity in that
foreign country (such as operations,
employees, factors of production) is not
creditable. This limitation is designed to
ensure that the foreign tax is an income
tax in the U.S. sense by requiring that
there is an appropriate nexus between
the taxable amount and the foreign
taxing jurisdiction (see Part I.C.3.ii of
this Special Analyses for discussion of
alternatives considered and taxpayers

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affected). Together, the clarifications
and changes to the net gain requirement
and the attribution requirement will
tighten the rules governing the
creditability of foreign taxes and will
likely restrict creditability of foreign
taxes to some extent relative to the
existing regulations.
Finally, these final regulations
address other issues raised in comments
to the 2019 FTC proposed regulations or
resulting from other legislation. For
example, comments on the 2019 FTC
proposed regulations asked for
clarification of uncertainty regarding the
appropriate level of aggregation
(affiliated group versus subgroup) at
which expenses of life insurance
companies should be allocated to
foreign source income, and comments
asked for clarification on when
contested taxes (that is, taxes owed to a
foreign government which a taxpayer
disputes) accrue for purposes of the
foreign tax credit. With respect to the
life insurance issue, the 2019 FTC
proposed regulations specified an
allocation method, but requested
comments regarding whether another
method might be superior. Subsequent
comments supported both methods for
different reasons, and the Treasury
Department and the IRS found both
methods to have merit. Therefore, the
2020 FTC proposed regulations and the
final regulations allow taxpayers to
choose the most appropriate method for
their circumstances. (See Part I.C.3.iii of
this Special Analyses for alternatives
considered and affected taxpayers).
With respect to the contested tax
issue, the final regulations establish that
contested taxes do not accrue (and
therefore cannot be claimed as a credit)
until the contest is resolved. However,
the final regulations will allow
taxpayers to claim a provisional credit
for the portion of taxes already remitted
to the foreign government, if the
taxpayer agrees to notify the IRS when
the contest concludes and agrees not to
assert the statute of limitations as a
defense to assessment of U.S. tax if the
IRS determines that the taxpayer failed
to take appropriate steps to secure a
refund of the foreign tax. (See Part
I.C.3.iv of this Special Analyses for
alternatives considered and affected
taxpayers). In this way, the final
regulations alleviate taxpayer cash flow
constraints that could result from
temporary double taxation during the
period of dispute resolution, while still
providing the taxpayer with the
incentive to resolve the tax dispute and
providing the IRS with the ability to
ensure that appropriate action was taken
regarding dispute resolution.

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The guidance and specificity
provided by these regulations clarify
which foreign taxes are creditable as
income taxes, and (with respect to
contested taxes) when they are
creditable. The guidance also helps to
resolve uncertainty and more generally
to address issues raised in comments.
C. Economic Analysis
1. Baseline
In this analysis, the Treasury
Department and the IRS assess the
benefits and costs of these final
regulations relative to a no-action
baseline reflecting anticipated Federal
income tax-related behavior in the
absence of these regulations.

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2. Summary of Economic Effects
The final regulations provide
certainty and clarity to taxpayers
regarding the creditability of foreign
taxes. In the absence of the enhanced
specificity provided by these
regulations, similarly situated taxpayers
might interpret the creditability of
foreign taxes differently, particularly
with respect to new extraterritorial
taxes, potentially resulting in inefficient
patterns of economic activity. For
example, some taxpayers may forego
specific economic projects, foreign or
domestic, that other taxpayers deem
worthwhile based on different
interpretations of the tax consequences
alone. The guidance provided in these
regulations helps to ensure that
taxpayers face more uniform incentives
when making economic decisions. In
general, economic performance is
enhanced when businesses face more
uniform signals about tax treatment.
In addition, these regulations
generally reduce the compliance and
administrative burdens associated with
information collection and analysis
required to claim foreign tax credits,
relative to the no-action baseline. The
regulations achieve this reduction
because they rely to a significantly
lesser extent on data-driven conclusions
than the regulatory approach provided
in the existing regulations and instead
rely more on the terms and structure of
the foreign tax law.
To the extent that taxpayers, in the
absence of further guidance, would
generally interpret the existing foreign
tax credit rules as being more favorable
to the taxpayer than the final regulations
provide, the final regulations may result
in reduced international activity relative
to the no-action baseline. This reduced
activity may have included both
activities that could have been
beneficial to the U.S. economy (perhaps
because the activities would have

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represented enhanced international
opportunities for businesses with U.S.
owners) and activities that may not have
been beneficial (perhaps because the
activities would have been accompanied
by reduced activity in the United
States). Thus, the Treasury Department
and the IRS recognize that foreign
economic activity by U.S. taxpayers may
be a complement or substitute to
activity within the United States and
that to the extent these regulations lead
to a reduction in foreign economic
activity relative to the no-action
baseline, a mix of results may occur. To
the extent that foreign governments, in
response to these regulations, alter their
tax regimes to reduce their reliance on
taxes that are not income taxes in the
U.S. sense, any such reduction in
foreign economic activity by U.S.
taxpayers as a result of these
regulations, relative to the no-action
baseline, will be mitigated.
The Treasury Department and the IRS
project that the regulations will have
economic effects greater than $100
million per year ($2021) relative to the
no-action baseline. This determination
is based on the substantial size of many
of the businesses potentially affected by
these regulations and the general
responsiveness of business activity to
effective tax rates,10 one component of
which is the creditability of foreign
taxes. Based on these two magnitudes,
even modest changes in the treatment of
foreign taxes, relative to the no-action
baseline, can be expected to have
annual effects greater than $100 million
($2021).
The Treasury Department and the IRS
have not undertaken quantitative
estimates of the economic effects of
these regulations. The Treasury
Department and the IRS do not have
readily available data or models to
estimate with reasonable precision (i)
the tax stances that taxpayers would
likely take in the absence of the final
regulations or under alternative
regulatory approaches; (ii) the difference
in business decisions that taxpayers
might make between the final
regulations and the no-action baseline
or alternative regulatory approaches; or
(iii) how this difference in those
business decisions will affect measures
of U.S. economic performance.
In the absence of such quantitative
estimates, the Treasury Department and
the IRS have undertaken a qualitative
analysis of the economic effects of the
final regulations relative to the no10 See E. Zwick and J. Mahon, ‘‘Tax Policy and
Heterogeneous Investment Behavior,’’ at American
Economic Review 2017, 107(1): 217–48 and articles
cited therein.

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action baseline and relative to
alternative regulatory approaches. This
analysis is presented in Part I.C.3 of this
Special Analyses.
3. Options Considered and Number of
Affected Taxpayers, by Specific
Provisions
i. ‘‘Net Gain Requirement’’ for
Determining a Creditable Foreign Tax
a. Summary
Under existing regulations, a foreign
tax is creditable if it reaches ‘‘net gain,’’
which is determined based in part on
data-driven analysis. Therefore, under
the existing regulations, a gross basis tax
can in certain cases be creditable if it
can be shown that the tax as applied
does not result in taxing more than the
taxpayer’s profit. In certain cases, in
order to determine creditability, the IRS
requests country-level or other aggregate
data to analyze whether the tax reaches
net gain. The creditability determination
is made based on data with respect to
a foreign tax in its entirety, as it is
applied to all taxpayers. In other words,
the tax is creditable or not creditable
based on its application to all taxpayers
rather than on a taxpayer-by-taxpayer
basis. However, different taxpayers can
and do take different positions with
respect to what the language of the
existing regulations and the empirical
tests imply about creditability.
b. Options Considered for the Final
Regulations
The Treasury Department and the IRS
considered three options to address
concerns with the ‘‘net gain’’ test. The
first option is not to implement any
changes and to continue to determine
the definition of a foreign income tax
based in part on conclusions based on
country-level or other aggregate data.
This option would mean that the
determination of whether a tax satisfies
the definition of foreign income tax
would continue to be administratively
difficult for taxpayers and the IRS, in
part because it requires the IRS and the
taxpayer to obtain information from the
foreign country to determine how the
tax applies in practice to taxpayers
subject to the tax. The existing
regulations apply a ‘‘predominant
character’’ analysis such that deviations
from the net gain requirement do not
cause a tax to fail this requirement if the
predominant character of the tax is that
of an income tax in the U.S. sense. For
example, the existing regulations allow
a credit for a foreign tax whose base,
judged on its predominant character, is
computed by reducing gross receipts by
significant costs and expenses, even if
gross receipts are not reduced by all

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allocable costs and expenses. This
requires some judgment in determining
whether the exclusion of some costs and
expenses causes the tax to fail the net
gain requirement.
The second option considered is not
to use data-driven conclusions for any
portion of the net gain requirement and
rely only on foreign tax law to make the
determination. This rule would be
easier to apply compared with the first
option because it requires looking only
at foreign law, regulations, and rulings.
However, this option could result in an
overly harsh outcome, to the extent the
rules determine whether a levy is an
income tax in its entirety (that is, not on
a taxpayer-by-taxpayer basis). For
example, if a country had a personal
income tax that satisfied all the
requirements, except that the country
also included imputed rental income in
the tax base, the Treasury Department
and the IRS would not necessarily want
to disallow as a credit the entire
personal income tax system of that
country due to the one deviation from
U.S. tax law definitions of income tax.
As part of this option, the Treasury
Department and the IRS therefore
considered also allowing a parsing of
each tax for conforming and nonconforming parts. For example, in the
prior example, only a portion of the
income tax could be disallowed (that is,
the portion attributable to imputed
rental income). However, this approach
would be extremely complicated to
administer since there would need to be
special rules for determining which
portion of the tax relates to the nonconforming parts and which do not. It
would also imply that taxpayers could
not know from the outset whether a
particular levy is an income tax but
would instead have to analyze the tax in
each fact and circumstances in which it
applied to a particular taxpayer.
The third option considered is to use
data-driven conclusions only for
portions of the net gain requirement.
The Treasury Department and the IRS
considered retaining data-based
conclusions in portions of the
realization requirement and the costrecovery requirement but removing
them in the gross receipts requirement.
This is the approach taken in these
regulations. In these regulations, the
cost recovery requirement retains the
rule that the tax base must allow for
recovery of significant costs and
expenses. Data are still used in limited
circumstances as part of the cost
recovery analysis to determine whether
a cost or expense is significant with
respect to all taxpayers; however, in
order to provide clarity and certainty to
taxpayers, the final regulations contain

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a non-exclusive per se list of significant
costs and expenses.
Because these options differ in terms
of the creditability of foreign taxes, they
may increase or decrease foreign activity
by U.S. taxpayers. The Treasury
Department and the IRS have not
projected the differences in economic
activity across the three alternatives
because they do not have readily
available data or models that capture
these effects. It is anticipated that the
final regulations will reduce taxpayer
compliance costs relative to the baseline
by significantly reducing the
circumstances in which taxpayers must
incur costs to obtain data (which may or
may not be readily available) in order to
evaluate the creditability of a tax.
The Treasury Department and the IRS
do not have data or models that would
allow them to quantify the reduced
administrative burden resulting from
these final regulations relative to
alternative regulatory approaches. The
Treasury Department and the IRS expect
that the regulations will reduce
administrative burden and compliance
burdens because the collection and
analysis of empirical data is time
consuming for taxpayers and the IRS,
and the existing regulations have
resulted in a variety of disputes. Hence
a reduction in required data collection
should reduce burdens. Further, greater
reliance on legal definitions rather than
empirical review of available data has
the potential to reduce the number of
disputes, which also should reduce
burdens.
c. Number of Affected Taxpayers
The Treasury Department and the IRS
have determined that the population of
taxpayers potentially affected by the net
gain provisions of the final regulations
includes any taxpayer with foreign
operations claiming foreign tax credits
(or with the potential to claim foreign
tax credits). Based on currently
available tax filings for tax year 2018,
there were about 9.3 million Form 1116s
filed by U.S. individuals to claim
foreign tax credits with respect to
foreign taxes paid on individual,
partnership, or S corporation income.
There were 17,500 Form 1118s filed by
C corporations to claim foreign tax
credits with respect to foreign taxes
paid. In addition, there were about
16,500 C corporations with CFCs that
filed at least one Form 5471 with their
Form 1120 return, indicating a potential
to claim a foreign tax credit even if no
credit was claimed in 2018. Similarly,
in these data there were about 41,000
individuals with CFCs that e-filed at
least one Form 5471 with their Form
1040 return. In 2018, there were about

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3,250 S corporations with CFCs that
filed at least one Form 5471 with their
Form 1120S return. The identified S
corporations had an estimated 23,000
shareholders. Finally, the Treasury
Department and the IRS estimate that
there were approximately 7,500 U.S.
partnerships with CFCs that e-filed at
least one Form 5741 in 2018. The
identified partnerships had
approximately 1.7 million partners, as
indicated by the number of Schedules
K–1 filed by the partnerships; however,
this number includes both domestic and
foreign partners. Furthermore, there is,
likely to be some overlap between the
Form 5471 and the Form 1116 and/or
1118 filers.
These numbers suggest that between
9.3 million (under the assumption that
all Form 5471 filers or shareholders of
filers also filed Form 1116 or 1118) and
11 million (under the assumption that
filers or shareholders of filers of Form
5471 are a separate pool from Form
1116 and 1118 filers) taxpayers will
potentially be affected by these
regulations. Based on Treasury
tabulations of Statistics of Income data,
the total volume of foreign tax credits
reported on Form 1118 in 2016 was
about $90 billion. Data do not exist that
would allow the Treasury Department
or the IRS to identify how this total
volume might change as a result of these
regulations; however, the Treasury
Department and the IRS anticipate that
only a small fraction of existing foreign
tax credits would be impacted by these
regulations.
ii. Jurisdictional Nexus
a. Summary
Rules under existing § 1.901–2 do not
explicitly require, for purposes of
determining whether a foreign tax is a
creditable foreign income tax, that the
tax be imposed only on income that has
a jurisdictional nexus (or adequate
connection) to the country imposing the
tax. In order to ensure that creditable
taxes under section 901 conform to
traditional international norms of taxing
jurisdiction and therefore are income
taxes in the U.S. sense, these regulations
add a jurisdictional nexus requirement.
b. Options Considered for the Final
Regulations
The Treasury Department and the IRS
considered the following three options
for designing a nexus requirement. The
first option considered is to create a
jurisdictional nexus requirement based
on Articles 5 (Permanent Establishment)
and 7 (Business Profits) in the U.S.
Model Income Tax Convention (the
‘‘U.S. Convention’’). The U.S.

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Convention includes widely accepted
and understood standards with respect
to a country’s right to tax a
nonresident’s income. The relevant
articles of the U.S. Convention generally
require a certain presence or level of
activity before the country can impose
tax on business income, and the tax can
only be imposed on income that is
attributable to the business activity.
This option was rejected due to
concerns that this standard would be
too rigid and prescriptive in light of the
fact that the Code contains a broader
rule for determining when a nonresident
is taxed on its income attributable to a
activity in the United States.
The second option considered was to
create a jurisdictional nexus
requirement based on Code section 864,
which contains a standard for income
effectively connected with the conduct
of a U.S. trade or business (ECI). The
Code does not provide a definition of
U.S. trade or business; it is instead
defined in case law, and the definition
is therefore not strictly delineated. This
option was therefore rejected as
potentially being ambiguous, and not
necessarily targeting the primary
concern with respect to the new
extraterritorial taxes, which is that, in
contrast to traditional international
income tax norms governing the
creditability of taxes, they are imposed
based on the location of customers or
users, or other destination-based
criteria.
The third option considered was to
require that foreign tax imposed on a
nonresident must be based on the
nonresident’s activities located in the
foreign country (including its functions,
assets, and risks located in the foreign
country) without taking into account as
a significant factor the location of
customers, users, or similar destinationbased criteria. This more narrowly
tailored approach better addresses the
concern that extraterritorial taxes that
are imposed on the basis of location of
customers, users, or similar criteria
should not be creditable under
traditional norms reflected in the
Internal Revenue Code that govern
nexus and taxing rights and therefore
should be excluded from creditable
income taxes. Taxes imposed on
nonresidents that would meet the Codebased ECI requirement could qualify, as
well as taxes that would meet the
permanent establishment and business
profit standard under the U.S.
Convention. This is the option adopted
by the Treasury Department and the
IRS.
This approach is consistent with the
fact that under traditional norms
reflected in the Internal Revenue Code,

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income tax is generally imposed taking
into account the location of the
operations, employees, factors of
production, residence, or management
of the taxpayer. In contrast,
consumption taxes such as sales taxes,
value-added taxes, or so-called
destination-based income taxes are
generally imposed on the basis of the
location of customers, users, or similar
destination-based criteria. Although the
tax incidence of these two groups of
taxes may vary, tax incidence does not
play a role in the definition of an
income tax in general, or an income tax
in the U.S. sense. Therefore, the choice
among regulatory options was based on
which option most closely aligned the
definition of foreign income taxes to
taxes that are income taxes in the U.S.
sense.
The Treasury Department and the IRS
have not attempted to estimate the
differences in economic activity that
might result under each of these
regulatory options because they do not
have readily available data or models
that capture (i) the jurisdictional nexus
of taxpayers’ activities under the
different regulatory approaches and (ii)
the economic activities that taxpayers
might undertake under different
jurisdictional nexus criteria. In addition,
the Treasury Department and the IRS
have not attempted to estimate the
difference in compliance costs under
each of these regulatory options.

identified S corporations had an
estimated 23,000 shareholders. Finally,
the Treasury Department and the IRS
estimate that there were approximately
7,500 U.S. partnerships with CFCs that
e-filed at least one Form 5471 in 2018.
The identified partnerships had
approximately 1.7 million partners, as
indicated by the number of Schedules
K–1 filed by the partnerships; however,
this number includes both domestic and
foreign partners. Furthermore, there is
likely to be overlap between the Form
5471 and the Form 1116 and/or 1118
filers.
These numbers suggest that between
9.3 million (under the assumption that
all Form 5471 filers or shareholders of
filers also filed Form 1116 or 1118) and
11 million (under the assumption that
filers or shareholders of filers of Form
5471 are a separate pool from Form
1116 and 1118 filers) taxpayers will
potentially be affected by these
regulations. Based on Treasury
Department tabulations of Statistics of
Income data, the total volume of foreign
tax credits reported on Form 1118 in
2016 was about $90 billion. Data do not
exist that would allow the Treasury
Department or the IRS to identify how
this total volume might change as a
result of these regulations; however, the
Treasury Department and the IRS
anticipate that only a small fraction of
existing foreign tax credits would be
impacted by these regulations.

c. Number of Affected Taxpayers
The Treasury Department and the IRS
have determined that the population of
taxpayers potentially affected by the
jurisdictional nexus requirement of the
regulations includes any taxpayer with
foreign operations claiming foreign tax
credits (or with the potential to claim
foreign tax credits). Based on currently
available tax filings for tax year 2018,
there were about 9.3 million Form 1116s
filed by U.S. individuals to claim
foreign tax credits with respect to
foreign taxes paid on individual,
partnership, or S corporation income.
There were 17,500 Form 1118s filed by
C corporations to claim foreign tax
credits with respect to foreign taxes
paid. In addition, there were about
16,500 C corporations with CFCs that
filed at least one Form 5471 with their
Form 1120 return, indicating a potential
to claim a foreign tax credit, even if no
credit was claimed in these years.
Similarly, for the same period, there
were about 41,000 individuals with
CFCs that e-filed at least one Form 5471
with their Form 1040 return. In 2018,
there were about 3,250 S corporations
with CFCs that filed at least one Form
5471 with their Form 1120S return. The

iii. Allocation and Apportionment of
Expenses for Insurance Companies

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a. Summary
Section 818(f) provides that for
purposes of applying the expense
allocation rules to a life insurance
company, the deduction for
policyholder dividends, reserve
adjustments, death benefits, and certain
other amounts (‘‘section 818(f)
expenses’’) are treated as items that
cannot be definitely allocated to an item
or class of gross income. That means, in
general, that the expenses are
apportioned ratably across all of the life
insurance company’s gross income.
Under the expense allocation rules,
for most purposes, affiliated groups are
treated as a single entity, although there
are exceptions for certain expenses. The
statute is unclear, however, about how
affiliated groups are to be treated with
respect to the allocation of section 818(f)
expenses of life insurance companies.
Depending on how section 818(f)
expenses are allocated across an
affiliated group, the results could be
different because the gross income
categories across the affiliated group
could be calculated in multiple ways.

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The Treasury Department and the IRS
received comments and are aware that
in the absence of further guidance
taxpayers are taking differing positions
on this treatment. Some taxpayers argue
that the expenses described in section
818(f) should be apportioned based on
the gross income of the entire affiliated
group, while others argue that expenses
should be apportioned on a separate
company or life subgroup basis taking
into account only the gross income of
life insurance companies.
b. Options Considered for the Final
Regulations
The Treasury Department and the IRS
are aware of at least five potential
methods for allocating section 818(f)
expenses in a life-nonlife consolidated
group. First, the expenses might be
allocated solely among items of the life
insurance company that has the reserves
(‘‘separate entity method’’). Second, to
the extent the life insurance company
has engaged in a reinsurance
arrangement that constitutes an
intercompany transaction (as defined in
§ 1.1502–13(b)(1)), the expenses might
be allocated in a manner that achieves
single entity treatment between the
ceding member and the assuming
member (‘‘limited single entity
method’’). Third, the expenses might be
allocated among items of all life
insurance members (‘‘life subgroup
method’’). Fourth, the expenses might
be allocated among items of all members
of the consolidated group (including
both life and non-life members) (‘‘single
entity method’’). Fifth, the expenses
might be allocated based on a facts and
circumstances analysis (‘‘facts and
circumstances method’’).
The 2019 FTC proposed regulations
proposed adopting the separate entity
method because it is consistent with
section 818(f) and with the separate
entity treatment of reserves under
§ 1.1502–13(e)(2). The Treasury
Department and the IRS recognized,
however, that this method may create
opportunities for consolidated groups to
use intercompany transactions to shift
their section 818(f) expenses and
achieve a more advantageous foreign tax
credit result. Accordingly, the Treasury
Department and the IRS requested
comments on whether a life subgroup
method more accurately reflects the
relationship between section 818(f)
expenses and the income producing
activities of the life subgroup as a
whole, and whether the life subgroup
method is less susceptible to abuse
because it might prevent a consolidated
group from inflating its foreign tax
credit limitation through intercompany
transfers of assets, reinsurance

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transactions, or transfers of section
818(f) expenses. Comments received
supported both methods and the 2020
FTC proposed regulations provided that
the life subgroup method should
generally be used, because it minimizes
opportunities for abuse and is more
consistent with the general rules for
allocating expenses among affiliated
group members. However, recognizing
that the separate entity method also has
merit, the 2020 FTC proposed
regulations and the final regulations
permit a taxpayer to make a one-time
election to use the separate entity
method for all life insurance members
in the affiliated group. This election is
binding for all future years and may not
be revoked without the consent of the
Commissioner. Because the election is
binding and applies to all members of
the group, taxpayers will not be able to
change allocation methods from year to
year depending on which is most
advantageous. The Treasury Department
and the IRS may consider future
proposed regulations to address any
additional anti-abuse concerns (such as
under section 845), if needed.
The Treasury Department and the IRS
have not attempted to assess the
differences in economic activity that
might result under each of these
regulatory options because they do not
have readily available data or models
that capture activities at this level of
specificity. The Treasury Department
and the IRS further have not estimated
the difference in compliance costs
under each of these regulatory options
because they lack adequate data.
c. Number of Affected Taxpayers
The Treasury Department and the IRS
have determined that the population of
taxpayers potentially affected by these
insurance expense allocation rules
consists of life insurance companies that
are members of an affiliated group. The
Treasury Department and the IRS have
established that there are approximately
60 such taxpayers.
iv. Creditability of Contested Foreign
Income Taxes
a. Summary
Section 901 allows a taxpayer to claim
a foreign tax credit for foreign income
taxes paid or accrued (depending on the
taxpayer’s method of accounting) in a
taxable year. Foreign income taxes
accrue in the taxable year in which all
the events have occurred that establish
the fact of the liability and the amount
of the liability can be determined with
reasonable accuracy (‘‘all events test’’).
When a taxpayer disputes or contests a
foreign tax liability with a foreign

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country, that contested tax does not
accrue until the contest concludes
because only then can the amount of the
liability be finally determined.
However, under two IRS revenue
rulings (Rev. Ruls. 70–290 and 84–125),
a taxpayer is allowed to claim a credit
for the portion of a contested tax that
the taxpayer has remitted to the foreign
country, even though the taxpayer
continues to dispute the liability. While
this alleviates cash flow constraints
associated with temporary double
taxation, it is not consistent with the all
events test. In addition, it potentially
disincentivizes the taxpayer from
continuing to contest the foreign tax,
since the tax is already credited and the
dispute could be time-consuming and
costly, which could result in U.S. tax
being reduced by foreign tax in excess
of amounts properly due.
The final regulations clarify the
treatment of contested foreign taxes of
accrual basis taxpayers. As described in
part VI.D.2 of the Summary of
Comments and Explanation of
Revisions, the final regulations also
clarify, in response to comments, the
circumstances in which cash method
taxpayers may claim a foreign tax credit
for contested taxes that are remitted
before the contest has been concluded.
b. Options Considered for the Final
Regulations
The Treasury Department and the IRS
considered three options for the
treatment of contested foreign taxes. The
first option considered is to not make
any changes to the existing rule and to
continue to allow taxpayers to claim a
credit for a foreign tax that is being
contested but that has been paid to the
foreign country. The Treasury
Department and the IRS determined that
this option is inconsistent with the all
events test for accrual method taxpayers
and with the § 1.901–2(e) compulsory
payment requirement. It would also
result in an accrual basis taxpayer
potentially having two foreign tax
redeterminations (FTRs) with respect to
one contested liability: One FTR at the
time the taxpayer pays the contested tax
to the foreign country, and a second
FTR when the contest concludes (if the
finally determined liability differs from
the amount that was paid and claimed
as a credit). Furthermore, this option
impinges on the IRS’s ability to enforce
the requirement in existing § 1.902–1(e)
that a tax has to be a compulsory
payment in order to be creditable—if a
taxpayer claims a credit for a contested
tax, then surrenders the contest once the
assessment statute closes, the IRS would
be time-barred from challenging that the
tax was not creditable on the grounds

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and that contest a foreign income tax
liability with a foreign country.
Although data reporting the number of
taxpayers that claim a credit for
contested foreign income tax in a given
year are not readily available, the
potentially affected population of
taxpayers would, under existing
§ 1.905–3, generally have a foreign tax
redetermination. Data reporting the
number of taxpayers subject to a foreign
tax redetermination in a given year are
not readily available; however, some
taxpayers currently subject to such
redetermination will file amended
returns. Based on currently available tax
filings for tax year 2018, the Treasury
Department and the IRS have
determined that approximately 11,400
filers would be affected by these
regulations. This estimate is based on
the number of U.S. corporations that
filed an amended return that had a Form
1118 attached to the Form 1120; S
corporations that filed an amended
return with a Form 5471 attached to the
Form 1120S or that reported an amount
of foreign tax on the Form 1120S,
Schedule K; partnerships that filed an
amended return with a Form 5471
attached to Form 1065 or that reported
an amount of foreign tax on Schedule K;
U.S. individuals that filed an amended
return and had a Form 1116 attached to
the Form 1040.

that the taxpayer failed to exhaust all
practical remedies.
The second option considered is to
only allow taxpayers to claim a credit
when the contest concludes. In some
cases, the taxpayer must pay the tax to
the foreign country in order to contest
the tax or in order to stop the running
of interest in the foreign country. This
option would leave the taxpayer out of
pocket to two countries (potentially
giving rise to cash flow issues for the
taxpayer) while the contest is pending,
which could take several years. The
Treasury Department and the IRS
determined that this outcome is unduly
harsh.
The third option considered is to
allow taxpayers the option to claim a
provisional credit for an amount of
contested tax that is actually paid, even
though in general, taxpayers can only
claim a credit when the contest is
resolved. This is the option adopted in
§ 1.905–1(c)(3) and (d)(4). As a
condition for making this election, the
taxpayer must enter into a provisional
foreign tax credit agreement in which it
agrees to notify the IRS when the
contest concludes and agrees to not
assert the expiration of the assessment
statute (for a period of three years from
the time the contest resolves) as a
defense to assessment, so that the IRS is
able to challenge the foreign tax credit
claimed with respect to the contested
tax if the IRS determines that the
taxpayer failed to exhaust all practical
remedies.
The Treasury Department and the IRS
have not attempted to assess the
differences in economic activity that
might result under each of these
regulatory options because they do not
have readily available data or models
that capture taxpayers’ activities under
the different treatments of contested
taxes. The Treasury Department and the
IRS further have not attempted to
estimate the difference in compliance
costs under each of these regulatory
options.

II. Paperwork Reduction Act
The Paperwork Reduction Act of 1995
(44 U.S.C. 3501–3520) (‘‘Paperwork
Reduction Act’’) requires that a federal
agency obtain the approval of the OMB
before collecting information from the
public, whether such collection of
information is mandatory, voluntary, or
required to obtain or retain a benefit.
A. Overview
The collections of information in
these final regulations are in §§ 1.905–
1(c)(3), (d)(4) and (d)(5), 1.901–1(d)(2),
and 1.905–3. These collections of
information are generally the same as
the collections of information in the
2020 FTC proposed regulations, except
for the addition of § 1.905–1(c)(3),
which extends the election and filing
requirements in § 1.905–1(d)(4) for
claiming a provisional foreign tax credit

c. Number of Affected Taxpayers
The Treasury Department and the IRS
have determined that the final
regulations potentially affect U.S.
taxpayers that claim foreign tax credits

for contested foreign income to cash
method taxpayers. See Part VI.D.2 of the
Summary of Comments and Explanation
of Revisions for explanation of this
change.
The collections of information in
§§ 1.905–1(c)(3) and (d)(4) apply to
taxpayers that elect to claim a
provisional credit for contested foreign
income taxes before the contest resolves.
Under the final regulations, both cash
and accrual method taxpayers making
this election are required to file an
agreement described in § 1.905–
1(d)(4)(ii) as well as an annual
notification described in § 1.905–
1(d)(4)(iv). The collection of information
in § 1.905–1(d)(5) requires taxpayers
that are correcting an improper method
of accruing foreign income tax expense
to file a Form 3115, Application for
Change in Accounting Method, to obtain
the Commissioner’s permission to make
the change. Sections 1.901–1(d)(2) and
1.905–3 require taxpayers that make a
change between claiming a credit and a
deduction for foreign income taxes to
comply with the notification and
reporting requirements in § 1.905–4,
which generally require taxpayers to file
an amended return for the year or years
affected, along with an updated Form
1116 or Form 1118 if foreign tax credits
are claimed, and a written statement
providing specific information.
The burdens associated with
collections of information in §§ 1.905–
1(d)(4)(iv) and (d)(5), 1.901–1(d)(2), and
1.905–3, which will be conducted
through existing IRS forms, are
described in Part II.B of this Special
Analyses. The burden associated with
the collection of information in § 1.905–
1(d)(4)(ii), which will be conducted on
a new IRS form, is described in Part II.C
of this Special Analyses.
B. Collections of Information—§§ 1.905–
1(d)(4)(iv), 1.905–1(d)(5), 1.901–1(d)(2),
and 1.905–3
The Treasury Department and the IRS
intend that the information collection
requirements described in this Part II.B
of this Special Analyses will be set forth
in the forms and instructions identified
in Table 1.

TABLE 1—TABLE OF TAX FORMS IMPACTED
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Tax forms impacted
Collection of information

Number of respondents
(estimated)

§ 1.905–1(d)(4)(iv) .............................................
§ 1.905–1(d)(5) ..................................................

11,400 ...............................................................
465,500–514,500 ..............................................

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313

Forms to which the information
may be attached
Form 1116, Form 1118.
Form 3115.

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TABLE 1—TABLE OF TAX FORMS IMPACTED—Continued
Tax forms impacted
Collection of information

Number of respondents
(estimated)

Forms to which the information
may be attached

§ 1.901–1(d)(2), § 1.905–3 .................................

10,400–13,500 ..................................................

Form 1065 series, Form 1040 series, Form
1041 series, and Form 1120 series.

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Source: [MeF, DCS, and IRS’s Compliance Data Warehouse].

As indicated in Table 1, the Treasury
Department and the IRS intend the
annual notification requirement in
§ 1.905–1(d)(4)(iv), which applies to
taxpayers that elect to claim a
provisional credit for contested taxes,
will be conducted through amendment
of existing Form 1116, Foreign Tax
Credit (Individual, Estate, or Trust)
(covered under OMB control numbers
1545–0074 for individuals, and 1545–
0121 for estates and trusts) and existing
Form 1118, Foreign Tax Credit
(Corporations) (covered under OMB
control number 1545–0123). The
collection of information in § 1.905–
1(d)(4)(iv) will be reflected in the
Paperwork Reduction Act submission
that the Treasury Department and the
IRS will submit to OMB for these forms.
The current status of the Paperwork
Reduction Act submissions related to
these forms is summarized in Table 2.
The estimate for the number of
impacted filers with respect to the
collection of information in § 1.905–
1(d)(4)(iv), as well as with respect to the
collection of information in § 1.905–
1(d)(4)(ii) (described in Part II.C), is
based on the number of U.S.
corporations that filed an amended
return that had a Form 1118 attached to
the Form 1120; S corporations that filed
an amended return with a Form 5471
attached to the Form 1120S or that
reported an amount of foreign tax on the
Form 1120S, Schedule K; partnerships
that filed an amended return with a
Form 5471 attached to Form 1065 or
that reported an amount of foreign tax
on Schedule K; and U.S. individuals
that filed an amended return and had a
Form 1116 attached to the Form 1040.
The Treasury Department and the IRS
expect that the collection of information
in § 1.905–1(d)(5) will be reflected in
the Paperwork Reduction Act
submission that the Treasury
Department and the IRS will submit to
OMB for Form 3115 (covered under
OMB control numbers 1545–0123 and
1545–0074). See Table 2 for the current
status of the Paperwork Reduction Act
submission for Form 3115. Exact data is
not available to estimate the number of
taxpayers that have used an incorrect
method of accounting for accruing

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foreign income taxes, and that are
potentially subject to the collection of
information in § 1.905–1(d)(5). The
estimate in Table 1 of the number of
taxpayers potentially affected by this
collection of information is based on the
total number of filers in the Form 1040,
Form 1041, Form 1120, Form 1120S,
and Form 1065 series that indicated on
their return that they use an accrual
method of accounting, and that either
claimed a foreign tax credit or claimed
a deduction for taxes (which could
include foreign income taxes). This
represents an upper bound of
potentially affected taxpayers. The
Treasury Department and the IRS expect
that only a small portion of this
population of taxpayers will be subject
to the collection of information in
§ 1.905–1(d)(5), because only taxpayers
that have used an improper method of
accounting are subject to § 1.905–
1(d)(5).
The collection of information
resulting from §§ 1.901–1(d)(2) and
1.905–3, which is contained in § 1.905–
4, will be reflected in the Paperwork
Reduction Act submission that the
Treasury Department and the IRS will
submit for OMB control numbers 1545–
0123, 1545–0074 (which cover the
reporting burden for filing an amended
return and amended Form 1116 and
Form 1118 for individual and business
filers), OMB control number 1545–0092
(which covers the reporting burden for
filing an amended return for estate and
trust filers), OMB control number 1545–
0121 (which covers the reporting
burden for filing a Form 1116 for estate
and trust filers), and OMB control
number 1545–1056 (which covers the
reporting burden for the written
statement for FTRs). Exact data are not
available to estimate the additional
burden imposed by §§ 1.901–1(d)(2) and
1.905–3, which amend the definition of
a foreign tax redetermination in § 1.905–
3 to include a taxpayer’s change from
claiming a deduction to claiming a
credit, or vice versa, for foreign income
taxes. Taxpayers making or changing
their election to claim a foreign tax
credit, under existing regulations, must
already file amended returns and, if
applicable, a Form 1116 or Form 1118,

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for the affected years. The Treasury
Department and the IRS do not
anticipate that regulations that will
require taxpayers making this change to
comply with the collection of
information and reporting burden in
§ 1.905–4 will substantially change the
reporting requirement. Exact data are
not available to estimate the number of
taxpayers potentially subject to
§§ 1.901–1(d)(2) and 1.905–3. The
estimate in Table 1 is based upon the
total number of filers in the Form 1040,
Form 1041, and Form 1120 series that
either claimed a foreign tax credit or
claimed a deduction for taxes (which
could include foreign income taxes),
and filed an amended return. This
estimate represents an upper bound of
potentially affected taxpayers.
OMB control number 1545–0123
represents a total estimated burden time
for all forms and schedules for
corporations of 1.085 billion hours and
total estimated monetized costs of
$44.279 billion ($2021). OMB control
number 1545–0074 represents a total
estimated burden time, including all
other related forms and schedules for
individuals, of 2.14 billion hours and
total estimated monetized costs of
$37.960 billion ($2021). OMB control
number 1545–0092 represents a total
estimated burden time, including
related forms and schedules, but not
including Form 1116, for trusts and
estates, of 307,844,800 hours and total
estimated monetized costs of $14.077
billion ($2018). OMB control number
1545–0121 represents a total estimated
burden time for all estate and trust filers
of Form 1116, of 2,506,600 hours and
total estimated monetized costs of
$1.744 billion ($2018). OMB control
number 1545–1056 has an estimated
number of 13,000 respondents and total
estimated burden time of 54,000 hours
and total estimated monetized costs of
$2,583,840 ($2017).
The overall burden estimates
provided for OMB control numbers
1545–0123, 1545–0074, and 1545–0092
are aggregate amounts that relate to the
entire package of forms associated with
these OMB control numbers and will in
the future include but not isolate the
estimated burden of the tax forms that

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
will be revised as a result of the
information collections in the final
regulations. The difference between the
burden estimates reported here and
those future burden estimates will
therefore not provide an estimate of the
burden imposed by the final regulations.
The burden estimates reported here
have been reported for other regulations
related to the taxation of cross-border

income. The Treasury Department and
IRS urge readers to recognize that many
of the burden estimates reported for
regulations related to taxation of crossborder income are duplicates and to
guard against overcounting the burden
that international tax provisions impose.
The Treasury Department and the IRS
have not identified the estimated
burdens for the collections of

315

information in §§ 1.905–1(d)(4)(iv) and
(d)(5), 1.901–1(d)(2), and 1.905–3
because no burden estimates specific to
§§ 1.905–1(d)(4)(iv) and (d)(5), 1.901–
1(d)(2), and 1.905–3 are currently
available. The Treasury Department and
the IRS estimate burdens on a taxpayertype basis rather than a provisionspecific basis.

TABLE 2—STATUS OF CURRENT PAPERWORK REDUCTION SUBMISSIONS
Form

Type of filer

OMB No. (s)

Form 1116 ......................................

Trusts & estates (NEW Model) ......
https://www.reginfo.gov/public/do/
PRAViewICR?ref_nbr=2020101545-010.
Individual (NEW Model) .................
https://www.reginfo.gov/public/do/
PRAViewICR?ref_nbr=2021081545-001.
Business (NEW Model) ..................
https://www.reginfo.gov/public/do/
PRAViewICR?ref_nbr=2020121545-012.
Business (NEW Model) ..................
https://www.reginfo.gov/public/do/
PRAViewICR?ref_nbr=2020121545-012.
Individual (NEW Model) .................
https://www.reginfo.gov/public/do/
PRAViewICR?ref_nbr=2021081545-001.
.........................................................
https://www.reginfo.gov/public/do/
PRAViewICR?ref_nbr=2021051545-005.
Business (NEW Model) ..................
https://www.reginfo.gov/public/do/
PRAViewICR?ref_nbr=2020121545-012.
Individual (NEW Model) .................
https://www.reginfo.gov/public/do/
PRAViewICR?ref_nbr=2021081545-001.
Trusts & estates .............................
https://www.reginfo.gov/public/do/
PRAViewICR?ref_nbr=2018061545-014.

1545–0121 ...

Approved by OMB through 12/31/2023.

1545–0074 ...

Approved by OMB through 12/31/2021.

1545–0123 ...

Approved by OMB through 12/31/2021.

1545–0123 ...

Approved by OMB through 12/31/2021.

1545–0074 ...

Approved by OMB through 12/31/2021.

1545–1056 ...

Approved by OMB through 7/31/2024.

1545–0123 ...

Approved by OMB through 12/31/2021.

1545–0074 ...

Approved by OMB through 12/31/2021.

1545–0092 ...

Approved by OMB through 5/31/2022.

Form 1118 ......................................

Form 3115 ......................................

Notification of FTRs ........................

Amended returns ............................

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C. Collections of Information—§§ 1.905–
1(c)(3) and 1.905–1(d)(4)(ii)
The collection of information
contained in § 1.905–1(d)(4)(ii)—
relating to the provisional foreign tax
credit agreement that taxpayers electing
to claim a provisional credit for
contested foreign income taxes must
file—was submitted to the OMB for
review in accordance with the
Paperwork Reduction Act and was
approved under OMB control number
1545–2296. No comments regarding this
collection of information were received.
As described in Part II.A of this Special
Analyses, the final regulations, under
§ 1.905–1(c)(3), extend the provisional
credit election and associated collection

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Status

of information in § 1.905–1(d)(4)(ii) to
cash method taxpayers. The burden
estimates for control number 1545–2296
will be updated to reflect this change.
The likely respondents are U.S.
persons who pay or accrue foreign
income taxes.
Estimated total annual reporting
burden: 22,800 hours.
Estimated average annual burden per
respondent: 2 hours.
Estimated number of respondents:
11,400.
Estimated frequency of responses:
annually.
III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibility
Act (5 U.S.C. chapter 6), it is hereby

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certified that the final regulations will
not have a significant economic impact
on a substantial number of small entities
within the meaning of section 601(6) of
the Regulatory Flexibility Act.
The final regulations provide
guidance needed to comply with the
statutory rules under sections 245A(d),
861, 901, 903, 904, 905, and 960 and
affect U.S. individuals and corporations
that claim a credit or a deduction for
foreign taxes. The domestic small
business entities that are subject to these
Code provisions and to the rules in the
final regulations are those that operate
in foreign jurisdictions or that have
income from sources outside of the
United States and pay foreign taxes. The
final regulations also contain clarifying

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rules relating to foreign derived
intangible income (FDII) under section
250. Specifically, § 1.250(b)–1(c)(7)
provides a clarification regarding the
determination of domestic oil and gas
extraction income and § 1.250(b)–5(c)(5)
clarifies the meaning of the term
‘‘electronically supplied services’’ as
used in the section 250 regulations.
Because these rules only clarify the
intended meaning of terms in the
section 250 regulations, they do not
change the economic impact that the
section 250 regulations have on small
business entities. See the Regulatory
Flexibility Act analysis of TD 9901, 85
FR 43078–79.
Many of the important aspects of the
final regulations, including the rules in
§§ 1.245A(d)–1, 1.367(b)–4, 1.367(b)–7,
1.367(b)–10, 1.861–3, and 1.960–1,
apply only to U.S. persons that are at
least 10 percent shareholders of foreign
corporations, and thus are eligible to
claim dividends received deductions or
compute foreign taxes deemed paid
under section 960 with respect to
inclusions under subpart F and section
951A from CFCs. Other provisions of
the final regulations, specifically the
rules in § 1.861–14, apply only to
members of an affiliated group of
insurance companies earning income
from sources outside of the United
States. It is infrequent for domestic
small entities to operate as part of an
affiliated group, to operate as an
insurance company, or to operate
outside the United States in corporate
Size
(by business receipts)

$500,000
under
$1,000,000
(percent)

Under
$500,000
(percent)

FTC/Total Receipts .....................
FTC/(Total Receipts—Total Deductions) ..................................
FTC/Business Receipts ...............

form. Consequently, the Treasury
Department and the IRS do not expect
that the final regulations will likely
affect a substantial number of domestic
small business entities. However, the
Treasury Department and the IRS do not
have adequate data readily available to
assess the number of small entities
potentially affected by the final
regulations.
The Treasury Department and the IRS
have determined that the final
regulations will not have a significant
economic impact on domestic small
business entities. A significant part of
the final regulations is the modification
of the requirements in §§ 1.901–2 and
1.903–1 for determining whether a
foreign tax is a creditable ‘‘foreign
income tax’’ or a creditable ‘‘tax in lieu
of an income tax’’ under sections 901
and 903, respectively. Of particular
note, the final regulations add a
jurisdictional nexus requirement to the
existing creditability requirements. A
principal reason for adding the
jurisdictional nexus requirement is to
ensure that certain novel extraterritorial
foreign taxes, such as digital services
taxes, are not creditable. Many of these
novel extraterritorial taxes only apply to
large multinational corporations; as
such, small business entities are
unlikely to be impacted by the denial of
credits for such extraterritorial taxes. In
addition, as described in Part I.C.3.i of
this Special Analysis, the final
regulations remove the empirical
analysis required by the existing
$1,000,000
under
$5,000,000
(percent)

$5,000,000
under
$10,000,000
(percent)

creditability requirements under
§ 1.901–2 in favor a creditability
analysis based principally on the terms
of foreign tax law. The Treasury
Department and the IRS anticipate that
the final regulations will reduce
taxpayer compliance costs relative to
the existing regulations by significantly
reducing the circumstances in which
taxpayers must incur costs to obtain
data in order to evaluate the
creditability of a tax.
To provide an upper bound estimate
of the impact these final regulations
could have on business entities, the
Treasury Department and the IRS
calculated, based on information from
the Statistics of Income 2017 Corporate
File, foreign tax credits 11 as a
percentage of three different tax-related
measures of annual receipts (see Table
for variables) by corporations. As
demonstrated by the data in the table
below, foreign tax credits as a
percentage of all three measures of
annual receipts is substantially less than
the 3 to 5 percent threshold for
significant economic impact for
corporations with business receipts less
than $250 million. The Treasury
Department and the IRS anticipate that
only a small fraction of existing foreign
tax credits would be impacted by these
regulations, and thus, the economic
impact of these regulations will be
considerably smaller than the effects
shown in the table.

$10,000,000
under
$50,000,000
(percent)

$50,000,000
under
$100,000,000
(percent)

$100,000,000
under
$250,000,000
(percent)

$250,000,000
or
more
(percent)

0.12

0.00

0.00

0.00

0.01

0.01

0.02

0.28

0.61
0.84

0.03
0.00

0.09
0.00

0.05
0.00

0.35
0.01

0.71
0.01

1.38
0.02

9.89
0.05

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Source: RAAS: (Tax Year 2017 SOI Data).

A portion of the economic impact of
these final regulations derive from the
collection of information requirements
in §§ 1.905–1(c)(3), (d)(4), and (d)(5),
1.901–1(d)(2), and 1.905–3. The data to
assess precise counts of small entities
affected by §§ 1.905–1(c)(3), (d)(4), and
(d)(5), 1.901–1(d)(2), and 1.905–3 are
not readily available. However, the
Treasury Department and the IRS do not
anticipate that these collections of
information significantly add to the
burden on small entities, compared to

the existing regulatory and statutory
requirements. The rules in §§ 1.901–
1(d)(2), and 1.905–3, which treat a
taxpayer’s change between claiming a
deduction and a credit for foreign
income taxes as a foreign tax
redetermination and thus require the
taxpayer to comply with reporting
requirements in § 1.905–4, do not
significantly add to the taxpayer’s
burden because taxpayers making this
change must already file amended
returns, along with Forms 1116 or 1118,

if applicable, for the affected years. In
fact, these rules reduce the uncertainty
faced by taxpayers seeking to make the
change but that have a time-barred
deficiency in one or more intervening
years and provide an efficient process
by which taxpayers can change between
crediting and deducting foreign income
taxes. Similarly, under the existing
rules, taxpayers that remit a contested
foreign tax liability to a foreign country
and seek to claim a foreign tax credit for
such liability would be subject to the

11 Although certain parts of the final regulations,
such as the rules under § 1.901–1(d) and § 1.905–
1, also impact taxpayers that claim a deduction,
instead of a credit, for foreign income taxes, the
Treasury Department and the IRS expect that the
vast majority of taxpayers that have creditable

foreign income taxes would choose a dollar-fordollar credit, instead of a deduction, for such taxes.
In addition, a significant aspect of these final
regulations, specifically the rules under §§ 1.901–2
and 1.903–1 regarding the definition of a foreign
income tax and a tax in lieu of an income tax, only

impact taxpayers that elect to claim a foreign tax
credit. Thus, the data in this table measuring
foreign tax credit against various variables is a
reasonable estimate of the economic impact of these
final regulations.

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
reporting requirements related to foreign
tax redeterminations under § 1.905–4,
and may have a second foreign tax
redetermination when the contest is
resolved if the taxpayer receives a
refund of any of the taxes claimed as a
credit. Under §§ 1.905–1(c) and (d) of
these final regulations, taxpayers do not
claim a credit for the foreign taxes until
the contest is resolved (and thus, would
generally only have one foreign tax
redetermination). The reporting
requirements in §§ 1.905–1(c)(3) and
(d)(4), relating to taxpayers claiming a
provisional credit for contested foreign
income taxes, apply only if the taxpayer
elects to claim the foreign tax credit
early. If a taxpayer makes this election,
it must file a provisional foreign tax
credit agreement described in Part II.C
of this Special Analysis and comply
with annual reporting requirements
described in Part II.B of this Special
Analysis. The Treasury Department and
the IRS estimate that the average burden
of the provisional foreign tax credit
agreement will be 2 hours per response.
In addition, the Treasury Department
and the IRS expect that the annual
reporting requirement, which will be
added to the existing Forms 1116 and
1118, will only marginally increase the
burden for completing those forms.
Finally, the Treasury Department and
the IRS expect that the collection of
information in § 1.905–1(d)(5), which
requires taxpayers seeking to change
their method of accounting for foreign
income taxes to file a Form 3115, will
not significantly impact small business
entities because only taxpayers that
have deducted or credited foreign
income taxes and that have used an
improper method of accounting for such
taxes are subject to the rules in § 1.905–
1(d)(5).
The Treasury Department and the IRS
do not have readily available data to
determine the incremental burdens
these collections of information will
have on small business entities.
However, as demonstrated in the table
in this Part III of the Special Analyses,
foreign tax credits do not have a
significant economic impact for any
gross-receipts class of business entities.
Therefore, the final regulations do not
have a significant economic impact on
small business entities. Accordingly, it
is hereby certified that the final
regulations will not have a significant
economic impact on a substantial
number of small entities.
IV. Section 7805(f)
Pursuant to section 7805(f), the
proposed regulations preceding these
final regulations (REG–101657–20) were
submitted to the Chief Counsel for

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Advocacy of the Small Business
Administration for comment on its
impact on small businesses. The
proposed regulations also request
comments from the public regarding the
RFA certification. No comments were
received.
V. Unfunded Mandates Reform Act
Section 202 of the Unfunded
Mandates Reform Act of 1995 (UMRA)
requires that agencies assess anticipated
costs and benefits and take certain other
actions before issuing a final rule that
includes any Federal mandate that may
result in expenditures in any one year
by a state, local, or tribal government, in
the aggregate, or by the private sector, of
$100 million in 1995 dollars, updated
annually for inflation. This final rule
does not include any Federal mandate
that may result in expenditures by state,
local, or tribal governments, or by the
private sector in excess of that
threshold.
VI. Executive Order 13132: Federalism
Executive Order 13132 (entitled
‘‘Federalism’’) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state
law, unless the agency meets the
consultation and funding requirements
of section 6 of the Executive order. This
final rule does not have federalism
implications and does not impose
substantial direct compliance costs on
state and local governments or preempt
state law within the meaning of the
Executive order.
Drafting Information
The principal authors of the final
regulations are Corina Braun, Karen J.
Cate, Jeffrey P. Cowan, Moshe A. Dlott,
Logan M. Kincheloe, Brad McCormack,
Jeffrey L. Parry, Teisha M. Ruggiero,
Tianlin (Laura) Shi, and Suzanne M.
Walsh of the Office of Associate Chief
Counsel (International), as well as Sarah
K. Hoyt and Brian R. Loss of Associate
Chief Counsel (Corporate). However,
other personnel from the Treasury
Department and the IRS participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is
amended as follows:

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317

PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding an entry
for § 1.245A(d)–1 in numerical order to
read in part as follows:

■

Authority: 26 U.S.C. 7805 * * *

*

*

*

*

*

Section 1.245A(d)–1 also issued under 26
U.S.C. 245A(g).

*

*
*
*
*
Par. 2. Section 1.164–2 is amended by
revising paragraph (d) and adding
paragraph (i) to read as follows:

■

§ 1.164–2 Deduction denied in case of
certain taxes.

*

*
*
*
*
(d) Foreign income taxes. Except as
provided in § 1.901–1(c)(2) and (3),
foreign income taxes, as defined in
§ 1.901–2(a), paid or accrued (as the
case may be, depending on the
taxpayer’s method of accounting for
such taxes) in a taxable year, if the
taxpayer chooses to take to any extent
the benefits of section 901, relating to
the credit for taxes of foreign countries
and possessions of the United States, for
taxes that are paid or accrued (according
to the taxpayer’s method of accounting
for such taxes) in such taxable year.
*
*
*
*
*
(i) Applicability dates. Paragraph (d)
of this section applies to foreign taxes
paid or accrued in taxable years
beginning on or after December 28,
2021.
■ Par. 3. Section 1.245A(d)–1 is added
to read as follows:
§ 1.245A(d)–1 Disallowance of foreign tax
credit or deduction.

(a) No foreign tax credit or deduction
allowed under section 245A(d)–(1)
Foreign income taxes paid or accrued by
domestic corporations or successors. No
credit under section 901 or deduction is
allowed in any taxable year for:
(i) Foreign income taxes paid or
accrued by a domestic corporation that
are attributable to section 245A(d)
income of the domestic corporation;
(ii) Foreign income taxes paid or
accrued by a successor to a domestic
corporation that are attributable to
section 245A(d) income of the
successor; and
(iii) Foreign income taxes paid or
accrued by a domestic corporation that
is a United States shareholder of a
foreign corporation, other than a foreign
corporation that is a passive foreign
investment company (as defined in
section 1297) with respect to the
domestic corporation and that is not a
controlled foreign corporation, that are
attributable to non-inclusion income of

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the foreign corporation and are not
otherwise disallowed under paragraph
(a)(1)(i) or (ii) of this section.
(2) Foreign income taxes paid or
accrued by foreign corporations. No
credit under section 901 or deduction is
allowed in any taxable year for foreign
income taxes paid or accrued by a
foreign corporation that are attributable
to section 245A(d) income, and such
taxes are not eligible to be deemed paid
under section 960 in any taxable year.
(3) Effect of disallowance on earnings
and profits. The disallowance of a credit
or deduction for foreign income taxes
under this paragraph (a) does not affect
whether the foreign income taxes reduce
earnings and profits of a corporation.
(b) Attribution of foreign income
taxes—(1) Section 245A(d) income.
Foreign income taxes are attributable to
section 245A(d) income to the extent
that the foreign income taxes are
allocated and apportioned under
§ 1.861–20 to the section 245A(d)
income group. For purposes of this
paragraph (b)(1), § 1.861–20 is applied
by treating the section 245A(d) income
group in each section 904 category of a
domestic corporation, successor, or
foreign corporation as a statutory
grouping and treating all other income,
including the receipt of a distribution of
previously taxed earnings and profits
other than section 245A(d) PTEP, as
income in the residual grouping. See
§ 1.861–20(d)(2) through (3) for rules
regarding the allocation and
apportionment of foreign income taxes
to the statutory and residual groupings
if the taxpayer does not realize,
recognize, or take into account a
corresponding U.S. item in the U.S.
taxable year in which the foreign
income taxes are paid or accrued. In the
case of a foreign law distribution or
foreign law disposition, a corresponding
U.S. item is assigned to the statutory
and residual groupings under § 1.861–
20(d)(2)(ii)(B) and (C) without regard to
the application of section 246(c), the
holding periods described in sections
964(e)(4)(A) and 1248(j), and § 1.245A–
5.
(2) Non-inclusion income of a foreign
corporation—(i) Scope. This paragraph
(b)(2) provides rules for attributing
foreign income taxes paid or accrued by
a domestic corporation that is a United
States shareholder of a foreign
corporation to non-inclusion income of
the foreign corporation. It applies only
in cases in which the foreign income
taxes are allocated and apportioned
under § 1.861–20 by reference to the
characterization of the tax book value of
stock, whether the stock is held directly
or indirectly through a partnership or
other passthrough entity, for purposes of

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allocating and apportioning the
domestic corporation’s interest expense,
or by reference to the income of a
foreign corporation that is a reverse
hybrid or foreign law CFC.
(ii) Foreign income taxes on a
remittance, U.S. return of capital
amount, or U.S. return of partnership
basis amount. This paragraph (b)(2)(ii)
applies to foreign income taxes paid or
accrued by a domestic corporation that
is a United States shareholder of a
foreign corporation with respect to
foreign taxable income that the domestic
corporation includes by reason of a
remittance, a distribution (including a
foreign law distribution) that is a U.S.
return of capital amount or U.S. return
of partnership basis amount, or a
disposition (including a foreign law
disposition) that gives rise to a U.S.
return of capital amount or a U.S. return
of partnership basis amount. These
foreign income taxes are attributable to
non-inclusion income of the foreign
corporation to the extent that they are
allocated and apportioned to the
domestic corporation’s section 245A
subgroup of general category stock,
section 245A subgroup of passive
category stock, or section 245A
subgroup of U.S. source category stock
in applying § 1.861–20 for purposes of
section 904 as the operative section. For
purposes of this paragraph (b)(2)(ii),
§ 1.861–20 is applied by treating the
domestic corporation’s section 245A
subgroup of general category stock,
section 245A subgroup of passive
category stock, and section 245A
subgroup of U.S. source category stock
as the statutory groupings and treating
the tax book value of the non-section
245A subgroup of stock for each
separate category as tax book value in
the residual grouping.
(iii) Foreign income taxes on income
of a reverse hybrid or a foreign law CFC.
This paragraph (b)(2)(iii) applies to
foreign income taxes paid or accrued by
a domestic corporation, other than a
regulated investment company (as
defined in section 851), real estate
investment trust (as defined in section
856), or S corporation (as defined in
section 1361), that is a United States
shareholder of a foreign corporation that
is a reverse hybrid or foreign law CFC
with respect to the foreign law passthrough income or foreign law inclusion
regime income of the reverse hybrid or
foreign law CFC, respectively. These
taxes are attributable to the noninclusion income of a reverse hybrid or
foreign law CFC to the extent that they
are allocated and apportioned to the
non-inclusion income group under
§ 1.861–20. For purposes of this
paragraph (b)(2)(iii), § 1.861–20 is

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applied by treating the non-inclusion
income group in each section 904
category of the domestic corporation
and the foreign corporation as a
statutory grouping and treating all other
income as income in the residual
grouping.
(3) Anti-avoidance rule. Foreign
income taxes are treated as attributable
to section 245A(d) income of a domestic
corporation or foreign corporation, or
non-inclusion income of a foreign
corporation, if a transaction, series of
related transactions, or arrangement is
undertaken with a principal purpose of
avoiding the purposes of section
245A(d) and this section with respect to
such foreign income taxes, including,
for example, by separating foreign
income taxes from the income, or
earnings and profits, to which such
foreign income taxes relate or by making
distributions (or causing inclusions)
under foreign law in multiple years that
give rise to foreign income taxes that are
allocated and apportioned with
reference to the same previously taxed
earnings and profits. See paragraph
(d)(4) of this section (Example 3).
(c) Definitions. The following
definitions apply for purposes of this
section.
(1) Corresponding U.S. item. The term
corresponding U.S. item has the
meaning set forth in § 1.861–20(b).
(2) Foreign income tax. The term
foreign income tax has the meaning set
forth in § 1.901–2(a).
(3) Foreign law CFC. The term foreign
law CFC has the meaning set forth in
§ 1.861–20(b).
(4) Foreign law disposition. The term
foreign law disposition has the meaning
set forth in § 1.861–20(b).
(5) Foreign law distribution. The term
foreign law distribution has the meaning
set forth in § 1.861–20(b).
(6) Foreign law inclusion regime. The
term foreign law inclusion regime has
the meaning set forth in § 1.861–20(b).
(7) Foreign law inclusion regime
income. The term foreign law inclusion
regime income has the meaning set forth
in § 1.861–20(b).
(8) Foreign law pass-through income.
The term foreign law pass-through
income has the meaning set forth in
§ 1.861–20(b).
(9) Foreign taxable income. The term
foreign taxable income has the meaning
set forth in § 1.861–20(b).
(10) Gross included tested income.
The term gross included tested income
means, with respect to a foreign
corporation that is described in
paragraph (b)(2)(iii) of this section, an
item of gross tested income multiplied
by the inclusion percentage of a
domestic corporation that is described

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in paragraph (b)(2)(iii) of this section for
the domestic corporation’s U.S. taxable
year with or within which the foreign
corporation’s taxable year described in
§ 1.861–20(d)(3)(i)(C) or § 1.861–
20(d)(3)(iii) ends.
(11) Hybrid dividend. The term hybrid
dividend has the meaning set forth in
§ 1.245A(e)–1(b)(2).
(12) Inclusion percentage. The term
inclusion percentage has the meaning
set forth in § 1.960–1(b).
(13) Non-inclusion income. The term
non-inclusion income means the items
of gross income of a foreign corporation
other than the items that are described
in § 1.960–1(d)(2)(ii)(B)(2) (items of
income assigned to the subpart F
income groups) and section 245(a)(5)
(without regard to section 245(a)(12)),
and other than gross included tested
income.
(14) Non-inclusion income group. The
term non-inclusion income group means
the income group within a section 904
category that consists of non-inclusion
income.
(15) Non-section 245A subgroup. The
term non-section 245A subgroup means
each non-section 245A subgroup
determined under § 1.861–13(a)(5),
applied as if the foreign corporation
whose stock is being characterized were
a controlled foreign corporation.
(16) Pass-through entity. The term
pass-through entity has the meaning set
forth in § 1.904–5(a)(4).
(17) Remittance. The term remittance
has the meaning set forth in § 1.861–
20(d)(3)(v)(E).
(18) Reverse hybrid. The term reverse
hybrid has the meaning set forth in
§ 1.861–20(b).
(19) Section 245A subgroup. The term
section 245A subgroup means each
section 245A subgroup determined
under § 1.861–13(a)(5), applied as if the
foreign corporation whose stock is being
characterized were a controlled foreign
corporation.
(20) Section 245A(d) income. With
respect to a domestic corporation, the
term section 245A(d) income means a
dividend (including a section 1248
dividend and a dividend received
indirectly through a pass-through entity)
or an inclusion under section
951(a)(1)(A) for which a deduction
under section 245A(a) is allowed, a
distribution of section 245A(d) PTEP, a
hybrid dividend, or an inclusion under
section 245A(e)(2) and § 1.245A(e)–
1(c)(1) by reason of a tiered hybrid
dividend. With respect to a successor of
a domestic corporation, the term section
245A(d) income means the receipt of a
distribution of section 245A(d) PTEP.
With respect to a foreign corporation,
the term section 245A(d) income means

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an item of subpart F income that gave
rise to a deduction under section
245A(a), a tiered hybrid dividend or a
distribution of section 245A(d) PTEP.
An item described in this paragraph
(c)(20) that qualifies for the deduction
under section 245A(a) is considered
section 245A(d) income regardless of
whether the domestic corporation
claims the deduction on its return with
respect to the item.
(21) Section 245A(d) income group.
The term section 245A(d) income group
means an income group within a section
904 category that consists of section
245A(d) income.
(22) Section 245A(d) PTEP. The term
section 245A(d) PTEP means previously
taxed earnings and profits described in
§ 1.960–3(c)(2)(v) or (ix) if such
previously taxed earnings and profits
arose either as a result of a dividend that
gave rise to a deduction under section
245A(a), or as a result of a tiered hybrid
dividend that, by reason of section
245A(e)(2) and § 1.245A(e)–1(c)(1), gave
rise to an inclusion in the gross income
of a United States shareholder. For
purposes of this paragraph (c)(22), a
dividend that qualifies for the deduction
under section 245A(a) is considered to
have given rise to a deduction under
section 245A(a) regardless of whether
the domestic corporation claims the
deduction on its return with respect to
the dividend.
(23) Section 904 category. The term
section 904 category has the meaning set
forth in § 1.960–1(b).
(24) Section 1248 dividend. The term
section 1248 dividend means an amount
of gain that is treated as a dividend
under section 1248.
(25) Successor. The term successor
means a person, including an individual
who is a citizen or resident of the
United States, that acquires from any
person any portion of the interest of a
United States shareholder in a foreign
corporation for purposes of section
959(a).
(26) Tested income. The term tested
income has the meaning set forth
§ 1.960–1(b).
(27) Tiered hybrid dividend. The term
tiered hybrid dividend has the meaning
set forth in § 1.245A(e)–1(c)(2).
(28) U.S. capital gain amount. The
term U.S. capital gain amount has the
meaning set forth in § 1.861–20(b).
(29) U.S. return of capital amount.
The term U.S. return of capital amount
has the meaning set forth in § 1.861–
20(b).
(30) U.S. return of partnership basis
amount. The term U.S. return of
partnership basis amount means, with
respect to a partnership in which a
domestic corporation is a partner, the

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portion of a distribution by the
partnership to the domestic corporation,
or the portion of the proceeds of a
disposition of the domestic
corporation’s interest in the partnership,
that exceeds the U.S. capital gain
amount.
(d) Examples. The following examples
illustrate the application of this section.
(1) Presumed facts. Except as
otherwise provided, the following facts
are presumed for purposes of the
examples:
(i) USP is a domestic corporation;
(ii) CFC is a controlled foreign
corporation organized in Country A, and
is not a reverse hybrid or a foreign law
CFC;
(iii) USP owns all of the outstanding
stock of CFC;
(iv) USP would be allowed a
deduction under section 245A(a) for
dividends received from CFC;
(v) All parties have a U.S. dollar
functional currency and a U.S. taxable
year and foreign taxable year that
correspond to the calendar year; and
(vi) References to income are to gross
items of income, and no party has
deductions for Country A tax purposes
or deductions for Federal income tax
purposes (other than foreign income tax
expense).
(2) Example 1: Distribution for foreign
and Federal income tax purposes—(i)
Facts. As of December 31, Year 1, CFC
has $800x of section 951A PTEP (as
defined in § 1.960–3(c)(2)(viii)) in a
single annual PTEP account (as defined
in § 1.960–3(c)(1)), and $500x of
earnings and profits described in section
959(c)(3). On December 31, Year 1, CFC
distributes $1,000x of cash to USP. For
Country A tax purposes, the entire
$1,000x distribution is a dividend and
is therefore a foreign dividend amount
(as defined in § 1.861–20(b)). Country A
imposes a withholding tax on USP of
$150x with respect to the $1,000x of
foreign gross dividend income under
Country A law. For Federal income tax
purposes, USP includes in gross income
$200x of the distribution as a dividend
for which a deduction is allowable
under section 245A(a). The remaining
$800x of the distribution is a
distribution of PTEP that is excluded
from USP’s gross income and not treated
as a dividend under section 959(a) and
(d), respectively. The entire $1,000x
dividend is a U.S. dividend amount (as
defined in § 1.861–20(b)).
(ii) Analysis—(A) In general. The
rules of this section are applied by first
determining the portion of the $150x
Country A withholding tax that is
attributable under paragraph (b)(1) of
this section to the section 245A(d)
income of USP, and then by

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determining the portion of the $150x
Country A withholding tax that is
described in paragraph (b)(2)(i) of this
section and that is attributable under
either paragraph (b)(2)(ii) or (b)(2)(iii) of
this section to the non-inclusion income
of CFC. No credit or deduction is
allowed in any taxable year under
paragraph (a)(1)(i) of this section for any
portion of the $150x Country A
withholding tax that is attributable to
the section 245A(d) income of USP, or,
under paragraph (a)(1)(iii) of this
section, for any portion of that tax that
is attributable to the non-inclusion
income of CFC, to the extent the tax is
not disallowed under paragraph (a)(1)(i)
of this section.
(B) Attribution of foreign income taxes
to section 245A(d) income. Under
paragraph (b)(1) of this section, the
$150x Country A withholding tax is
attributable to the section 245A(d)
income of USP to the extent that it is
allocated and apportioned to the section
245A(d) income group (the statutory
grouping) under § 1.861–20. Section
1.861–20(c) allocates and apportions
foreign income tax to the statutory and
residual groupings to which the items of
foreign gross income that were included
in the foreign tax base are assigned
under § 1.861–20(d). Section 1.861–
20(d)(3)(i) assigns foreign gross income
that is a foreign dividend amount, to the
extent of the U.S. dividend amount, to
the statutory and residual groupings to
which the U.S. dividend amount is
assigned. The $1,000x foreign dividend
amount is therefore assigned to the
statutory and residual groupings to
which the $1,000x U.S. dividend
amount is assigned under Federal
income tax law. The $1,000x U.S.
dividend amount comprises a $200x
dividend for which a deduction under
section 245A(a) is allowed, which is an
item of section 245A(d) income, and
$800x of section 951A PTEP, the receipt
of which is income in the residual
grouping. Accordingly, $200x of the
$1,000x of foreign gross dividend
income is assigned to the section
245A(d) income group, and $800x is
assigned to the residual grouping. Under
§ 1.861–20(f), $30x ($150x × $200x/
$1,000x) of the $150x Country A
withholding tax is apportioned to the
section 245A(d) income group and is
attributable to the section 245A(d)
income of USP. The remaining $120x
($150x × $800x/$1,000x) of the tax is
apportioned to the residual grouping.
(C) Attribution of foreign income taxes
to non-inclusion income. Under
paragraph (b)(2) of this section, the
$150x Country A withholding tax may
be attributed to non-inclusion income of
CFC if the tax is allocated and

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apportioned under § 1.861–20 by
reference to either the characterization
of the tax book value of stock under
§ 1.861–9 or the income of a foreign
corporation that is a reverse hybrid or
foreign law CFC. CFC is neither a
reverse hybrid nor a foreign law CFC. In
addition, no portion of the $150x
Country A withholding tax is allocated
and apportioned under § 1.861–20 by
reference to the characterization of the
tax book value of CFC’s stock. See
§ 1.861–20(d)(3)(i). Therefore, none of
the tax is attributable to non-inclusion
income of CFC.
(D) Disallowance. Under paragraph
(a)(1)(i) of this section, no credit under
section 901 or deduction is allowed in
any taxable year to USP for the $30x
portion of the Country A withholding
tax that is attributable to section
245A(d) income of USP.
(3) Example 2: Distribution for foreign
law purposes—(i) Facts. As of December
31, Year 1, CFC has $800x of section
951A PTEP (as defined in § 1.960–
3(c)(2)(viii)) in a single annual PTEP
account (as defined in § 1.960–3(c)(1)),
and $500x of earnings and profits
described in section 959(c)(3). On
December 31, Year 1, CFC distributes
$1,000x of its stock to USP. For Country
A tax purposes, the entire $1,000x stock
distribution is treated as a dividend to
USP and is therefore a foreign dividend
amount (as defined in § 1.861–20(b)).
Country A imposes a withholding tax on
USP of $150x with respect to the
$1,000x of foreign gross dividend
income that USP includes under
Country A law. For Federal income tax
purposes, USP does not recognize gross
income as a result of the stock
distribution under section 305(a). The
$1,000x stock distribution is therefore a
foreign law distribution.
(ii) Analysis—(A) In general. The
rules of this section are applied by first
determining the portion of the $150x
Country A withholding tax that is
attributable under paragraph (b)(1) of
this section to the section 245A(d)
income of USP, and then by
determining the portion of the $150x
Country A withholding tax that is
described in paragraph (b)(2)(i) of this
section and that is attributable under
either paragraph (b)(2)(ii) or (b)(2)(iii) of
this section to the non-inclusion income
of CFC. No credit or deduction is
allowed in any taxable year under
paragraph (a)(1)(i) of this section for any
portion of the $150x Country A
withholding tax that is attributable to
the section 245A(d) income of USP or,
under paragraph (a)(1)(iii) of this
section, for any portion of that tax that
is attributable to the non-inclusion
income of CFC, to the extent the tax is

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not disallowed under paragraph (a)(1)(i)
of this section.
(B) Attribution of foreign income taxes
to section 245A(d) income. Under
paragraph (b)(1) of this section, the
$150x Country A withholding tax is
attributable to the section 245A(d)
income of USP to the extent that it is
allocated and apportioned to the section
245A(d) income group (the statutory
grouping) under § 1.861–20. Section
1.861–20(c) allocates and apportions
foreign income tax to the statutory and
residual groupings to which the items of
foreign gross income that were included
in the foreign tax base are assigned
under § 1.861–20(d). In general, § 1.861–
20(d) assigns foreign gross income to the
statutory and residual groupings to
which the corresponding U.S. item is
assigned. If a taxpayer does not
recognize a corresponding U.S. item in
the year in which it pays or accrues
foreign income tax with respect to
foreign gross income that it includes by
reason of a foreign law dividend,
§ 1.861–20(d)(2)(ii)(B) assigns the
foreign dividend amount to the same
statutory or residual groupings to which
the foreign dividend amount would be
assigned if a distribution were made for
Federal income tax purposes in the
amount of, and on the date of, the
foreign law distribution. Further,
§ 1.861–20(d)(2)(ii)(B) computes the
U.S. dividend amount (as defined in
§ 1.861–20(b)) as if the distribution
occurred on the date the distribution
occurs for foreign law purposes.
Therefore, the foreign dividend amount
is assigned to the same statutory and
residual groupings to which it would be
assigned if a $1,000x distribution
occurred on December 31, Year 1 for
Federal income tax purposes. If such a
distribution occurred, it would result in
a $200x dividend to USP for which a
deduction would be allowed under
section 245A(a). The remaining $800x of
the distribution would be excluded from
USP’s gross income and not treated as
a dividend under section 959(a) and (d),
respectively. Under paragraphs (c)(20)
and (b)(1) of this section, the $1,000x
U.S. dividend amount comprises a
$200x dividend for which a deduction
under section 245A(a) would be
allowed, which is an item of section
245A(d) income, and $800x of section
951A PTEP, which is income in the
residual grouping. Accordingly, $200x
of the $1,000x foreign gross dividend
income is assigned to the section
245A(d) income group, and $800x is
assigned to the residual grouping. Under
§ 1.861–20(f), $30x ($150x × $200x/
$1,000x) of the Country A foreign
income tax is apportioned to the section

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245A(d) income group and is
attributable to the section 245A(d)
income of USP. The remaining $120x
($150x × $800x/$1,000x) of the tax is
apportioned to the residual grouping.
(C) Attribution of foreign income taxes
to non-inclusion income. Under
paragraph (b)(2) of this section, the
$150x Country A withholding tax may
be attributed to non-inclusion income of
CFC if the tax is allocated and
apportioned under § 1.861–20 by
reference to either the characterization
of the tax book value of stock under
§ 1.861–9 or the income of a foreign
corporation that is a reverse hybrid or
foreign law CFC. CFC is neither a
reverse hybrid nor a foreign law CFC. In
addition, no portion of the $150x
Country A withholding tax is allocated
and apportioned under § 1.861–20 by
reference to the characterization of the
tax book value of CFC’s stock. See
§ 1.861–20(d)(3)(i). Therefore, none of
the tax is attributable to non-inclusion
income of CFC.
(D) Disallowance. Under paragraph
(a)(1)(i) of this section, no credit under
section 901 or deduction is allowed in
any taxable year to USP for the $30x
portion of the Country A withholding
tax that is attributable to section
245A(d) income of USP.
(4) Example 3: Successive foreign law
distributions subject to anti-avoidance
rule—(i) Facts. For Year 1, CFC earns
$500x of subpart F income that gives
rise to a $500x gross income inclusion
to USP under section 951(a), and
income that creates $500x of earnings
and profits described in section
959(c)(3). CFC earns no income in Years
2 through 4. As of January 1, Year 2, and
through December 31, Year 4, CFC has
$500x of earnings and profits described
in section 959(c)(3) and $500x of section
951(a)(1)(A) PTEP (as defined in
§ 1.960–3(c)(2)(x)) in a single annual
PTEP account (as defined in § 1.960–
3(c)(1))). In each of Years 2 and 3, USP
makes a consent dividend election
under Country A law that, for Country
A tax purposes, deems CFC to distribute
to USP, and USP immediately to
contribute to CFC, $500x on December
31 of each year. For Country A tax
purposes, each deemed distribution is a
dividend of $500x to USP, and each
deemed contribution is a non-taxable
contribution of $500x to the capital of
CFC. Each $500x deemed distribution is
therefore a foreign dividend amount (as
defined in § 1.861–20(b)). Country A
imposes $150x of withholding tax on
USP in each of Years 2 and 3 with
respect to the $500x of foreign gross
dividend income that USP includes in
income under Country A law. For
Federal income tax purposes, the

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Country A deemed distributions in
Years 2 and 3 are disregarded such that
USP recognizes no income, and the
deemed distributions are therefore
foreign law distributions. On December
31, Year 4, CFC distributes $1,000x to
USP, which for Country A tax purposes
is treated as a return of contributed
capital on which no withholding tax is
imposed. For Federal income tax
purposes, $500x of the $1,000x
distribution is a dividend to USP for
which a deduction under section
245A(a) is allowed; the remaining $500x
of the distribution is a distribution of
section 951(a)(1)(A) PTEP that is
excluded from USP’s gross income and
not treated as a dividend under section
959(a) and (d), respectively. The entire
$1,000x dividend is a U.S. dividend
amount (as defined in § 1.861–20(b)).
The Country A consent dividend
elections in Years 2 and 3 are made with
a principal purpose of avoiding the
purposes of section 245A(d) and this
section to disallow a credit or deduction
for Country A withholding tax incurred
with respect to USP’s section 245A(d)
income.
(ii) Analysis—(A) In general. The
rules of this section are applied by first
determining the portion of the $150x
Country A withholding tax paid by USP
in each of Years 2 and 3 that is
attributable under paragraph (b)(1) of
this section to the section 245A(d)
income of USP, and then by
determining the portion of the $150x
Country A withholding tax paid by USP
in each of Years 2 and 3 that is
described in paragraph (b)(2)(i) of this
section and that is attributable under
either paragraph (b)(2)(ii) or (b)(2)(iii) of
this section to the non-inclusion income
of CFC. Finally, the anti-avoidance rule
under paragraph (b)(3) of this section
applies to treat any portion of the $150x
Country A withholding tax paid by USP
in each of Years 2 and 3 as attributable
to section 245A(d) income of USP or
non-inclusion income of CFC, if a
transaction, series of related
transactions, or arrangement is
undertaken with a principal purpose of
avoiding the purposes of section
245A(d) and this section. No credit or
deduction is allowed in any taxable year
under paragraph (a)(1)(i) of this section
for any portion of the $150x Country A
withholding tax paid by USP in each of
Years 2 and 3 that is attributable to the
section 245A(d) income of USP or,
under paragraph (a)(1)(iii) of this
section, for any portion of that tax that
is attributable to the non-inclusion
income of CFC, to the extent the tax is
not disallowed under paragraph (a)(1)(i)
of this section.

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(B) Attribution of foreign income taxes
to section 245A(d) income. Under
paragraph (b)(1) of this section, the
$150x Country A withholding tax paid
by USP in each of Years 2 and 3 is
attributable to the section 245A(d)
income of USP to the extent that it is
allocated and apportioned to the section
245A(d) income group (the statutory
grouping) under § 1.861–20. Section
1.861–20(c) allocates and apportions
foreign income tax to the statutory and
residual groupings to which the items of
foreign gross income that were included
in the foreign tax base are assigned
under § 1.861–20(d). In general, § 1.861–
20(d) assigns foreign gross income to the
statutory and residual groupings to
which the corresponding U.S. item is
assigned. If a taxpayer does not
recognize a corresponding U.S. item in
the year in which it pays or accrues
foreign income tax with respect to
foreign gross income that it includes by
reason of a foreign law dividend,
§ 1.861–20(d)(2)(ii)(B) assigns the
foreign dividend amount to the same
statutory or residual groupings to which
the foreign dividend amount would be
assigned if a distribution were made for
Federal income tax purposes in the
amount of, and on the date of, the
foreign law distribution. Therefore, the
$500x foreign dividend amount in each
of Years 2 and 3 is assigned to the same
statutory and residual groupings to
which it would be assigned if a $500x
distribution occurred on December 31 of
each of those years for Federal income
tax purposes.
(1) Year 2 $500x deemed distribution.
CFC made no distributions in Year 1
and earned no income and made no
distributions in Year 2 for Federal
income tax purposes. As of December
31, Year 2, CFC has $500x of earnings
and profits described in section
959(c)(3) and $500x of section
951(a)(1)(A) PTEP. If CFC distributed
$500x on that date, the distribution
would be a distribution of section
951(a)(1)(A) PTEP. A distribution of
previously taxed earnings and profits is
a U.S. dividend amount. Section 1.861–
20(d)(3)(i) assigns the foreign dividend
amount, to the extent of the U.S.
dividend amount, to the statutory and
residual groupings to which the U.S.
dividend amount is assigned. The
receipt of a distribution of previously
taxed earnings and profits is assigned to
the residual grouping under paragraph
(b)(1) of this section. Therefore, all
$500x foreign dividend amount would
be assigned to the residual grouping,
and none of the $150x withholding tax
paid or accrued by USP in Year 2 would

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be treated as attributable to section
245A(d) income of USP.
(2) Year 3 $500x deemed distribution.
CFC made no distributions in Year 1
and earned no income and made no
distributions in Year 2 or Year 3 for
Federal income tax purposes.
Consequently, as of December 31, Year
3, CFC has $500x of earnings and profits
described in section 959(c)(3) and $500x
of section 951(a)(1)(A) PTEP. If CFC
distributed $500x on that date, the
distribution would be a distribution of
section 951(a)(1)(A) PTEP. For the
reasons described in paragraph
(d)(4)(ii)(B)(1) of this section, all $500x
of the foreign dividend amount would
be assigned to the residual grouping,
and none of the $150x withholding tax
paid or accrued by USP in Year 2 would
be treated as attributable to section
245A(d) income of USP.
(3) Year 4 $1,000x distribution. The
Year 4 $1,000x distribution is, for
Country A purposes, a return of capital
distribution that is not subject to
withholding tax. For Federal income tax
purposes, it comprises a $500x dividend
for which a deduction under section
245A(a) is allowed, which is an item of
section 245A(d) income of USP, and a
$500x distribution of section
951(a)(1)(A) PTEP, the receipt of which
is income in the residual grouping.
(C) Attribution of foreign income taxes
to non-inclusion income. Under
paragraph (b)(2) of this section, the
$150x Country A withholding tax paid
by USP in each of Years 2 and 3 may
be attributed to non-inclusion income of
CFC if the tax is allocated and
apportioned under § 1.861–20 by
reference to either the characterization
of the tax book value of stock under
§ 1.861–9 or the income of a foreign
corporation that is a reverse hybrid or
foreign law CFC. CFC is neither a
reverse hybrid nor a foreign law CFC. In
addition, no portion of the Country A
withholding tax is allocated and
apportioned under § 1.861–20 by
reference to the characterization of the
tax book value of CFC’s stock. See
§ 1.861–20(d)(3)(i). Therefore, none of
the tax is attributable to non-inclusion
income of CFC.
(D) Attribution of foreign income
taxes pursuant to anti-avoidance rule.
USP made two successive foreign law
distributions in Years 2 and 3 that were
subject to Country A withholding tax
and that did not individually exceed,
but together exceeded, the section
951(a)(1)(A) PTEP of CFC. The Country
A withholding tax on each consent
dividend is allocated to the residual
grouping rather than to the statutory
grouping of section 245A(d) income
under §§ 1.861–20(d)(2)(ii) and 1.861–

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20(d)(3)(i). USP paid no Country A
withholding tax on the Year 4
distribution as a result of the Country A
consent dividends in Years 2 and 3. If
CFC had distributed its earnings and
profits in Year 4 without the prior
consent dividends, the distribution
would have been subject to withholding
tax, a portion of which would have been
attributable to the section 245A(d)
income arising from the distribution.
But for the application of the antiavoidance rule in paragraph (b)(3) of
this section, USP would avoid the
disallowance under section 245A(d)
with respect to this portion of the
withholding tax. Because USP made
foreign law distributions that caused
withholding tax from multiple foreign
law distributions to be associated with
the same previously taxed earnings and
profits with a principal purpose of
avoiding the purposes of section
245A(d) and this section, the $150x
Country A withholding tax paid by USP
in each of Years 2 and 3 is treated as
being attributable to section 245A(d)
income of USP.
(E) Disallowance. Under paragraph
(a)(1)(i) of this section, no credit under
section 901 or deduction is allowed in
any taxable year to USP for the $150x
Country A withholding tax paid by USP
in each of Years 2 and 3 that is
attributable to section 245A(d) income
of USP.
(5) Example 4: Distribution that is in
part a dividend and in part a return of
capital—(i) Facts. CFC uses the
modified gross income method to
allocate and apportion its interest
expense, and its stock has a tax book
value of $10,000x. For Year 1, CFC earns
$500x of income that is specified foreign
source general category gross income as
that term is defined in § 1.861–
13(a)(1)(i)(A)(9) and is therefore neither
tested income nor subpart F income of
CFC. As of December 31, Year 1, CFC
has $500x of earnings and profits
described in section 959(c)(3). On that
date, CFC distributes $1,000x of cash to
USP. For Country A tax purposes, the
entire $1,000x distribution is a dividend
to USP and is therefore a foreign
dividend amount (as defined in § 1.861–
20(b)). Country A imposes a
withholding tax on USP of $150x with
respect to the $1,000x of foreign gross
dividend income that USP includes
under the law of Country A. For Federal
income tax purposes, USP includes
$500x of the distribution in its gross
income as a dividend for which a $500x
deduction is allowed to USP under
section 245A(a); the remaining $500x of
the distribution is applied against and
reduces USP’s basis in its CFC stock
under section 301(c)(2). The portion of

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the distribution that is a $500x dividend
is a U.S. dividend amount (as defined in
§ 1.861–20(b)). The remaining $500x of
the distribution is a U.S. return of
capital amount.
(ii) Analysis—(A) In general. The
rules of this section are applied by first
determining the portion of the $150x
Country A withholding tax that is
attributable under paragraph (b)(1) of
this section to the section 245A(d)
income of USP, and then by
determining the portion of the $150x
Country A withholding tax that is
described in paragraph (b)(2)(i) of this
section and that is attributable under
either paragraph (b)(2)(ii) or (b)(2)(iii) of
this section to the non-inclusion income
of CFC. No credit or deduction is
allowed under paragraph (a)(1)(i) of this
section for any portion of the $150x
Country A withholding tax that is
attributable to the section 245A(d)
income of USP or, under paragraph
(a)(1)(iii) of this section, for any portion
of that tax that is attributable to the noninclusion income of CFC, to the extent
the tax is not disallowed under
paragraph (a)(1)(i) of this section.
(B) Attribution of foreign income taxes
to section 245A(d) income. Under
paragraph (b)(1) of this section, the
$150x Country A withholding tax is
attributable to the section 245A(d)
income of USP to the extent that it is
allocated and apportioned to the section
245A(d) income group (the statutory
grouping) under § 1.861–20. Section
1.861–20(c) allocates and apportions
foreign income tax to the statutory and
residual groupings to which the items of
foreign gross income that were included
in the foreign tax base are assigned
under § 1.861–20(d). Section 1.861–
20(d)(3)(i) assigns foreign gross income
that is a foreign dividend amount, to the
extent of the U.S. dividend amount, to
the statutory and residual groupings to
which the U.S. dividend amount is
assigned. Of the $1,000x foreign
dividend amount, $500x is therefore
assigned to the statutory and residual
groupings to which the $500x U.S.
dividend amount is assigned under
Federal income tax law. The entire
$500x U.S. dividend amount is a
dividend for which a section 245A(a)
deduction is allowed and is therefore
section 245A(d) income that is assigned
to the section 245A(d) income group.
Accordingly, $500x of the foreign
dividend amount is assigned to the
section 245A(d) income group. Under
§ 1.861–20(f), $75x ($150x × $500x/
$1,000x) of the Country A withholding
tax is allocated to the section 245A(d)
income group and so under paragraph
(b)(1) of this section is attributable to the
section 245A(d) income of USP.

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
(C) Attribution of foreign income taxes
to non-inclusion income. The remaining
$75x of the Country A withholding tax
is described in paragraph (b)(2)(i) of this
section because the $500x of foreign
dividend amount that corresponds to
the $500x U.S. return of capital amount
is assigned, and the remaining
withholding tax imposed on that foreign
dividend amount is allocated and
apportioned, by reference to the
characterization of the tax book value of
the stock of CFC. Under paragraph
(b)(2)(ii) of this section, the remaining
$75x Country A withholding tax is
attributable to non-inclusion income of
CFC to the extent that the tax is
allocated and apportioned under
§ 1.861–20 to USP’s section 245A
subgroup of general category stock,
section 245A subgroup of passive
category stock, and section 245A
subgroup of U.S. source category stock
(the statutory groupings) for purposes of
section 904 as the operative section.
Under § 1.861–20(d)(3)(i), the $500x
portion of the foreign dividend amount
that corresponds to the $500x U.S.
return of capital amount is assigned to
the statutory and residual groupings to
which $500x of earnings of CFC would
be assigned if CFC recognized them in
Year 1. Those earnings are deemed to
arise in the statutory and residual
groupings in the same proportions as
the proportions of the tax book value of
CFC’s stock in the groupings for Year 1
for purposes of applying the asset
method of expense allocation and
apportionment under § 1.861–9. Under
§ 1.861–9, § 1.861–9T(f), and § 1.861–13,
for purposes of section 904 as the
operative section, all of the tax book
value of the stock of CFC is assigned to
USP’s section 245A subgroup of general
category stock because CFC uses the
modified gross income method to
allocate and apportion its interest
expense and earns only specified
foreign source general category gross
income for Year 1. Under § 1.861–
20(d)(3)(i), if CFC recognized $500x of
earnings in Year 1 these earnings would
be deemed to arise in the section 245A
subgroup of general category stock.
Accordingly, the remaining $500x of
foreign dividend amount is assigned to
USP’s section 245A subgroup of general
category stock. Under § 1.861–20(f), the
remaining $75x of withholding tax is
allocated to the section 245A subgroup
and, under paragraph (b)(2)(ii) of this
section, is attributable to the noninclusion income of CFC.
(D) Disallowance. Under paragraph
(a)(1)(i) of this section, no credit under
section 901 or deduction is allowed in
any taxable year to USP for the $75x

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portion of the Country A withholding
tax that is attributable to section
245A(d) income of USP. Under
paragraph (a)(1)(iii) of this section, no
credit under section 901 or deduction is
allowed in any taxable year to USP for
the $75x portion of the Country A
withholding tax that is attributable to
non-inclusion income of CFC.
(6) Example 5: Income of a reverse
hybrid—(i) Facts. CFC is a reverse
hybrid. In Year 1, CFC earns a $500x
item of services income that is noninclusion income. CFC also earns for
Federal income tax purposes and
Country A tax purposes a $1,000x item
of royalty income, of which $500x is
gross included tested income and $500x
is non-inclusion income. USP includes
the $500x item of foreign gross services
income and the $1,000x item of foreign
gross royalty income in its Country A
taxable income, and the items are
foreign law pass-through income. If CFC
included these items under Country A
tax law, its $1,000x of royalty income
for Federal income tax purposes would
be the corresponding U.S. item for the
foreign gross royalty income, and its
$500x of services income for Federal
income tax purposes would be the
corresponding U.S. item for the foreign
gross services income. Country A
imposes a $150x foreign income tax on
USP with respect to $1,500x of foreign
gross income.
(ii) Analysis—(A) In general. The
rules of this section are applied by first
determining the portion of the $150x
Country A tax that is attributable under
paragraph (b)(1) of this section to the
section 245A(d) income of USP, and
then by determining the portion of the
$150x Country A tax that is described in
paragraph (b)(2)(i) of this section and
that is attributable under either
paragraph (b)(2)(ii) or (iii) of this section
to the non-inclusion income of CFC. No
credit or deduction is allowed under
paragraph (a)(1)(i) of this section for any
portion of the $150x Country A tax that
is attributable to the section 245A(d)
income of USP or, under paragraph
(a)(1)(iii) of this section, for any portion
of that tax that is attributable to the noninclusion income of CFC, to the extent
the tax is not disallowed under
paragraph (a)(1)(i) of this section.
(B) Attribution of foreign income taxes
to section 245A(d) income. Under
paragraph (b)(1) of this section, the
$150x Country A tax is attributable to
section 245A(d) income to the extent the
tax is allocated and apportioned to the
section 245A(d) income group (the
statutory grouping) under § 1.861–20.
Section 1.861–20(c) allocates and
apportions foreign income tax to the
statutory and residual groupings to

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323

which the items of foreign gross income
that were included in the foreign tax
base are assigned under § 1.861–20(d).
In general, § 1.861–20(d) assigns foreign
gross income to the statutory and
residual groupings to which the
corresponding U.S. item is assigned.
Section 1.861–20(d)(3)(i)(C) assigns the
foreign law pass-through income that
USP includes by reason of its ownership
of CFC to the statutory and residual
groupings by treating USP’s foreign law
pass-through income as foreign gross
income of CFC, and by treating CFC as
paying the $150x of Country A tax in
CFC’s U.S. taxable year within which its
foreign taxable year ends (Year 1). CFC
is therefore treated as including a
$1,000x foreign gross royalty item and a
$500x foreign gross services income
item and paying $150x of Country A tax
in Year 1. These foreign gross income
items are assigned to the statutory and
residual groupings to which the
corresponding U.S. items are assigned
under Federal income tax law. No
foreign gross income is assigned to the
section 245A(d) income group because
neither the corresponding U.S. item of
royalty income nor the corresponding
U.S. item of services income is assigned
to the section 245A(d) income group.
Therefore, none of USP’s Country A tax
is allocated to the section 245A(d)
income group.
(C) Attribution of foreign income taxes
to non-inclusion income. The $150x
Country A tax is described in paragraph
(b)(2) of this section because USP is a
United States shareholder of CFC, CFC
is a reverse hybrid, and § 1.861–
20(d)(3)(i)(C) allocates and apportions
the tax by reference to the income of
CFC. Under paragraph (b)(2)(iii) of this
section, the $150x Country A tax is
attributable to the non-inclusion income
of CFC to the extent that the foreign
income taxes are allocated and
apportioned to the non-inclusion
income group under § 1.861–20. For the
reasons described in paragraph
(d)(6)(ii)(B) of this section, under
§ 1.861–20(d)(3)(i)(C) CFC is treated as
including a $1,000x foreign gross
royalty item and a $500x foreign gross
services income item and paying $150x
of Country A tax in Year 1. These
foreign gross income items are assigned
to the statutory and residual groupings
to which the corresponding U.S. items
are assigned under Federal income tax
law. For Federal income tax purposes,
the $500x item of services income and
$500x of the $1,000x item of royalty
income are items of non-inclusion
income that are therefore assigned to the
non-inclusion income group. The
remaining $500x of the foreign gross

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations

royalty income item is assigned to the
residual grouping. Under § 1.861–20(f),
$100x ($150x × $1,000x/$1,500x) of the
Country A tax is apportioned to the noninclusion income group, and $50x
($150x × $500x/$1,500x) is apportioned
to the residual grouping. Under
paragraph (b)(2)(iii) of this section, the
$100x of Country A tax that is
apportioned to the non-inclusion
income group under § 1.861–
20(d)(3)(i)(C) is attributable to noninclusion income of CFC.
(D) Disallowance. Under paragraph
(a)(1)(iii) of this section, no credit under
section 901 or deduction is allowed in
any taxable year to USP for the $100x
of Country A foreign income tax that is
attributable to non-inclusion income of
CFC.
(e) Applicability date. This section
applies to taxable years of a foreign
corporation that begin after December
31, 2019, and end on or after November
2, 2020, and with respect to a United
States person, taxable years in which or
with which such taxable years of the
foreign corporation end.
§ 1.245A(e)–1

[AMENDED]

Par. 4. Section 1.245A(e)–1 is
amended by adding the language ‘‘and
§ 1.245A(d)–1’’ after the language ‘‘rules
of section 245A(d)’’ in paragraphs
(b)(1)(ii), (c)(1)(iii), (g)(1)(ii)
introductory text, (g)(1)(iii) introductory
text, and (g)(2)(ii) introductory text.

■

Par. 5. Section 1.250(b)–1 is amended
by adding two sentences to the end of
paragraph (c)(7) to read as follows:

■

§ 1.250(b)–1 Computation of foreignderived intangible income (FDII).

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*

*
*
*
*
(c) * * *
(7) * * * A taxpayer must use a
consistent method to determine the
amount of its domestic oil and gas
extraction income (‘‘DOGEI’’) and its
foreign oil and gas extraction income
(‘‘FOGEI’’) from the sale of oil or gas
that has been transported or processed.
For example, a taxpayer must use a
consistent method to determine the
amount of FOGEI from the sale of
gasoline from foreign crude oil sources
in computing the exclusion from gross
tested income under § 1.951A–2(c)(1)(v)
and the amount of DOGEI from the sale
of gasoline from domestic crude oil
sources in computing its section 250
deduction.
*
*
*
*
*
Par. 6. Section 1.250(b)–5 is amended
by revising paragraph (c)(5) to read as
follows:

■

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§ 1.250(b)–5 Foreign-derived deduction
eligible income (FDDEI) services.

*

*
*
*
*
(c) * * *
(5) Electronically supplied service.
The term electronically supplied service
means, with respect to a general service
other than an advertising service, a
service that is delivered primarily over
the internet or an electronic network
and for which value of the service to the
end user is derived primarily from
automation or electronic delivery.
Electronically supplied services include
the provision of access to digital content
(as defined in § 1.250(b)–3), such as
streaming content; on-demand network
access to computing resources, such as
networks, servers, storage, and software;
the provision or support of a business or
personal presence on a network, such as
a website or a web page; online
intermediation platform services;
services automatically generated from a
computer via the internet or other
network in response to data input by the
recipient; and similar services.
Electronically supplied services do not
include services that primarily involve
the application of human effort by the
renderer (not considering the human
effort involved in the development or
maintenance of the technology enabling
the electronically supplied services).
Accordingly, electronically supplied
services do not include certain services
(such as legal, accounting, medical, or
teaching services) involving primarily
human effort that are provided
electronically.
*
*
*
*
*
■ Par. 7. Section 1.336–2 is amended
by:
■ 1. Revising the paragraph (g)(3)(ii)
heading.
■ 2. In paragraph (g)(3)(ii)(A):
■ a. Revising the first sentence; and
■ b. In the second sentence, removing
the language ‘‘foreign tax’’ and adding
in its place the language ‘‘foreign
income tax’’.
■ 3. Revising paragraphs (g)(3)(ii)(B) and
(g)(3)(iii).
■ 4. Removing both occurrences of
paragraph (h) at the end of the section.
The revisions read as follows:
§ 1.336–2 Availability, mechanics, and
consequences of section 336(e) election.

*

*
*
*
*
(g) * * *
(3) * * *
(ii) Allocation of foreign income
taxes—(A) * * * Except as provided in
paragraph (g)(3)(ii)(B) of this section, if
a section 336(e) election is made for
target and target’s taxable year under
foreign law (if any) does not close at the
end of the disposition date, foreign

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income tax as defined in § 1.960–1(b)
(other than a withholding tax as defined
in section 901(k)(1)(B)) paid or accrued
by new target with respect to such
foreign taxable year is allocated between
old target and new target. * * *
(B) Foreign income taxes imposed on
partnerships and disregarded entities. If
a section 336(e) election is made for
target and target holds an interest in a
disregarded entity (as described in
§ 301.7701–2(c)(2)(i) of this chapter) or
partnership, the rules of § 1.901–2(f)(4)
and (5) apply to determine the person
who is considered for Federal income
tax purposes to pay foreign income tax
imposed at the entity level on the
income of the disregarded entity or
partnership.
(iii) Disallowance of foreign tax
credits under section 901(m). For rules
that may apply to disallow foreign tax
credits by reason of a section 336(e)
election, see section 901(m) and
§§ 1.901(m)–1 through 1.901(m)–8.
*
*
*
*
*
■ Par. 8. Section 1.336–5 is revised to
read as follows:
§ 1.336–5

Applicability dates.

Except as otherwise provided in this
section, the provisions of §§ 1.336–1
through 1.336–4 apply to any qualified
stock disposition for which the
disposition date is on or after May 15,
2013. The provisions of § 1.336–
1(b)(5)(i)(A) relating to section 1022
apply on and after January 19, 2017. The
provisions of § 1.336–2(g)(3)(ii) and (iii)
apply to foreign income taxes paid or
accrued in taxable years beginning on or
after December 28, 2021.
■ Par. 9. Section 1.338–9 is amended by
revising paragraph (d) to read as
follows:
§ 1.338–9
338.

International aspects of section

*

*
*
*
*
(d) Allocation of foreign income
taxes—(1) In general. Except as
provided in paragraph (d)(3) of this
section, if a section 338 election is made
for target (whether foreign or domestic),
and target’s taxable year under foreign
law (if any) does not close at the end of
the acquisition date, foreign income tax
as defined in § 1.901–2(a)(1)) (other than
a withholding tax as defined in section
901(k)(1)(B)) paid or accrued by new
target with respect to such foreign
taxable year is allocated between old
target and new target. If there is more
than one section 338 election with
respect to target during target’s foreign
taxable year, foreign income tax paid or
accrued with respect to that foreign
taxable year is allocated among all old
targets and new targets. The allocation

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
is made based on the respective portions
of the taxable income (as determined
under foreign law) for the foreign
taxable year that are attributable under
the principles of § 1.1502–76(b) to the
period of existence of each old target
and new target during the foreign
taxable year.
(2) Foreign income taxes imposed on
partnerships and disregarded entities. If
a section 338 election is made for target
and target holds an interest in a
disregarded entity (as described in
§ 301.7701–2(c)(2)(i) of this chapter) or
partnership, the rules of § 1.901–2(f)(4)
and (5) apply to determine the person
who is considered for Federal income
tax purposes to pay foreign income tax
imposed at the entity level on the
income of the disregarded entity or
partnership.
(3) Disallowance of foreign tax credits
under section 901(m). For rules that
may apply to disallow foreign tax
credits by reason of a section 338
election, see section 901(m) and
§§ 1.901(m)–1 through 1.901(m)–8.
(4) Applicability date. This paragraph
(d) applies to foreign income taxes paid
or accrued in taxable years beginning on
or after December 28, 2021.
*
*
*
*
*
§ 1.367(b)–2

[Amended]

Par. 10. Section 1.367(b)–2 is
amended by removing the last sentence
of paragraph (e)(4) Example 1.

■

§ 1.367(b)–3

[Amended]

Par. 11. Section 1.367(b)–3 is
amended:
■ 1. In paragraph (b)(3)(ii), by removing
the last sentence of paragraph (ii) of
Example 1 and paragraph (ii) of
Example 2.
■ 2. In paragraph (c)(5), by removing the
last sentence of paragraph (iii) of
Example 1.
■ Par. 12. Section 1.367(b)–4 is
amended:
■ 1. By revising paragraph (b)(2)(i)(B).
■ 2. By adding a sentence to the end of
paragraph (h).
The revision and addition read as
follows:
■

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§ 1.367(b)–4 Acquisition of foreign
corporate stock or assets by a foreign
corporation in certain nonrecognition
transactions.

*

*
*
*
*
(b) * * *
(2) * * *
(i) * * *
(B) Immediately after the exchange, a
domestic corporation directly or
indirectly owns 10 percent or more of

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the voting power or value of the
transferee foreign corporation; and
*
*
*
*
*
(h) * * * Paragraph (b)(2)(i)(B) of this
section applies to exchanges completed
in taxable years of exchanging
shareholders ending on or after
November 2, 2020, and to taxable years
of exchanging shareholders ending
before November 2, 2020 resulting from
an entity classification election made
under § 301.7701–3 of this chapter that
was effective on or before November 2,
2020 but was filed on or after November
2, 2020.
■ Par. 13. Section 1.367(b)–7 is
amended:
■ 1. By adding a sentence to the end of
paragraph (b)(1).
■ 2. By revising paragraph (g).
■ 3. By adding paragraph (h).
The revision and additions read as
follows:
§ 1.367(b)–7 Carryover of earnings and
profits and foreign income taxes in certain
foreign-to-foreign nonrecognition
transactions.

*

*
*
*
*
(b) * * *
(1) * * * See paragraph (g) of this
section for rules applicable to taxable
years of foreign corporations beginning
on or after January 1, 2018, and taxable
years of United States shareholders in
which or with which such taxable years
of foreign corporations end (‘‘post-2017
taxable years’’).
*
*
*
*
*
(g) Post-2017 taxable years. As a
result of the repeal of section 902
effective for taxable years of foreign
corporations beginning on or after
January 1, 2018, all foreign target
corporations, foreign acquiring
corporations, and foreign surviving
corporations are treated as nonpooling
corporations in post-2017 taxable years.
Any amounts remaining in post-1986
undistributed earnings and post-1986
foreign income taxes of any such
corporation in any separate category as
of the end of the foreign corporation’s
last taxable year beginning before
January 1, 2018, are treated as earnings
and taxes in a single pre-pooling annual
layer in the foreign corporation’s post2017 taxable years for purposes of this
section. Foreign income taxes that are
related to non-previously taxed earnings
of a foreign acquiring corporation and a
foreign target corporation that were
accumulated in taxable years before the
current taxable year of the foreign
corporation, or in a foreign target’s
taxable year that ends on the date of the
section 381 transaction, are not treated
as current year taxes (as defined in
§ 1.960–1(b)(4)) of a foreign surviving

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325

corporation in any post-2017 taxable
year. In addition, foreign income taxes
that are related to a hovering deficit are
not treated as current year taxes of the
foreign surviving corporation in any
post-2017 taxable year, regardless of
whether the hovering deficit is
absorbed.
(h) Applicability dates. Except as
otherwise provided in this paragraph
(h), this section applies to foreign
section 381 transactions that occur on or
after November 6, 2006. Paragraph (g) of
this section applies to taxable years of
foreign corporations ending on or after
November 2, 2020, and to taxable years
of United States shareholders in which
or with which such taxable years of
foreign corporations end.
■ Par. 14. Section 1.367(b)–10 is
amended:
■ 1. In paragraph (c)(1), by removing the
language ‘‘sections 902 or’’ and adding
in its place the language ‘‘section’’.
■ 2. In paragraph (e), by revising the
heading and adding a sentence to the
end of the paragraph.
The revision and addition read as
follows:
§ 1.367(b)–10 Acquisition of parent stock
or securities for property in triangular
reorganizations.

*

*
*
*
*
(e) Applicability dates. * * *
Paragraph (c)(1) of this section applies
to deemed distributions that occur in
taxable years ending on or after
November 2, 2020.
§ 1.461–1

[AMENDED]

Par. 15. Section 1.461–1 is amended
by removing the language ‘‘paragraph
(b)’’ and adding in its place the language
‘‘paragraph (g)’’ in the last sentence of
paragraph (a)(4).
■ Par. 16. Section 1.861–3 is amended:
■ 1. By revising the section heading.
■ 2. By redesignating paragraph (d) as
paragraph (e).
■ 3. By adding a new paragraph (d).
■ 4. In newly redesignated paragraph
(e):
■ i. By revising the heading.
■ ii. By removing ‘‘this paragraph’’ and
adding ‘‘this paragraph (e),’’ in its place.
■ iii. By adding a sentence to the end of
the paragraph.
The revisions and additions read as
follows:
■

§ 1.861–3 Dividends and income
inclusions under sections 951, 951A, and
1293 and associated section 78 dividends.

*

*
*
*
*
(d) Source of income inclusions under
sections 951, 951A, and 1293 and
associated section 78 dividends. For
purposes of sections 861 and 862 and

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations

§§ 1.861–1 and 1.862–1, and for
purposes of applying this section, the
amount included in gross income of a
United States person under sections
951, 951A, and 1293 and the associated
section 78 dividend for the taxable year
with respect to a foreign corporation are
treated as dividends received directly by
the United States person from the
foreign corporation that generated the
inclusion. See section 904(h) and
§ 1.904–5(m) for rules concerning the
resourcing of inclusions under sections
951, 951A, and 1293.
(e) Applicability dates. * * *
Paragraph (d) of this section applies to
taxable years ending on or after
November 2, 2020.
■ Par. 17. Section 1.861–8 is amended:
■ 1. By removing the language ‘‘and
example (17) of paragraph (g) of this
section’’ from the third sentence of
paragraph (b)(2).
■ 2. By revising paragraph (e)(4)(i).
■ 3. By adding paragraph (h)(4).
The revision and addition read as
follows:
§ 1.861–8 Computation of taxable income
from sources within the United States and
from other sources and activities.

*
*
*
*
(e) * * *
(4) * * *
(i) Expenses attributable to controlled
services. If a taxpayer performs a
controlled services transaction (as
defined in § 1.482–9(l)(1)), which
includes any activity by one member of
a group of controlled taxpayers (the
renderer) that results in a benefit to a
controlled taxpayer (the recipient), and
the renderer charges the recipient for
such services, section 482 and § 1.482–
1 provide for an allocation where the
charge is not consistent with an arm’s
length result. The deductions for
expenses incurred by the renderer in
performing such services are considered
definitely related to the amounts so
charged and are to be allocated to such
amounts.
*
*
*
*
*
(h) * * *
(4) Paragraph (e)(4)(i) of this section
applies to taxable years ending on or
after November 2, 2020.
■ Par. 18. Section 1.861–9 is amended
by adding a sentence to the end of
paragraph (g)(3) and revising paragraph
(k) to read as follows:
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*

§ 1.861–9 Allocation and apportionment of
interest expense and rules for asset-based
apportionment.

*

*
*
*
*
(g) * * *
(3) * * * In applying § 1.861–
9T(g)(3), for purposes of applying

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section 904 as the operative section, the
statutory or residual grouping of income
that assets generate, have generated, or
may reasonably be expected to generate
is determined after taking into account
any reallocation of income required
under § 1.904–4(f)(2)(vi).
*
*
*
*
*
(k) Applicability dates. (1) Except as
provided in paragraphs (k)(2) and (3) of
this section, this section applies to
taxable years that both begin after
December 31, 2017, and end on or after
December 4, 2018.
(2) Paragraphs (b)(1)(i), (b)(8), and
(e)(9) of this section apply to taxable
years that end on or after December 16,
2019. For taxable years that both begin
after December 31, 2017, and end on or
after December 4, 2018, and also end
before December 16, 2019, see § 1.861–
9T(b)(1)(i) as contained in 26 CFR part
1 revised as of April 1, 2019.
(3) The last sentence of paragraph
(g)(3) of this section applies to taxable
years beginning on or after December
28, 2021.
■ Par. 19. Section 1.861–10 is amended:
■ 1. By adding paragraph (a).
■ 2. By revising paragraphs (e)(8)(v) and
(f).
■ 3. By adding paragraphs (g) and (h).
The additions and revisions read as
follows:
§ 1.861–10
expense.

Special allocations of interest

(a) In general. This section applies to
all taxpayers and provides exceptions to
the rules of § 1.861–9 that require the
allocation and apportionment of interest
expense based on all assets of all
members of the affiliated group. Section
1.861–10T(b) provides rules for the
direct allocation of interest expense to
the income generated by certain assets
that are subject to qualified nonrecourse
indebtedness. Section 1.861–10T(c)
provides rules for the direct allocation
of interest expense to income generated
by certain assets that are acquired in an
integrated financial transaction. Section
1.861–10T(d) provides special rules that
apply to all transactions described in
§ 1.861–10T(b) and (c). Paragraph (e) of
this section requires the direct
allocation of third-party interest
expense of an affiliated group to such
group’s investments in related
controlled foreign corporations in cases
involving excess related person
indebtedness (as defined therein). See
also § 1.861–9T(b)(5), which requires
the direct allocation of amortizable bond
premium. Paragraph (f) of this section
provides a special rule for certain
regulated utility companies. Paragraph
(g) of this section is reserved. Paragraph

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(h) of this section sets forth applicability
dates.
*
*
*
*
*
(e) * * *
(8) * * *
(v) Classification of loans between
controlled foreign corporations. In
determining the amount of related group
indebtedness for any taxable year, loans
outstanding from one controlled foreign
corporation to a related controlled
foreign corporation are not treated as
related group indebtedness. For
purposes of determining the foreign
base period ratio under paragraph
(e)(2)(iv) of this section for a taxable
year that ends on or after November 2,
2020, the rules of this paragraph
(e)(8)(v) apply to determine the related
group debt-to-asset ratio in each taxable
year included in the foreign base period,
including in taxable years that end
before November 2, 2020.
*
*
*
*
*
(f) Indebtedness of certain regulated
utilities. If an automatically excepted
regulated utility trade or business (as
defined in § 1.163(j)–1(b)(15)(i)(A)) has
qualified nonrecourse indebtedness
within the meaning of the second
sentence in § 1.163(j)–10(d)(2), interest
expense from the indebtedness is
directly allocated to the taxpayer’s
assets in the manner and to the extent
provided in § 1.861–10T(b).
(g) [Reserved]
(h) Applicability dates. Except as
provided in this paragraph (h), this
section applies to taxable years ending
on or after December 4, 2018. Paragraph
(e)(8)(v) of this section applies to taxable
years ending on or after November 2,
2020, and paragraph (f) of this section
applies to taxable years beginning on or
after December 28, 2021.
§ 1.861–13(a)

[AMENDED]

Par. 20. Section 1.861–13(a) is
amended by removing the language
‘‘section 904,’’ and adding the language
‘‘sections 245A and 904,’’ in its place.
■ Par. 21. Section 1.861–14 is amended
by revising paragraphs (h) and (k) to
read as follows:
■

§ 1.861–14 Special rules for allocating and
apportioning certain expenses (other than
interest expense) of an affiliated group of
corporations.

*

*
*
*
*
(h) Special rule for the allocation and
apportionment of section 818(f)(1) items
of a life insurance company—(1) In
general. Except as provided in
paragraph (h)(2) of this section, life
insurance company items specified in
section 818(f)(1) (‘‘section 818(f)(1)
items’’) are allocated and apportioned as
if all members of the life subgroup (as

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
defined in § 1.1502–47(b)(8)) were a
single corporation (‘‘life subgroup
method’’). See also § 1.861–8(e)(16) for
rules on the allocation of reserve
expenses with respect to dividends
received by a life insurance company.
(2) Alternative separate entity
treatment. A consolidated group may
choose not to apply the life subgroup
method and may instead allocate and
apportion section 818(f)(1) items solely
among items of the life insurance
company that generated the section
818(f)(1) items (‘‘separate entity
method’’). A consolidated group
indicates its choice to apply the separate
entity method by applying this
paragraph (h)(2) for purposes of the
allocation and apportionment of section
818(f)(1) items on its Federal income tax
return filed for its first taxable year to
which this section applies. A
consolidated group’s use of the separate
entity method constitutes a binding
choice to use the method chosen for that
year for all members of the consolidated
group and all taxable years of such
members thereafter. The choice to use
the separate entity method may not be
revoked without the prior consent of the
Commissioner.
*
*
*
*
*
(k) Applicability dates. Except as
provided in this paragraph (k), this
section applies to taxable years
beginning after December 31, 2019.
Paragraph (h) of this section applies to
taxable years beginning on or after
December 28, 2021.
■ Par. 22. Section 1.861–20 is amended:
■ 1. In paragraph (b)(4), by removing the
language ‘‘301(c)(3)(A)’’ and adding in
its place the language ‘‘301(c)(3)(A) or
section 731(a)’’.
■ 2. By revising paragraph (b)(7).
■ 3. By redesignating the paragraphs in
the first column as the paragraphs in the
second column:

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Old paragraph

New paragraph

(b)(17) ...................................
(b)(18).
(b)(18)
(b)(18) ...................................
(b)(19).
(b)(19)
(b)(19) ...................................
(b)(20).
(b)(20)
(b)(20) ...................................
(b)(21).
(b)(21)
(b)(21) ...................................
(b)(23).
(b)(23)
(b)(22) ...................................
(b)(24).
(b)(24)
(b)(23) ...................................
(b)(25).
(b)(25)
(b)(24) ...................................
(b)(26).
(b)(26)

4. By adding new paragraph (b)(17).
5. By revising newly-redesignated
paragraph (b)(20).

■
■

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6. By adding new paragraph (b)(22).
7. By revising newly-redesignated
paragraph (b)(25).
■ 8. By revising the first and second
sentences in paragraph (c) introductory
text.
■ 9. In paragraph (d)(2)(ii)(B), by adding
the language ‘‘, and paragraph
(d)(3)(ii)(B) of this section for rules
regarding the assignment of foreign
gross income arising from a distribution
by a partnership’’ at the end of the
paragraph.
■ 10. By adding paragraph (d)(2)(ii)(D).
■ 11. In paragraph (d)(3)(i)(A), by
removing the language ‘‘foreign and
Federal income tax law or an inclusion
of foreign law pass-through income’’
and adding the language ‘‘foreign law
and Federal income tax law, an
inclusion of foreign law pass-through
income, or a disposition under both
foreign law and Federal income tax
law’’ in its place.
■ 12. In the first sentence of paragraph
(d)(3)(i)(B)(2), by removing the language
‘‘from which a distribution of the U.S.
dividend amount is made’’ and adding
the language ‘‘to which a distribution of
the U.S. dividend amount is assigned’’
in its place.
■ 13. In the second sentence of
paragraph (d)(3)(i)(B)(2), by removing
the language ‘‘to which earnings equal
to the U.S. return of capital amount’’
and adding the language ‘‘to which
earnings of the distributing corporation’’
in its place.
■ 14. By adding paragraphs (d)(3)(i)(D),
(d)(3)(ii), (v) and (vi), (g)(10) through
(14), and (h).
■ 15. By revising paragraph (i).
The additions and revisions read as
follows:
■
■

§ 1.861–20 Allocation and apportionment
of foreign income taxes.

*

*
*
*
*
(b) * * *
(7) Foreign income tax. The term
foreign income tax has the meaning
provided in § 1.901–2(a).
*
*
*
*
*
(17) Previously taxed earnings and
profits. The term previously taxed
earnings and profits has the meaning
provided in § 1.960–1(b).
*
*
*
*
*
(20) U.S. capital gain amount. The
term U.S. capital gain amount means
gain recognized by a taxpayer on the
sale, exchange, or other disposition of
stock or an interest in a partnership or,
in the case of a distribution with respect
to stock or a partnership interest, the
portion of the distribution to which
section 301(c)(3)(A) or 731(a)(1),
respectively, applies. A U.S. capital gain
amount includes gain that is subject to

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327

section 751 and § 1.751–1, but does not
include the portion of any gain
recognized by a taxpayer that is
included in gross income as a dividend
under section 964(e) or 1248.
*
*
*
*
*
(22) U.S. equity hybrid instrument.
The term U.S. equity hybrid instrument
means an instrument that is treated as
stock or a partnership interest for
Federal income tax purposes but for
foreign income tax purposes is treated
as indebtedness or otherwise gives rise
to the accrual of income to the holder
with respect to such instrument that is
not characterized as a dividend or
distributive share of partnership income
for foreign tax law purposes.
*
*
*
*
*
(25) U.S. return of capital amount.
The term U.S. return of capital amount
means, in the case of the sale, exchange,
or other disposition of stock, the
taxpayer’s adjusted basis of the stock, or
in the case of a distribution with respect
to stock, the portion of the distribution
to which section 301(c)(2) applies.
*
*
*
*
*
(c) * * * A foreign income tax (other
than certain in lieu of taxes described in
paragraph (h) of this section) is
allocated and apportioned to the
statutory and residual groupings that
include the items of foreign gross
income included in the base on which
the tax is imposed. Each such foreign
income tax (that is, each separate levy)
is allocated and apportioned separately
under the rules in paragraphs (c)
through (f) of this section. * * *
*
*
*
*
*
(d) * * *
(2) * * *
(ii) * * *
(D) Foreign law transfers between
taxable units. This paragraph (d)(2)(ii)
applies to an item of foreign gross
income arising from an event that
foreign law treats as a transfer of
property, or as giving rise to an item of
accrued income, gain, deduction, or loss
with respect to a transaction, between
taxable units (as defined in paragraph
(d)(3)(v)(E) of this section) of the same
taxpayer, and that would be treated as
a disregarded payment (as defined in
paragraph (d)(3)(v)(E) of this section) if
the transfer of property occurred, or the
item accrued, for Federal income tax
purposes in the same U.S. taxable year
in which the foreign income tax is paid
or accrued. An item of foreign gross
income to which this paragraph
(d)(2)(ii) applies is characterized and
assigned to the grouping to which a
disregarded payment in the amount of
the item of foreign gross income (or the
gross receipts giving rise to the item of

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foreign gross income) would be assigned
under the rules of paragraph (d)(3)(v) of
this section if the event giving rise to the
foreign gross income resulted in a
disregarded payment in the U.S. taxable
year in which the foreign income tax is
paid or accrued. For example, an item
of foreign gross income that a taxpayer
recognizes by reason of a foreign law
distribution (such as a stock dividend or
a consent dividend) from a disregarded
entity is assigned to the same statutory
or residual groupings to which the
foreign gross income would be assigned
if a distribution of property in the
amount of the taxable distribution under
foreign law were made for Federal
income tax purposes on the date on
which the foreign law distribution
occurred.
*
*
*
*
*
(3) * * *
(i) * * *
(D) Foreign gross income items arising
from a disposition of stock. An item of
foreign gross income that arises from a
transaction that is treated as a sale,
exchange, or other disposition for both
foreign law and Federal income tax
purposes of an interest that is stock in
a corporation for Federal income tax
purposes is assigned first, to the extent
of any U.S. dividend amount that results
from the disposition, to the same
statutory or residual grouping (or ratably
to the groupings) to which the U.S.
dividend amount is assigned under
Federal income tax law. If the foreign
gross income item exceeds the U.S.
dividend amount, the foreign gross
income item is next assigned, to the
extent of the U.S. capital gain amount,
to the statutory or residual grouping (or
ratably to the groupings) to which the
U.S. capital gain amount is assigned
under Federal income tax law. Any
excess of the foreign gross income item
over the sum of the U.S. dividend
amount and the U.S. capital gain
amount is assigned to the same statutory
or residual grouping (or ratably to the
groupings) to which earnings equal to
such excess amount would be assigned
if they were recognized for Federal
income tax purposes in the U.S. taxable
year in which the disposition occurred.
These earnings are deemed to arise in
the statutory and residual groupings in
the same proportions as the proportions
in which the tax book value of the stock
is (or would be if the taxpayer were a
United States person) assigned to the
groupings under the asset method in
§ 1.861–9 in the U.S. taxable year in
which the disposition occurs. See
paragraph (g)(10) of this section
(Example 9).

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(ii) Items of foreign gross income
included by a taxpayer by reason of its
ownership of an interest in a
partnership—(A) Scope. The rules of
this paragraph (d)(3)(ii) apply to assign
to a statutory or residual grouping
certain items of foreign gross income
that a taxpayer includes in foreign
taxable income by reason of its
ownership of an interest in a
partnership. See paragraphs (d)(1) and
(2) of this section for rules that apply in
characterizing items of foreign gross
income that are attributable to a
partner’s distributive share of income of
a partnership. See paragraph (d)(3)(iii)
of this section for rules that apply in
characterizing items of foreign gross
income that are attributable to an
inclusion under a foreign law inclusion
regime.
(B) Foreign gross income items arising
from a distribution with respect to an
interest in a partnership. If a
partnership makes a distribution that is
treated as a distribution of property for
both foreign law and Federal income tax
purposes, any foreign gross income item
arising from the distribution (including
foreign gross income attributable to a
distribution from a partnership that
foreign law classifies as a dividend from
a corporation) is, to the extent of the
U.S. capital gain amount arising from
the distribution, assigned to the
statutory and residual groupings to
which the U.S. capital gain amount is
assigned under Federal income tax law.
If the foreign gross income item arising
from the distribution exceeds the U.S.
capital gain amount, such excess
amount is assigned to the statutory and
residual groupings to which a
distributive share of income of the
partnership in the amount of such
excess would be assigned if such
income were recognized for Federal
income tax purposes in the U.S. taxable
year in which the distribution is made.
The items constituting this distributive
share of income are deemed to arise in
the statutory and residual groupings in
the same proportions as the proportions
in which the tax book value of the
partnership interest or the partner’s pro
rata share of the partnership assets, as
applicable, is assigned (or would be
assigned if the partner were a United
States person) for purposes of
apportioning the partner’s interest
expense under § 1.861–9(e) in the U.S.
taxable year in which the distribution is
made.
(C) Foreign gross income items arising
from the disposition of an interest in a
partnership. An item of foreign gross
income arising from a transaction that is
treated as a sale, exchange, or other
disposition for both foreign law and

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Federal income tax purposes of an
interest that is an interest in a
partnership for Federal income tax
purposes is assigned first, to the extent
of the U.S. capital gain amount arising
from the disposition, to the statutory or
residual grouping (or ratably to the
groupings) to which the U.S. capital
gain amount is assigned. If the foreign
gross income item arising from the
disposition exceeds the U.S. capital gain
amount, such excess amount is assigned
to the statutory and residual grouping
(or ratably to the groupings) to which a
distributive share of income of the
partnership in the amount of such
excess would be assigned if such
income were recognized for Federal
income tax purposes in the U.S. taxable
year in which the disposition occurred.
The items constituting this distributive
share of income are deemed to arise in
the statutory and residual groupings in
the same proportions as the proportions
in which the tax book value of the
partnership interest, or the partner’s pro
rata share of the partnership assets, as
applicable, is assigned (or would be
assigned if the partner were a United
States person) for purposes of
apportioning the partner’s interest
expense under § 1.861–9(e) in the U.S.
taxable year in which the disposition
occurred.
*
*
*
*
*
(v) Disregarded payments—(A) In
general. This paragraph (d)(3)(v) applies
to assign to a statutory or residual
grouping a foreign gross income item
that a taxpayer includes by reason of the
receipt of a disregarded payment. In the
case of a taxpayer that is an individual
or a domestic corporation, this
paragraph (d)(3)(v) applies to a
disregarded payment made between a
taxable unit that is a foreign branch, a
foreign branch owner, or a non-branch
taxable unit, and another such taxable
unit of the same taxpayer. In the case of
a taxpayer that is a foreign corporation,
this paragraph (d)(3)(v) applies to a
disregarded payment made between
taxable units that are tested units of the
same taxpayer. For purposes of this
paragraph (d)(3)(v), an individual or
corporation is treated as the taxpayer
with respect to its distributive share of
foreign income taxes paid or accrued by
a partnership, estate, trust or other passthrough entity. The rules of paragraph
(d)(3)(v)(B) of this section apply to
attribute U.S. gross income comprising
the portion of a disregarded payment
that is a reattribution payment to a
taxable unit, and to associate the foreign
gross income item arising from the
receipt of the reattribution payment
with the statutory and residual

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
groupings to which that U.S. gross
income is assigned. The rules of
paragraph (d)(3)(v)(C) of this section
apply to assign to statutory and residual
groupings items of foreign gross income
arising from the receipt of the portion of
a disregarded payment that is a
remittance or a contribution. The rules
of paragraph (d)(3)(v)(D) of this section
apply to assign to statutory and residual
groupings items of foreign gross income
arising from disregarded payments in
connection with disregarded sales or
exchanges of property. Paragraph
(d)(3)(v)(E) of this section provides
definitions that apply for purposes of
this paragraph (d)(3)(v) and paragraph
(g) of this section.
(B) Reattribution payments—(1) In
general. This paragraph (d)(3)(v)(B)
assigns to a statutory or residual
grouping a foreign gross income item
that a taxpayer includes by reason of the
receipt by a taxable unit of the portion
of a disregarded payment that is a
reattribution payment. The foreign gross
income item is assigned to the statutory
or residual groupings to which one or
more reattribution amounts that
constitute the reattribution payment are
assigned upon receipt by the taxable
unit. If a reattribution payment
comprises multiple reattribution
amounts and the amount of the foreign
gross income item that is attributable to
the reattribution payment differs from
the amount of the reattribution
payment, foreign gross income is
apportioned among the statutory and
residual groupings in proportion to the
reattribution amounts in each statutory
and residual grouping. The statutory or
residual grouping of a reattribution
amount received by a taxable unit is the
grouping that includes the U.S. gross
income attributed to the taxable unit by
reason of its receipt of the gross
reattribution amount, regardless of
whether, after taking into account
disregarded payments made by the
taxable unit, the taxable unit has an
attribution item as a result of its receipt
of the reattribution amount. See
paragraph (g)(13) of this section
(Example 12).
(2) Attribution of U.S. gross income to
a taxable unit. This paragraph
(d)(3)(v)(B)(2) provides attribution rules
to determine the reattribution amounts
received by a taxable unit in the
statutory and residual groupings in
order to apply paragraph (d)(3)(v)(B)(1)
of this section to assign foreign gross
income items arising from a
reattribution payment to the groupings.
In the case of a taxpayer that is an
individual or a domestic corporation,
the attribution rules in § 1.904–4(f)(2)
apply to determine the reattribution

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amounts received by a taxable unit in
the separate categories (as defined in
§ 1.904–5(a)(4)(v)) in order to apply
paragraph (d)(3)(v)(B)(1) of this section
for purposes of § 1.904–6(b)(2)(i). In the
case of a taxpayer that is a foreign
corporation, the attribution rules in
§ 1.951A–2(c)(7)(ii)(B) apply to
determine the reattribution amounts
received by a taxable unit in the
statutory and residual groupings in
order to apply paragraph (d)(3)(v)(B)(1)
of this section for purposes of
§§ 1.951A–2(c)(3), 1.951A–2(c)(7), and
1.960–1(d)(3)(ii). For purposes of other
operative sections (as described in
§ 1.861–8(f)(1)), the principles of
§ 1.904–4(f)(2)(vi) or § 1.951A–
2(c)(7)(ii)(B), as applicable, apply to
determine the reattribution amounts
received by a taxable unit in the
statutory and residual groupings. The
rules and principles of § 1.904–
4(f)(2)(vi) or § 1.951A–2(c)(7)(ii)(B), as
applicable, apply to determine the
extent to which a disregarded payment
made by the taxable unit is a
reattribution payment and the
reattribution amounts that constitute a
reattribution payment, and to adjust the
U.S. gross income initially attributed to
each taxable unit to reflect the
reattribution payments that the taxable
unit makes and receives. The rules in
this paragraph (d)(3)(v)(B)(2) limit the
amount of a disregarded payment that is
a reattribution payment to the U.S. gross
income of the payor taxable unit that is
recognized in the U.S. taxable year in
which the disregarded payment is made.
(3) Effect of reattribution payment on
foreign gross income items of payor
taxable unit. The statutory or residual
grouping to which an item of foreign
gross income of a taxable unit is
assigned is determined without regard
to reattribution payments made by the
taxable unit, and without regard to
whether the taxable unit has one or
more attribution items after taking into
account such reattribution payments.
No portion of the foreign gross income
of the payor taxable unit is treated as
foreign gross income of the payee
taxable unit by reason of the
reattribution payment, notwithstanding
that U.S. gross income of the payor
taxable unit that is used to assign
foreign gross income of the payor
taxable unit to statutory and residual
groupings is reattributed to the payee
taxable unit under paragraph
(d)(3)(v)(B)(1) of this section by reason
of the reattribution payment. See
paragraph (e) of this section for rules
reducing the amount of a foreign gross
income item of a taxable unit by
deductions allowed under foreign law,

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329

including deductions by reason of
disregarded payments made by a taxable
unit that are included in the foreign
gross income of the payee taxable unit.
(C) Remittances and contributions—
(1) Remittances—(i) In general. An item
of foreign gross income that a taxpayer
includes by reason of the receipt of a
remittance by a taxable unit is assigned
to the statutory or residual groupings of
the recipient taxable unit that
correspond to the groupings out of
which the payor taxable unit made the
remittance under the rules of this
paragraph (d)(3)(v)(C)(1)(i). A remittance
paid by a taxable unit is considered to
be made ratably out of all of the
accumulated after-tax income of the
taxable unit. The accumulated after-tax
income of the taxable unit that pays the
remittance is deemed to have arisen in
the statutory and residual groupings in
the same proportions as the proportions
in which the tax book value of the assets
of the taxable unit are (or would be if
the owner of the taxable unit were a
United States person) assigned for
purposes of apportioning interest
expense under the asset method in
§ 1.861–9 in the taxable year in which
the remittance is made. See paragraph
(g)(11) and (12) of this section
(Examples 10 and 11). If the payor
taxable unit is determined to have no
assets under paragraph (d)(3)(v)(C)(1)(ii)
of this section, then the foreign gross
income that is included by reason of the
receipt of the remittance is assigned to
the residual grouping.
(ii) Assets of a taxable unit. The assets
of a taxable unit are determined in
accordance with § 1.987–6(b), except
that for purposes of applying § 1.987–
6(b)(2) under this paragraph
(d)(3)(v)(C)(1)(ii), a taxable unit is
deemed to be a section 987 QBU (within
the meaning of § 1.987–1(b)(2)) and
assets of the taxable unit include stock
held by the taxable unit, the portion of
the tax book value of a reattribution
asset that is assigned to the taxable unit,
and the taxable unit’s pro rata share of
the assets of another taxable unit (other
than a corporation or a partnership),
including the portion of any
reattribution assets assigned to the other
taxable unit, in which it owns an
interest. If a taxable unit owns an
interest in a taxable unit that is a
partnership, the assets of the taxable
unit that is the owner include its
interest in the partnership or its pro rata
share of the partnership assets, as
applicable, determined under the
principles of § 1.861–9(e). The portion
of the tax book value of a reattribution
asset that is assigned to a taxable unit
is an amount that bears the same ratio
to the total tax book value of the

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reattribution asset as the sum of the
attribution items of that taxable unit
arising from gross income produced by
the reattribution asset bears to the total
gross income produced by the
reattribution asset. The portion of a
reattribution asset that is assigned to a
taxable unit under this paragraph
(d)(3)(v)(C)(1)(ii) is not treated as an
asset of the taxable unit making the
reattribution payment for purposes of
applying paragraph (d)(3)(v)(C)(1)(i) of
this section.
(2) Contributions. An item of foreign
gross income that a taxpayer includes by
reason of the receipt of a contribution by
a taxable unit is assigned to the residual
grouping. See, however, § 1.904–
6(b)(2)(ii) (assigning certain items of
foreign gross income to the foreign
branch category for purposes of
applying section 904 as the operative
section).
(3) Disregarded payment that
comprises both a reattribution payment
and a remittance or contribution. If both
a reattribution payment and either a
remittance or a contribution result from
a single disregarded payment, the
foreign gross income is first attributed to
the portion of the disregarded payment
that is a reattribution payment to the
extent of the amount of the reattribution
payment, and any excess of the foreign
gross income item over the amount of
the reattribution payment is then to
attributed to the portion of the
disregarded payment that is a
remittance or contribution.
(D) Disregarded payments in
connection with disregarded sales or
exchanges of property. An item of
foreign gross income attributable to gain
recognized under foreign law by reason
of a disregarded payment received in
exchange for property is characterized
and assigned under the rules of
paragraph (d)(2) of this section. If a
taxpayer recognizes U.S. gross income
as a result of a disposition of property
that was previously received in
exchange for a disregarded payment,
any item of foreign gross income that
the taxpayer recognizes as a result of
that same disposition is assigned to a
statutory or residual grouping under
paragraph (d)(1) of this section, without
regard to any reattribution of the U.S.
gross income under § 1.904–
4(f)(2)(vi)(A) (or the principles of
§ 1.904–4(f)(2)(vi)(A)) by reason of a
disregarded payment described in
§ 1.904–4(f)(2)(vi)(B)(2) (or by reason of
§ 1.904–4(f)(2)(vi)(D)). See paragraph
(d)(3)(v)(B)(3) of this section.
(E) Definitions. The following
definitions apply for purposes of this
paragraph (d)(3)(v) and paragraph (g) of
this section.

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(1) Attribution item. The term
attribution item means the portion of an
item of gross income, computed under
Federal income tax law, that is
attributed to a taxable unit after taking
into account all reattribution payments
made and received by the taxable unit.
(2) Contribution. The term
contribution means the excess of a
disregarded payment made by a taxable
unit to another taxable unit that the first
taxable unit owns over the portion of
the disregarded payment, if any, that is
a reattribution payment.
(3) Disregarded entity. The term
disregarded entity means an entity
described in § 301.7701–2(c)(2) of this
chapter that is disregarded as an entity
separate from its owner for Federal
income tax purposes.
(4) Disregarded payment. The term
disregarded payment means an amount
of property (within the meaning of
section 317(a)) that is transferred to or
from a taxable unit, including a transfer
of property that would be a contribution
to capital described in section 118 or a
transfer described in section 351 if the
taxable unit were a corporation under
Federal income tax law, a transfer of
property that would be a distribution by
a corporation to a shareholder with
respect to its stock if the taxable unit
were a corporation under Federal
income tax law, or a payment in
exchange for property or in satisfaction
of an account payable, in connection
with a transaction that is disregarded for
Federal income tax purposes and that is
reflected on the separate set of books
and records of the taxable unit. A
disregarded payment also includes any
other amount that is reflected on the
separate set of books and records of a
taxable unit in connection with a
transaction that is disregarded for
Federal income tax purposes and that
would constitute an item of accrued
income, gain, deduction, or loss of the
taxable unit if the transaction to which
the amount is attributable were regarded
for Federal income tax purposes.
(5) Reattribution amount. The term
reattribution amount means an amount
of gross income, computed under
Federal income tax law, that is initially
assigned to a single statutory or residual
grouping that includes gross income of
a taxable unit but that is, by reason of
a disregarded payment made by that
taxable unit, attributed to another
taxable unit under paragraph
(d)(3)(v)(B)(2) of this section.
(6) Reattribution asset. The term
reattribution asset means an asset that
produces one or more items of gross
income, computed under Federal
income tax law, to which a disregarded

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payment is allocated under the rules of
paragraph (d)(3)(v)(B)(2) of this section.
(7) Reattribution payment. The term
reattribution payment means the
portion of a disregarded payment equal
to the sum of all reattribution amounts
that are attributed to the recipient of the
disregarded payment.
(8) Remittance. The term remittance
means the excess of a disregarded
payment, other than an amount that is
treated as a contribution under
paragraph (d)(3)(v)(E)(2) of this section,
made by a taxable unit to a second
taxable unit (including a second taxable
unit that shares the same owner as the
payor taxable unit) over the portion of
the disregarded payment, if any, that is
a reattribution payment.
(9) Taxable unit. In the case of a
taxpayer that is an individual or a
domestic corporation, the term taxable
unit means a foreign branch, a foreign
branch owner, or a non-branch taxable
unit, as defined in § 1.904–6(b)(2)(i)(B).
In the case of a taxpayer that is a foreign
corporation, the term taxable unit
means a tested unit, as defined in
§ 1.951A–2(c)(7)(iv)(A).
(vi) Foreign gross income included by
reason of U.S. equity hybrid instrument
ownership—(A) Foreign gross income
included by reason of an accrual.
Foreign gross income included by
reason of an accrual under foreign law
with respect to a U.S. equity hybrid
instrument is considered to arise from
the same transaction or realization event
as a distribution of property described
in paragraph (d)(3)(i) or (ii) of this
section and is assigned to the statutory
and residual groupings by treating each
amount accrued as a foreign law
distribution made on the date of the
accrual under foreign law.
(B) Foreign gross income included by
reason of a payment. Foreign gross
income included by reason of a payment
of interest under foreign law with
respect to a U.S. equity hybrid
instrument is considered to arise from
the same transaction or realization event
as a distribution of property described
in paragraph (d)(3)(i) or (ii) of this
section and is assigned to the statutory
and residual groupings by treating each
payment as a distribution made on the
date of the payment.
*
*
*
*
*
(g) * * *
(10) Example 9: Gain on disposition of
stock—(i) Facts. USP owns all of the
outstanding stock of CFC, which
conducts business in Country A. In Year
1, USP sells all of the stock of CFC to
US2 for $1,000x. For Country A tax
purposes, USP’s basis in the stock of
CFC is $200x. Accordingly, USP

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recognizes $800x of gain on which
Country A imposes $80x of foreign
income tax based on its rules for taxing
capital gains of nonresidents, which
satisfy the requirement in § 1.901–
2(b)(5)(i)(C). For Federal income tax
purposes, USP’s basis in the stock of
CFC is $400x. Accordingly, USP
recognizes $600x of gain on the sale of
the stock of CFC, of which $150x is
included in the gross income of USP as
a dividend under section 1248(a) that,
as provided in section 1248(j), is treated
as a dividend eligible for the deduction
under section 245A(a). Under
paragraphs (b)(20) and (21) of this
section, respectively, the sale of CFC
stock by USP gives rise to a $450x U.S.
capital gain amount and a $150x U.S.
dividend amount. Under §§ 1.904–4(d)
and 1.904–5(c)(4), the $150x U.S.
dividend amount is general category
section 245A subgroup income, and the
$450x U.S. capital gain amount is
passive category income to USP. For
purposes of allocating and apportioning
its interest expense under §§ 1.861–
9(g)(2)(i)(B) and 1.861–13, USP’s stock
in CFC is characterized as general
category stock in the section 245A
subgroup.
(ii) Analysis. For purposes of
allocating and apportioning the $80x of
Country A foreign income tax, the $800x
of Country A gross income from the sale
of the stock of CFC is first assigned to
separate categories. Under paragraph
(d)(3)(i)(D) of this section, the $800x of
Country A gross income is first assigned
to the separate category to which the
$150x U.S. dividend amount is
assigned, to the extent thereof, and is
next assigned to the separate category to
which the $450x U.S. capital gain
amount is assigned, to the extent
thereof. Accordingly, $150x of Country
A gross income is assigned to the
general category in the section 245A
subgroup, and $450x of Country A gross
income is assigned to the passive
category. Under paragraph (d)(3)(i)(D) of
this section, the remaining $200x of
Country A gross income is assigned to
the statutory and residual groupings to
which earnings of CFC in that amount
would be assigned if they were
recognized for Federal income tax
purposes in the U.S. taxable year in
which the disposition occurred. These
earnings are all deemed to arise in the
section 245A subgroup of the general
category, based on USP’s
characterization of its stock in CFC.
Thus, under paragraph (d)(3)(i)(D) of
this section the $800x of foreign gross
income, and therefore the foreign
taxable income, is characterized as
$350x ($150x + $200x) of income in the

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general category section 245A subgroup
and $450x of income in the passive
category. This is the result even though
for Country A tax purposes all $800x of
Country A gross income is characterized
as gain from the sale of stock, which
would be passive category income
under section 904(d)(2)(B)(i), because
the income is assigned to a separate
category based on the characterization
of the gain under Federal income tax
law. Under paragraph (f) of this section,
the $80x of Country A tax is ratably
apportioned between the general
category section 245A subgroup and the
passive category based on the relative
amounts of foreign taxable income in
each grouping. Accordingly, $35x ($80x
× $350x/$800x) of the Country A tax is
apportioned to the general category
section 245A subgroup, and $45x ($80x
× $450x/$800x) of the Country A tax is
apportioned to the passive category. See
also § 1.245A(d)–1 for rules that may
disallow a credit or deduction for the
$35x of Country A tax apportioned to
the general category section 245A
subgroup.
(11) Example 10: Disregarded transfer
of built-in gain property—(i) Facts. USP
owns FDE, a disregarded entity that is
treated for Federal income tax purposes
as a foreign branch operating in Country
A. FDE transfers Asset F, equipment
used in FDE’s trade or business in
Country A, for no consideration to USP
in a transaction that is a remittance
described in paragraph (d)(3)(v)(E) of
this section for Federal income tax
purposes but is treated as a distribution
of Asset F from a corporation to its
shareholder, USP, for Country A tax
purposes. At the time of the transfer,
Asset F has a fair market value of $250x
and an adjusted basis of $100x for both
Federal and Country A income tax
purposes. Country A imposes $30x of
tax on FDE with respect to the $150x of
built-in gain on a deemed sale of Asset
F, which is recognized for Country A tax
purposes by reason of the transfer to
USP. If FDE had sold Asset F for $250x
in a transaction that was regarded for
Federal income tax purposes, FDE
would also have recognized gain of
$150x for Federal income tax purposes,
and that gain would have been
characterized as foreign branch category
income under § 1.904–4(f). Country A
also imposes $25x of withholding tax, a
separate levy, on USP by reason of the
distribution of Asset F to USP.
(ii) Analysis—(A) Net income tax on
built-in gain. For purposes of allocating
and apportioning the $30x of Country A
foreign income tax imposed on FDE by
reason of the transfer of Asset F to USP
for Country A tax purposes, under
paragraph (c)(1) of this section the

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$150x of Country A gross income is first
assigned to a separate category. Because
the transfer does not result in a deemed
sale for Federal income tax purposes,
there is no corresponding U.S. item.
However, FDE would have recognized
gain of $150x, which would have been
the corresponding U.S. item, if the
deemed sale had been recognized for
Federal income tax purposes. Therefore,
under paragraph (d)(2)(ii) of this
section, the $150x item of foreign gross
income is characterized and assigned to
the grouping to which such
corresponding U.S. item would have
been assigned if the deemed sale were
recognized under Federal income tax
law. Because the sale of Asset F in a
regarded transaction would have
resulted in foreign branch category
income, the foreign gross income is
characterized as foreign branch category
income. Under paragraph (f) of this
section, the $30x of Country A tax is
also allocated to the foreign branch
category, the statutory grouping to
which the $150x of Country A gross
income is assigned. No apportionment
of the $30x of Country A tax is
necessary because the class of gross
income to which the foreign gross
income is allocated consists entirely of
a single statutory grouping.
(B) Withholding tax on distribution.
For purposes of allocating and
apportioning the $25x of Country A
withholding tax imposed on USP by
reason of the transfer of Asset F, under
paragraph (c)(1) of this section the
$250x of Country A gross income arising
from the transfer of Asset F is first
assigned to a separate category. For
Federal income tax purposes, the
transfer of Asset F is a remittance from
FDE to USP, and thus there is no
corresponding U.S. item. Under
paragraph (d)(3)(v)(C)(1)(i) of this
section, the item of foreign gross income
is assigned to the groupings to which
the income out of which the payment is
made is assigned; the payment is
considered to be made ratably out of all
of the accumulated after-tax income of
FDE, as computed for Federal income
tax purposes; and the accumulated aftertax income of FDE is deemed to have
arisen in the statutory and residual
groupings in the same proportions as
those in which the tax book value of
FDE’s assets in the groupings,
determined in accordance with
paragraph (d)(3)(v)(C)(1)(ii) of this
section, are assigned for purposes of
apportioning USP’s interest expense.
Because all of FDE’s assets produce
foreign branch category income, under
paragraph (d)(3)(v)(C)(1) of this section
the foreign gross income is

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characterized as foreign branch category
income. Under paragraph (f) of this
section, the $25x of Country A
withholding tax is also allocated
entirely to the foreign branch category,
the statutory grouping to which the
$250x of Country A gross income is
assigned. No apportionment of the $25x
is necessary because the class of gross
income to which the foreign gross
income is allocated consists entirely of
a single statutory grouping.
(12) Example 11: Disregarded
payment that is a remittance—(i) Facts.
USP wholly owns CFC1, which is a
tested unit within the meaning of
§ 1.951A–2(c)(7)(iv)(A) (the ‘‘CFC1
tested unit’’). CFC1 wholly owns FDE, a
disregarded entity that is organized in
Country B, which is a tested unit within
the meaning of § 1.951A–2(c)(7)(iv)(A)
(the ‘‘FDE tested unit’’). The sole assets
of FDE (determined in accordance with
paragraph (d)(3)(v)(C)(1)(ii) of this
section) are all the outstanding stock of
CFC3, a controlled foreign corporation
organized in Country B. In Year 1, CFC3
pays a $400x dividend to FDE that is
excluded from CFC1’s foreign personal
holding company income (‘‘FPHCI’’) by
reason of section 954(c)(6). FDE makes
no payments to CFC1 and pays no
Country B tax in Year 1. In Year 2, FDE
makes a $400x remittance to CFC1 as
defined in paragraph (d)(3)(v)(E) of this
section. Under the laws of Country B,
the remittance gives rise to a $400x
dividend. Country B imposes a 5%
($20x) withholding tax (which is an
eligible current year tax as defined in
§ 1.960–1(b)) on CFC1 on the dividend.
In Year 2, CFC3 pays no dividends to
FDE, and FDE earns no income. For
Federal income tax purposes, the $400x
payment from FDE to CFC1 is a
disregarded payment and results in no
income to CFC1. For purposes of this
paragraph (g)(12) (Example 11), section
960(a) is the operative section and the
income groups described in § 1.960–
1(d)(2) are the statutory and residual
groupings. See § 1.960–1(d)(3)(ii)(A)
(applying § 1.960–1 to allocate and
apportion current year taxes to income
groups). For Federal income tax
purposes, in Year 2 the stock of CFC3
owned by FDE has a tax book value of
$1,000x, $750x of which is assigned
under the asset method in § 1.861–9 (as
applied by treating CFC1 as a United
States person) to the general category
tested income group described in
§ 1.960–1(d)(2)(ii)(C), and $250x of
which is assigned to a passive category
FPHCI group described in § 1.960–
1(d)(2)(ii)(B)(2)(i).
(ii) Analysis. (A) The $20x Country B
withholding tax on the Year 2
remittance from FDE is imposed on a

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$400x item of foreign gross income that
CFC1 includes in foreign gross income
by reason of its receipt of a disregarded
payment. In order to allocate and
apportion the $20x of Country B
withholding tax under paragraph (c) of
this section for purposes of § 1.960–
1(d)(3)(ii)(A), paragraph (d)(3)(v) of this
section applies to assign the $400x item
of foreign gross dividend income to a
statutory or residual grouping. Under
paragraph (d)(3)(v)(C)(1) of this section,
the $400x item of foreign gross income
is assigned to the statutory or residual
groupings of the CFC1 tested unit that
correspond to the statutory and residual
groupings out of which FDE made the
remittance.
(B) Under paragraph (d)(3)(v)(C)(1)(i)
of this section, FDE is considered to
have made the remittance ratably out of
all of its accumulated after-tax income,
which is deemed to have arisen in the
statutory and residual groupings in the
same proportions as the proportions in
which the tax book value of FDE’s assets
would be assigned (if CFC1 were a
United States person) for purposes of
apportioning interest expense under the
asset method in Year 2, the taxable year
in which FDE made the remittance.
Accordingly, $300x ($400x × $750x/
$1,000x) of the remittance is deemed
made out of the general category tested
income of the FDE tested unit, and
$100x ($400x × $250x/$1,000x) of the
remittance is deemed made out of the
passive category FPHCI of the FDE
tested unit.
(C) Under paragraph (d)(3)(v)(C)(1)(i)
of this section, $300x of the $400x item
of foreign gross income from the
remittance, and therefore an equal
amount of foreign taxable income, is
assigned to the income group that
includes general category tested income
attributable to the CFC1 tested unit, and
$100x of this foreign gross income item,
and therefore an equal amount of
foreign taxable income, is assigned to
the income group that includes passive
category FPHCI attributable to the CFC1
tested unit. Under paragraph (f) of this
section, the $20x of Country B
withholding tax is ratably apportioned
between the income groups based on the
relative amounts of foreign taxable
income in each grouping. Accordingly,
$15x ($20x × $300x/$400x) of the
Country B withholding tax is
apportioned to the CFC1 tested unit’s
general category tested income group,
and $5x ($20x × $100x/$400x) of the
Country B withholding tax is
apportioned to the CFC1 tested unit’s
passive category FPHCI income group.
See § 1.960–2 for rules on determining
the amount of such taxes that may be

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deemed paid under section 960(a) and
(d).
(13) Example 12: Disregarded
payment that is a reattribution
payment—(i) Facts. (A) USP wholly
owns CFC1, a tested unit within the
meaning of § 1.951A–2(c)(7)(iv)(A)(1)
(the ‘‘CFC1 tested unit’’). CFC1 wholly
owns FDE1, a disregarded entity
organized in Country B, that is a tested
unit within the meaning of § 1.951A–
2(c)(7)(iv)(A)(2) (the ‘‘FDE1 tested
unit’’). Country B imposes a 20 percent
net income tax on its residents. CFC1
also wholly owns FDE2, a disregarded
entity organized in Country C, that is a
tested unit within the meaning of
§ 1.951A–2(c)(7)(iv)(A)(2) (the ‘‘FDE2
tested unit’’). Country C imposes a 15
percent net income tax on its residents.
The net income tax imposed by each of
Country B and Country C on their tax
residents is a foreign income tax within
the meaning of § 1.901–2(a) and a
separate levy within the meaning of
§ 1.901–2(d). For purposes of this
paragraph (g)(13) (Example 12), the
operative section is the high-tax
exclusion of section 951A(c)(2)(A)(i)(III)
and § 1.951A–2(c)(7), and the statutory
groupings are the tested income groups
of each tested unit, as defined in
§ 1.951A–2(c)(7)(iv)(A).
(B) FDE2 owns Asset A, which is
intangible property with a tax book
value of $12,000x that is properly
reflected on the separate set of books
and records of FDE2. In Year 1,
pursuant to a license agreement between
FDE1 and FDE2 for the use of Asset A,
FDE1 makes a disregarded royalty
payment to FDE2 of $1,000x that would
be deductible if regarded for Federal
income tax purposes. Because it is
disregarded for Federal income tax
purposes, the $1,000x disregarded
royalty payment by FDE1 to FDE2
results in no income to CFC1 for Federal
income tax purposes. Also, in Year 1,
pursuant to a sub-license agreement
between FDE1 and an unrelated third
party for the use of Asset A, FDE1 earns
$1,200x of royalty income for Federal
income tax purposes (the ‘‘U.S. gross
royalty’’) for the use of Asset A. The
$1,200 of royalty income received by
FDE1 from the unrelated third party is
excluded from CFC1’s foreign personal
holding company income by reason of
the active business exception in section
954(c)(2) because CFC1 satisfies the
requirements of § 1.954–2(d)(1). As a
result, the $1,200x of royalty income
that FDE1 earns from the sub-license
agreement is gross tested income (as
defined in § 1.951A–2(c)(1)), which is
properly reflected on the separate set of
books and records of FDE1.

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
(C) Under the laws of Country B, the
transaction that gives rise to the $1,200x
item of U.S. gross royalty income causes
FDE1 to include a $1,200x item of gross
royalty income in its Country B taxable
income (the ‘‘Country B gross royalty’’).
In addition, FDE1 deducts its $1,000x
disregarded royalty payment to FDE2 for
Country B tax purposes. For Country B
tax purposes, FDE1 therefore has $200x
($1,200x¥$1,000x) of taxable income
on which Country B imposes $40x (20%
× $200x) of net income tax.
(D) Under the laws of Country C, the
$1,000x disregarded royalty payment
from FDE1 to FDE2 causes FDE2 to
include a $1,000x item of gross royalty
income in its Country C taxable income
(the ‘‘Country C gross royalty’’). FDE2
therefore has $1,000x of taxable income
for Country C tax purposes, on which
Country C imposes $150x (15% ×
$1,000x) of net income tax.
(ii) Analysis—(A) Country B net
income tax—(1) The Country B net
income tax is imposed on foreign
taxable income of FDE1 that consists of
a $1,200x item of Country B gross
royalty income and a $1,000x item of
royalty expense. For Federal income tax
purposes, the FDE1 tested unit has a
$1,200x item of U.S. gross royalty
income that is initially attributable to it
under paragraph (d)(3)(v)(B)(2) of this
section and § 1.951A–2(c)(7)(ii)(B). The
transaction that produced the $1,200x
item of U.S. gross royalty income also
produced the $1,200x item of Country B
gross royalty income. Under paragraph
(b)(2) of this section, the $1,200x item
of U.S. gross royalty income is therefore
the corresponding U.S. item for the
$1,200x item of Country B gross royalty
income of FDE1.
(2) The $1,000x disregarded royalty
payment from FDE1 to FDE2 is allocated
under paragraph (d)(3)(v)(B)(2) of this
section and § 1.951A–2(c)(7)(ii)(B) to the
$1,200x of U.S. gross income of the
FDE1 tested unit to the extent of that
gross income. As a result, the $1,000x
disregarded royalty payment causes
$1,000x of the $1,200x item of U.S.
gross royalty income to be reattributed
from the FDE1 tested unit to the FDE2
tested unit, and results in a $1,000x
reattribution amount that is also a
reattribution payment.
(3) The $1,200x Country B gross
royalty item that is included in the
Country B taxable income of FDE1 is
assigned under paragraph (d)(1) of this
section to the statutory or residual
grouping to which the $1,200x
corresponding U.S. item is initially
assigned under § 1.951A–2(c)(7)(ii),
namely, the FDE1 income group. This
assignment is made without regard to
the $1,000x reattribution payment from

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the FDE1 tested unit to the FDE2 tested
unit; none of the FDE1 tested unit’s
$1,200x Country B gross royalty income
is reattributed to the FDE2 tested unit
for this purpose. See paragraph
(d)(3)(v)(B)(3) of this section. Under
paragraph (f) of this section, all of the
$40x of Country B net income tax on the
$200x of Country B taxable income is
allocated to the FDE1 income group, the
statutory grouping to which the $1,200x
item of Country B gross royalty income
of FDE1 is assigned. No apportionment
of the $40x is necessary because the
class of gross income to which the
foreign gross income is allocated
consists entirely of a single statutory
grouping.
(B) Country C net income tax. The
Country C net income tax is imposed on
foreign taxable income of FDE2 that
consists of a $1,000x item of Country C
gross royalty income. For Federal
income tax purposes, under paragraph
(d)(3)(v)(B)(2) of this section and
§ 1.951A–2(c)(7)(ii)(B), the FDE2 tested
unit has a reattribution amount of
$1,000x of U.S. gross royalty income by
reason of its receipt of the $1,000x
reattribution payment from FDE1. The
$1,000x item of U.S. gross royalty
income that is included in the taxable
income of the FDE2 tested unit by
reason of the $1,000x reattribution
payment is assigned under paragraph
(d)(3)(v)(B)(1) of this section to the
statutory or residual grouping to which
the $1,000x reattribution amount of U.S.
gross royalty income that constitutes the
reattribution payment is assigned upon
receipt by the FDE2 tested unit under
§ 1.951A–2(c)(7)(ii), namely, the FDE2
income group. Under paragraph
(d)(3)(v)(B)(1) of this section, the
$1,000x item of Country C gross royalty
income is assigned to the statutory
grouping to which the $1,000x
corresponding U.S. item is assigned.
Accordingly, under paragraph (f) of this
section, all of the $150x of Country C
net income tax is allocated to the FDE2
income group, the statutory grouping to
which the $1,000x item of Country C
gross royalty income of FDE2 is
assigned. No apportionment of the
$150x is necessary because the class of
gross income to which the foreign gross
income is allocated consists entirely of
a single statutory grouping.
(14) Example 13: Assets of a taxable
unit that owns an interest in a lower-tier
taxable unit—(i) Facts. USP wholly
owns CFC1, a tested unit within the
meaning of § 1.951A–2(c)(7)(iv)(A) (the
‘‘CFC1 tested unit’’). CFC1 wholly owns
FDE1, a disregarded entity that is
organized in Country A, and FDE2, a
disregarded entity that is organized in
Country B. CFC1’s interests in FDE1 and

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333

FDE2 are each tested units within the
meaning of § 1.951A–2(c)(7)(iv)(A) (the
‘‘FDE1 tested unit’’ and ‘‘FDE2 tested
unit’’, respectively). The FDE1 tested
unit and FDE2 tested unit each own
50% of the interests in FDE3, a
disregarded entity that is organized in
Country C. CFC1’s indirect interests in
FDE3 are also a tested unit within the
meaning of § 1.951A–2(c)(7)(iv)(A) (the
‘‘FDE3 tested unit’’). The FDE2 tested
unit owns Asset A with a tax book value
of $10,000x, and makes a reattribution
payment to FDE3 that causes $5,000x of
the tax book value of Asset A to be
assigned to FDE3 under paragraph
(d)(3)(v)(C)(1)(ii) of this section. FDE3
owns Asset B, which has a tax book
value of $5,000x.
(ii) Analysis—(A) Assets of the FDE3
tested unit. The assets of the FDE3
tested unit consist of the portion of
Asset A that is assigned to it under
paragraph (d)(3)(v)(C)(1)(ii) of this
section and any other assets determined
in accordance with § 1.987–6(b). The
assets of the FDE3 tested unit thus
consist of $5,000x of the tax book value
of Asset A and all $5,000x of the tax
book value of Asset B.
(B) Assets of the FDE2 tested unit. The
assets of the FDE2 tested unit consist of
the tax book value of any assets that it
owns directly plus its pro rata share of
the assets of the FDE3 tested unit,
including the portion of reattribution
assets assigned to the FDE3 tested unit.
Asset A is a reattribution asset under
paragraphs (d)(3)(v)(C)(1)(ii) and
(d)(3)(v)(E) of this section. The assets of
the FDE2 tested unit therefore consist of
the portion of Asset A that it owns
directly and that was not assigned to the
FDE3 tested unit (or $5,000x) plus its
pro rata share of the portion of Asset A
that was assigned to the FDE3 tested
unit, or $2,500x (50% of $5,000x). In
addition, the assets of the FDE2 tested
unit include its pro rata share of the tax
book value of Asset B, or $2,500x (50%
of $5,000x).
(C) Assets of the FDE1 tested unit. The
assets of the FDE1 tested unit consist of
its pro rata share of the assets of the
FDE3 tested unit, including the portion
of reattribution assets assigned to the
FDE3 tested unit. Asset A is a
reattribution asset under paragraphs
(d)(3)(v)(C)(1)(ii) and (d)(3)(v)(E) of this
section. The assets of the FDE1 tested
unit therefore consist of its pro rata
share of the portion of Asset A that was
reattributed to the FDE3 tested unit, or
$2,500x (50% of $5,000x), plus its pro
rata share of the tax book value of Asset
B, or $2,500x (50% of $5,000x).
(h) Allocation and apportionment of
certain foreign in lieu of taxes described
in section 903. A tax that is a foreign

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations

income tax by reason of § 1.903–1(c)(1)
is allocated and apportioned to statutory
and residual groupings in the same
proportions as the foreign taxable
income that comprises the excluded
income (as defined in § 1.903–1(c)(1)).
See paragraph (f) of this section for rules
on allocating and apportioning certain
withholding taxes described in § 1.903–
1(c)(2).
(i) Applicability dates. Except as
provided in this paragraph (i), this
section applies to taxable years
beginning after December 31, 2019.
Paragraphs (b)(19) and (23) and (d)(3)(i),
(ii), and (v) of this section apply to
taxable years that begin after December
31, 2019, and end on or after November
2, 2020. Paragraph (h) of this section
applies to taxable years beginning after
December 28, 2021.
■ Par. 23. Section 1.901–1 is amended:
■ 1. By revising the section heading.
■ 2. By revising paragraphs (a) through
(d).
■ 3. In paragraph (e), by removing the
language ‘‘a husband and wife’’ and
adding the language ‘‘spouses’’ in its
place.
■ 4. By revising paragraphs (f) and
(h)(1).
■ 5. By removing paragraph (h)(2).
■ 6. By redesignating paragraph (h)(3) as
paragraph (h)(2).
■ 7. By revising the heading and second
sentence in paragraph (j).
The revisions and additions read as
follows:

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§ 1.901–1 Allowance of credit for foreign
income taxes.

(a) In general. Citizens of the United
States, domestic corporations, certain
aliens resident in the United States or
Puerto Rico, and certain estates and
trusts may choose to claim a credit, as
provided in section 901, against the tax
imposed by chapter 1 of the Internal
Revenue Code (Code) for certain taxes
paid or accrued to foreign countries and
possessions of the United States, subject
to the conditions prescribed in this
section.
(1) Citizen of the United States. An
individual who is a citizen of the United
States, whether resident or nonresident,
may claim a credit for—
(i) The amount of any foreign income
taxes, as defined in § 1.901–2(a), paid or
accrued (as the case may be, depending
on the individual’s method of
accounting for such taxes) during the
taxable year;
(ii) The individual’s share of any such
taxes of a partnership of which the
individual is a member, or of an estate
or trust of which the individual is a
beneficiary; and
(iii) In the case of an individual who
has made an election under section 962,

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the taxes deemed to have been paid
under section 960 (see § 1.962–1(b)(2)).
(2) Domestic corporation. A domestic
corporation may claim a credit for—
(i) The amount of any foreign income
taxes, as defined in § 1.901–2(a), paid or
accrued (as the case may be, depending
on the corporation’s method of
accounting for such taxes) during the
taxable year;
(ii) The corporation’s share of any
such taxes of a partnership of which the
corporation is a member, or of an estate
or trust of which the corporation is a
beneficiary; and
(iii) The taxes deemed to have been
paid under section 960.
(3) Alien resident of the United States
or Puerto Rico. Except as provided in a
Presidential proclamation described in
section 901(c), an individual who is a
resident alien of the United States (as
defined in section 7701(b)), or an
individual who is a bona fide resident
of Puerto Rico (as defined in section
937(a)) during the entire taxable year,
may claim a credit for—
(i) The amount of any foreign income
taxes, as defined in § 1.901–2(a), paid or
accrued (as the case may be, depending
on the individual’s method of
accounting for such taxes) during the
taxable year;
(ii) The individual’s share of any such
taxes of a partnership of which the
individual is a member, or of an estate
or trust of which the individual is a
beneficiary; and
(iii) In the case of an individual who
has made an election under section 962,
the taxes deemed to have been paid
under section 960 (see § 1.962–1(b)(2)).
(4) Estates and trusts. An estate or
trust may claim a credit for—
(i) The amount of any foreign income
taxes, as defined in § 1.901–2(a), paid or
accrued (as the case may be, depending
on the estate or trust’s method of
accounting for such taxes) during the
taxable year to the extent not allocable
to and taken into account by its
beneficiaries under paragraph (a)(1)(ii),
(a)(2)(ii), or (a)(3)(ii) of this section (see
section 642(a)); and
(ii) In the case of an estate or trust that
has made an election under section 962,
the taxes deemed to have been paid
under section 960 (see § 1.962–1(b)(2)).
(b) Limitations. Certain Code sections,
including sections 245A(d) and (e)(3),
814, 901(e) through (m), 904, 906, 907,
908, 909, 911, 965(g), 999, and 6038,
reduce, defer, or otherwise limit the
credit against the tax imposed by
chapter 1 of the Code for certain
amounts of foreign income taxes.
(c) Deduction denied if credit
claimed—(1) In general. Except as
provided in paragraphs (c)(2) and (3) of

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this section, if a taxpayer chooses with
respect to any taxable year to claim a
credit under section 901 to any extent,
such choice will apply to all of the
foreign income taxes paid or accrued (as
the case may be, depending on the
taxpayer’s method of accounting for
such taxes) by the taxpayer in such
taxable year, and no deduction from
gross income is allowed for any portion
of such taxes in any taxable year. See
section 275(a)(4).
(2) Exception for taxes not subject to
section 275. A deduction may be
allowed under section 164(a)(3) for
foreign income tax for which a credit is
disallowed under any Code section and
to which section 275 does not apply.
See, for example, sections 901(f),
901(j)(3), 901(k)(7), 901(l)(4), 901(m)(6),
and 908(b). For rules on the taxable year
in which a deduction for foreign income
taxes is allowed under section 164(a)(3),
see §§ 1.446–1(c)(1)(ii), 1.461–2(a)(2),
and 1.461–4(g)(6)(iii)(B).
(3) Exception for taxes paid by an
accrual basis taxpayer that relate to a
prior year in which the taxpayer
deducted foreign income taxes. If a
taxpayer claims a credit for foreign
income taxes accrued in a taxable year
(including a cash method taxpayer that
elects under section 905(a) to claim a
credit in the year the taxes accrue), a
deduction may be claimed in that
taxable year for additional foreign
income taxes that are finally determined
and paid as a result of a foreign tax
redetermination in that taxable year if
the additional foreign income taxes
relate to a prior taxable year in which
the taxpayer claimed a deduction, rather
than a credit, for foreign income taxes
paid or accrued (as the case may be,
depending on the taxpayer’s overall
method of accounting) in that prior year.
(4) Example. The following example
illustrates the application of paragraph
(c)(3) of this section.
(i) Facts. U.S.C. is a domestic
corporation that is engaged in a trade or
business in Country X through a branch.
U.S.C. uses the accrual method of
accounting and a calendar year for U.S.
and Country X tax purposes. For taxable
Years 1 through 3, U.S.C. deducted
foreign income taxes accrued in those
years. In Years 4 through 6, U.S.C.
claimed a credit for foreign income
taxes accrued in those years. In Year 6,
U.S.C. paid an additional $50x tax to
Country X that relates to Year 1 because
of the close of a Country X tax audit.
(ii) Analysis. The additional $50x
Country X tax paid by U.S.C. in Year 6
that relates to Year 1 cannot be claimed
by U.S.C. as a deduction on an amended
return for Year 1 because the additional
tax accrued in Year 6. See section 461(f)

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
(flush language); §§ 1.461–1(a)(2)(i) and
1.461–2(a)(2). In addition, because the
additional $50x Country X tax relates to
and is considered to accrue in Year 1 for
foreign tax credit purposes, U.S.C.
cannot claim a credit for the additional
$50x Country X tax on its Federal
income tax return for Year 6. See
§ 1.905–1(d)(1). However, pursuant to
paragraph (c)(3) of this section, U.S.C.
can claim a deduction for the additional
$50x Country X tax that relates to Year
1 on its Federal income tax return for
Year 6, even though it claims a credit for
foreign income taxes that accrue in Year
6 and that relate to Year 6.
(d) Period during which election can
be made or changed—(1) In general.
The taxpayer may, for a particular
taxable year, elect to claim a credit
under section 901 (or claim a deduction
in lieu of electing to claim a credit) at
any time before the expiration of the
period within which a claim for credit
or refund of Federal income tax for such
taxable year that is attributable to such
credit or deduction, as the case may be,
may be made (or, if longer, the period
prescribed by section 6511(c) if the
refund period for that taxable year is
extended by an agreement to extend the
assessment period under section
6501(c)(4)). Thus, an election to claim a
credit for foreign income taxes paid or
accrued (as the case may be, depending
on the taxpayer’s method of accounting
for such taxes) in a particular taxable
year can be made within the period
prescribed by section 6511(d)(3)(A) for
claiming a credit or refund of Federal
income tax for that taxable year that is
attributable to a credit for the foreign
income taxes paid or accrued in that
particular taxable year or, if longer, the
period prescribed by section 6511(c)
with respect to that particular taxable
year. A choice to claim a deduction
under section 164(a)(3), rather than a
credit under section 901, for foreign
income taxes paid or accrued in a
particular taxable year can be made
within the period prescribed by section
6511(a) or 6511(c), as applicable, for
claiming a credit or refund of Federal
income tax for that particular taxable
year.
(2) Manner in which election is made
or changed. A taxpayer claims a
deduction or a credit for foreign income
taxes paid or accrued in a particular
taxable year by filing an original or
amended return for that taxable year
within the relevant period specified in
paragraph (d)(1) of this section. A claim
for a credit shall be accompanied by
Form 1116 in the case of an individual,
estate or trust, and by Form 1118 in the
case of a corporation (and an individual,
estate or trust making an election under

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section 962). See §§ 1.905–3 and 1.905–
4 for rules requiring the filing of
amended returns for all affected years
when a timely change in the taxpayer’s
election to claim a deduction or credit
results in U.S. tax deficiencies.
*
*
*
*
*
(f) Taxes against which credit is
allowed. The credit for foreign income
taxes is allowed only against the tax
imposed by chapter 1 of the Code. The
credit is not allowed against a tax that,
under section 26(b)(2), is not treated as
a tax imposed by such chapter.
*
*
*
*
*
(h) * * *
(1) Except as provided in paragraphs
(c)(2) and (3) of this section, a taxpayer
that claims a deduction for foreign
income taxes paid or accrued (as the
case may be, depending on the
taxpayer’s method of accounting for
such taxes) for that taxable year (see
sections 164 and 275); and
*
*
*
*
*
(j) Applicability date. * * * This
section applies to foreign taxes paid or
accrued in taxable years beginning on or
after December 28, 2021.
■ Par. 24. Section 1.901–2 is amended:
■ 1. By revising paragraph (a) heading
and paragraph (a)(1).
■ 2. By revising paragraph (a)(3).
■ 3. By revising paragraph (b).
■ 4. By removing and reserving
paragraph (c).
■ 5. By revising paragraphs (d) and (e).
■ 6. By revising paragraph (f)(2)(ii).
■ 7. In paragraph (f)(3)(ii)(A), by
removing the language ‘‘§ 1.909–
2T(b)(2)(vi)’’ and adding the language
‘‘§ 1.909–2(b)(2)(vi)’’ in its place.
■ 8. In paragraph (f)(3)(iii)(B)(2), by
removing the language ‘‘§ 1.909–
2T(b)(3)(i)’’ and adding the language
‘‘§ 1.909–2(b)(3)(i)’’ in its place and by
removing the language ‘‘or accrued’’.
■ 9. By revising paragraphs (f)(4)
through (6) and adding paragraph (f)(7).
■ 10. By revising paragraphs (g) and (h).
The revisions and additions read as
follows:
§ 1.901–2 Income, war profits, or excess
profits tax paid or accrued.

(a) Definition of foreign income tax—
(1) Overview and scope. Paragraphs (a)
and (b) of this section define a foreign
income tax for purposes of section 901.
Paragraph (c) of this section is reserved.
Paragraph (d) of this section contains
rules describing what constitutes a
separate levy. Paragraph (e) of this
section provides rules for determining
the amount of foreign income tax paid
by a taxpayer. Paragraph (f) of this
section contains rules for determining
by whom foreign income tax is paid.

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335

Paragraph (g) of this section defines the
terms used in this section, and in
particular provides that the term ‘‘paid’’
means ‘‘paid’’ or ‘‘accrued,’’ depending
on the taxpayer’s method of accounting
for foreign income taxes. Paragraph (h)
of this section provides the applicability
date for this section.
(i) In general. Section 901 allows a
credit for the amount of income, war
profits, and excess profits taxes paid
during the taxable year to any foreign
country, and section 903 provides that
for purposes of Part III of subchapter N
of the Code and sections 164(a) and
275(a), such taxes include a tax paid in
lieu of a tax on income, war profits or
excess profits that is otherwise generally
imposed by a foreign country
(collectively, for purposes of this
section, a ‘‘foreign income tax’’).
Whether a foreign levy is a foreign
income tax is determined independently
for each separate levy. A foreign tax
either is or is not a foreign income tax,
in its entirety, for all persons subject to
the foreign tax.
(ii) Requirements. A foreign levy is a
foreign income tax only if—
(A) It is a foreign tax; and
(B) Either:
(1) The foreign tax is a net income tax,
as defined in paragraph (a)(3) of this
section; or
(2) The foreign tax is a tax in lieu of
an income tax, as defined in § 1.903–
1(b).
(iii) Coordination with treaties. A
foreign levy that is treated as an income
tax under the relief from double taxation
article of an income tax treaty entered
into by the United States and the foreign
country imposing the tax is a foreign
income tax if paid by a citizen or
resident of the United States (as
determined under such income tax
treaty) that elects benefits under the
treaty. In addition, a foreign levy paid
by a controlled foreign corporation that
is modified by an applicable income tax
treaty between the foreign jurisdiction
of which the controlled foreign
corporation is a resident and the foreign
jurisdiction imposing the tax may
qualify as a foreign income tax
notwithstanding that the unmodified
foreign levy does not satisfy the
requirements in paragraph (b) of this
section or the requirements of § 1.903–
1(b) if the levy, as modified by such
treaty, satisfies the requirements of
paragraph (b) of this section or the
requirements of § 1.903–1(b). See
paragraph (d)(1)(iv) of this section for
rules treating as a separate levy a foreign
tax that is limited in its application or
otherwise modified by the terms of an

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income tax treaty to which the foreign
country imposing the tax is a party.
*
*
*
*
*
(3) Net income tax. A foreign tax is a
net income tax only if the foreign tax
meets the net gain requirement in
paragraph (b) of this section.
(b) Net gain requirement—(1) In
general. A foreign tax satisfies the net
gain requirement only if the tax satisfies
the realization, gross receipts, cost
recovery, and attribution requirements
in paragraphs (b)(2), (3), (4), and (5) of
this section, respectively, or if the
foreign tax is a surtax described in
paragraph (b)(6) of this section.
Paragraphs (b)(2) through (6) of this
section are applied with respect to a
foreign tax solely on the basis of the
foreign tax law governing the
calculation of the foreign taxable base,
unless otherwise provided, and without
any consideration of the rate of tax
imposed on the foreign taxable base.
(2) Realization requirement—(i) In
general. A foreign tax satisfies the
realization requirement if it is imposed
upon one or more of the events
described in paragraphs (b)(2)(i)(A)
through (C) of this section. If a foreign
tax meets the realization requirement in
paragraphs (b)(2)(i)(A) through (C) of
this section except with respect to one
or more specific and defined classes of
nonrealization events (such as, for
example, imputed rental income from a
personal residence used by the owner),
and as judged based on the application
of the foreign tax to all taxpayers subject
to the foreign tax, the incidence and
amounts of gross receipts attributable to
such nonrealization events is
insignificant relative to the incidence
and amounts of gross receipts
attributable to events covered by the
foreign tax that do meet the realization
requirement, then the foreign tax is
treated as meeting the realization
requirement in paragraph (b)(2) of this
section (despite the fact that the foreign
tax is also imposed on the basis of some
nonrealization events, and that some
persons subject to the foreign tax may
only be taxed on nonrealization events).
(A) Realization events. The foreign tax
is imposed upon or after the occurrence
of events (‘‘realization events’’) that
result in the realization of income under
the income tax provisions of the Internal
Revenue Code.
(B) Pre-realization recapture events.
The foreign tax is imposed upon the
occurrence of an event before a
realization event (a ‘‘pre-realization
event’’) that results in the recapture (in
whole or part) of a tax deduction, tax
credit, or other tax allowance previously
accorded to the taxpayer (for example,

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the recapture of an incentive tax credit
if required investments are not
completed within a specified period).
(C) Pre-realization timing difference
events. The foreign tax is imposed upon
the occurrence of a pre-realization
event, other than one described in
paragraph (b)(2)(i)(B) of this section, but
only if the foreign country does not,
upon the occurrence of a later event,
impose tax under the same or a separate
levy (a ‘‘second tax’’) on the same
taxpayer (for purposes of this paragraph
(b)(2)(i)(C), treating a disregarded entity
as defined in § 301.7701–3(b)(2)(i)(C) of
this chapter as a taxpayer separate from
its owner), with respect to the income
on which tax is imposed by reason of
such pre-realization event (or, if it does
impose a second tax, a credit or other
comparable relief is available against the
liability for such a second tax for tax
paid on the occurrence of the prerealization event) and—
(1) The imposition of the tax upon
such pre-realization event is based on
the difference in the fair market value of
property at the beginning and end of a
period;
(2) The pre-realization event is the
physical transfer, processing, or export
of readily marketable property (as
defined in paragraph (b)(2)(ii) of this
section) and the imposition of the tax
upon the pre-realization event is based
on the fair market value of such
property; or
(3) The pre-realization event relates to
a deemed distribution (for example, by
a corporation to a shareholder) or
inclusion (for example, under a
controlled foreign corporation inclusion
regime) of amounts (such as earnings
and profits) that meet the realization
requirement in paragraph (b)(2) of this
section in the hands of the person that,
under foreign tax law, is deemed to
distribute such amounts.
(ii) Readily marketable property.
Property is readily marketable if—
(A) It is stock in trade or other
property of a kind that properly would
be included in inventory if on hand at
the close of the taxable year or if it is
held primarily for sale to customers in
the ordinary course of business, and
(B) It can be sold on the open market
without further processing or it is
exported from the foreign country.
(iii) Examples. The following
examples illustrate the rules of
paragraph (b)(2) of this section:
(A) Example 1. Residents of Country
X are subject to a tax of 10 percent on
the aggregate net appreciation in fair
market value during the calendar year of
all shares of stock held by them at the
end of the year. In addition, all such
residents are subject to a Country X tax

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that qualifies as a net income tax within
the meaning of paragraph (a)(3) of this
section. Included in the base of the net
income tax are gains and losses realized
on the sale of stock, and the basis of
stock for purposes of determining such
gain or loss is its cost. The operation of
the stock appreciation tax and the net
income tax as applied to sales of stock
is exemplified as follows: A, a resident
of Country X, purchases stock in June of
Year 1 for 100u (units of Country X
currency) and sells it in May of Year 3
for 160u. On December 31, Year 1, the
stock is worth 120u and on December
31, Year 2, it is worth 155u. Pursuant to
the stock appreciation tax, A pays 2u for
Year 1 (10 percent of (120u¥100u)),
3.5u for Year 2 (10 percent of
(155u¥120u)), and nothing for Year 3
because no stock was held at the end of
that year. For purposes of the net
income tax, A must include 60u
(160u¥100u) in his income for Year 3,
the year of sale. Pursuant to paragraph
(b)(2)(i)(C) of this section, the stock
appreciation tax does not satisfy the
realization requirement because Country
X imposes a second tax upon the
occurrence of a later event (that is, the
sale of stock) with respect to the income
that was taxed by the stock appreciation
tax and no credit or comparable relief is
available against such second tax for the
stock appreciation tax paid.
(B) Example 2. The facts are the same
as those in paragraph (b)(2)(iii)(A) of
this section (the facts in Example 1),
except that if stock was held on the
December 31 last preceding the date of
its sale, the basis of such stock for
purposes of computing gain or loss
under the net income tax is the value of
the stock on such December 31. Thus,
in Year 3, A includes only 5u
(160u¥155u) as income from the sale
for purposes of the net income tax.
Because the net income tax imposed
upon the occurrence of a later event (the
sale) does not impose a tax with respect
to the income that was taxed by the
stock appreciation tax, under paragraph
(b)(2)(i)(C) of this section, the stock
appreciation tax satisfies the realization
requirement. The result would be the
same if, instead of a basis adjustment to
reflect taxation pursuant to the stock
appreciation tax, the Country X net
income tax allowed a credit (or other
comparable relief) to take account of the
stock appreciation tax. If a credit
mechanism is used, see also paragraph
(e)(4)(i) of this section.
(C) Example 3. Country X imposes a
tax on the realized net income of
corporations that do business in
Country X. Country X also imposes a
branch profits tax on corporations
organized under the law of a country

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other than Country X that do business
in Country X. The branch profits tax is
imposed when realized net income is
remitted or deemed to be remitted by
branches in Country X to home offices
outside of Country X. Because the
branch profits tax is imposed
subsequent to the occurrence of events
that would result in realization of
income by corporations subject to such
tax under the income tax provisions of
the Internal Revenue Code, under
paragraph (b)(2)(i)(A) of this section the
branch profits tax satisfies the
realization requirement.
(D) Example 4. Country X imposes a
tax on the realized net income of
corporations that do business in
Country X (the ‘‘Country X corporate
tax’’). Country X also imposes a separate
tax on shareholders of such corporations
(the ‘‘Country X shareholder tax’’). The
Country X shareholder tax is imposed
on the sum of the actual distributions
received during the taxable year by such
a shareholder from the corporation’s
realized net income for that year (that is,
income from past years is not taxed in
a later year when it is actually
distributed) plus the distributions
deemed to be received by such a
shareholder. Deemed distributions are
defined as a shareholder’s pro rata share
of the corporation’s realized net income
for the taxable year, less such
shareholder’s pro rata share of the
corporation’s Country X corporate tax
for that year, less actual distributions
made by such corporation to such
shareholder from such net income. A
shareholder’s receipt of actual
distributions is a realization event
within the meaning of paragraph
(b)(2)(i)(A) of this section. The deemed
distributions are not realization events,
but they are described in paragraph
(b)(2)(i)(C)(3) of this section.
Accordingly, the Country X shareholder
tax satisfies the realization requirement.
(3) Gross receipts requirement—(i)
Rule. A foreign tax satisfies the gross
receipts requirement if it is imposed on
the basis of the amounts described in
paragraphs (b)(3)(i)(A) through (D) of
this section.
(A) Actual gross receipts.
(B) In the case of either an
insignificant nonrealization event
described in the second sentence of
paragraph (b)(2)(i) of this section or a
realization event described in paragraph
(b)(2)(i)(A) of this section that does not
result in actual gross receipts, deemed
gross receipts in an amount that is
reasonably calculated to produce an
amount that is not greater than fair
market value.
(C) Deemed gross receipts in the
amount of a tax deduction that is

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recaptured by reason of a pre-realization
recapture event described in paragraph
(b)(2)(i)(B) of this section.
(D) The amount of deemed gross
receipts arising from pre-realization
timing difference events described in
paragraph (b)(2)(i)(C) of this section.
(ii) Examples. The following
examples illustrate the rules of
paragraph (b)(3)(i) of this section.
(A) Example 1: Cost-plus tax—(1)
Facts. Country X imposes a ‘‘cost-plus
tax’’ on Country X corporations that
serve as regional headquarters
companies for affiliated nonresident
corporations, and this tax is a separate
levy (within the meaning of paragraph
(d)(1) of this section). A headquarters
company for purposes of this tax is a
corporation that performs
administrative, management or
coordination functions solely for
nonresident affiliated entities. Due to
the difficulty of determining on a caseby-case basis the arm’s length gross
receipts that headquarters companies
would charge affiliates for such services,
gross receipts of a headquarters
company are deemed, for purposes of
this tax, to equal 110 percent of the
business expenses incurred by the
headquarters company.
(2) Analysis. Because the cost-plus tax
is based on costs and not on actual gross
receipts, the cost-plus tax does not
satisfy the gross receipts requirement of
paragraph (b)(3)(i) of this section.
(B) Example 2: Actual gross receipts
determined under appropriate transfer
pricing methodology—(1) Facts. Country
X imposes a tax on resident
corporations that meets the attribution
requirement of paragraph (b)(5)(ii) of
this section. The Country X tax is based
on actual gross receipts, including gross
receipts recorded on the taxpayer’s
books and records as due from related
and unrelated persons. Corporation A, a
resident of Country X, properly
determines the arm’s length transfer
price for services provided to related
persons using a cost-plus methodology,
recording on its books and records
receivables for the arm’s length amounts
due from those related persons and
using those amounts to determine the
realized gross receipts included in the
base of the Country X tax.
(2) Analysis. Because the Country X
tax is based on actual gross receipts, it
satisfies the gross receipts requirement
of paragraph (b)(3)(i) of this section.
(C) Example 3: Petroleum taxed on
extraction—(1) Facts. Country X
imposes a tax that is a separate levy
(within the meaning of paragraph (d)(1)
of this section) on income from the
extraction of petroleum. Under the
terms of that tax, gross receipts from

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337

extraction income are deemed to equal
105 percent of the fair market value of
petroleum extracted.
(2) Analysis. Because it is imposed on
deemed gross receipts that exceed the
fair market value of the petroleum
extracted, the tax on extraction income
does not satisfy the gross receipts
requirement of paragraph (b)(3)(i) of this
section.
(4) Cost recovery requirement—(i)
Costs and expenses that must be
recovered—(A) In general. A foreign tax
satisfies the cost recovery requirement if
the base of the tax is computed by
reducing gross receipts (as described in
paragraph (b)(3) of this section) to
permit recovery of the significant costs
and expenses (including significant
capital expenditures) described in
paragraph (b)(4)(i)(C) of this section
attributable, under reasonable
principles, to such gross receipts. A
foreign tax need not permit recovery of
significant costs and expenses, such as
certain personal expenses, that are not
attributable, under reasonable
principles, to gross receipts included in
the foreign taxable base. A foreign tax
whose base is gross receipts, with no
reduction for costs and expenses,
satisfies the cost recovery requirement
only if there are no significant costs and
expenses attributable to the gross
receipts included in the foreign tax base
that must be recovered under the rules
of paragraph (b)(4)(i)(C)(1) of this
section. See paragraph (b)(4)(iv)(A) of
this section (Example 1). A foreign tax
that provides an alternative cost
allowance satisfies the cost recovery
requirement only as provided in
paragraph (b)(4)(i)(B) of this section. See
paragraph (b)(4)(i)(D) of this section for
rules regarding principles for attributing
costs and expenses to gross receipts.
(B) Alternative cost allowances—(1) In
general. Except as provided in
paragraph (b)(4)(i)(B)(2) of this section,
if foreign tax law does not permit
recovery of one or more significant costs
and expenses in computing the base of
the foreign tax but provides an
alternative cost allowance, the foreign
tax satisfies the cost recovery
requirement only if the alternative
allowance permits recovery of an
amount that by its terms may be greater,
but can never be less, than the actual
amounts of such significant costs and
expenses (for example, under a
provision identical to percentage
depletion allowed under section 613). If
foreign tax law provides an optional
alternative cost allowance or an election
to recover costs and expenses under an
alternative method, the foreign tax
satisfies the cost recovery requirement if
the foreign tax law also expressly

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provides an option to recover actual
costs and expenses. See § 1.901–2(e)(5)
for rules limiting the amount of foreign
income tax paid to the amount due
under the option that minimizes the
taxpayer’s liability for foreign income
tax over time. If foreign tax law provides
an alternative cost allowance that does
not by its terms permit recovery of an
amount equal to or greater than the
actual amounts of significant costs and
expenses, the foreign tax does not
satisfy the cost recovery requirement,
even if, in practice, the amounts
recovered under the alternative
allowance equal or exceed the amount
of actual costs and expenses.
(2) Small business exception. If
foreign tax law provides an alternative
method for determining the amount of
costs and expenses allowed in
computing the taxable base of small
business enterprises, the foreign tax
satisfies the cost recovery requirement if
the foreign tax law contains reasonable
limits on the maximum size of business
enterprises to which the alternative cost
allowance applies (for example,
business enterprises having asset values
or annual gross revenues below
specified thresholds). See paragraph
(b)(4)(iv)(B) of this section (Example 2).
(C) Significant costs and expenses—
(1) Amounts that must be recovered.
Whether a cost or expense is significant
for purposes of this paragraph (b)(4)(i) is
determined based on whether, for all
taxpayers in the aggregate to which the
foreign tax applies, the item of cost or
expense constitutes a significant portion
of the taxpayers’ total costs and
expenses. Costs and expenses (as
characterized under foreign law) related
to capital expenditures, interest, rents,
royalties, wages or other payments for
services, and research and
experimentation are always treated as
significant costs or expenses for
purposes of this paragraph (b)(4)(i).
Significant costs and expenses (such as
interest expense) are not considered to
be recovered by reason of the time value
of money attributable to the acceleration
of a tax benefit or other economic
benefit attributable to the timing of the
recovery of other costs and expenses
(such as the current expensing of debtfinanced capital expenditures). Foreign
tax law is considered to permit recovery
of significant costs and expenses even if
recovery of all or a portion of certain
costs or expenses is disallowed, if such
disallowance is consistent with the
principles underlying the disallowances
required under the Internal Revenue
Code, including disallowances intended
to limit base erosion or profit shifting.
For example, a foreign tax is considered
to permit recovery of significant costs

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and expenses if the foreign tax law
limits interest deductions so as not to
exceed 10 percent of a reasonable
measure of taxable income (determined
either before or after depreciation and
amortization) based on principles
similar to those underlying section
163(j), disallows interest and royalty
deductions in connection with hybrid
transactions based on principles similar
to those underlying section 267A,
disallows deductions attributable to
gross receipts that in whole or in part
are excluded, exempt or eliminated
from taxable income, or disallows
certain expenses based on public policy
considerations similar to those
disallowances contained in section 162.
See paragraph (b)(4)(iv)(C) of this
section (Example 3).
(2) Amounts that need not be
recovered. A foreign tax is considered to
permit recovery of significant costs and
expenses even if the foreign tax law
does not permit recovery of any costs
and expenses attributable to wage
income or to investment income that is
not derived from a trade or business. In
addition, in determining whether a
foreign tax (the ‘‘tested foreign tax’’)
meets the cost recovery requirement, it
is immaterial whether the tested foreign
tax allows a deduction for other taxes
that would qualify as foreign income
taxes (determined without regard to
whether such other tax allows a
deduction for the tested foreign tax). See
paragraph (b)(4)(iv)(D) and (E) of this
section (Examples 4 and 5).
(3) Timing of recovery. A foreign tax
law permits recovery of significant costs
and expenses even if such costs and
expenses are recovered earlier or later
than they are recovered under the
Internal Revenue Code, unless the time
of recovery is so much later (for
example, after the property becomes
worthless or is disposed of) as
effectively to constitute a denial of such
recovery. The amount of costs and
expenses that is recovered under the
foreign tax law is neither discounted nor
augmented by taking into account the
time value of money attributable to any
acceleration or deferral of a tax benefit
resulting from the foreign law cost
recovery method compared to when tax
would be paid under the Internal
Revenue Code. Therefore, a foreign tax
satisfies the cost recovery requirement if
items deductible under the Internal
Revenue Code are capitalized under the
foreign tax law and recovered either
immediately, on a recurring basis over
time, or upon the occurrence of some
future event, or if the recovery of items
capitalized under the Internal Revenue
Code occurs more or less rapidly than
under the foreign tax law.

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(D) Attribution of costs and expenses
to gross receipts. Principles used in the
foreign tax law to attribute costs and
expenses to gross receipts may be
reasonable even if they differ from
principles that apply under the Internal
Revenue Code (for example, principles
that apply under section 265, 465 or
861(b) of the Internal Revenue Code).
See also paragraph (b)(5) of this section
for additional requirements relating to
foreign tax law rules for attributing costs
and expenses to gross receipts.
(ii) Consolidation of profits and
losses. In determining whether a foreign
tax satisfies the cost recovery
requirement, one of the factors to be
taken into account is whether, in
computing the base of the tax, a loss
incurred in one activity (for example, a
contract area in the case of oil and gas
exploration) in a trade or business is
allowed to offset profit earned by the
same person in another activity (for
example, a separate contract area) in the
same trade or business. If such an offset
is allowed, it is immaterial whether the
offset may be made in the taxable period
in which the loss is incurred or only in
a different taxable period, unless the
period is such that under the
circumstances there is effectively a
denial of the ability to offset the loss
against profit. In determining whether a
foreign tax satisfies the cost recovery
requirement, it is immaterial that no
such offset is allowed if a loss incurred
in one such activity may be applied to
offset profit earned in that activity in a
different taxable period, unless the
period is such that under the
circumstances there is effectively a
denial of the ability to offset such loss
against profit. In determining whether a
foreign tax satisfies the cost recovery
requirement, it is immaterial whether a
person’s profits and losses from one
trade or business (for example, oil and
gas extraction) are allowed to offset its
profits and losses from another trade or
business (for example, oil and gas
refining and processing), or whether a
person’s business profits and losses and
its passive investment profits and losses
are allowed to offset each other in
computing the base of the foreign tax.
Moreover, it is immaterial whether
foreign tax law permits or prohibits
consolidation of profits and losses of
related persons, unless foreign tax law
requires separate entities to be used to
carry on separate activities in the same
trade or business. If foreign tax law
requires that separate entities carry on
such separate activities, the
determination whether the cost recovery
requirement is satisfied is made by
applying the same considerations as if

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such separate activities were carried on
by a single entity.
(iii) Carryovers. In determining
whether a foreign tax satisfies the cost
recovery requirement, it is immaterial,
except as otherwise provided in
paragraph (b)(4)(ii) of this section,
whether losses incurred during one
taxable period may be carried over to
offset profits incurred in different
taxable periods.
(iv) Examples. The following
examples illustrate the rules of
paragraph (b)(4) of this section.
(A) Example 1: Tax on gross interest
income of certain residents; no
deductions allowed—(1) Facts. Country
X imposes a net income tax on
corporations resident in Country X.
Country X imposes a second tax (the
‘‘bank tax’’) of 1 percent on the gross
amount of interest income derived by
banks resident in Country X; no
deductions are allowed in determining
the base of the bank tax. Banks resident
in Country X incur substantial costs and
expenses, including interest expense,
attributable to their interest income.
(2) Analysis. Because the terms of the
bank tax do not permit recovery of
significant costs and expenses
attributable to the gross receipts
included in the tax base, the bank tax
does not satisfy the cost recovery
requirement of paragraph (b)(4)(i) of this
section.
(B) Example 2: Small business
alternative allowance—(1) Facts.
Country X imposes a tax on the income
of corporations resident in Country X.
Under Country X tax law, corporations
are generally allowed to deduct actual
costs and expenses attributable to the
realized gross receipts included in the
Country X tax base. However, in lieu of
deductions for actual costs and
expenses, businesses with gross
revenues of less than the Country X
currency equivalent of $500,000 are
allowed a flat cost allowance of 50
percent of gross revenues.
(2) Analysis. Under paragraph
(b)(4)(i)(B)(2) of this section, the
alternative cost allowance for small
businesses provided under Country X
tax law satisfies the cost recovery
requirement.
(C) Example 3: Permissible deduction
disallowance—(1) Facts. Country X
imposes a tax on the income of
corporations resident in Country X.
Under Country X tax law, deductions
for the significant costs and expenses
attributable to the gross receipts
included in the Country X tax base are
allowed, except that deductions for
interest expense incurred by
corporations are limited to 30 percent of
the corporation’s earnings before

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income taxes, depreciation, and
amortization, and unused interest
expense may be carried forward for a
period of 5 years. In addition, Country
X tax law contains anti-hybrid rules that
deny deductions for interest, royalties,
rents, and services payments made by a
Country X resident to a related entity
outside Country X that is treated as a
transparent entity in the jurisdiction in
which it is organized but as a separate
entity in the jurisdiction of the entity’s
owners (a ‘‘reverse hybrid entity’’) to the
extent that the payment is not included
in the income of the reverse hybrid
entity or its owners.
(2) Analysis. Under paragraph
(b)(4)(i)(C)(1) of this section, costs and
expenses related to interest, rents,
royalties, and payments for services are
treated as significant costs or expenses
that must be recoverable under Country
X tax law. However, because the interest
expense limitation rule and the antihybrid rules in Country X tax law are
consistent with the principles
underlying the disallowances required
under the Internal Revenue Code
(namely, section 163(j) and section
267A), the Country X tax satisfies the
cost recovery requirement.
(D) Example 4: Gross basis tax on
wages—(1) Facts. A foreign country
imposes payroll tax on resident
employees at the rate of 10 percent of
the amount of gross wages; no
deductions are allowed in computing
the base of the payroll tax.
(2) Analysis. Although the foreign tax
law does not allow for the recovery of
any costs and expenses attributable to
gross receipts included in the taxable
base, under paragraph (b)(4)(i)(C)(2) of
this section, because the only gross
receipts included in the taxable base are
from wages, the payroll tax satisfies the
cost recovery requirement.
(E) Example 5: No deduction for
another net income tax—(1) Facts. Each
of Country X and Province Y (a political
subdivision of Country X) imposes a tax
on resident corporations, called the
‘‘Country X income tax’’ and the
‘‘Province Y income tax,’’ respectively.
Each tax has an identical base, which is
computed by reducing a corporation’s
realized gross receipts by deductions
that, based on the laws of Country X and
Province Y, generally permit recovery of
the significant costs and expenses
(including significant capital
expenditures) that are attributable under
reasonable principles to such gross
receipts. However, the Country X
income tax does not allow a deduction
for the Province Y income tax for which
a taxpayer is liable, nor does the
Province Y income tax allow a

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deduction for the Country X income tax
for which a taxpayer is liable.
(2) Analysis. Under paragraph (d)(1)(i)
of this section, each of the Country X
income tax and the Province Y income
tax is a separate levy. Without regard to
whether the Province Y income tax may
allow a deduction for the Country X
income tax, and without regard to
whether the Country X income tax may
allow a deduction for the Province Y
income tax, both taxes would qualify as
net income taxes under paragraph (a)(3)
of this section. Therefore, under
paragraph (b)(4)(i)(C)(2) of this section
the fact that neither levy’s base allows
a deduction for the other levy is
immaterial, and both levies satisfy the
cost recovery requirement.
(5) Attribution requirement. A foreign
tax satisfies the attribution requirement
if the amount of gross receipts and costs
that are included in the base of the
foreign tax are determined based on
rules described in paragraph (b)(5)(i) of
this section (with respect to a separate
levy imposed on nonresidents of the
foreign country) or paragraph (b)(5)(ii)
of this section (with respect to a
separate levy imposed on residents of
the foreign country).
(i) Tax on nonresidents. The gross
receipts and costs attributable to each of
the items of income of nonresidents of
a foreign country that is included in the
base of the foreign tax must satisfy the
requirements of paragraph (b)(5)(i)(A),
(B), or (C) of this section.
(A) Income attribution based on
activities. The gross receipts and costs
that are included in the base of the
foreign tax are limited to gross receipts
and costs that are attributable, under
reasonable principles, to the
nonresident’s activities within the
foreign country imposing the foreign tax
(including the nonresident’s functions,
assets, and risks located in the foreign
country). For purposes of the preceding
sentence, attribution of gross receipts
under reasonable principles includes
rules similar to those for determining
effectively connected income under
section 864(c) but does not include rules
that take into account as a significant
factor the mere location of customers,
users, or any other similar destinationbased criterion, or the mere location of
persons from whom the nonresident
makes purchases in the foreign country.
In addition, for purposes of the first
sentence of this paragraph (b)(5)(i)(A),
reasonable principles do not include
rules that deem the existence of a trade
or business or permanent establishment
based on the activities of another person
(other than an agent or other person
acting on behalf of the nonresident or a
pass-through entity of which the

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nonresident is an owner), or that
attribute gross receipts or costs to a
nonresident based upon the activities of
another person (other than an agent or
other person acting on behalf of the
nonresident or a pass-through entity of
which the nonresident is an owner).
(B) Income attribution based on
source. The amount of gross income
arising from gross receipts (other than
gross receipts from sales or other
dispositions of property) that is
included in the base of the foreign tax
on the basis of source (instead of on the
basis of activities or the situs of property
as described in paragraphs (b)(5)(i)(A)
and (C) of this section) is limited to
gross income arising from sources
within the foreign country that imposes
the tax, and the sourcing rules of the
foreign tax law are reasonably similar to
the sourcing rules that apply under the
Internal Revenue Code. A foreign tax
law’s application of such sourcing rules
need not conform in all respects to the
application of those sourcing rules for
Federal income tax purposes. For
purposes of determining whether the
sourcing rules of the foreign tax law are
reasonably similar to the sourcing rules
that apply under the Internal Revenue
Code, the character of gross income
arising from gross receipts is determined
under the foreign tax law (except as
provided in paragraph (b)(5)(i)(B)(3) of
this section), and the following rules
apply:
(1) Services. Under the foreign tax
law, gross income from services must be
sourced based on where the services are
performed, as determined under
reasonable principles (which do not
include determining the place of
performance of the services based on the
location of the service recipient).
(2) Royalties. A foreign tax on gross
income from royalties must be sourced
based on the place of use of, or the right
to use, the intangible property.
(3) Sales of property. Gross income
arising from gross receipts from sales or
other dispositions of property
(including copyrighted articles sold
through an electronic medium) must be
included in the foreign tax base on the
basis of the rules in paragraph
(b)(5)(i)(A) or (C) of this section, and not
on the basis of source. In the case of
sales of copyrighted articles (as
determined under rules similar to
§ 1.861–18), a foreign tax satisfies the
attribution requirement of paragraph
(b)(5) of this section only if the
transaction is treated as a sale of
tangible property and not as a license of
intangible property.
(C) Attribution based on situs of
property. A foreign tax on gains of
nonresidents from the sale or

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disposition of property, including
shares in a corporation or an interest in
a partnership or other pass-through
entity, based on the situs of property
satisfies the attribution requirement
only as provided in this paragraph
(b)(5)(i)(C). The amount of gross receipts
from the sale or disposition of property
that is included in the base of the
foreign tax on the basis of the situs of
real property (instead of on the basis of
activities as described in paragraph
(b)(5)(i)(A) of this section) may only
include gross receipts that are
attributable to the disposition of real
property situated in the foreign country
imposing the foreign tax (or an interest
in a resident corporation or other entity
that owns such real property) under
rules reasonably similar to the rules in
section 897. The amount of gross
receipts from the sale or disposition of
property other than shares in a
corporation, including an interest in a
partnership or other pass-through entity,
that is included in the base of the
foreign tax on the basis of the situs of
property other than real property may
only include gross receipts that are
attributable to property forming part of
the business property of a taxable
presence in the foreign country
imposing the foreign tax under rules
that are reasonably similar to the rules
in section 864(c).
(ii) Tax on residents. The base of a
foreign tax imposed on residents of the
foreign country imposing the foreign tax
may include all of the worldwide gross
receipts of the resident, but must
provide that any allocation to or from
the resident of income, gain, deduction,
or loss with respect to transactions
between such resident and
organizations, trades, or businesses
owned or controlled directly or
indirectly by the same interests (that is,
any allocation made pursuant to the
foreign country’s transfer pricing rules)
is determined under arm’s length
principles, without taking into account
as a significant factor the location of
customers, users, or any other similar
destination-based criterion.
(iii) Examples. The following
examples illustrate the rules of
paragraph (b)(5) of this section.
(A) Example 1—(1) Facts. Country X
imposes a separate levy on nonresident
companies that furnish, from a location
outside of Country X, specified types of
electronically supplied services to users
located in Country X (the ‘‘ESS tax’’).
The base of the ESS tax is computed by
taking the nonresident company’s
overall net income related to supplying
electronically supplied services, and
deeming a portion of such net income
to be attributable to a deemed

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permanent establishment of the
nonresident company in Country X. The
amount of the nonresident company’s
net income attributable to the deemed
permanent establishment is determined
on a formulary basis based on the
percentage of the nonresident
company’s total users that are located in
Country X.
(2) Analysis. The taxable base of the
ESS tax is not computed based on a
nonresident company’s activities
located in Country X, but instead takes
into account the location of the
nonresident company’s users. Therefore,
the ESS tax does not meet the
requirement in paragraph (b)(5)(i)(A) of
this section. The ESS tax also does not
meet the requirement in paragraph
(b)(5)(i)(B) of this section because it is
not imposed on the basis of source, and
it does not meet the requirement in
paragraph (b)(5)(i)(C) of this section
because it is not imposed on the sale or
other disposition of property.
(B) Example 2—(1) Facts. The facts
are the same as those in paragraph
(b)(5)(iii)(A)(1) of this section (the facts
in Example 1), except that instead of
imposing the ESS tax by deeming
nonresident companies to have a
permanent establishment in Country X,
Country X treats gross income from
electronically supplied services
provided to users located in Country X
as sourced in Country X. The gross
income sourced to Country X is reduced
by costs that are reasonably attributed to
such gross income, to arrive at the
taxable base of the ESS tax. The amount
of the nonresident’s gross income and
costs that are sourced to Country X is
determined by multiplying the
nonresident’s total gross income and
costs by the percentage of its total users
that are located in Country X.
(2) Analysis. Country X tax law’s rule
for sourcing electronically supplied
services is not based on where the
services are performed and is instead
based on the location of the service
recipient. Therefore, the ESS tax, which
is imposed on the basis of source, does
not meet the requirement in paragraph
(b)(5)(i)(B) of this section. The ESS tax
also does not meet the requirement in
paragraph (b)(5)(i)(A) of this section
because it is not imposed on the basis
of a nonresident’s activities located in
Country X, and it does not meet the
requirement in paragraph (b)(5)(i)(C) of
this section because it is not imposed on
the sale or other disposition of property.
(6) Surtax on net income tax. A
foreign tax satisfies the net gain
requirement in this paragraph (b) if the
base of the foreign tax is the amount of
a net income tax. For example, if a tax
(surtax) is computed as a percentage of

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a separate levy that is itself a net income
tax, then such surtax is considered to
satisfy the net gain requirement.
*
*
*
*
*
(d) Separate levies—(1) In general.
Each foreign levy must be analyzed
separately to determine whether it is a
net income tax within the meaning of
paragraph (a)(3) of this section and
whether it is a tax in lieu of an income
tax within the meaning of § 1.903–
1(b)(2). Whether a single levy or
separate levies are imposed by a foreign
country depends on U.S. principles and
not on whether foreign tax law imposes
the levy or levies pursuant to a single
or separate statutes. A foreign levy is a
separate levy described in this
paragraph (d)(1) if it is described in
paragraph (d)(1)(i), (ii), (iii), or (iv) of
this section. In the case of levies that
apply to dual capacity taxpayers, see
also § 1.901–2A(a).
(i) Taxing authority. A levy imposed
by one taxing authority (for example,
the national government of a foreign
country) is always separate from a levy
imposed by another taxing authority (for
example, a political subdivision of that
foreign country), even if the base of the
levy is the same.
(ii) Different taxable base. Where the
base of a foreign levy is computed
differently for different classes of
persons subject to the levy, the levy is
considered to impose separate levies
with respect to each such class of
persons. For example, foreign levies
identical to the taxes imposed by
sections 1, 11, 541, 871(a), 871(b), 881,
882, 3101 and 3111 of the Internal
Revenue Code are each separate levies,
because the levies are imposed on
different classes of taxpayers, and the
base of each of those levies contains
different items than the base of each of
the others. A taxable base of a separate
levy may consist of a particular type of
income (for example, wage income,
investment income, or income from selfemployment). The taxable base of a
separate levy may also consist of an
amount unrelated to income (for
example, wage expense or assets). A
separate levy may provide that items
included in the base of the tax are
computed separately merely for
purposes of a preliminary computation
and are then combined as a single
taxable base. Income included in the
taxable base of a separate levy may also
be included in the taxable base of
another levy (which may or may not
also include other items of income);
separate levies are considered to be
imposed if the taxable bases are not
combined as a single taxable base, even
if the taxable bases are determined using

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the same computational rules. For
example, a foreign levy identical to the
tax imposed by section 1 is a separate
levy from a foreign levy identical to the
tax imposed by section 1411, because
tax is imposed under each levy on a
separate taxable base that is not
combined with the other as a single
taxable base. Where foreign tax law
imposes a levy that is the sum of two
or more separately computed amounts
of tax, and each such amount is
computed by reference to a different
base, separate levies are considered to
be imposed. Levies are not separate
merely because different rates apply to
different classes of taxpayers that are
subject to the same provisions in
computing the base of the tax. For
example, a foreign levy identical to the
tax imposed on U.S. citizens and
resident alien individuals by section 1
of the Internal Revenue Code is a single
levy notwithstanding that the levy has
graduated rates and applies different
rate schedules to unmarried individuals,
married individuals who file separate
returns, and married individuals who
file joint returns. In addition, in general,
levies are not separate merely because
some provisions determining the base of
the levy apply, by their terms or in
practice, to some, but not all, persons
subject to the levy. For example, a
foreign levy identical to the tax imposed
by section 11 of the Internal Revenue
Code is a single levy even though some
provisions apply by their terms to some
but not all corporations subject to the
section 11 tax (for example, section 465
is by its terms applicable to corporations
described in sections 465(a)(1)(B), but
not to other corporations), and even
though some provisions apply in
practice to some but not all corporations
subject to the section 11 tax (for
example, section 611 does not, in
practice, apply to any corporation that
does not have a qualifying interest in
the type of property described in section
611(a)).
(iii) Tax imposed on nonresidents. A
foreign levy imposed on nonresidents is
always treated as a separate levy from
that imposed on residents, even if the
base of the tax as applied to residents
and nonresidents is the same, and even
if the levies are treated as a single levy
under foreign tax law. In addition, a
withholding tax (as defined in section
901(k)(1)(B)) that is imposed on gross
income of nonresidents is treated as a
separate levy as to each separate class of
income described in section 61 (for
example, interest, dividends, rents, or
royalties) subject to the withholding tax.
If two or more subsets of a separate class
of income are subject to a withholding

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341

tax based on different income
attribution rules (for example, if
technical services are subject to tax
based on the residence of the payor and
other services are subject to tax based on
where the services are performed),
separate levies are considered to be
imposed with respect to each subset of
that separate class of income.
(iv) Foreign levy modified by an
applicable income tax treaty. A foreign
levy that is limited in its application by,
or is otherwise modified by, an income
tax treaty to which the foreign country
imposing the levy is a party is a separate
levy from the levy imposed under the
domestic law (without regard to the
treaty) of the foreign country, and is also
a separate levy from the foreign levy as
modified by a different income tax
treaty to which the foreign country
imposing the levy is a party, even if the
two treaties modify the foreign levy in
exactly the same manner. Accordingly,
a foreign levy paid by taxpayers that
qualify for and claim benefits under an
income tax treaty is a separate levy from
the levy as applied to taxpayers that are
ineligible for, or that do not claim,
benefits under that treaty, even if the
two foreign levies would apply in the
same manner to a particular taxpayer,
and regardless of whether the
unmodified foreign levy is a foreign
income tax within the meaning of
paragraph (a)(1)(ii) of this section.
(2) Contractual modifications.
Notwithstanding paragraph (d)(1) of this
section, if foreign tax law imposing a
levy is modified for one or more persons
subject to the levy by a contract entered
into by such person or persons and the
foreign country, then the foreign tax law
is considered for purposes of sections
901 and 903 to impose a separate levy
for all persons to whom such
contractual modification of the levy
applies, as contrasted to the levy as
applied to all persons to whom such
contractual modification does not apply.
(3) Examples. The following examples
illustrate the rules of paragraph (d)(1) of
this section.
(i) Example 1: Separate taxable
bases—(A) Facts. A foreign statute
imposes a levy on corporations equal to
the sum of 15% of the corporation’s
realized net income plus 3% of its net
worth.
(B) Analysis. As the levy is the sum
of two separately computed amounts,
each of which is computed by reference
to a separate base, under paragraph
(d)(1)(ii) of this section each of the
portion of the levy based on income and
the portion of the levy based on net
worth is considered, for purposes of
sections 901 and 903, to be a separate
levy.

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(ii) Example 2: Separate taxable
bases—(A) Facts. A foreign statute
imposes a levy on nonresident alien
individuals analogous to the taxes
imposed by section 871 of the Internal
Revenue Code.
(B) Analysis. As the levy is imposed
on separately computed amounts, each
of which is computed by reference to a
separate taxable base and portions of
which comprise withholding tax on
gross income of nonresidents, under
paragraphs (d)(1)(ii) and (iii) of this
section, each of the portions of the
foreign levy imposed on each separate
class of gross income analogous to the
tax imposed by section 871(a) and the
portion of the foreign levy analogous to
the tax imposed by sections 871(b) and
1 is considered, for purposes of sections
901 and 903, to be a separate levy.
(iii) Example 3: Separate taxable
bases—(A) Facts—(1) A single foreign
statute or separate foreign statutes
impose a foreign levy that is the sum of
the products of specified rates applied
to specified bases, as follows:

TABLE 1 TO PARAGRAPH
(d)(3)(III)(A)(1)
Rate
(percent)

Base

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Net income from mining .............
Net income from manufacturing
Net income from technical services ..........................................
Net income from other services
Net income from investments .....
All other net income ...................

45
50
50
45
15
50

(2) In computing each such base,
deductible expenditures are allocated to
the type of income they generate. If
allocated deductible expenditures
exceed the gross amount of a specified
type of income, the excess may not be
applied against income of a different
specified type.
(B) Analysis. The levy is the sum of
several separately computed amounts,
each of which is computed by reference
to a separate base. Accordingly, under
paragraph (d)(1)(ii) of this section, each
of the levies on mining net income,
manufacturing net income, technical
services net income, other services net
income, investment net income and
other net income is considered, for
purposes of sections 901 and 903, to be
a separate levy.
(iv) Example 4: Combined taxable
base after preliminary separate
computation—(A) Facts. The facts are
the same as those in paragraph
(d)(3)(iii)(A) of this section (the facts in
Example 3), except that excess
deductible expenditures allocated to
one type of income are applied against

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other types of income to which the same
rate applies.
(B) Analysis. Under paragraph
(d)(1)(ii) of this section, the levies on
mining net income and other services
net income together are considered, for
purposes of sections 901 and 903, to be
a single levy since, despite a separate
preliminary computation of the bases,
by reason of the permitted application
of excess allocated deductible
expenditures the bases are not
separately computed. For the same
reason, the levies on manufacturing net
income, technical services net income
and other net income together are
considered, for purposes of sections 901
and 903, to be a single levy. The levy
on investment net income is considered,
for purposes of sections 901 and 903, to
be a separate levy. These results are not
dependent on whether the application
of excess allocated deductible
expenditures to a different type of
income is permitted in the same taxable
period in which the expenditures are
taken into account for purposes of the
preliminary computation, or only in a
different (for example, later) taxable
period.
(v) Example 5: Combined taxable base
with income subject to different rates—
(A) Facts. The facts are the same as
those in paragraph (d)(3)(iii)(A) of this
section (the facts in Example 3), except
that excess deductible expenditures
allocated to any type of income other
than investment income are applied
against the other types of income
(including investment income)
according to a specified set of priorities
of application. Excess deductible
expenditures allocated to investment
income are not applied against any
other type of income.
(B) Analysis. For the same reasons as
those set forth in paragraph (d)(3)(iv)(B)
of this section (the analysis in Example
4), all of the levies are together
considered, for purposes of sections 901
and 903, to be a single levy.
(vi) Example 6: Minimum Tax—(A)
Facts. Country X imposes a net income
tax (‘‘Income Tax’’) and a minimum tax
(‘‘Minimum Tax’’) on its residents.
Under Country X tax law, alternative
minimum taxable income for purposes
of the Minimum Tax equals the taxable
income under the Income Tax increased
by certain disallowed deductions. The
Minimum Tax equals the excess, if any,
of the alternative minimum taxable
income times the Minimum Tax rate
over the amount of the Income Tax.
(B) Analysis. Under paragraph
(d)(1)(ii) of this section, the Minimum
Tax is a separate levy from the Income
Tax, because the taxable base of each
levy is separately computed and not

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combined as a single taxable base. The
result would be the same if under
Country X tax law the Minimum Tax
equaled the alternative minimum
taxable income times the Minimum Tax
rate, and residents of Country X were
required to pay the greater of the Income
Tax or the Minimum Tax (rather than
the Income Tax plus the excess, if any,
of the Minimum Tax over the Income
Tax).
(vii) Example 7: Diverted Profits
Tax—(A) Facts. Country X imposes a
20% net income tax (‘‘Income Tax’’) and
a 25% ‘‘Diverted Profits Tax’’ on
nonresident corporations. Under
Country X tax law, taxable income
under the Diverted Profits Tax is
determined first by attributing gross
receipts of the nonresident corporation
to a hypothetical permanent
establishment in Country X. Country X
applies the same computational rules
that apply under the Income Tax to
determine the taxable income
attributable to a hypothetical permanent
establishment under the Diverted Profits
Tax.
(B) Analysis. Under paragraph
(d)(1)(ii) of this section, the Diverted
Profits Tax is a separate levy from the
Income Tax, because the taxable income
under the Diverted Profits Tax is not
combined with the taxable income
under the Income Tax as a single taxable
base.
(viii) Example 8: Modified Income
Tax—(A) Facts. Country X imposes a
net income tax (‘‘Income Tax’’) on
nonresident corporations that carry on a
trade or business in Country X through
a permanent establishment. Under
Country X tax law, the taxable base of
the Income Tax as initially enacted is
determined by attributing profits of the
nonresident corporation to its
permanent establishment in Country X
based upon rules similar to Articles 5
and 7 of the 2016 U.S. Model Income
Tax Convention. However, Country X
later amends the Income Tax to provide
that nonresident corporations that are
engaged in certain digital transactions in
Country X and earning revenues above
certain thresholds are deemed to have a
permanent establishment; under the
Income Tax as originally enacted, such
activities would not have created a
permanent establishment in Country X.
(B) Analysis. Under paragraph
(d)(1)(ii) of this section, the Income Tax
as applied to nonresident corporations
engaged in digital transactions and
deemed to have a permanent
establishment under the modified
Income Tax is not a separate levy from
the Income Tax as applied to the same
or other nonresident corporations that
would have permanent establishments

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under the Income Tax as originally
enacted, because income attributable to
both actual and deemed permanent
establishments is combined as a single
taxable base.
(ix) Example 9: Disallowed
deductions—(A) Facts. Country X
imposes a net income tax (‘‘Income
Tax’’) on resident corporations. In
determining the taxable base for the
Income Tax, Country X tax law has a
cap on allowed interest deductions for
companies engaged in the extraction,
production, or refinement of oil or
natural gas.
(B) Analysis. Under paragraph
(d)(1)(ii) of this section, the Income Tax
as applied to corporations engaged in
the extraction, production, or
refinement of oil or natural gas is not a
separate levy from the Income Tax as
applied to other corporations subject to
the levy. The Income Tax is a single
levy even though the cap on allowed
interest expense deductions applies by
its terms to some, but not all,
corporations subject to the Income Tax.
(x) Example 10: Different taxable base
for class of taxpayers—(A) Facts.
Country X imposes a net income tax
(‘‘Income Tax’’) and an oil tax. The oil
tax applies only to resident corporations
engaged in the extraction, production,
or refinement of oil, and resident
corporations subject to the oil tax are
not subject to the Income Tax. The
taxable base under the oil tax is the
taxable income under the Income Tax
increased by disallowed interest
expense.
(B) Analysis. Under paragraph
(d)(1)(ii) of this section, the oil tax is a
separate levy from the Income Tax,
because the taxable income under the
oil tax is not combined with the taxable
income under the Income Tax as a
single taxable base. The levies are
imposed on different classes of
taxpayers (resident taxpayers engaged in
the extraction, production, or
refinement of oil, in the case of the oil
tax, and all other resident corporations,
in the case of the Income Tax), and the
base of each of those levies contains
different items.
(e) Amount of foreign income tax that
is creditable—(1) In general. Credit is
allowed under section 901 for the
amount of foreign income tax that is
paid by the taxpayer. Under paragraph
(g) of this section, the term ‘‘paid’’
means ‘‘paid’’ or ‘‘accrued,’’ depending
on the taxpayer’s method of accounting
for such taxes. The amount of foreign
income tax paid by the taxpayer is
determined separately for each taxpayer
under the rules in this paragraph (e).
(2) Refunds and credits—(i)
Refundable amounts. An amount

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remitted to a foreign country is not an
amount of foreign income tax paid to
the extent that it is reasonably certain
that the amount will be refunded,
rebated, abated, or forgiven. It is
reasonably certain that an amount will
be refunded, rebated, abated, or forgiven
to the extent the amount exceeds a
reasonable approximation of final
foreign income tax liability to the
foreign country. See section 905(c) and
§ 1.905–3 for the required
redeterminations if amounts claimed as
a credit (on either the cash or accrual
basis) exceed the amount of the final
foreign income tax liability.
(ii) Credits. Except as provided in
paragraph (e)(2)(iii) of this section, an
amount of foreign income tax liability is
not an amount of foreign income tax
paid to the extent the foreign income tax
liability is reduced, satisfied, or
otherwise offset by a tax credit,
including a tax credit that under the
foreign tax law is payable in cash only
to the extent it exceeds the taxpayer’s
liability for foreign income tax or a tax
credit acquired from another taxpayer.
(iii) Exception for overpayments and
other fully refundable credits. An
amount of foreign income tax paid is not
reduced (or treated as constructively
refunded) solely by reason of the fact
that a credit is allowed (or may be
allowed) for the amount paid to reduce
the amount of a different separate levy
owed by the taxpayer. See paragraphs
(e)(2)(ii) and (e)(4) of this section.
However, under paragraph (e)(2)(i) of
this section (and taking into account any
redetermination required under section
905(c) and § 1.905–3), an amount
remitted with respect to a separate levy
for a foreign taxable period that
constitutes an overpayment of the
taxpayer’s final liability for that levy for
that period, and that is refundable in
cash at the taxpayer’s option, is not an
amount of tax paid. Therefore, if such
an overpayment of one tax is applied as
a credit against a different foreign
income tax liability of the taxpayer for
the same or a different taxable period,
the credited amount of the overpayment
may qualify as an amount paid of that
different foreign income tax, if the
credited amount does not exceed a
reasonable approximation of the
taxpayer’s final foreign income tax
liability for the taxable period to which
the overpayment is applied. Similarly, if
under the foreign tax law, the full
amount of a tax credit is payable in cash
at the taxpayer’s option, the taxpayer’s
choice to apply all or a portion of the
tax credit in satisfaction of a foreign
income tax liability of the taxpayer is
treated as a constructive payment of
cash to the taxpayer in the amount so

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343

applied, followed by a constructive
payment of the foreign income tax
liability against which the credit is
applied. An overpayment or other tax
credit that under the foreign tax law is
otherwise fully payable in cash at the
taxpayer’s option and that is applied in
part in satisfaction of a foreign income
tax liability is treated as an amount of
foreign income tax paid
notwithstanding that a portion of the
amount otherwise payable in cash to the
taxpayer is subject to a lien or otherwise
seized in order to satisfy a different, preexisting liability of the taxpayer to the
foreign government or to a third party.
(iv) Examples. The following
examples illustrate the rules of
paragraph (e)(2) of this section.
(A) Example 1. The domestic law of
Country X imposes a 25 percent tax
described in § 1.903–1(b) on the gross
amount of interest from sources in
Country X that is received by a
nonresident of Country X. Country X
imposes the tax on the nonresident
recipient and requires any resident of
Country X that pays such interest to a
nonresident to withhold and pay over to
Country X 25 percent of such interest,
which is applied to offset the recipient’s
liability for the 25 percent tax. A tax
treaty between the United States and
Country X modifies domestic law of
Country X and provides that Country X
may not tax interest received by a
resident of the United States from a
resident of Country X at a rate in excess
of 10 percent of the gross amount of
such interest. A resident of the United
States may claim the benefit of the
treaty only by applying for a refund of
the excess withheld amount (15 percent
of the gross amount of interest income)
after the end of the taxable year. A, a
resident of the United States, receives a
gross amount of 100u (units of Country
X currency) of interest income from a
resident of Country X from sources in
Country X in Year 1, from which 25u of
Country X tax is withheld. A files a
timely claim for refund of the 15u
excess withheld amount. 15u of the
amount withheld (25u ¥ 10u) is
reasonably certain to be refunded;
therefore, under paragraph (e)(2)(i) of
this section 15u is not considered an
amount of foreign income tax paid to
Country X.
(B) Example 2. A’s initial foreign
income tax liability under Country X tax
law is 100u (units of Country X
currency). However, under Country X
tax law A’s initial income tax liability
is reduced in order to compute A’s final
tax liability by an investment credit of
15u and a credit for charitable
contributions of 5u. Under paragraph

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(e)(2)(ii) of this section, the amount of
foreign income tax paid by A is 80u.
(C) Example 3. A computes foreign
income tax liability in Country X for
Year 1 of 100u (units of Country X
currency), files a tax return on that
basis, and remits 100u of tax. The day
after A files that return, A files a claim
for refund of 90u. The difference
between the 100u of liability reflected in
A’s original return and the 10u of
liability reflected in A’s refund claim
depends on whether a particular
expenditure made by A is
nondeductible or deductible,
respectively. Based on an analysis of the
Country X tax law, A’s Country X tax
advisors have advised A that it is not
clear whether or not that expenditure is
deductible. In view of the uncertainty as
to the proper treatment of the item in
question under Country X tax law, no
portion of the 100u paid by A is
reasonably certain to be refunded. If A
receives a refund, A must treat the
refund as required by section 905(c) of
the Internal Revenue Code.
(D) Example 4. A levy of Country X,
which qualifies as a foreign income tax
within the meaning of paragraph
(a)(1)(ii) of this section, provides that
each person who makes payment to
Country X pursuant to the levy will
receive a bond to be issued by Country
X with an amount payable at maturity
equal to 10 percent of the amount paid
pursuant to the levy. A remits 38,000u
(units of Country X currency) to Country
X and is entitled to receive a bond with
an amount payable at maturity of
3,800u. It is reasonably certain that a
refund in the form of property (the
bond) will be made. The amount of that
refund is equal to the fair market value
of the bond. Therefore, only the portion
of the 38,000u payment in excess of the
fair market value of the bond is an
amount of foreign income tax paid.
(3) Subsidies—(i) General rule. An
amount of foreign income tax is not an
amount of foreign income tax paid by a
taxpayer to a foreign country to the
extent that—
(A) The amount is used, directly or
indirectly, by the foreign country
imposing the tax to provide a subsidy by
any means (including, but not limited
to, a rebate, a refund, a credit, a
deduction, a payment, a discharge of an
obligation, or any other method) to the
taxpayer, to a related person (within the
meaning of section 482), to any party to
the transaction, or to any party to a
related transaction; and
(B) The subsidy is determined,
directly or indirectly, by reference to the
amount of the tax or by reference to the
base used to compute the amount of the
tax.

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(ii) Subsidy. The term ‘‘subsidy’’
includes any benefit conferred, directly
or indirectly, by a foreign country to one
of the parties enumerated in paragraph
(e)(3)(i)(A) of this section. Substance
and not form shall govern in
determining whether a subsidy exists.
The fact that the U.S. taxpayer may
derive no demonstrable benefit from the
subsidy is irrelevant in determining
whether a subsidy exists.
(iii) Official exchange rate. A subsidy
described in paragraph (e)(3)(i)(B) of
this section does not include the actual
use of an official foreign government
exchange rate converting foreign
currency into dollars where a free
exchange rate also exists if—
(A) The economic benefit represented
by the use of the official exchange rate
is not targeted to or tied to transactions
that give rise to a claim for a foreign tax
credit;
(B) The economic benefit of the
official exchange rate applies to a broad
range of international transactions, in all
cases based on the total payment to be
made without regard to whether the
payment is a return of principal, gross
income, or net income, and without
regard to whether it is subject to tax;
and
(C) Any reduction in the overall cost
of the transaction is merely coincidental
to the broad structure and operation of
the official exchange rate.
(iv) Examples. The following
examples illustrate the rules of
paragraph (e)(3) of this section.
(A) Example 1—(1) Facts. Country X
imposes a 30 percent tax on nonresident
lenders with respect to interest which
the nonresident lenders receive from
borrowers who are residents of Country
X, and it is established that this tax is
a tax in lieu of an income tax within the
meaning of § 1.903–1(b). Country X
provides the nonresident lenders with
receipts upon their payment of the 30
percent tax. Country X remits to
resident borrowers an incentive
payment for engaging in foreign loans,
which payment is an amount equal to
20 percent of the interest paid to
nonresident lenders.
(2) Analysis. Because the incentive
payment is based on the interest paid,
it is determined by reference to the base
used to compute the tax that is imposed
on the nonresident lender. The
incentive payment is a subsidy under
paragraph (e)(3)(i) of this section since
it is provided to a party (the borrower)
to the transaction and is based on the
amount of tax that is imposed on the
lender with respect to the transaction.
Therefore, two-thirds (20 percent/30
percent) of the amount withheld by the
resident borrower from interest

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payments to the nonresident lender is
not an amount of foreign income tax
paid.
(B) Example 2—(1) Facts. A U.S. bank
lends money to a development bank in
Country X. The development bank
relends the money to companies
resident in Country X. A withholding
tax is imposed by Country X on the U.S.
bank with respect to the interest that the
development bank pays to the U.S.
bank, and appropriate receipts are
provided. On the date that the tax is
withheld, fifty percent of the tax is
credited by Country X to an account of
the development bank. Country X
requires the development bank to
transfer the amount credited to the
borrowing companies.
(2) Analysis. The amount successively
credited to the account of the
development bank and then to the
account of the borrowing companies is
determined by reference to the amount
of the tax and the tax base. Since the
amount credited to the borrowing
companies is a subsidy provided to a
party (the borrowing companies) to a
related transaction and is based on the
amount of tax and the tax base, under
paragraph (e)(3)(i) of this section it is
not an amount of foreign income tax
paid.
(C) Example 3—(1) Facts. A U.S. bank
lends dollars to a Country X borrower.
Country X imposes a withholding tax on
the lender with respect to the interest.
The tax is to be paid in Country X
currency, although the interest is
payable in dollars. Country X has a dual
exchange rate system, comprised of a
controlled official exchange rate and a
free exchange rate. Priority transactions
such as exports of merchandise, imports
of merchandise, and payments of
principal and interest on foreign
currency loans payable abroad to foreign
lenders are governed by the official
exchange rate which yields more dollars
per unit of Country X currency than the
free exchange rate. The Country X
borrower remits the net amount of
dollar interest due to the U.S. bank
(interest due less withholding tax), pays
the tax withheld in Country X currency
to the Country X government, and
provides to the U.S. bank a receipt for
payment of the Country X taxes.
(2) Analysis. Under paragraph
(e)(3)(iii) of this section, the use of the
official exchange rate by the U.S. bank
to determine foreign taxes with respect
to interest is not a subsidy described in
paragraph (e)(3)(i)(B) of this section. The
official exchange rate is not targeted to
or tied to transactions that give rise to
a claim for a foreign tax credit. The use
of the official exchange rate applies to
the interest paid and to the principal

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paid. Any benefit derived by the U.S.
bank through the use of the official
exchange rate is merely coincidental to
the broad structure and operation of the
official exchange rate.
(D) Example 4—(1) Facts. B, a U.S.
corporation, is engaged in the
production of oil and gas in Country X
pursuant to a production sharing
agreement among B, Country X, and the
state petroleum authority of Country X.
The agreement is approved and enacted
into law by the Legislature of Country
X. Both B and the petroleum authority
are subject to the Country X income tax.
Each entity files an annual income tax
return and pays, to the tax authority of
Country X, the amount of income tax
due on its annual income. B is a dual
capacity taxpayer as defined in § 1.901–
2(a)(2)(ii)(A). Country X has agreed to
return to the petroleum authority onehalf of the income taxes paid by B by
allowing it a credit in calculating its
own tax liability to Country X.
(2) Analysis. The petroleum authority
is a party to a transaction with B and the
amount returned by Country X to the
petroleum authority is determined by
reference to the amount of the tax
imposed on B. Therefore, under
paragraph (e)(3)(i) of this section the
amount returned is a subsidy, and onehalf of the tax imposed on B is not an
amount of foreign income tax paid.
(E) Example 5—(1) Facts. The facts
are the same as those in paragraph
(e)(3)(iv)(D)(1) of this section (the facts
in Example 4), except that the state
petroleum authority of Country X does
not receive amounts from Country X
related to tax paid by B. Instead, the
authority of Country X receives a
general appropriation from Country X
which is not calculated with reference
to the amount of tax paid by B.
(2) Analysis. Because the general
appropriation is not calculated with
reference to the amount of tax paid by
B, it is not a subsidy described in
paragraph (e)(3)(i) of this section.
(4) Multiple levies—(i) In general. If,
under foreign law, a taxpayer’s tentative
liability for one levy (the ‘‘reduced
levy’’) is or can be reduced by the
amount of the taxpayer’s liability for a
different levy (the ‘‘applied levy’’), then
the amount considered paid by the
taxpayer to the foreign country pursuant
to the applied levy is an amount equal
to its entire liability for that applied
levy (which is not considered to be
reduced by the amount applied against
the reduced levy), and the remainder of
the total amount paid, if any, is
considered paid pursuant to the reduced
levy. See also paragraphs (e)(2)(ii) and
(iii) of this section.

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(ii) Examples. The following
examples illustrate the rules of
paragraphs (e)(2)(ii) and (iii) and (e)(4)(i)
of this section.
(A) Example 1: Tax reduced by
credits—(1) Facts. A’s tentative liability
for foreign income tax imposed by
Country X is 100u (units of Country X
currency). However, under Country X
tax law, in determining A’s final foreign
income tax liability, its tentative
liability is reduced by a 15u credit for
a separate Country X levy that does not
qualify as a foreign income tax and that
A accrued and paid on its gross services
income and is also reduced by a 5u
credit for charitable contributions.
Under Country X tax law, the amount of
the charitable contributions credit is
refundable in cash to the extent the
credit exceeds the taxpayer’s Country X
income tax liability after applying the
credit for the tax on gross services
income. A timely remits the 80u due to
Country X.
(2) Analysis. Under paragraphs
(e)(2)(ii) and (e)(4) of this section, the
amount of Country X income tax paid
by A is 80u (100u tentative liability ¥
20u tax credits), and the amount of
Country X tax on gross services income
paid by A is 15u.
(B) Example 2: Tax paid by credit for
overpayment—(1) Facts. The facts are
the same as those in paragraph
(e)(4)(ii)(A)(1) of this section (the facts
in Example 1), except that A’s final
Country X income tax liability of 80u is
satisfied by applying a credit for an
otherwise refundable 60u overpayment
from the previous taxable year of A’s
liability for a separate levy imposed by
Country X that is also a foreign income
tax and remitting the balance due of
20u.
(2) Analysis. The result is the same as
in paragraph (e)(4)(ii)(A)(2) of this
section (the analysis in Example 1).
Under paragraph (e)(2)(iii) of this
section, the portion of A’s Country X
income tax liability that was satisfied by
applying the 60u overpayment of A’s
different foreign income tax liability for
the previous taxable year qualifies as an
amount of Country X income tax paid,
because that refundable overpayment
exceeded (and so is not treated as a
payment of) A’s different foreign income
tax liability for the previous taxable
year.
(5) Noncompulsory amounts—(i) In
general. An amount remitted to a
foreign country (a ‘‘foreign payment’’) is
not a compulsory payment, and thus is
not an amount of foreign income tax
paid, to the extent that the foreign
payment exceeds the amount of liability
for foreign income tax under the foreign
tax law (as defined in paragraph (g) of

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this section). A foreign payment does
not exceed the amount of such liability
if the foreign payment is determined by
the taxpayer in a manner that is
consistent with a reasonable
interpretation and application of the
substantive and procedural provisions
of foreign tax law (including applicable
tax treaties) in such a way as to reduce,
over time, the taxpayer’s reasonably
expected liability under foreign tax law
for foreign income tax, and if the
taxpayer exhausts all effective and
practical remedies, including invocation
of competent authority procedures
available under applicable tax treaties,
to reduce, over time, the taxpayer’s
liability for foreign income tax
(including liability pursuant to a foreign
tax audit adjustment). See paragraphs
(e)(5)(ii) through (v) of this section.
Whether a taxpayer has satisfied its
obligation to minimize the aggregate
amount of its liability for foreign income
taxes over time is determined without
regard to the present value of a deferred
tax liability or other time value of
money considerations. However, a
taxpayer is not required to reduce its
foreign income tax liability to the extent
the reasonably expected, arm’s length
costs of reducing the liability would
exceed the amount by which the
liability could be reduced. For this
purpose, such costs may include an
additional liability for a different foreign
tax (but not U.S. taxes) that is not a
foreign income tax only to the extent the
amount of the additional liability is
determined in a manner consistent with
the rules of this paragraph (e)(5). A
taxpayer is not required to alter its form
of doing business, its business conduct,
or the form of any business transaction
in order to reduce its liability under
foreign law for foreign income tax.
(ii) Reasonable application of foreign
tax law. An interpretation or application
of foreign tax law is not reasonable if
there is actual notice or constructive
notice (for example, a published court
decision) to the taxpayer that the
interpretation or application is likely to
be erroneous. In interpreting foreign tax
law, a taxpayer may generally rely on
advice obtained in good faith from
competent foreign tax advisors to whom
the taxpayer has disclosed the relevant
facts. Except as provided in paragraphs
(e)(5)(i) and (e)(5)(iv) of this section,
voluntarily forgoing a tax benefit to
which a taxpayer is entitled under the
foreign tax law results in a foreign
payment in excess of the taxpayer’s
liability for foreign income tax.
(iii) Effect of foreign tax law
elections—(A) In general. Where foreign
tax law includes options or elections
whereby a taxpayer’s foreign income tax

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liability may be shifted, in whole or
part, to a different year or years, the
taxpayer’s use or failure to use such
options or elections does not result in a
foreign payment in excess of the
taxpayer’s liability for foreign income
tax. Except as provided in paragraph
(e)(5)(iii)(B) of this section, where
foreign tax law provides a taxpayer with
options or elections in computing its
liability for foreign income tax whereby
a taxpayer’s foreign income tax liability
may be permanently decreased in the
aggregate over time, the taxpayer’s
failure to use such options or elections
results in a foreign payment in excess of
the taxpayer’s liability for foreign
income tax.
(B) Exception for certain options or
elections—(1) Entity classification
elections. If foreign tax law provides an
option or election to treat an entity as
fiscally transparent or non-fiscally
transparent, a taxpayer’s decision to use
or not use such option or election is not
considered to increase the taxpayer’s
liability for foreign income tax over time
for purposes of this paragraph (e)(5).
(2) Foreign consolidation, group relief,
or other loss sharing regime. If foreign
tax law provides an option or election
for one foreign entity to join in the filing
of a consolidated return with another
foreign entity, or to surrender its loss in
order to offset the income of another
foreign entity pursuant to a foreign
group relief or other loss-sharing regime,
a taxpayer’s decision whether to file a
consolidated return, whether to
surrender a loss, or whether to use a
surrendered loss, is not considered to
increase the taxpayer’s liability for
foreign income tax over time for
purposes of this paragraph (e)(5).
(C) Alternative creditable levies. If
under foreign tax law a taxpayer has the
option to determine its foreign income
tax liability under only one of multiple
separate levies, each of which qualifies
as a foreign income tax, then the amount
of foreign income tax paid equals the
smallest liability of the amounts that
would be due under each of the
alternative levies, regardless of which
levy the taxpayer uses to determine its
foreign income tax liability.
(iv) Exception for increase in liability
in connection with anti-hybrid rules—
(A) In general. If a taxpayer (the ‘‘first
taxpayer’’) that makes a payment to
another taxpayer (the ‘‘second
taxpayer’’) is permitted to increase the
first taxpayer’s liability for foreign
income tax (for example, by waiving an
otherwise allowable deduction), and
doing so results in a greater decrease in
the amount of liability for foreign
income tax of the second taxpayer by
reason of the deactivation of a hybrid

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mismatch rule that would otherwise
apply to the second taxpayer, then the
increase in the first taxpayer’s liability
is not considered to result in a foreign
payment in excess of the first taxpayer’s
liability for foreign income tax for
purposes of this paragraph (e)(5).
(B) Definition of hybrid mismatch
rule. The term hybrid mismatch rule
means foreign tax law rules
substantially similar to sections 245A(e)
and 267A and includes rules the
purpose of which is to eliminate the
deduction/no-inclusion outcome of
hybrid and branch mismatch
arrangements. Examples of such rules
include rules based on, or substantially
similar to, the recommendations
contained in OECD/G–20, Neutralising
the Effects of Hybrid Mismatch
Arrangements, Action 2: 2015 Final
Report (October 2015), and OECD/G–20,
Neutralising the Effects of Branch
Mismatch Arrangements, Action 2:
Inclusive Framework on BEPS (July
2017).
(v) Exhaustion of remedies. In
determining whether a taxpayer has
exhausted all effective and practical
remedies, a remedy is effective and
practical only if the cost of pursuing it
(including the reasonably expected risk
of incurring an offsetting or additional
foreign income tax or other tax liability)
is reasonable considering the amount at
issue and the likelihood of success. An
available remedy is considered effective
and practical if an economically rational
taxpayer would pursue it whether or not
a compulsory payment of the amount at
issue would be eligible for a U.S. foreign
tax credit. A settlement by a taxpayer of
two or more issues will be evaluated on
an overall basis, not on an issue-byissue basis, in determining whether an
amount is a compulsory payment.
(vi) Examples. The following
examples illustrate the rules of
paragraph (e)(5) of this section.
(A) Example 1. A, a corporation
organized and doing business solely in
the United States, owns all of the stock
of B, a corporation organized in Country
X. In Year 1, A buys merchandise from
unrelated persons for $1,000,000, and
shortly thereafter resells that
merchandise to B for $600,000. Later in
Year 1, B resells the merchandise to
unrelated persons for $1,200,000. Under
the Country X income tax, which is a
net income tax within the meaning of
paragraph (a)(3) of this section, all
corporations organized in Country X are
subject to a tax equal to 3 percent of
their net income. In computing its Year
1 Country X income tax liability, B
reports $600,000 ($1,200,000 ¥
$600,000) of profit from the purchase
and resale of merchandise. The Country

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X tax law requires that transactions
between related persons be reported at
arm’s length prices, and a reasonable
interpretation of this requirement, as it
has been applied in Country X, would
consider B’s arm’s length purchase price
of the merchandise purchased from A to
be $1,050,000. When it computes its
Country X tax liability B is aware that
$600,000 is not an arm’s length price (by
Country X standards). B’s knowing use
of a non-arm’s length price (by Country
X standards) of $600,000, instead of a
price of $1,050,000 (an arm’s length
price under Country X’s law), is not
consistent with a reasonable
interpretation and application of
Country X tax law, determined in such
a way as to reduce over time B’s
reasonably expected liability for
Country X income tax. Accordingly,
$13,500 (3 percent of $450,000
($1,050,000 ¥ $600,000)), the amount of
Country X income tax remitted by B to
Country X that is attributable to the
purchase of the merchandise from B’s
parent at less than an arm’s length price,
is in excess of the amount of B’s liability
for Country X income tax, and thus is
not an amount of foreign income tax
paid.
(B) Example 2. A, a corporation
organized and doing business solely in
the United States, owns all of the stock
of B, a corporation organized in Country
X. Country X has in force an income tax
treaty with the United States. The tax
treaty provides that the profits of related
persons shall be determined as if the
persons were not related. A and B deal
extensively with each other. A and B,
with respect to a series of transactions
involving both of them, treat A as
having $300,000 of income and B as
having $700,000 of income for purposes
of A’s United States income tax and B’s
Country X income tax, respectively. B
has no actual or constructive notice that
its treatment of these transactions under
Country X tax law is likely to be
erroneous. Subsequently, the Internal
Revenue Service reallocates $200,000 of
this income from B to A under the
authority of section 482 and the tax
treaty. This reallocation constitutes
actual notice to A and constructive
notice to B that B’s interpretation and
application of Country X’s tax law and
the tax treaty is likely to be erroneous.
B does not exhaust all effective and
practical remedies to obtain a refund of
the amount remitted by B to Country X
that is attributable to the reallocated
$200,000 of income. Under paragraph
(e)(5)(i) of this section, this amount is in
excess of the amount of B’s liability for
Country X income tax and thus is not
an amount of foreign income tax paid.

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(C) Example 3. The facts are the same
as those in paragraph (e)(5)(vi)(B) of this
section (the facts in Example 2), except
that B files a claim for refund (an
administrative proceeding) of Country X
tax and A or B invokes the competent
authority procedures of the tax treaty,
the cost of which is reasonable in view
of the amount at issue and the
likelihood of success. Nevertheless, B
does not obtain any refund of Country
X income tax. The cost of pursuing any
judicial remedy in Country X would be
unreasonable in light of the amount at
issue and the likelihood of B’s success,
and B does not pursue any such remedy.
Under paragraph (e)(5)(i) of this section,
the entire amount paid by B to Country
X is a compulsory payment and thus is
an amount of foreign income tax paid by
B.
(D) Example 4. The facts are the same
as those in paragraph (e)(5)(vi)(B) of this
section (the facts in Example 2), except
that, when the Internal Revenue Service
makes the reallocation, the Country X
statute of limitations on refunds has
expired, and neither the internal law of
Country X nor the tax treaty authorizes
the Country X tax authorities to pay a
refund that is barred by the statute of
limitations. B does not file a claim for
refund, and neither A nor B invokes the
competent authority procedures of the
tax treaty. Because the Country X tax
authorities would be barred by the
statute of limitations from paying a
refund, B has no effective and practical
remedies. Under paragraph (e)(5)(i) of
this section, the entire amount paid by
B to Country X is a compulsory payment
and thus is an amount of foreign income
tax paid by B.
(E) Example 5. A is a U.S. person
doing business in Country X. In
computing its income tax liability to
Country X, A is permitted, at its
election, to recover the cost of
machinery used in its business either by
deducting that cost in the year of
acquisition or by depreciating that cost
on the straight-line method over a
period of 2, 4, 6 or 10 years. A elects to
depreciate machinery over 10 years.
This election merely shifts A’s tax
liability to different years (compared to
the timing of A’s tax liability under a
different depreciation period); it does
not result in a payment in excess of the
amount of A’s liability for Country X
income tax in any year since the amount
of Country X income tax paid by A is
consistent with a reasonable
interpretation of Country X tax law in
such a way as to reduce over time A’s
reasonably expected liability for
Country X income tax. Because the
standard of paragraph (e)(5)(i) of this
section refers to A’s reasonably expected

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liability, not its actual liability, events
actually occurring in subsequent years
(for example, whether A has sufficient
profit in such years so that such
depreciation deductions actually reduce
A’s Country X tax liability or whether
the Country X tax rates change) are
immaterial.
(F) Example 6. The domestic law of
Country X imposes a 25 percent tax
described in § 1.903–1(b) on the gross
amount of interest from sources in
Country X that is received by a
nonresident of Country X. Country X tax
law imposes the tax on the nonresident
recipient and requires any resident of
Country X that pays such interest to a
nonresident to withhold and pay over to
Country X 25 percent of such interest,
which is applied to offset the recipient’s
liability for the 25 percent tax. A tax
treaty between the United States and
Country X overrides domestic law of
Country X and provides that Country X
may not tax interest received by a
resident of the United States from a
resident of Country X at a rate in excess
of 10 percent of the gross amount of
such interest. A resident of the United
States may claim the benefit of the tax
treaty only by applying for a refund of
the excess withheld amount (15 percent
of the gross amount of interest income)
after the end of the taxable year. A, a
resident of the United States, receives a
gross amount of 100u (units of Country
X currency) of interest income from a
resident of Country X from sources in
Country X in Year 1, from which 25u of
Country X tax is withheld. A does not
file a timely claim for refund. Under
paragraph (e)(5)(i) of this section, 15u of
the amount withheld (25u ¥ 10u) is not
a compulsory payment and thus is not
an amount of foreign income tax paid.
(G) Example 7: Reasonable steps to
minimize creditable tax—larger
noncreditable tax cost—(1) Facts.
Corporations resident in Country X are
subject to a 20% generally applicable
net income tax, which qualifies as a
foreign income tax under paragraph
(a)(1)(ii) of this section (‘‘Income Tax’’),
and a separate levy equal to 25% of
certain deductible payments above a
specified threshold made to related
parties that are not residents of Country
X, which does not qualify as a foreign
income tax under paragraph (a)(1)(ii) of
this section (‘‘Base Erosion Tax’’). CFC,
a Country X corporation, makes
payments to nonresident related parties
that exceed the specified threshold of
the Base Erosion Tax by 100u (units of
Country X currency), which if claimed
as deductions would result in a Base
Erosion Tax of 25u (.25 × 100u), and
would also result in 300u of taxable
income for purposes of the Income Tax,

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thus resulting in Income Tax of 60u (.20
× 300u). If in computing its liability for
Income Tax CFC does not claim
deductions for the 100u of excess
related party payments, its liability for
the Base Erosion Tax would be zero, and
its liability for Income Tax would be
80u (.20 × 400u).
(2) Analysis. If CFC chooses not to
deduct the 100u of excess related party
payments that would subject it to the
Base Erosion Tax and pays 80u of
Income Tax, the amount of foreign
income tax paid under paragraph (e)(5)
of this section is 80u. Under paragraph
(e)(5)(i) of this section, although CFC
could reduce its liability for Income Tax
from 80u to 60u by claiming the
deductions, no portion of the Income
Tax remitted is a noncompulsory
payment because reducing the Income
Tax by 20u would incur a Base Erosion
Tax of 25u, which exceeds the amount
of the potential reduction.
(H) Example 8: Reasonable steps to
minimize creditable tax—smaller
noncreditable tax cost—(1) Facts. The
facts are the same as those in paragraph
(e)(5)(vi)(G)(1) of this section (the facts
in Example 7) except that the rate of the
Base Erosion Tax is 20% and the rate of
the Income Tax is 25%. Accordingly, if
CFC claims the 100u of excess
deductions its liability for Base Erosion
Tax would be 20u (.20 × 100u), and its
liability for Income Tax would be 75u
(.25 × 300u). If CFC chooses not to claim
the 100u of excess deductions its
liability for Base Erosion Tax would be
zero, and its liability for Income Tax
would be 100u (.25 × 400u).
(2) Analysis. If CFC chooses not to
claim the 100u of excess deductions in
computing its liability for Income Tax
and pays 100u of Income Tax, the
amount of foreign income tax paid
under paragraph (e)(5) of this section is
75u. CFC’s additional payment of 25u is
not an amount of Income Tax paid,
because CFC could have reduced its
Income Tax liability by 25u by claiming
the excess deductions and paying 20u of
Base Erosion Tax.
(I) Example 9: Alternative creditable
taxes—(1) Facts. The facts are the same
as those in paragraph (e)(5)(vi)(G)(1) of
this section (the facts in Example 7),
except that Country X does not have a
Base Erosion Tax, and it allows resident
corporations to elect to pay either the
Income Tax or a separate levy using an
alternative cost allowance (the
‘‘Alternative Tax’’), which qualifies as a
tax in lieu of an income tax under
§ 1.903–1(b)(2). CFC’s liability under the
Income Tax is 80u, and its liability
under the Alternative Tax is 100u. CFC
chooses to pay the 100u of Alternative
Tax rather than the 80u of Income Tax.

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(2) Analysis. Under paragraph
(e)(5)(iii)(C) of this section, the amount
of foreign income tax paid by CFC is
80u, the smaller of the amounts due
under the two alternative foreign
income taxes.
(vii) Structured passive investment
arrangements—(A) In general.
Notwithstanding paragraph (e)(5)(i) of
this section, an amount paid to a foreign
country (a ‘‘foreign payment’’) is not a
compulsory payment, and thus is not an
amount of foreign income tax paid, if
the foreign payment is attributable
(within the meaning of paragraph
(e)(5)(vii)(B)(1)(ii) of this section) to a
structured passive investment
arrangement (as described in paragraph
(e)(5)(vii)(B) of this section).
(B) Conditions. An arrangement is a
structured passive investment
arrangement if all of the following
conditions are satisfied:
(1) Special purpose vehicle (SPV). An
entity that is part of the arrangement
meets the following requirements:
(i) Substantially all of the gross
income (for U.S. tax purposes) of the
entity, if any, is passive investment
income, and substantially all of the
assets of the entity are assets held to
produce such passive investment
income.
(ii) There is a foreign payment
attributable to income of the entity (as
determined under the laws of the
foreign country to which such foreign
payment is made), including the entity’s
share of income of a lower-tier entity
that is a branch or pass-through entity
under the laws of such foreign country,
that, if the foreign payment were an
amount of foreign income tax paid,
would be paid in a U.S. taxable year in
which the entity meets the requirements
of paragraph (e)(5)(vii)(B)(1)(i) of this
section. A foreign payment attributable
to income of an entity includes a foreign
payment attributable to income that is
required to be taken into account by an
owner of the entity, if the entity is a
branch or pass-through entity under the
laws of such foreign country. A foreign
payment attributable to income of the
entity also includes a withholding tax
(within the meaning of section
901(k)(1)(B)) imposed on a dividend or
other distribution (including
distributions made by a pass-through
entity or an entity that is disregarded as
an entity separate from its owner for
U.S. tax purposes) with respect to the
equity of the entity.
(2) U.S. party. A person would be
eligible to claim a credit under section
901(a) (including a credit for foreign
taxes deemed paid under section 960)
for all or a portion of the foreign
payment described in paragraph

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(e)(5)(vii)(B)(1)(ii) of this section if the
foreign payment were an amount of
foreign income tax paid.
(3) Direct investment. The U.S. party’s
proportionate share of the foreign
payment or payments described in
paragraph (e)(5)(vii)(B)(1)(ii) of this
section is (or is expected to be)
substantially greater than the amount of
credits, if any, that the U.S. party
reasonably would expect to be eligible
to claim under section 901(a) for foreign
income taxes attributable to income
generated by the U.S. party’s
proportionate share of the assets owned
by the SPV if the U.S. party directly
owned such assets. For this purpose,
direct ownership shall not include
ownership through a branch, a
permanent establishment or any other
arrangement (such as an agency
arrangement or dual resident status) that
would result in the income generated by
the U.S. party’s proportionate share of
the assets being subject to tax on a net
basis in the foreign country to which the
payment is made. A U.S. party’s
proportionate share of the assets of the
SPV shall be determined by reference to
such U.S. party’s proportionate share of
the total value of all of the outstanding
interests in the SPV that are held by its
equity owners and creditors. A U.S.
party’s proportionate share of the assets
of the SPV, however, shall not include
any assets that produce income subject
to gross basis withholding tax.
(4) Foreign tax benefit. The
arrangement is reasonably expected to
result in a credit, deduction, loss,
exemption, exclusion or other tax
benefit under the laws of a foreign
country that is available to a
counterparty or to a person that is
related to the counterparty (determined
under the principles of paragraph
(e)(5)(vii)(C)(7) of this section by
applying the tax laws of a foreign
country in which the counterparty is
subject to tax on a net basis). However,
a foreign tax benefit in the form of a
credit is described in this paragraph
(e)(5)(vii)(B)(4) only if the amount of
any such credit corresponds to 10
percent or more of the amount of the
U.S. party’s share (for U.S. tax purposes)
of the foreign payment referred to in
paragraph (e)(5)(vii)(B)(1)(ii) of this
section. In addition, a foreign tax benefit
in the form of a deduction, loss,
exemption, exclusion or other tax
benefit is described in this paragraph
(e)(5)(vii)(B)(4) only if such amount
corresponds to 10 percent or more of the
foreign base with respect to which the
U.S. party’s share (for U.S. tax purposes)
of the foreign payment is imposed. For
purposes of the preceding two
sentences, if an arrangement involves

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more than one U.S. party or more than
one counterparty or both, the aggregate
amount of foreign tax benefits available
to all of the counterparties and persons
related to such counterparties is
compared to the aggregate amount of all
of the U.S. parties’ shares of the foreign
payment or foreign base, as the case may
be. Where a U.S. party indirectly owns
interests in an SPV that are treated as
equity interests for both U.S. and foreign
tax purposes, a foreign tax benefit
available to a foreign entity in the chain
of ownership that begins with the SPV
and ends with the first-tier entity in the
chain does not correspond to the U.S.
party’s share of the foreign payment
attributable to income of the SPV to the
extent that such benefit relates to
earnings of the SPV that are distributed
with respect to equity interests in the
SPV that are owned directly or
indirectly by the U.S. party for purposes
of both U.S. and foreign tax law.
(5) Counterparty. The arrangement
involves a counterparty. A counterparty
is a person that, under the tax laws of
a foreign country in which the person is
subject to tax on the basis of place of
management, place of incorporation or
similar criterion or otherwise subject to
a net basis tax, directly or indirectly
owns or acquires equity interests in, or
assets of, the SPV. However, a
counterparty does not include the SPV
or a person with respect to which for
U.S. tax purposes the same domestic
corporation, U.S. citizen or resident
alien individual directly or indirectly
owns more than 80 percent of the total
value of the stock (or equity interests) of
each of the U.S. party and such person.
A counterparty also does not include a
person with respect to which for U.S.
tax purposes the U.S. party directly or
indirectly owns more than 80 percent of
the total value of the stock (or equity
interests), but only if the U.S. party is
a domestic corporation, a U.S. citizen or
a resident alien individual. In addition,
a counterparty does not include an
individual who is a U.S. citizen or
resident alien.
(6) Inconsistent treatment. The United
States and an applicable foreign country
treat one or more of the aspects of the
arrangement listed in paragraph
(e)(5)(vii)(B)(6)(i) through (iv) of this
section differently under their
respective tax systems, and for one or
more tax years when the arrangement is
in effect one or both of the following
two conditions applies; either the
amount of income attributable to the
SPV that is recognized for U.S. tax
purposes by the SPV, the U.S. party or
parties, and persons related to a U.S.
party or parties is materially less than
the amount of income that would be

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recognized if the foreign tax treatment
controlled for U.S. tax purposes; or the
amount of credits claimed by the U.S.
party or parties (if the foreign payment
described in paragraph
(e)(5)(vii)(B)(1)(ii) of this section were
an amount of foreign income tax paid)
is materially greater than it would be if
the foreign tax treatment controlled for
U.S. tax purposes:
(i) The classification of the SPV (or an
entity that has a direct or indirect
ownership interest in the SPV) as a
corporation or other entity subject to an
entity-level tax, a partnership or other
flow-through entity or an entity that is
disregarded for tax purposes.
(ii) The characterization as debt,
equity or an instrument that is
disregarded for tax purposes of an
instrument issued by the SPV (or an
entity that has a direct or indirect
ownership interest in the SPV) to a U.S.
party, a counterparty or a person related
to a U.S. party or a counterparty.
(iii) The proportion of the equity of
the SPV (or an entity that directly or
indirectly owns the SPV) that is
considered to be owned directly or
indirectly by a U.S. party and a
counterparty.
(iv) The amount of taxable income
that is attributable to the SPV for one or
more tax years during which the
arrangement is in effect.
(C) Definitions. The following
definitions apply for purposes of
paragraph (e)(5)(vii) of this section.
(1) Applicable foreign country. An
applicable foreign country means each
foreign country to which a foreign
payment described in paragraph
(e)(5)(vii)(B)(1)(ii) of this section is made
or which confers a foreign tax benefit
described in paragraph (e)(5)(vii)(B)(4)
of this section.
(2) Counterparty. The term
counterparty means a person described
in paragraph (e)(5)(vii)(B)(5) of this
section.
(3) Entity. The term entity includes a
corporation, trust, partnership or
disregarded entity described in
§ 301.7701–2(c)(2)(i).
(4) Indirect ownership. Indirect
ownership of stock or another equity
interest (such as an interest in a
partnership) shall be determined in
accordance with the principles of
section 958(a)(2), regardless of whether
the interest is owned by a U.S. or
foreign entity.
(5) Passive investment income—(i) In
general. The term passive investment
income means income described in
section 954(c), as modified by this
paragraph (e)(5)(vii)(C)(5)(i) and
paragraph (e)(5)(vii)(C)(5)(ii) of this
section. In determining whether income

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is described in section 954(c),
paragraphs (c)(1)(H), (c)(3), and (c)(6) of
section 954 shall be disregarded.
Sections 954(c), 954(h), and 954(i) shall
be applied at the entity level as if the
entity (as defined in paragraph
(e)(5)(vii)(C)(3) of this section) were a
controlled foreign corporation (as
defined in section 957(a)). For purposes
of determining if sections 954(h) and
954(i) apply for purposes of this
paragraph (e)(5)(vii)(C)(5)(i) and
paragraph (e)(5)(vii)(C)(5)(ii) of this
section, any income of an entity
attributable to transactions that,
assuming the entity is an SPV, are with
a person that is a counterparty, or with
persons that are related to a
counterparty within the meaning of
paragraph (e)(5)(vii)(B)(4) of this
section, shall not be treated as qualified
banking or financing income or as
qualified insurance income, and shall
not be taken into account in applying
sections 954(h) and 954(i) for purposes
of determining whether other income of
the entity is excluded from section
954(c)(1) under section 954(h) or 954(i),
but only if any such person (or a person
that is related to such person within the
meaning of paragraph (e)(5)(vii)(B)(4) of
this section) is eligible for a foreign tax
benefit described in paragraph
(e)(5)(vii)(B)(4) of this section. In
addition, in applying section 954(h) for
purposes of this paragraph
(e)(5)(vii)(C)(5)(i) and paragraph
(e)(5)(vii)(C)(5)(ii) of this section, section
954(h)(3)(E) shall not apply, section
954(h)(2)(A)(ii) shall be satisfied only if
the entity conducts substantial activity
with respect to its business through its
own employees, and the term ‘‘any
foreign country’’ shall be substituted for
‘‘home country’’ wherever it appears in
section 954(h).
(ii) Income attributable to lower-tier
entities; holding company exception.
Income of an upper-tier entity that is
attributable to an equity interest in a
lower-tier entity, including dividends,
an allocable share of partnership
income, and income attributable to the
ownership of an interest in an entity
that is disregarded as an entity separate
from its owner is passive investment
income unless substantially all of the
upper-tier entity’s assets consist of
qualified equity interests in one or more
lower-tier entities, each of which is
engaged in the active conduct of a trade
or business and derives more than 50
percent of its gross income from such
trade or business, and substantially all
of the upper-tier entity’s opportunity for
gain and risk of loss with respect to each
such interest in a lower-tier entity is
shared by the U.S. party (or persons that

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are related to a U.S. party) and,
assuming the entity is an SPV, a
counterparty (or persons that are related
to a counterparty) (‘‘holding company
exception’’). If an arrangement involves
more than one U.S. party or more than
one counterparty or both, then
substantially all of the upper-tier
entity’s opportunity for gain and risk of
loss with respect to its interest in any
lower-tier entity must be shared
(directly or indirectly) by one or more
U.S. parties (or persons related to such
U.S. parties) and, assuming the uppertier entity is an SPV, one or more
counterparties (or persons related to
such counterparties). Substantially all of
the upper-tier entity’s opportunity for
gain and risk of loss with respect to its
interest in any lower-tier entity is not
shared if the opportunity for gain and
risk of loss is borne (directly or
indirectly) by one or more U.S. parties
(or persons related to such U.S. party or
parties) or, assuming the upper-tier
entity is an SPV, by one or more
counterparties (or persons related to
such counterparty or counterparties).
Whether and the extent to which a
person is considered to share in an
upper-tier entity’s opportunity for gain
and risk of loss is determined based on
all the facts and circumstances,
provided, however, that a person does
not share in an upper-tier entity’s
opportunity for gain and risk of loss if
its equity interest in the upper-tier
entity was acquired in a sale-repurchase
transaction or if its interest is treated as
debt for U.S. tax purposes. If a U.S.
party owns an interest in an entity
indirectly through a chain of entities,
the application of the holding company
exception begins with the lowest-tier
entity in the chain that may satisfy the
holding company exception and
proceeds upward; provided, however,
that the opportunity for gain and risk of
loss borne by any upper-tier entity in
the chain that is a counterparty shall be
disregarded to the extent borne
indirectly by a U.S. party. An upper-tier
entity that satisfies the holding
company exception is itself considered
to be engaged in the active conduct of
a trade or business and to derive more
than 50 percent of its gross income from
such trade or business for purposes of
applying the holding company
exception to the owners of such entity.
A lower-tier entity that is engaged in a
banking, financing, or similar business
shall not be considered to be engaged in
the active conduct of a trade or business
unless the income derived by such
entity would be excluded from section
954(c)(1) under section 954(h) or 954(i)

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as modified by paragraph
(e)(5)(vii)(C)(5)(i) of this section.
(6) Qualified equity interest. With
respect to an interest in a corporation,
the term qualified equity interest means
stock representing 10 percent or more of
the total combined voting power of all
classes of stock entitled to vote and 10
percent or more of the total value of the
stock of the corporation or disregarded
entity, but does not include any
preferred stock (as defined in section
351(g)(3)). Similar rules shall apply to
determine whether an interest in an
entity other than a corporation is a
qualified equity interest.
(7) Related person. Two persons are
related if—
(i) One person directly or indirectly
owns stock (or an equity interest)
possessing more than 50 percent of the
total value of the other person; or
(ii) The same person directly or
indirectly owns stock (or an equity
interest) possessing more than 50
percent of the total value of both
persons.
(8) Special purpose vehicle (SPV). The
term SPV means the entity described in
paragraph (e)(5)(vii)(B)(1) of this
section.
(9) U.S. party. The term U.S. party
means a person described in paragraph
(e)(5)(vii)(B)(2) of this section.
(D) Examples. The following
examples illustrate the rules of
paragraph (e)(5)(vii) of this section. No
inference is intended as to whether a
taxpayer would be eligible to claim a
credit under section 901(a) if a foreign
payment were an amount of foreign
income tax paid. The examples set forth
below do not limit the application of
other principles of existing law to
determine the proper tax consequences
of the structures or transactions
addressed in the regulations.
(1) Example 1: U.S. borrower
transaction—(i) Facts. A domestic
corporation (USP) forms a Country M
corporation (Newco), contributing $1.5
billion in exchange for 100% of the
stock of Newco. Newco, in turn, loans
the $1.5 billion to a second Country M
corporation (FSub) wholly owned by
USP. USP then sells its entire interest in
Newco to a Country M corporation (FP)
for the original purchase price of $1.5
billion, subject to an obligation to
repurchase the interest in five years for
$1.5 billion. The sale has the effect of
transferring ownership of the Newco
stock to FP for Country M tax purposes.
Assume the sale-repurchase transaction
is structured in a way that qualifies as
a collateralized loan for U.S. tax
purposes. Therefore, USP remains the
owner of the Newco stock for U.S. tax
purposes. All of FSub’s income is

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subpart F income. In Year 1, FSub pays
Newco $120 million of interest. Newco
pays $36 million to Country M with
respect to such interest income and
distributes the remaining $84 million to
FP. Under Country M law, the $84
million distribution is excluded from
FP’s income. None of FP’s stock is
owned, directly or indirectly, by USP or
any shareholders of USP that are
domestic corporations, U.S. citizens, or
resident alien individuals. Under an
income tax treaty between Country M
and the United States, Country M does
not impose Country M tax on interest
received by U.S. residents from sources
in Country M.
(ii) Result. The $36 million payment
by Newco to Country M is not a
compulsory payment, and thus is not an
amount of foreign income tax paid
because the foreign payment is
attributable to a structured passive
investment arrangement. First, Newco is
an SPV because all of Newco’s income
is passive investment income described
in paragraph (e)(5)(iv)(C)(5) of this
section; Newco’s only asset, a note, is
held to produce such income; the
payment to Country M is attributable to
such income; and if the payment were
an amount of foreign income tax paid it
would be paid in a U.S. taxable year in
which Newco meets the requirements of
paragraph (e)(5)(vii)(B)(1)(i) of this
section. Second, if the foreign payment
were treated as an amount of foreign
income tax paid, USP would be deemed
to pay the foreign payment under
section 960(a) and, therefore, would be
eligible to claim a credit for such
payment under section 901(a). Third,
USP would not pay any Country M tax
if it directly owned Newco’s loan
receivable. Fourth, the distribution from
Newco to FP is exempt from tax under
Country M law, and the exempt amount
corresponds to more than 10% of the
foreign base with respect to which
USP’s share (which is 100% under U.S.
tax law) of the foreign payment was
imposed. Fifth, FP is a counterparty
because FP owns stock of Newco under
Country M law and none of FP’s stock
is owned by USP or shareholders of USP
that are domestic corporations, U.S.
citizens, or resident alien individuals.
Sixth, FP is the owner of 100% of
Newco’s stock for Country M tax
purposes, while USP is the owner of
100% of Newco’s stock for U.S. tax
purposes, and the amount of credits
claimed by USP if the payment to
Country M were an amount of foreign
income tax paid is materially greater
than it would be if Country M tax
treatment controlled for U.S. tax
purposes such that FP, rather than USP,

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owned 100% of Newco’s stock. Because
the payment to Country M is not an
amount of foreign income tax paid, USP
is not deemed to pay any Country M tax
under section 960(a). USP includes $84
million in income under subpart F with
respect to Newco and also has interest
expense of $84 million. FSub’s income
and earnings and profits are reduced by
$120 million of interest expense.
(2) Example 2: U.S. borrower
transaction—(i) Facts. The facts are the
same as those in paragraph
(e)(5)(vii)(D)(1)(i) of this section (the
facts in Example 1), except that FSub is
a wholly-owned subsidiary of Newco. In
addition, assume FSub is engaged in the
active conduct of manufacturing and
selling widgets and derives more than
50% of its gross income from such
business.
(ii) Result. The result is the same as
in paragraph (e)(5)(vii)(D)(1)(ii) of this
section (the result in Example 1), except
that Newco’s income is tested income
rather than subpart F income, and if the
$36 million foreign payment were an
amount of foreign income tax paid USP
would be deemed to pay a portion of the
foreign payment under section 960(d),
rather than 960(a). Although Newco
wholly owns FSub, which is engaged in
the active conduct of manufacturing and
selling widgets and derives more than
50% of its income from such business,
Newco’s income that is attributable to
Newco’s equity interest in FSub is
passive investment income because the
sale-repurchase transaction limits FP’s
interest in Newco and its assets to that
of a creditor, so that substantially all of
Newco’s opportunity for gain and risk of
loss with respect to its stock in FSub is
borne by USP. See paragraph
(e)(5)(vii)(C)(5)(ii) of this section.
Accordingly, Newco’s stock in FSub is
held to produce passive investment
income. Thus, Newco is an SPV because
all of Newco’s income is passive
investment income described in
paragraph (e)(5)(vii)(C)(5) of this
section, Newco’s assets are held to
produce such income, the payment to
Country M is attributable to such
income, and if the payment were an
amount of foreign income tax paid it
would be paid in a U.S. taxable year in
which Newco meets the requirements of
paragraph (e)(5)(vii)(B)(1)(i) of this
section.
(3) Example 3: U.S. borrower
transaction—(i) Facts. A domestic
corporation (USP) loans $750 million to
its wholly-owned domestic subsidiary
(Sub). USP and Sub form a Country M
partnership (Partnership) to which each
contributes $750 million. Partnership
loans all of its $1.5 billion of capital to
Issuer, a wholly-owned Country M

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affiliate of USP, in exchange for a note
and coupons providing for the payment
of interest at a fixed rate over a five-year
term. Partnership sells all of the
coupons to Coupon Purchaser, a
Country N partnership owned by a
Country M corporation (Foreign Bank)
and a wholly-owned Country M
subsidiary of Foreign Bank, for $300
million. At the time of the coupon sale,
the fair market value of the coupons
sold is $290 million and, pursuant to
section 1286(b)(3), Partnership’s basis
allocated to the coupons sold is $290
million. Several months later and prior
to any interest payments on the note,
Foreign Bank and its subsidiary sell all
of their interests in Coupon Purchaser to
an unrelated Country O corporation for
$280 million. None of Foreign Bank’s
stock or its subsidiary’s stock is owned,
directly or indirectly, by USP or Sub or
by any shareholders of USP or Sub that
are domestic corporations, U.S. citizens,
or resident alien individuals. Assume
that both the United States and Country
M respect the sale of the coupons for tax
law purposes. In the year of the coupon
sale, for Country M tax purposes USP’s
and Sub’s shares of Partnership’s profits
total $300 million, a payment of $60
million to Country M is made with
respect to those profits, and Foreign
Bank and its subsidiary, as partners of
Coupon Purchaser, are entitled to
deduct the $300 million purchase price
of the coupons from their taxable
income. For U.S. tax purposes, USP and
Sub recognize their distributive shares
of the $10 million premium income and
claim a direct foreign tax credit for their
shares of the $60 million payment to
Country M. Country M imposes no
additional tax when Foreign Bank and
its subsidiary sell their interests in
Coupon Purchaser. Country M also does
not impose Country M tax on interest
received by U.S. residents from sources
in Country M.
(ii) Result. The payment to Country M
is not a compulsory payment, and thus
is not an amount of foreign income tax
paid, because the foreign payment is
attributable to a structured passive
investment arrangement. First,
Partnership is an SPV because all of
Partnership’s income is passive
investment income described in
paragraph (e)(5)(vii)(C)(5) of this
section; Partnership’s only asset,
Issuer’s note, is held to produce such
income; the payment to Country M is
attributable to such income; and if the
payment were an amount of foreign
income tax paid, it would be paid in a
U.S. taxable year in which Partnership
meets the requirements of paragraph
(e)(5)(vii)(B)(1)(i) of this section.

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Second, if the foreign payment were an
amount of tax paid, USP and Sub would
be eligible to claim a credit for such
payment under section 901(a). Third,
USP and Sub would not pay any
Country M tax if they directly owned
Issuer’s note. Fourth, for Country M tax
purposes, Foreign Bank and its
subsidiary deduct the $300 million
purchase price of the coupons and are
exempt from Country M tax on the $280
million received upon the sale of
Coupon Purchaser, and the deduction
and exemption correspond to more than
10% of the $300 million base with
respect to which USP’s and Sub’s 100%
share of the foreign payments was
imposed. Fifth, Foreign Bank and its
subsidiary are counterparties because
they indirectly acquired assets of
Partnership, the interest coupons on
Issuer’s note, and are not directly or
indirectly owned by USP or Sub or
shareholders of USP or Sub that are
domestic corporations, U.S. citizens, or
resident alien individuals. Sixth, the
amount of taxable income of Partnership
for one or more years is different for
U.S. and Country M tax purposes, and
the amount of income attributable to
USP and Sub for U.S. tax purposes is
materially less than the amount of
income they would recognize if the
Country M tax treatment of the coupon
sale controlled for U.S. tax purposes.
Because the payment to Country M is
not an amount of foreign income tax
paid, USP and Sub are not considered
to pay tax under section 901. USP and
Sub have income of $10 million in the
year of the coupon sale.
(4) Example 4: Active business; no
SPV—(i) Facts. A, a domestic
corporation, wholly owns B, a Country
X corporation engaged in the
manufacture and sale of widgets. On
January 1, Year 1, C, also a Country X
corporation, loans $400 million to B in
exchange for an instrument that is debt
for U.S. tax purposes and equity in B for
Country X tax purposes. As a result, C
is considered to own stock of B for
Country X tax purposes. B loans $55
million to D, a Country Y corporation
wholly owned by A. In year 1, B has
$166 million of net income attributable
to its sales of widgets and $3.3 million
of interest income attributable to the
loan to D. Substantially all of B’s assets
are used in its widget business. Country
Y does not impose tax on interest paid
to nonresidents. B makes a payment of
$50.8 million to Country X with respect
to B’s net income. Country X does not
impose tax on dividend payments
between Country X corporations. None
of C’s stock is owned, directly or
indirectly, by A or by any shareholders

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351

of A that are domestic corporations, U.S.
citizens, or resident alien individuals.
(ii) Result. B is not an SPV within the
meaning of paragraph (e)(5)(vii)(B)(1) of
this section because the amount of
interest income received from D does
not constitute substantially all of B’s
income and the $55 million note from
D does not constitute substantially all of
B’s assets. Accordingly, the $50.8
million payment to Country X is not
attributable to a structured passive
investment arrangement.
(5) Example 5: U.S. lender
transaction—(i) Facts. A Country X
corporation (Foreign Bank) contributes
$2 billion to a newly-formed Country X
company (Newco) in exchange for 90%
of the common stock of Newco and
securities that are treated as debt of
Newco for U.S. tax purposes and
preferred stock of Newco for Country X
tax purposes. A domestic corporation
(USP) contributes $1 billion to Newco in
exchange for 10% of Newco’s common
stock and securities that are treated as
preferred stock of Newco for U.S. tax
purposes and debt of Newco for Country
X tax purposes. Newco loans the $3
billion to a wholly-owned, Country X
subsidiary of Foreign Bank (FSub) in
return for a $3 billion, seven-year note
paying interest currently. The Newco
securities held by USP represent more
than 50% of the voting power in Newco
and more than 50% of the value of the
securities in Newco that are treated as
equity for U.S. tax purposes. The Newco
securities held by USP entitle the holder
to fixed distributions of $4 million per
year, and the Newco securities held by
Foreign Bank entitle the holder to
receive $82 million per year, payable
only on maturity of the $3 billion FSub
note in Year 7. At the end of Year 5,
pursuant to a prearranged plan, Foreign
Bank acquires USP’s Newco stock and
securities for a prearranged price of $1
billion. Country X does not impose tax
on dividends received by one Country X
corporation from a second Country X
corporation. Under an income tax treaty
between Country X and the United
States, Country X does not impose
Country X tax on interest received by
U.S. residents from sources in Country
X. None of Foreign Bank’s stock is
owned, directly or indirectly, by USP or
any shareholders of USP that are
domestic corporations, U.S. citizens, or
resident alien individuals. In each of
Years 1 through 7, FSub pays Newco
$124 million of interest on the $3 billion
note. Newco distributes $4 million to
USP in each of Years 1 through 5. The
distributions are deductible for Country
X tax purposes, and Newco pays
Country X $36 million with respect to
$120 million of taxable income from the

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FSub note in each year. For U.S. tax
purposes, in each year Newco’s subpart
F income and earnings and profits are
increased by $124 million of interest
income and reduced by accrued interest
expense with respect to the Newco
securities held by Foreign Bank.
(ii) Result. The $36 million payment
to Country X is not a compulsory
payment, and thus is not an amount of
foreign income tax paid, because the
foreign payment is attributable to a
structured passive investment
arrangement. First, Newco is an SPV
because all of Newco’s income is
passive investment income described in
paragraph (e)(5)(vii)(C)(5) of this
section; Newco’s only asset, a note of
FSub, is held to produce such income;
the payment to Country X is attributable
to such income; and if the payment
were an amount of foreign income tax
paid it would be paid in a U.S. taxable
year in which Newco meets the
requirements of paragraph
(e)(5)(vii)(B)(1)(i) of this section.
Second, if the foreign payment were an
amount of foreign income tax paid, USP
would be deemed to pay its pro rata
share of the foreign payment under
section 960(a) in each of Years 1
through 5 and, therefore, would be
eligible to claim a credit under section
901(a). Third, USP would not pay any
Country X tax if it directly owned its
proportionate share of Newco’s assets, a
note of FSub. Fourth, for Country X tax
purposes, Foreign Bank is eligible to
receive a tax-free distribution of $82
million attributable to each of Years 1
through 5, and that amount corresponds
to more than 10% of the foreign base
with respect to which USP’s share of the
foreign payment was imposed. Fifth,
Foreign Bank is a counterparty because
it owns stock of Newco for Country X
tax purposes and none of Foreign Bank’s
stock is owned, directly or indirectly, by
USP or shareholders of USP that are
domestic corporations, U.S. citizens, or
resident alien individuals. Sixth, the
United States and Country X treat
various aspects of the arrangement
differently, including whether the
Newco securities held by Foreign Bank
and USP are debt or equity. The amount
of credits claimed by USP if the
payment to Country X were an amount
of foreign income tax paid is materially
greater than it would be if the Country
X tax treatment controlled for U.S. tax
purposes such that the securities held
by USP were treated as debt or the
securities held by Foreign Bank were
treated as equity, and the amount of
income recognized by Newco for U.S.
tax purposes is materially less than the
amount of income recognized for

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Country X tax purposes. Because the
payment to Country X is not an amount
of foreign income tax paid, USP is not
deemed to pay any Country X tax under
section 960(a). USP has a subpart F
inclusion of $4 million in each of Years
1 through 5.
(6) Example 6: Holding company; no
SPV—(i) Facts. A, a Country X
corporation, and B, a domestic
corporation, each contribute $1 billion
to a newly-formed Country X entity (C)
in exchange for 50% of the common
stock of C. C is treated as a corporation
for Country X purposes and a
partnership for U.S. tax purposes. C
contributes $1.95 billion to a newlyformed Country X corporation (D) in
exchange for 100% of D’s common
stock. C loans its remaining $50 million
to D. Accordingly, C’s sole assets are
stock and debt of D. D uses the entire
$2 billion to engage in the business of
manufacturing and selling widgets. In
Year 1, D derives $300 million of
income from its widget business and
derives $2 million of interest income.
Also in Year 1, C has dividend income
of $200 million and interest income of
$3.2 million with respect to its
investment in D. Country X does not
impose tax on dividends received by
one Country X corporation from a
second Country X corporation. C makes
a payment of $960,000 to Country X
with respect to C’s net income.
(ii) Result. C qualifies for the holding
company exception described in
paragraph (e)(5)(vii)(C)(5)(ii) of this
section because C holds a qualified
equity interest in D, D is engaged in an
active trade or business and derives
more than 50% of its gross income from
such trade or business, C’s interest in D
constitutes substantially all of C’s assets,
and A and B share in substantially all
of C’s opportunity for gain and risk of
loss with respect to D. As a result, C’s
dividend income from D is not passive
investment income and C’s stock in D is
not held to produce such income.
Accordingly, C is not an SPV within the
meaning of paragraph (e)(5)(vii)(B)(1) of
this section, and the $960,000 payment
to Country X is not attributable to a
structured passive investment
arrangement.
(7) Example 7: Holding company; no
SPV—(i) Facts. The facts are the same as
those in paragraph (e)(5)(vii)(D)(6)(i) of
this section (the facts in Example 6),
except that instead of loaning $50
million to D, C contributes the $50
million to E in exchange for 10% of the
stock of E. E is a Country Y corporation
that is not engaged in the active conduct
of a trade or business. Also in Year 1,
D pays no dividends to C, E pays $3.2
million in dividends to C, and C makes

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a payment of $960,000 to Country X
with respect to C’s net income.
(ii) Result. C qualifies for the holding
company exception described in
paragraph (e)(5)(vii)(C)(5)(ii) of this
section because C holds a qualified
equity interest in D, D is engaged in an
active trade or business and derives
more than 50% of its gross income from
such trade or business, C’s interest in D
constitutes substantially all of C’s assets,
and A and B share in substantially all
of C’s opportunity for gain and risk of
loss with respect to D. As a result, less
than substantially all of C’s assets are
held to produce passive investment
income. Accordingly, C is not an SPV
because it does not meet the
requirements of paragraph
(e)(5)(vii)(B)(1) of this section, and the
$960,000 payment to Country X is not
attributable to a structured passive
investment arrangement.
(8) Example 8: Holding company; no
SPV—(i) Facts. The facts are the same as
those in paragraph (e)(5)(vii)(D)(6)(i) of
this section (the facts in Example 6),
except that B’s $1 billion investment in
C consists of 30% of C’s common stock
and 100% of C’s preferred stock. A’s $1
billion investment in C consists of 70%
of C’s common stock. B sells its
preferred stock to F, a Country X
corporation, subject to a repurchase
obligation. Assume that under Country
X tax law, but not U.S. tax law, F is
treated as the owner of the preferred
shares and receives a distribution in
Year 1 of $50 million. The remaining
earnings are distributed 70% to A and
30% to B.
(ii) Result. C qualifies for the holding
company exception described in
paragraph (e)(5)(vii)(C)(5)(ii) of this
section because C holds a qualified
equity interest in D, D is engaged in an
active trade or business and derives
more than 50% of its gross income from
such trade or business, and C’s interest
in D constitutes substantially all of C’s
assets. Additionally, although F does
not share in C’s opportunity for gain and
risk of loss with respect to C’s interest
in D because F acquired its interest in
C in a sale-repurchase transaction, B
(the U.S. party) and in the aggregate A
and F (who would be counterparties
assuming C were an SPV) share in
substantially all of C’s opportunity for
gain and risk of loss with respect to D
and such opportunity for gain and risk
of loss is not borne exclusively either by
B or by A and F in the aggregate.
Accordingly, C’s shares in D are not
held to produce passive investment
income and the $200 million dividend
from D is not passive investment
income. C is not an SPV within the
meaning of paragraph (e)(5)(vii)(B)(1) of

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this section, and the $960,000 payment
to Country X is not attributable to a
structured passive investment
arrangement.
(9) Example 9: Asset holding
transaction—(i) Facts. A domestic
corporation (USP) contributes $6 billion
of Country Z debt obligations to a
Country Z entity (DE) in exchange for all
of the class A and class B stock of DE.
DE is a disregarded entity for U.S. tax
purposes and a corporation for Country
Z tax purposes. A corporation unrelated
to USP and organized in Country Z (FC)
contributes $1.5 billion to DE in
exchange for all of the class C stock of
DE. DE uses the $1.5 billion contributed
by FC to redeem USP’s class B stock.
The terms of the class C stock entitle its
holder to all income from DE, but FC is
obligated immediately to contribute
back to DE all distributions on the class
C stock. USP and FC enter into a
contract under which USP agrees to buy
after five years the class C stock for $1.5
billion and an agreement under which
USP agrees to pay FC periodic payments
on $1.5 billion. The transaction is
structured in such a way that, for U.S.
tax purposes, there is a loan of $1.5
billion from FC to USP, and USP is the
owner of the class C stock and the class
A stock. In Year 1, DE earns $400
million of interest income on the
Country Z debt obligations. DE makes a
payment to Country Z of $100 million
with respect to such income and
distributes the remaining $300 million
to FC. FC contributes the $300 million
back to DE. None of FC’s stock is
owned, directly or indirectly, by USP or
shareholders of USP that are domestic
corporations, U.S. citizens, or resident
alien individuals. Assume that Country
Z imposes a withholding tax on interest
income derived by U.S. residents.
Country Z treats FC as the owner of the
class C stock. Pursuant to Country Z tax
law, FC is required to report the $400
million of income with respect to the
$300 million distribution from DE, but
is allowed to claim credits for DE’s $100
million payment to Country Z. For
Country Z tax purposes, FC is entitled
to current deductions equal to the $300
million contributed back to DE.
(ii) Result. The payment to Country Z
is not a compulsory payment, and thus
is not an amount of foreign income tax
paid, because the payment is
attributable to a structured passive
investment arrangement. First, DE is an
SPV because all of DE’s income is
passive investment income described in
paragraph (e)(5)(vii)(C)(5) of this
section; all of DE’s assets are held to
produce such income; the payment to
Country Z is attributable to such
income; and if the payment were an

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amount of tax paid it would be paid in
a U.S. taxable year in which DE meets
the requirements of paragraph
(e)(5)(vii)(B)(1)(i) of this section.
Second, if the payment were an amount
of foreign income tax paid, USP would
be eligible to claim a credit for such
amount under section 901(a). Third,
USP’s proportionate share of DE’s
foreign payment of $100 million is
substantially greater than the amount of
credits USP would be eligible to claim
if it directly held its proportionate share
of DE’s assets, excluding any assets that
would produce income subject to gross
basis withholding tax if directly held by
USP. Fourth, FC is entitled to claim a
credit under Country Z tax law for the
payment and recognizes a deduction for
the $300 million contributed to DE
under Country Z law. The credit
claimed by FC corresponds to more than
10% of USP’s share (for U.S. tax
purposes) of the foreign payment and
the deductions claimed by FC
correspond to more than 10% of the
base with respect to which USP’s share
of the foreign payment was imposed.
Fifth, FC is a counterparty because FC
is considered to own equity of DE under
Country Z law and none of FC’s stock
is owned, directly or indirectly, by USP
or shareholders of USP that are
domestic corporations, U.S. citizens, or
resident alien individuals. Sixth, the
United States and Country Z treat
certain aspects of the transaction
differently, including the proportion of
equity owned in DE by USP and FC, and
the amount of credits claimed by USP
if the Country Z payment were an
amount of tax paid is materially greater
than it would be if the Country Z tax
treatment controlled for U.S. tax
purposes such that FC, rather than USP,
owned the class C stock. Because the
payment to Country Z is not an amount
of foreign income tax paid, USP is not
considered to pay tax under section 901.
USP has $400 million of interest
income.
(10) Example 10: Loss surrender—(i)
Facts. The facts are the same as those in
paragraph (e)(5)(vii)(D)(9)(i) of this
section (the facts in Example 9), except
that the deductions attributable to the
arrangement contribute to a loss
recognized by FC for Country Z tax
purposes, and pursuant to a group relief
regime in Country Z FC elects to
surrender the loss to its Country Z
subsidiary.
(ii) Result. The results are the same as
in paragraph (e)(5)(vii)(D)(9)(ii) of this
section (the results in Example 9). The
surrender of the loss to a related party
is a foreign tax benefit that corresponds
to the base with respect to which USP’s

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share of the foreign payment was
imposed.
(11) Example 11: Joint venture; no
foreign tax benefit—(i) Facts. FC, a
Country X corporation, and USC, a
domestic corporation, each contribute
$1 billion to a newly-formed Country X
entity (C) in exchange for stock of C. FC
and USC are entitled to equal 50%
shares of all of C’s income, gain,
expense and loss. C is treated as a
corporation for Country X purposes and
a partnership for U.S. tax purposes. In
Year 1, C earns $200 million of net
passive investment income, makes a
payment to Country X of $60 million
with respect to that income, and
distributes $70 million to each of FC
and USC. Country X does not impose
tax on dividends received by one
Country X corporation from a second
Country X corporation.
(ii) Result. FC’s tax-exempt receipt of
$70 million, or its 50% share of C’s
profits, is not a foreign tax benefit
within the meaning of paragraph
(e)(5)(vii)(B)(4) of this section because it
does not correspond to any part of the
foreign base with respect to which
USC’s share of the foreign payment was
imposed. Accordingly, the $60 million
payment to Country X is not attributable
to a structured passive investment
arrangement.
(12) Example 12: Joint venture; no
foreign tax benefit—(i) Facts. The facts
are the same as those in paragraph
(e)(5)(vii)(D)(11)(i) of this section (the
facts in Example 11), except that C in
turn contributes $2 billion to a whollyowned and newly-formed Country X
entity (D) in exchange for stock of D. D
is treated as a corporation for Country
X purposes and disregarded as an entity
separate from its owner for U.S. tax
purposes. C has no other assets and
earns no other income. In Year 1, D
earns $200 million of passive
investment income, makes a payment to
Country X of $60 million with respect
to that income, and distributes $140
million to C.
(ii) Result. C’s tax-exempt receipt of
$140 million is not a foreign tax benefit
within the meaning of paragraph
(e)(5)(vii)(B)(4) of this section because it
does not correspond to any part of the
foreign base with respect to which
USC’s share of the foreign payment was
imposed. Fifty percent of C’s foreign tax
exemption is not a foreign tax benefit
within the meaning of paragraph
(e)(5)(vii)(B)(4) of this section because it
relates to earnings of D that are
distributed with respect to an equity
interest in D that is owned indirectly by
USC under both U.S. and foreign tax
law. The remaining 50% of C’s foreign
tax exemption, as well as FC’s tax-

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exempt receipt of $70 million from C, is
also not a foreign tax benefit because it
does not correspond to any part of the
foreign base with respect to which
USC’s share of the foreign payment was
imposed. Accordingly, the $60 million
payment to Country X is not attributable
to a structured passive investment
arrangement.
(6) Soak-up taxes—(i) In general. An
amount remitted to a foreign country is
not an amount of foreign income tax
paid to the extent that liability for the
foreign income tax is dependent (by its
terms or otherwise) on the availability of
a credit for the tax against income tax
liability to another country. Liability for
foreign income tax is dependent on the
availability of a credit for the foreign
income tax against income tax liability
to another country only if and to the
extent that the foreign income tax would
not be imposed but for the availability
of such a credit.
(ii) Examples. The following
examples illustrate the application of
paragraph (e)(6)(i) of this section.
(A) Example 1: Tax rates dependent
on availability of credit—(1) Facts.
Country X imposes a tax on the receipt
of royalties from sources in Country X
by nonresidents of Country X. The tax
is 15% of the gross amount of such
royalties unless the recipient is a
resident of the United States or of
country A, B, C, or D, in which case the
tax is 20% of the gross amount of such
royalties. Like the United States, each of
countries A, B, C, and D allows its
residents a credit against the income tax
otherwise payable to it for income taxes
paid to other countries.
(2) Analysis. Because the 20% rate
applies only to residents of countries
that allow a credit for taxes paid to other
countries and the 15% rate applies to
residents of countries that do not allow
such a credit, one-fourth of the Country
X tax would not be imposed on
residents of the United States but for the
availability of such a credit. One-fourth
of the Country X tax imposed on
residents of the United States who
receive royalties from sources in
Country X is dependent on the
availability of a credit for the Country X
tax against income tax liability to
another country and, accordingly, under
paragraph (e)(6)(i) of this section that
amount is not an amount of foreign
income tax paid.
(B) Example 2: Tax not dependent on
availability of credit—(1) Facts. Country
X imposes a net income tax on the
realized net income of nonresidents of
Country X from carrying on a trade or
business in Country X. Although
Country X tax law does not prohibit
other nonresidents from carrying on

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business in Country X, United States
persons are the only nonresidents of
Country X that carry on business in
Country X. The Country X tax would be
imposed in its entirety on a nonresident
of Country X irrespective of the
availability of a credit for the Country X
tax against income tax liability to
another country.
(2) Analysis. Because no portion of
the Country X tax liability is dependent
on the availability of a credit for such
tax in another country, under paragraph
(e)(6)(i) of this section no portion of the
Country X tax is a soak-up tax.
(C) Example 3: Tax holiday denied to
corporations with shareholders eligible
for credit—(1) Facts. Country X imposes
a net income tax on the realized net
income of all corporations incorporated
in Country X. Country X allows a tax
holiday to qualifying corporations
incorporated in Country X that are
owned by nonresidents of Country X,
pursuant to which no Country X tax is
imposed on the net income of a
qualifying corporation for the first 10
years of its operations in Country X. A
corporation qualifies for the tax holiday
if it meets certain minimum investment
criteria and if the development office of
Country X certifies that in its opinion
the operations of the corporation will be
consistent with specified development
goals of Country X. The development
office will not issue this certification to
any corporation owned by persons
resident in countries that allow a credit
to shareholders (such as a deemed paid
credit under section 960) for Country X
tax paid by a corporation incorporated
in Country X. In practice, tax holidays
are granted to a large number of
corporations, but the Country X net
income tax is imposed on a significant
number of other corporations
incorporated in Country X (for example,
those owned by Country X persons and
those which have had operations for
more than 10 years) in addition to
corporations denied a tax holiday
because their shareholders qualify for a
credit for the Country X tax against
income tax liability to another country.
(2) Analysis. Under paragraph (e)(6)(i)
of this section, no portion of the
Country X tax paid by Country X
corporations denied a tax holiday
because they have U.S. shareholders is
dependent on the availability of a credit
for the Country X tax against income tax
liability to another country, because a
significant number of other Country X
corporations pay the Country X tax
irrespective of the availability of a credit
to their shareholders.
(D) Example 4: Tax deferral allowed
for corporations with shareholders
eligible for credit—(1) Facts. The facts

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are the same as those in paragraph
(e)(6)(ii)(C)(1) of this section (the facts of
Example 3), except that Country X
corporations owned by persons resident
in countries that allow a credit for
Country X tax when dividends are
distributed by the corporations are
granted a provisional tax holiday. Under
the provisional tax holiday, instead of
relieving such a corporation from
Country X tax for 10 years, liability for
such tax is deferred until the Country X
corporation distributes dividends.
(2) Analysis. Because a significant
number of other Country X corporations
pay the Country X tax irrespective of the
availability of a credit to their
shareholders, the result is the same as
in paragraph (e)(6)(ii)(C)(2) of this
section.
(E) Example 5: Tax based on greater
of tax in lieu of income tax or amount
eligible for credit—(1) Facts. Pursuant to
a contract with Country X, A, a
domestic corporation engaged in
manufacturing activities in Country X,
must pay tax to Country X equal to the
greater of 5u (units of Country X
currency) per item produced, or the
maximum amount creditable by A
against its U.S. income tax liability for
that year with respect to income from its
Country X operations. Also pursuant to
the contract, A is exempted from
Country X’s otherwise generallyimposed net income tax. The
contractual tax is a tax in lieu of income
tax as defined in § 1.903–1(b). In Year 1,
A produces 16 items, which would
result in Country X tax of 16 × 5u = 80u,
and taking into account the section 904
limitation, the maximum amount of
Country X tax that A can claim as a
credit against its U.S. income tax
liability is 125u. Accordingly, A’s
contractual liability for Country X tax in
lieu of income tax is 125u, the greater
of the two amounts.
(2) Analysis. Under paragraph (e)(6)(i)
of this section, the amount of tax paid
by A that is dependent on the
availability of a credit against income
tax of another country is 125u¥80u =
45u, the amount that would not be
imposed but for the availability of a
credit.
(f) * * *
(2) * * *
(ii) Examples. The following
examples illustrate the rules of
paragraphs (f)(1) and (2)(i) of this
section.
(A) Example 1. Under a loan
agreement between A, a resident of
Country X, and B, a United States
person, A agrees to pay B a certain
amount of interest net of any tax that
Country X may impose on B with
respect to its interest income. Country X

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imposes a 10 percent tax on the gross
amount of interest income received by
nonresidents of Country X from sources
in Country X, and it is established that
this tax is a tax in lieu of an income tax
within the meaning of § 1.903–1(b).
Under the law of Country X this tax is
imposed on the nonresident recipient,
and any resident of Country X that pays
such interest to a nonresident is
required to withhold and pay over to
Country X 10 percent of the amount of
such interest, which is applied to offset
the recipient’s liability for the tax.
Because legal liability for the tax is
imposed on the recipient of such
interest income, B is the taxpayer with
respect to the Country X tax imposed on
B’s interest income from B’s loan to A.
Accordingly, B’s interest income for
Federal income tax purposes includes
the amount of Country X tax that is
imposed on B with respect to such
interest income and that is paid on B’s
behalf by A pursuant to the loan
agreement, and, under paragraph (f)(2)(i)
of this section, such tax is considered
for purposes of section 903 to be paid
by B.
(B) Example 2. The facts are the same
as those in paragraph (f)(2)(ii)(A) of this
section (the facts in Example 1), except
that in collecting and receiving the
interest B is acting as a nominee for, or
agent of, C, who is a United States
person. Because C (not B) is the
beneficial owner of the interest, legal
liability for the tax is imposed on C, not
B (C’s nominee or agent). Thus, C is the
taxpayer with respect to the Country X
tax imposed on C’s interest income from
C’s loan to A. Accordingly, C’s interest
income for Federal income tax purposes
includes the amount of Country X tax
that is imposed on C with respect to
such interest income and that is paid on
C’s behalf by A pursuant to the loan
agreement. Under paragraph (f)(2)(i) of
this section, such tax is considered for
purposes of section 903 to be paid by C.
No such tax is considered paid by B.
(C) Example 3. Country X imposes a
tax called the ‘‘Country X income tax.’’
A, a United States person engaged in
construction activities in Country X, is
subject to that tax. Country X has
contracted with A for A to construct a
naval base. A is a dual capacity taxpayer
(as defined in paragraph (a)(2)(ii)(A) of
this section) and, in accordance with
paragraphs (a)(1) and (c)(1) of § 1.901–
2A, A has established that the Country
X income tax as applied to dual capacity
persons and the Country X income tax
as applied to persons other than dual
capacity persons together constitute a
single levy. A has also established that
that levy is a net income tax within the
meaning of paragraph (a)(3) of this

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section. Pursuant to the terms of the
contract, Country X has agreed to
assume any Country X tax liability that
A may incur with respect to A’s income
from the contract. For Federal income
tax purposes, A’s income from the
contract includes the amount of tax
liability that is imposed by Country X
on A with respect to its income from the
contract and that is assumed by Country
X; and for purposes of section 901 the
amount of such tax liability assumed by
Country X is considered to be paid by
A. By reason of paragraph (f)(2)(i) of this
section, Country X is not considered to
provide a subsidy, within the meaning
of paragraph (e)(3) of this section, to A.
*
*
*
*
*
(4) Taxes imposed on partnerships
and disregarded entities—(i)
Partnerships. If foreign law imposes tax
at the entity level on the income of a
partnership, the partnership is
considered to be legally liable for such
tax under foreign law and therefore is
considered to pay the tax for Federal
income tax purposes. The rules of this
paragraph (f)(4)(i) apply regardless of
which person is obligated to remit the
tax, which person actually remits the
tax, or which person the foreign country
could proceed against to collect the tax
in the event all or a portion of the tax
is not paid. See §§ 1.702–1(a)(6) and
1.704–1(b)(4)(viii) for rules relating to
the determination of a partner’s
distributive share of such tax.
(ii) Disregarded entities. If foreign law
imposes tax at the entity level on the
income of an entity described in
§ 301.7701–2(c)(2)(i) of this chapter (a
disregarded entity), the person (as
defined in section 7701(a)(1)) who is
treated as owning the assets of the
disregarded entity for Federal income
tax purposes is considered to be legally
liable for such tax under foreign law.
Such person is considered to pay the tax
for Federal income tax purposes. The
rules of this paragraph (f)(4)(ii) apply
regardless of which person is obligated
to remit the tax, which person actually
remits the tax, or which person the
foreign country could proceed against to
collect the tax in the event all or a
portion of the tax is not paid.
(5) Allocation of taxes in the case of
certain ownership or classification
changes—(i) In general. If a partnership,
disregarded entity, or corporation
undergoes one or more covered events
during its foreign taxable year that do
not result in a closing of the foreign
taxable year, then a portion of the
foreign income tax (other than a
withholding tax described in section
901(k)(1)(B)) paid by a person under
paragraphs (f)(1) through (4) of this

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355

section with respect to the continuing
foreign taxable year in which such
covered event or events occur is
allocated to and among all persons that
were predecessor entities or prior
owners during such foreign taxable year.
The allocation is made based on the
respective portions of the taxable
income (as determined under foreign
law) for the continuing foreign taxable
year that are attributable under the
principles of § 1.1502–76(b) to the
period of existence or ownership of each
predecessor entity or prior owner during
the continuing foreign taxable year.
Foreign income tax allocated to a person
that is a predecessor entity is treated
(other than for purposes of section 986)
as paid by the person as of the close of
the last day of its last U.S. taxable year.
Foreign income tax allocated to a person
that is a prior owner, for example a
transferor of a disregarded entity, is
treated (other than for purposes of
section 986) as paid by the person as of
the close of the last day of its U.S.
taxable year in which the covered event
occurred.
(ii) Covered event. For purposes of
this paragraph (f)(5), a covered event is
a partnership termination under section
708(b)(1), a transfer of a disregarded
entity, or a change in the entity
classification of a disregarded entity or
a corporation.
(iii) Predecessor entity and prior
owner. For purposes of this paragraph
(f)(5), a predecessor entity is a
partnership or a corporation that
undergoes a covered event as described
in paragraph (f)(5)(ii) of this section. A
prior owner is a person that either
transfers a disregarded entity or owns a
disregarded entity immediately before a
change in the entity classification of the
disregarded entity as described in
paragraph (f)(5)(ii) of this section.
(iv) Partnership variances. In the case
of a change in any partner’s interest in
the partnership (a variance), except as
otherwise provided in section 706(d)(2)
(relating to certain cash basis items) or
706(d)(3) (relating to tiered
partnerships), foreign tax paid by the
partnership during its U.S. taxable year
in which the variance occurs is
allocated between the portion of the
U.S. taxable year ending on, and the
portion of the U.S. taxable year
beginning on the day after, the day of
the variance. The allocation is made
under the principles of this paragraph
(f)(5) as if the variance were a covered
event.
(6) Allocation of foreign taxes in
connection with elections under section
336(e) or 338 or § 1.245A–5(e). For rules
relating to the allocation of foreign taxes
in connection with elections made

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pursuant to section 336(e), see § 1.336–
2(g)(3)(ii). For rules relating to the
allocation of foreign taxes in connection
with elections made pursuant to section
338, see § 1.338–9(d). For rules relating
to the allocation of foreign taxes in
connection with elections made
pursuant to § 1.245A–5(e)(3)(i), see
§ 1.245A–5(e)(3)(i)(B).
(7) Examples. The following examples
illustrate the rules of paragraphs (f)(3)
through (6) of this section.
(i) Example 1—(A) Facts. A, a United
States person, owns 100 percent of B, an
entity organized in Country X. B owns
100 percent of C, also an entity
organized in Country X. B and C are
corporations for U.S. and foreign tax
purposes that use the ‘‘u’’ as their
functional currency. Pursuant to a
consolidation regime, Country X
imposes a net income tax described in
paragraph (a)(3) of this section on the
combined income of B and C within the
meaning of paragraph (f)(3)(ii) of this
section. In year 1, C pays 25u of interest
to B. If B and C did not report their
income on a combined basis for Country
X tax purposes, the interest paid from C
to B would result in 25u of interest
income to B and 25u of deductible
interest expense to C. For purposes of
reporting the combined income of B and
C, Country X first requires B and C to
determine their own income (or loss) on
a separate schedule. For this purpose,
however, neither B nor C takes into
account the 25u of interest paid from C
to B because the income of B and C is
included in the same combined base.
The separate income of B and C
reported on their Country X schedules
for year 1, which do not reflect the 25u
intercompany payment, is 100u and
200u, respectively. The combined
income reported for Country X purposes
is 300u (the sum of the 100u separate
income of B and 200u separate income
of C).
(B) Result. On the separate schedules
described in paragraph (f)(3)(iii)(A) of
this section, B’s separate income is 100u
and C’s separate income is 200u. Under
paragraph (f)(3)(iii)(B)(1) of this section,
the 25u interest payment from C to B is
taken into account for purposes of
determining B’s and C’s portions of the
combined income under paragraph
(f)(3)(iii) of this section, because B and
C would have taken the items into
account if they did not compute their
income on a combined basis. Thus, B’s
portion of the combined income is 125u
(100u plus 25u) and C’s portion of the
combined income is 175u (200u less
25u). The result is the same regardless
of whether the 25u interest payment
from C to B is deductible for U.S.

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Federal income tax purposes. See
paragraph (f)(3)(iii)(B)(2) of this section.
(ii) Example 2—(A) Facts. A, a United
States person, owns 100 percent of B, an
entity organized in Country X. B is a
corporation for Country X tax purposes,
and a disregarded entity for U.S. income
tax purposes. B owns 100 percent of C
and D, entities organized in country X
that are corporations for both U.S. and
Country X tax purposes. B, C, and D use
the ‘‘u’’ as their functional currency and
file on a combined basis for Country X
income tax purposes. Country X
imposes a net income tax described in
paragraph (a)(3) of this section at the
rate of 30 percent on the taxable income
of corporations organized in Country X.
Under the Country X combined
reporting regime, income (or loss) of C
and D is attributed to, and treated as
income (or loss) of, B. B has the sole
obligation to pay Country X income tax
imposed with respect to income of B
and income of C and D that is attributed
to, and treated as income of, B. Under
Country X tax law, Country X may
proceed against B, but not C or D, if B
fails to pay over to Country X all or any
portion of the Country X income tax
imposed with respect to such income. In
year 1, B has income of 100u, C has
income of 200u, and D has a net loss of
(60u). Under Country X tax law, B is
considered to have 240u of taxable
income with respect to which 72u of
Country X income tax is imposed.
Country X does not provide mandatory
rules for allocating D’s loss.
(B) Result. Under paragraph (f)(3)(ii)
of this section, the 72u of Country X tax
is considered to be imposed on the
combined income of B, C, and D.
Because Country X tax law does not
provide mandatory rules for allocating
D’s loss between B and C, under
paragraph (f)(3)(iii)(C) of this section D’s
(60u) loss is allocated pro rata: 20u to
B ((100u/300u) × 60u) and 40u to C
((200u/300u) × 60u). Under paragraph
(f)(3)(i) of this section, the 72u of
Country X tax must be allocated pro rata
among B, C, and D. Because D has no
income for Country X tax purposes, no
Country X tax is allocated to D.
Accordingly, 24u (72u × (80u/240u)) of
the Country X tax is allocated to B, and
48u (72u × (160u/240u)) of such tax is
allocated to C. Under paragraph (f)(4)(ii)
of this section, A is considered to have
legal liability for the 24u of Country X
tax allocated to B under paragraph (f)(3)
of this section.
(g) Definitions. For purposes of this
section and §§ 1.901–2A and 1.903–1,
the following definitions apply.
(1) Foreign country and possession
(territory) of the United States. The term
foreign country means any foreign state,

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any possession (territory) of the United
States, and any political subdivision of
any foreign state or of any possession
(territory) of the United States. The term
possession (or territory) of the United
States means American Samoa, Guam,
the Commonwealth of the Northern
Mariana Islands, the Commonwealth of
Puerto Rico, and the U.S. Virgin Islands.
(2) Foreign levy. The term foreign levy
means a levy imposed by a foreign
country.
(3) Foreign tax. The term foreign tax
means a foreign levy that is a tax as
defined in paragraph (a)(2) of this
section.
(4) Foreign tax law. The term foreign
tax law means the laws of the foreign
country imposing a foreign tax,
including a separate levy that is
modified by an applicable income tax
treaty. The foreign tax law is construed
on the basis of the foreign country’s
statutes, regulations, case law, and
administrative rulings or other official
pronouncements, as modified by an
applicable income tax treaty.
(5) Paid, payment, and paid by. The
term paid means ‘‘paid’’ or ‘‘accrued’’;
the term payment means ‘‘payment’’ or
‘‘accrual’’; and the term paid by means
‘‘paid by’’ or ‘‘accrued by or on behalf
of,’’ depending on the taxpayer’s
method of accounting for foreign
income taxes. In the case of a taxpayer
that claims a foreign tax credit, the
taxpayer’s method of accounting for
foreign income taxes refers to whether
the taxpayer claims the foreign tax
credit for taxes paid (that is, remitted)
or taxes accrued (as determined under
§ 1.905–1(d)) during the taxable year.
The term paid does not include foreign
taxes deemed paid under section 904(c)
or section 960.
(6) Resident and nonresident. The
terms resident and nonresident, when
used in the context of the foreign tax
law of a foreign country, have the
meaning provided in paragraphs (g)(6)(i)
and (ii) of this section.
(i) Resident. An individual is a
resident of a foreign country if the
individual is liable to income tax in
such country by reason of the
individual’s residence, domicile,
citizenship, or similar criterion under
such country’s foreign tax law. An
entity (including a corporation,
partnership, trust, estate, or an entity
that is disregarded as an entity separate
from its owner for Federal income tax
purposes) is a resident of a foreign
country if the entity is liable to tax on
its income (regardless of whether tax is
actually imposed) under the laws of the
foreign country by reason of the entity’s
place of incorporation or place of
management in that country (or in a

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political subdivision or local authority
thereof), or by reason of a criterion of
similar nature, or if the entity is of a
type that is specifically identified as a
resident in an income tax treaty with the
United States to which the foreign
country is a party.
(ii) Nonresident. A nonresident with
respect to a foreign country is any
individual or entity that is not a resident
of such foreign country.
(7) Taxpayer. The term taxpayer has
the meaning set forth in paragraph (f)(1)
of this section.
(h) Applicability dates. Except as
otherwise provided in this paragraph
(h), this section applies to foreign taxes
paid (within the meaning of paragraph
(g) of this section) in taxable years
beginning on or after December 28,
2021. For foreign taxes paid to Puerto
Rico by reason of section 1035.05 of the
Puerto Rico Internal Revenue Code of
2011, as amended (13 L.P.R.A. § 30155)
(treating certain income, gain or loss as
effectively connected with the active
conduct of a trade or business with
Puerto Rico), this section applies to
foreign taxes paid (within the meaning
of paragraph (g) of this section) in
taxable years beginning on or after
January 1, 2023. For foreign taxes
described in the preceding sentence that
are paid in taxable years beginning
before January 1, 2023, see § 1.901–2 as
contained in 26 CFR part 1 revised as of
April 1, 2021.
■ Par. 25. Section 1.903–1 is revised to
read as follows:

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§ 1.903–1

Taxes in lieu of income taxes.

(a) Overview. Section 903 provides
that the term ‘‘income, war profits, and
excess profits taxes’’ includes a tax paid
in lieu of a tax on income, war profits,
or excess profits that is otherwise
generally imposed by any foreign
country. Paragraphs (b) and (c) of this
section define a tax described in section
903. Paragraph (d) of this section
provides examples illustrating the
application of this section. Paragraph (e)
of this section sets forth the
applicability date of this section. For
purposes of this section and §§ 1.901–2
and 1.901–2A, a tax described in section
903 is referred to as a ‘‘tax in lieu of an
income tax’’ or an ‘‘in lieu of tax’’ and
the definitions in § 1.901–2(g) apply for
purposes of this section. Determinations
of the amount of a tax in lieu of an
income tax that is paid by a person and
determinations of the person by whom
such tax is paid are made under
§ 1.901–2(e) and (f), respectively.
Section 1.901–2A contains additional
rules applicable to dual capacity
taxpayers (as defined in § 1.901–
2(a)(2)(ii)(A)).

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(b) Definition of tax in lieu of an
income tax—(1) In general. Paragraphs
(b)(2) and (c) of this section provide the
requirements for a foreign levy to
qualify as a tax in lieu of an income tax.
The rules of this section are applied
independently to each separate levy
(within the meaning of §§ 1.901–2(d)
and 1.901–2A(a)). A foreign tax either is
or is not a tax in lieu of an income tax
in its entirety for all persons subject to
the tax. It is immaterial whether the
base of the in lieu of tax bears any
relation to realized net gain. The base of
the foreign tax may, for example, be
gross income, gross receipts or sales, or
the number of units produced or
exported. The foreign country’s reason
for imposing a foreign tax on a base
other than net income (for example,
because of administrative difficulty in
determining the amount of income that
would otherwise be subject to a net
income tax) is immaterial, although
paragraph (c)(1) of this section generally
requires a showing that the foreign
country made a deliberate and cognizant
choice to impose the in lieu of tax
instead of a net income tax (see
paragraph (c)(1)(iii) of this section).
(2) Requirements. A foreign levy is a
tax in lieu of an income tax only if—
(i) It is a foreign tax; and
(ii) It satisfies the substitution
requirement of paragraph (c) of this
section.
(c) Substitution requirement—(1) In
general. A foreign tax (the ‘‘tested
foreign tax’’) satisfies the substitution
requirement if, based on the foreign tax
law, the requirements in paragraphs
(c)(1)(i) through (iv) of this section are
satisfied with respect to the tested
foreign tax, or the tested foreign tax is
a covered withholding tax described in
paragraph (c)(2) of this section.
(i) Existence of generally-imposed net
income tax. A separate levy that is a net
income tax (as described in § 1.901–
2(a)(3)) is generally imposed by the
same foreign country (the ‘‘generallyimposed net income tax’’) that imposes
the tested foreign tax.
(ii) Non-duplication. Neither the
generally-imposed net income tax nor
any other separate levy that is a net
income tax is also imposed, in addition
to the tested foreign tax, by the same
foreign country on any persons with
respect to any portion of the income to
which the amounts (such as sales or
units of production) that form the base
of the tested foreign tax relate (the
‘‘excluded income’’). Therefore, a tested
foreign tax does not meet the
requirement of this paragraph (c)(1)(ii) if
a net income tax imposed by the same
foreign country applies to the excluded
income of any persons that are subject

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357

to the tested foreign tax, even if not all
persons subject to the tested foreign tax
are subject to the net income tax.
(iii) Close connection to excluded
income. But for the existence of the
tested foreign tax, the generally-imposed
net income tax would otherwise have
been imposed on the excluded income.
The requirement in the preceding
sentence is met only if the imposition of
such tested foreign tax bears a close
connection to the failure to impose the
generally-imposed net income tax on
the excluded income; the relationship
cannot be merely incidental, tangential,
or minor. A close connection must be
established with proof that the foreign
country made a cognizant and deliberate
choice to impose the tested foreign tax
instead of the generally-imposed net
income tax. Such proof must be based
on foreign tax law, or the legislative
history of either the tested foreign tax or
the generally-imposed net income tax
that describes the provisions excluding
taxpayers subject to the tested foreign
tax from the generally-imposed net
income tax. Thus, a close connection
exists if the generally-imposed net
income tax would apply by its terms to
the excluded income, but for the fact
that the excluded income is expressly
excluded, and the tested foreign tax is
enacted contemporaneously with the
generally-imposed net income tax. A
close connection also exists if the
generally-imposed net income tax by its
terms does not apply to, but does not
expressly exclude, the excluded income,
and the tested foreign tax is enacted
contemporaneously with the generallyimposed net income tax. Where the
tested foreign tax is not enacted
contemporaneously with the generallyimposed net income tax and the
generally-imposed net income tax is not
amended contemporaneously with the
enactment of the tested foreign tax to
exclude the excluded income or to
narrow the scope of the generallyimposed net income tax so as not to
apply to the excluded income, a close
connection can be established only by
reference to the legislative history of the
tested foreign tax (or a predecessor in
lieu of tax). Not all income derived by
persons subject to the tested foreign tax
need be excluded income, provided the
tested foreign tax applies only to
amounts that relate to the excluded
income.
(iv) Jurisdiction to tax excluded
income. If the generally-imposed net
income tax, or a hypothetical new tax
that is a separate levy with respect to
the generally-imposed net income tax,
were applied to the excluded income,
such generally-imposed net income tax
or separate levy would meet the

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attribution requirement described in
§ 1.901–2(b)(5).
(2) Covered withholding tax. A tested
foreign tax is a covered withholding tax
if, based on the foreign tax law, the
requirements in paragraphs (c)(1)(i) and
(c)(2)(i) through (iii) of this section are
met with respect to the tested foreign
tax. See also § 1.901–2(d)(1)(iii) for rules
treating withholding taxes as separate
levies with respect to each class of
income subject to the tax or with respect
to each subset of a class of income that
is subject to different income attribution
rules.
(i) Withholding tax on nonresidents.
The tested foreign tax is a withholding
tax (as defined in section 901(k)(1)(B))
that is imposed on gross income of
persons who are nonresidents of the
foreign country imposing the tested
foreign tax. It is immaterial whether the
tested foreign tax is withheld by the
payor or is imposed directly on the
nonresident taxpayer.
(ii) Non-duplication. The tested
foreign tax is not in addition to any net
income tax that is imposed by the
foreign country on any portion of the
net income attributable to the gross
income that is subject to the tested
foreign tax. Therefore, a tested foreign
tax does not meet the requirement of
this paragraph (c)(2)(ii) if by its terms it
applies to gross income of nonresidents
that are also subject to a net income tax
imposed by the same foreign country on
the same income, even if not all
nonresidents subject to the tested
foreign tax are also subject to the net
income tax.
(iii) Source-based attribution
requirement. The income subject to the
tested foreign tax satisfies the
attribution requirement described in
§ 1.901–2(b)(5)(i)(B).
(d) Examples. The following examples
illustrate the rules of this section.
(1) Example 1: Tax on gross income
from services; non-duplication
requirement—(i) Facts. Country X
imposes a tax at the rate of 3 percent on
the gross receipts of companies,
wherever resident, from furnishing
specified types of electronically
supplied services to customers located
in Country X (the ‘‘ESS tax’’). No
deductions are allowed in determining
the taxable base of the ESS tax. In
addition to the ESS tax, Country X
imposes a net income tax within the
meaning of § 1.901–2(a)(3) on resident
companies (the ‘‘resident income tax’’)
and also imposes a net income tax
within the meaning of § 1.901–2(a)(3) on
the income of nonresident companies
that is attributable, under reasonable
principles, to the nonresident’s
permanent establishment within

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Country X (the ‘‘nonresident income
tax’’). Under Country X tax law, a
permanent establishment is defined in
the same manner as under the 2016 U.S.
Model Income Tax Convention. Both the
resident income tax and the nonresident
income tax, which are separate levies
under § 1.901–2(d)(1)(iii), qualify as
generally-imposed net income taxes.
Under Country X tax law, the ESS tax
applies to both resident and nonresident
companies regardless of whether the
company is also subject to the resident
income tax or the nonresident income
tax, respectively.
(ii) Analysis. Under § 1.901–
2(d)(1)(iii), the ESS tax comprises two
separate levies, one imposed on resident
companies (the ‘‘resident ESS tax’’), and
one imposed on nonresident companies
(the ‘‘nonresident ESS tax’’). Under
paragraph (c)(1)(ii) of this section,
neither the resident ESS tax nor the
nonresident ESS tax satisfies the
substitution requirement, because by its
terms the income to which the gross
receipts subject to the ESS tax relate is
also subject to one of the two generallyimposed net income taxes imposed by
Country X. Similarly, under paragraph
(c)(2)(ii) of this section, the nonresident
ESS tax is not a covered withholding tax
because by its terms it is imposed in
addition to the nonresident income tax.
The fact that nonresident taxpayers that
do not have a permanent establishment
in Country X are in practice subject to
the nonresident ESS tax but not to the
nonresident income tax on the gross
receipts included in the base of the
nonresident ESS tax is not relevant to
the determination of whether the ESS
tax meets the substitution requirement
under paragraph (c)(1) of this section.
Therefore, neither the resident ESS tax
nor the nonresident ESS tax is a tax in
lieu of an income tax.
(2) Example 2: Tax on gross income
from services; attribution of income—(i)
Facts. The facts are the same as those in
paragraph (d)(1)(i) of this section (the
facts in Example 1), except that under
Country X tax law, the nonresident ESS
tax is imposed only if the nonresident
company does not have a permanent
establishment in Country X. If the
nonresident company has a Country X
permanent establishment, the
nonresident income tax applies to the
profits attributable to that permanent
establishment. In addition, the statutory
language and legislative history to the
nonresident ESS tax demonstrate that
Country X made a cognizant and
deliberate choice to impose the
nonresident ESS tax instead of the
nonresident income tax with respect to
the gross receipts that are subject to the
nonresident ESS tax.

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(ii) Analysis—(A) General application
of substitution requirement. The
nonresident ESS tax meets the
requirements in paragraphs (c)(1)(i) and
(ii) of this section because Country X
has two generally-imposed net income
taxes and neither generally-imposed net
income tax nor any other separate levy
that is a net income tax is imposed by
Country X on a nonresident’s income to
which gross receipts that form the base
of the nonresident ESS tax relate (which
is the excluded income). The statutory
language and legislative history to the
nonresident ESS tax demonstrate that
Country X made a cognizant and
deliberate choice not to impose the
nonresident income tax on the excluded
income. Therefore, the nonresident ESS
tax meets the requirement in paragraph
(c)(1)(iii) of this section because, but for
the existence of the tested foreign tax,
the nonresident income tax would
otherwise have been imposed on the
excluded income. However, the
nonresident ESS tax does not meet the
requirement in paragraph (c)(1)(iv) of
this section, because if Country X had
chosen to apply the nonresident income
tax (rather than the nonresident ESS tax)
to the excluded income, the modified
nonresident income tax would fail the
attribution requirement in § 1.901–
2(b)(5). First, the modified tax would
not satisfy the requirement in § 1.901–
2(b)(5)(i)(A) because the modified tax
would not apply to income attributable
under reasonable principles to the
nonresident’s activities within the
foreign country, since the modified tax
is determined by taking into account the
location of customers. Second, the
modified tax would not satisfy the
requirement in § 1.901–2(b)(5)(i)(B)
because the excluded income is from
services performed outside of Country
X. Third, the modified tax would not
satisfy the requirement in § 1.901–
2(b)(5)(i)(C) because the excluded
income is not from sales or dispositions
of real property located in Country X or
from property forming part of the
business property of a taxable presence
in Country X. Because the Country X
nonresident income tax as applied to
the excluded income would fail to meet
the attribution requirement in § 1.901–
2(b)(5), as required by paragraph
(c)(1)(iv) of this section, the nonresident
ESS tax does not satisfy the substitution
requirement in paragraph (c)(1) of this
section.
(B) Covered withholding tax analysis.
The nonresident ESS tax meets the
requirement in paragraph (c)(1)(i) of this
section because there exists a generallyimposed net income tax. It also meets
the requirements in paragraphs (c)(2)(i)

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and (ii) of this section because it is a
withholding tax on gross receipts of
nonresidents and the income
attributable to those gross receipts is not
subject to a net income tax. However,
the nonresident ESS tax does not meet
the requirement in paragraph (c)(2)(iii)
of this section because the services
income subject to the nonresident ESS
tax is from electronically supplied
services performed outside of Country
X. See § 1.901–2(b)(5)(i)(B). Therefore,
the nonresident ESS tax is not a covered
withholding tax under paragraph (c)(2)
of this section. Because the nonresident
ESS tax does not satisfy the substitution
requirement of paragraph (c) of this
section, it is not a tax in lieu of an
income tax.
(3) Example 3: Withholding tax on
royalties; attribution requirement—(i)
Facts. YCo, a resident of Country Y, is
a controlled foreign corporation whollyowned by USP, a domestic corporation.
In Year 1, YCo grants a license to XCo,
a resident of Country X unrelated to
YCo or USP, for the right to use YCo’s
intangible property (IP) throughout the
world, including in Country X. Under
Country X’s domestic tax law, all
royalties paid by a resident of Country
X to a nonresident are sourced in
Country X and are subject to a 30%
withholding tax on the gross income,
regardless of whether the nonresident
payee has a taxable presence in Country
X. Country X’s withholding tax on
royalties is a separate levy under
§ 1.901–2(d)(1)(iii). In Year 1, XCo
withholds 30u (units of Country X
currency) tax from 100u of royalties
owed and paid to YCo under the
licensing arrangement, of which 50u is
attributable to XCo’s use of the YCo IP
in Country X and 50u is attributable to
use of the YCo IP outside Country X.
The United States and Country X have
an income tax treaty (U.S.-Country X
treaty); under the royalties article of the
treaty, Country X agreed to impose its
withholding tax on royalties paid to a
U.S. resident only on royalties paid for
IP used in Country X. Country X and
Country Y do not have an income tax
treaty.
(ii) Analysis. Under § 1.901–
2(d)(1)(iv), the Country X withholding
tax on royalties, as modified by the U.S.Country X treaty, is a separate levy from
the unmodified Country X withholding
tax to which YCo was subject (because
YCo is not a U.S. resident eligible for
benefits under the U.S.-Country X
treaty). The Country X withholding tax
on royalties, unmodified by the U.S.Country X treaty, does not meet the
attribution requirement in § 1.901–
2(b)(5)(i)(B) because Country X’s source
rule for royalties (based upon residence

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of the payor) is not reasonably similar
to the sourcing rules that apply under
the Internal Revenue Code. Thus, under
paragraph (c)(2)(iii) of this section, the
Country X withholding tax paid by YCo
is not a covered withholding tax, and
none of the 30u of Country X
withholding tax paid by YCo with
respect to the 100u of royalties for the
use of the IP is a payment of foreign
income tax.
(4) Example 4: Withholding tax on
royalties; attribution requirement—(i)
Facts. The facts are the same as in
paragraph (d)(3)(i) of this section (the
facts of Example 3), except that XCo
only uses the IP in Country X and the
100u of royalties paid to YCo in Year 1
is all attributable to XCo’s use of the IP
in Country X.
(ii) Analysis. The result is the same as
in paragraph (d)(3) of this section (the
analysis of Example 3). Because Country
X’s source rule for royalties (based upon
residence of the payor) is not reasonably
similar to the sourcing rules that apply
under the Internal Revenue Code, the
withholding tax paid by YCo does not
meet the attribution requirement in
§ 1.901–2(b)(5)(i)(B). Under paragraph
(c)(2)(iii) of this section, the Country X
withholding tax paid by YCo is not a
covered withholding tax, and none of
the 30u of Country X withholding tax
paid by YCo with respect to the 100u of
royalties for IP used in Country X is a
payment of foreign income tax.
(5) Example 5: Multiple in-lieu-of
taxes—(i) Facts. Country X imposes a
net income tax within the meaning of
§ 1.901–2(a)(3) on the income of
nonresident companies that is
attributable, under reasonable
principles, to the nonresident’s
activities within Country X (the ‘‘trade
or business tax’’). The trade or business
tax applies to all nonresident
corporations that engage in business in
Country X except for nonresident
corporations that engage in insurance
activities, which are instead subject to
two different taxes (‘‘insurance taxes’’).
The insurance taxes apply to
nonresident corporations that engage in
insurance activities that are attributable,
under reasonable principles, to the
nonresident’s activities within Country
X. The insurance taxes do not satisfy the
cost recovery requirement in § 1.901–
2(b)(4). The trade or business tax and
the two insurance taxes were enacted
contemporaneously, and the statutory
language of the trade or business tax
expressly excludes gross income
derived by nonresident corporations
engaged in insurance activities from the
trade or business tax.
(ii) Analysis. The insurance taxes
meet the requirements in paragraphs

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359

(c)(1)(i) and (ii) of this section because
Country X has a generally-imposed net
income tax, the trade or business tax,
and neither the trade or business tax nor
any other separate levy that is a net
income tax is imposed by Country X on
a nonresident’s gross income to which
the amounts that form the base of the
insurance taxes (the ‘‘excluded
income’’) relate. The Country X tax law
expressly provides that the trade or
business tax does not apply to
nonresident corporations engaged in
insurance activities. In addition, the two
insurance taxes were enacted
contemporaneously with the trade or
business tax. Therefore, it is
demonstrated that Country X made a
cognizant and deliberate choice to
impose the insurance taxes in lieu of the
generally-imposed trade or business tax,
and the insurance taxes meet the
requirement in paragraph (c)(1)(iii) of
this section. If the trade or business tax
also applied to the excluded income, the
trade or business tax would meet the
requirement in § 1.901–2(b)(5)(i)(A),
because it would apply only to income
attributable, under reasonable
principles, to the nonresident’s
activities within the foreign country.
Thus, the insurance taxes meet the
requirement in paragraph (c)(1)(iv) of
this section. Therefore, the insurance
taxes satisfy the substitution
requirement in paragraph (c)(1) of this
section.
(6) Example 6: Later-enacted in-lieuof tax; close connection requirement—
(i) Facts. The facts are the same as those
in paragraph (d)(5)(i) of this section (the
facts in Example 5), except that one of
the two insurance taxes applies only to
nonresident corporations engaged in the
life insurance business in Country X
and was enacted five years after the
enactment of the trade or business tax
and the other insurance tax enacted
contemporaneously with the trade or
business tax. The legislative history to
the later-enacted insurance tax shows
that Country X intended to increase the
tax imposed on nonresident
corporations engaged in life insurance
activities and, instead of amending the
first insurance tax to increase the rate
applicable to life insurance companies,
it enacted the second insurance tax that
only applies to life insurance
corporations.
(ii) Analysis. The later-enacted
insurance tax meets the requirements in
paragraphs (c)(1)(i) and (ii) of this
section because Country X has a
generally-imposed net income tax, the
trade or business tax, and neither the
trade or business tax nor any other
separate levy that is a net income tax is
imposed by Country X on the income

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attributable to the activities that form
the base of the later-enacted insurance
tax. The later-enacted insurance tax
meets the requirement in paragraph
(c)(1)(iii) of this section because the
legislative history to the later-enacted
insurance tax demonstrates that Country
X made a cognizant and deliberate
choice to impose the later-enacted
insurance tax on life insurance
companies instead of the trade or
business tax. The later-enacted
insurance tax also meets the
requirement of paragraph (c)(1)(iv) of
this section for the reasons set forth in
paragraph (d)(5)(ii) of this section.
Therefore, the later-enacted insurance
tax satisfies the substitution
requirement in paragraph (c)(1) of this
section.
(7) Example 7: Excise tax creditable
against net income tax—(i) Facts.
Country X imposes an excise tax that
does not satisfy the cost recovery
requirement in § 1.901–2(b)(4), and a net
income tax within the meaning of
§ 1.901–2(a)(3). The excise tax, which is
payable independently of the net
income tax, is allowed as a credit
against the net income tax. In Year 1, A
has a tentative net income tax liability
of 100u (units of Country X currency)
but is allowed a credit for 30u of excise
tax that it paid that year.
(ii) Analysis. Pursuant to § 1.901–
2(e)(4), the amount of excise tax A has
paid to Country X is 30u and the
amount of net income tax A has paid to
Country X is 70u. The excise tax paid
by A does not satisfy the substitution
requirement set forth in paragraph (c)(1)
of this section because the excise tax is
imposed in addition to, and not in
substitution for, the generally-imposed
net income tax.
(e) Applicability dates. Except as
otherwise provided in this paragraph
(e), this section applies to foreign taxes
paid (within the meaning of § 1.901–
2(g)(5)) in taxable years beginning on or
after December 28, 2021. For foreign
taxes paid to Puerto Rico under section
3070.01 of the Puerto Rico Internal
Revenue Code of 2011, as amended (13
L.P.R.A. § 31771) (imposing an excise
tax on a controlled group member’s
acquisition from another group member
of certain personal property
manufactured or produced in Puerto
Rico and certain services performed in
Puerto Rico), this section applies to
foreign taxes paid (within the meaning
of § 1.901–2(g)(5)) in taxable years
beginning on or after January 1, 2023.
For foreign taxes described in the
preceding sentence that are paid in
taxable years beginning before January
1, 2023, see § 1.903–1 as contained in 26
CFR part 1 revised as of April 1, 2021.

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Par. 26. Section 1.904–4 is amended:
1. By revising paragraph (b)(2)(i)(A).
2. By revising the last sentence of
paragraph (c)(4).
■ 3. In paragraph (f)(1)(i) introductory
text, by removing the language
‘‘paragraph (f)(1)(ii) of this section’’ and
adding in its place the language
‘‘paragraph (f)(1)(ii), (iii), or (iv) of this
section’’.
■ 4. By adding paragraphs (f)(1)(iii) and
(iv).
■ 5. By removing and reserving
paragraphs (f)(2)(ii) and (iii).
■ 6. By revising paragraphs (f)(2)(vi)(A)
and (f)(2)(vi)(B)(1)(ii).
■ 7. By adding paragraph (f)(2)(vi)(G).
■ 8. By revising paragraph (f)(3)(v).
■ 9. In the second sentence of paragraph
(f)(3)(vii)(B), by removing the language
‘‘treated as carried out pursuant to’’ and
adding in its place the language ‘‘carried
out constitute’’.
■ 10. By redesignating paragraphs
(f)(3)(viii) and (ix) as paragraphs
(f)(3)(ix) and (xii), respectively.
■ 11. By adding a new paragraph
(f)(3)(viii).
■ 12. In newly redesignated paragraph
(f)(3)(ix), by removing the language
‘‘paragraph (f)(3)(viii)’’ and adding the
language ‘‘paragraph (f)(3)(ix)’’ in its
place.
■ 13. By redesignating paragraph
(f)(3)(x) as paragraph (f)(3)(xiii).
■ 14. By adding new paragraphs (f)(3)(x)
and (xi).
■ 15. In paragraphs (f)(4)(i)(B)(1) and
(2), by removing the language
‘‘paragraph (f)(3)(viii)’’ and adding the
language ‘‘paragraph (f)(3)(ix)’’ in its
place.
■ 16. In paragraphs (f)(4)(iv)(B)(1) and
(f)(4)(v)(B)(2), by removing the language
‘‘paragraph (f)(3)(x)’’ and adding the
language ‘‘paragraph (f)(3)(xiii)’’ in its
place.
■ 17. By adding paragraphs (f)(4)(xiii)
through (xvi) and (q)(3).
The additions and revisions read as
follows:
■
■
■

§ 1.904–4 Separate application of section
904 with respect to certain categories of
income.

*

*
*
*
*
(b) * * *
(2) * * *
(i) * * *
(A) Income received or accrued by
any person that is of a kind that would
be foreign personal holding company
income (as defined in section 954(c),
taking into account any exceptions or
exclusions to section 954(c), including,
for example, section 954(c)(3), (c)(6), (h),
or (i)) if the taxpayer were a controlled
foreign corporation, including any
amount of gain on the sale or exchange

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of stock in excess of the amount treated
as a dividend under section 1248;
*
*
*
*
*
(c) * * *
(4) * * * The grouping rules of
paragraphs (c)(3)(i) through (iv) of this
section also apply separately to income
attributable to each tested unit, as
defined in § 1.951A–2(c)(7)(iv), of a
controlled foreign corporation, and to
each foreign QBU of a noncontrolled 10percent owned foreign corporation or
any other look-through entity defined in
§ 1.904–5(i), or of any United States
person.
*
*
*
*
*
(f) * * *
(1) * * *
(iii) Income arising from U.S.
activities excluded from foreign branch
category income. Gross income that is
attributable to a foreign branch and that
arises from activities carried out in the
United States by any foreign branch,
including income that is reflected on a
foreign branch’s separate books and
records, is not assigned to the foreign
branch category. Instead, such income is
assigned to the general category or a
specified separate category under the
rules of this section. However, under
paragraph (f)(2)(vi) of this section, gross
income (including U.S. source gross
income) attributable to activities carried
on outside the United States by the
foreign branch may be assigned to the
foreign branch category by reason of a
disregarded payment to a foreign branch
from a foreign branch owner or another
foreign branch that is allocable to
income recorded on the books and
records of the payor foreign branch or
foreign branch owner.
(iv) Income arising from stock
excluded from foreign branch category
income—(A) In general. Except as
provided in paragraph (f)(1)(iv)(B) of
this section, gross income that is
attributable to a foreign branch and that
comprises items of income arising from
stock of a corporation (whether foreign
or domestic), including gain from the
disposition of such stock or any
inclusion under section 951(a), 951A(a),
1248, or 1293(a), is not assigned to the
foreign branch category. Instead, such
income is assigned to the general
category or a specified separate category
under the rules of this section.
(B) Exception for dealer property.
Paragraph (f)(1)(iv)(A) of this section
does not apply to gain recognized from
dispositions of stock of a corporation, if
the stock would be dealer property (as
defined in § 1.954–2(a)(4)(v)) if the
foreign branch were a controlled foreign
corporation.
*
*
*
*
*

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(2) * * *
(vi) * * *
(A) In general. If a foreign branch
makes a disregarded payment to its
foreign branch owner or a second
foreign branch, and the disregarded
payment is allocable to gross income
that would be attributable to the foreign
branch under the rules in paragraphs
(f)(2)(i) through (v) of this section, the
gross income attributable to the foreign
branch is adjusted downward (but not
below zero) to reflect the allocable
amount of the disregarded payment, and
the gross income attributable to the
foreign branch owner or the second
foreign branch is adjusted upward by
the same amount as the downward
adjustment, translated (if necessary)
from the foreign branch’s functional
currency to U.S. dollars (or the second
foreign branch’s functional currency, as
applicable) at the spot rate (as defined
in § 1.988–1(d)) on the date of the
disregarded payment. For rules
addressing multiple disregarded
payments in a taxable year, see
paragraph (f)(2)(vi)(F) of this section.
Similarly, if a foreign branch owner
makes a disregarded payment to its
foreign branch and the disregarded
payment is allocable to gross income
attributable to the foreign branch owner,
the gross income attributable to the
foreign branch owner is adjusted
downward (but not below zero) to
reflect the allocable amount of the
disregarded payment, and the gross
income attributable to the foreign
branch is adjusted upward by the same
amount as the downward adjustment,
translated (if necessary) from U.S.
dollars to the foreign branch’s
functional currency at the spot rate on
the date of the disregarded payment. An
adjustment to the amount of attributable
gross income under this paragraph
(f)(2)(vi) does not change the total
amount, character, or source of the
United States person’s gross income;
does not change the amount of a United
States person’s income in any separate
category other than the foreign branch
and general categories (or a specified
separate category associated with the
foreign branch and general categories);
and has no bearing on the analysis of
whether an item of gross income is
eligible to be resourced under an
income tax treaty.
(B) * * *
(1) * * *
(ii) Disregarded payments from a
foreign branch to its foreign branch
owner or to another foreign branch are
allocable to gross income attributable to
the payor foreign branch to the extent a
deduction for that payment or any
disregarded cost recovery deduction

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relating to that payment, if regarded,
would be allocated and apportioned to
gross income attributable to the payor
foreign branch under the principles of
§§ 1.861–8 through 1.861–14T and
1.861–17 (without regard to exclusive
apportionment) by treating foreign
source gross income and U.S. source
gross income in each separate category
(determined before the application of
this paragraph (f)(2)(vi) to the
disregarded payment at issue) each as a
statutory grouping.
*
*
*
*
*
(G) Effect of disregarded payments
made and received by non-branch
taxable units—(1) In general. For
purposes of determining the amount,
source, and character of gross income
attributable to a foreign branch and its
foreign branch owner under paragraph
(f)(2) of this section, the rules of
paragraph (f)(2) of this section apply to
a non-branch taxable unit as though the
non-branch taxable unit were a foreign
branch or a foreign branch owner, as
appropriate, to attribute gross income to
the non-branch taxable unit and to
further attribute, under this paragraph
(f)(2)(vi)(G), the income of a non-branch
taxable unit to one or more foreign
branches or to a foreign branch owner.
See paragraph (f)(4)(xvi) of this section
(Example 16).
(2) Foreign branch group income. The
income of a foreign branch group is
attributed to the foreign branch that
owns the group. The income of a foreign
branch group is the aggregate of the U.S.
gross income that is attributed, under
the rules of this paragraph (f)(2), to each
member of the foreign branch group,
determined after accounting for all
disregarded payments made and
received by each member of the foreign
branch group.
(3) Foreign branch owner group
income. The income of a foreign branch
owner group is attributed to the foreign
branch owner that owns the group. The
income of a foreign branch owner group
income is the aggregate of the U.S. gross
income that is attributed, under the
rules of this paragraph (f)(2), to each
member of the foreign branch owner
group, determined after accounting for
all disregarded payments made and
received by each member of the foreign
branch owner group.
(3) * * *
(v) Disregarded payment. A
disregarded payment includes an
amount of property (within the meaning
of section 317(a)) that is transferred to
or from a non-branch taxable unit,
foreign branch, or foreign branch owner,
including a payment in exchange for
property or in satisfaction of an account

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payable, or a remittance or contribution,
in connection with a transaction that is
disregarded for Federal income tax
purposes and that is reflected on the
separate set of books and records of a
non-branch taxable unit (other than an
individual or domestic corporation) or a
foreign branch. A disregarded payment
also includes any other amount that is
reflected on the separate set of books
and records of a non-branch taxable unit
(other than an individual or a domestic
corporation) or a foreign branch in
connection with a transaction that is
disregarded for Federal income tax
purposes and that would constitute an
item of accrued income, gain,
deduction, or loss of the non-branch
taxable unit (other than an individual or
a domestic corporation) or the foreign
branch if the transaction to which the
amount is attributable were regarded for
Federal income tax purposes.
*
*
*
*
*
(viii) Foreign branch group. The term
foreign branch group means a foreign
branch and one or more non-branch
taxable units (other than an individual
or a domestic corporation), to the extent
that the foreign branch owns the nonbranch taxable unit directly or
indirectly through one or more other
non-branch taxable units.
*
*
*
*
*
(x) Foreign branch owner group. The
term foreign branch owner group means
a foreign branch owner and one or more
non-branch taxable units (other than an
individual or a domestic corporation), to
the extent that the foreign branch owner
owns the non-branch taxable unit
directly or indirectly through one or
more other non-branch taxable units.
(xi) Non-branch taxable unit. The
term non-branch taxable unit has the
meaning provided in § 1.904–
6(b)(2)(i)(B).
*
*
*
*
*
(4) * * *
(xiii) Example 13: Disregarded
payment from domestic corporation to
foreign branch—(A) Facts. P, a domestic
corporation, owns FDE, a disregarded
entity that is a foreign branch. FDE’s
functional currency is the U.S. dollar. In
Year 1, P accrues and records on its
books and records for Federal income
tax purposes $400x of gross income
from the license of intellectual property
to unrelated parties that is not passive
category income, all of which is U.S.
source income. P also accrues $600x of
foreign source passive category interest
income. P compensates FDE for services
that FDE performs in a foreign country
with an arm’s length payment of $350x,
which FDE records on its books and
records; the transaction is disregarded

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for Federal income tax purposes. Absent
the application of paragraph (f)(2)(vi) of
this section, the $400x of gross income
earned by P from the license would be
general category income that would not
be attributable to FDE. If the $350x
disregarded payment from P to FDE
were regarded for Federal income tax
purposes, the deduction for the payment
would be allocated and apportioned
entirely to P’s $400x of general category
gross licensing income under the
principles of §§ 1.861–8 and 1.861–8T
(treating U.S. source general category
gross income and foreign source passive
category gross income each as a
statutory grouping). P and FDE incur no
other expenses.
(B) Analysis. The $350x disregarded
payment from P, a United States person,
to FDE, its foreign branch, is not
recorded on FDE’s separate books and
records (as adjusted to conform to
Federal income tax principles) under
paragraph (f)(2)(i) of this section
because it is disregarded for Federal
income tax purposes. The disregarded
payment is allocable to gross income
attributable to P because a deduction for
the payment, if it were regarded, would
be allocated and apportioned to the
$400x of P’s U.S. source licensing
income. Accordingly, under paragraphs
(f)(2)(vi)(A) and (f)(2)(vi)(B)(3) of this
section, the amount of gross income
attributable to the FDE foreign branch
(and the gross income attributable to P)
is adjusted in Year 1 to take the
disregarded payment into account.
Accordingly, $350x of P’s $400x U.S.
source general category gross income
from the license is attributable to the
FDE foreign branch for purposes of this
section. Therefore, $350x of the U.S.
source gross income that P earned with
respect to its license in Year 1
constitutes U.S. source gross income
that is assigned to the foreign branch
category and $50x remains U.S. source
general category income. P’s $600x of
foreign source passive category interest
income is unchanged.
(xiv) Example 14: Regarded payment
from non-consolidated domestic
corporation to a foreign branch—(A)
Facts. The facts are the same as those in
paragraph (f)(4)(xiii)(A) of this section
(the facts in Example 13), except P
wholly owns USS, and USS (rather than
P) owns FDE. P and USS do not file a
consolidated return. USS has no gross
income other than the $350x foreign
source services income from the $350x
payment it receives from P, through
FDE.
(B) Analysis. The $350x services
payment from P, a United States person,
to FDE, a foreign branch of USS, is not
a disregarded payment because the

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transaction is regarded for Federal
income tax purposes. Under §§ 1.861–8
and 1.861–8T, P’s $350x deduction for
the services payment is allocated and
apportioned to its U.S. source general
category gross income. The payment of
$350x from P to USS is services income
attributable to FDE, and foreign branch
category income of USS under
paragraph (f)(2)(i) of this section.
Accordingly, USS has $350x of foreign
source foreign branch category gross
income. P has $600x of foreign source
passive category income and $400x of
U.S. source general category gross
income and a $350x deduction for the
services payment, resulting in $50x of
U.S. source general category taxable
income to P.
(xv) Example 15: Regarded payment
from a member of a consolidated group
to a foreign branch of another member
of the consolidated group—(A) Facts.
The facts are the same as those in
paragraph (f)(4)(xiv)(A) of this section
(the facts in Example 14), except that P
and USS are members of an affiliated
group that files a consolidated return
pursuant to section 1502 (P group).
(B) Analysis—(1) Definitions under
§ 1.1502–13. Under § 1.1502–13(b)(1),
the $350x services payment from P to
FDE, a foreign branch of USS, is an
intercompany transaction between P
and USS; USS is the selling member, P
is the buying member, P has a deduction
of $350x for the services payment that
is a corresponding item, and USS has
$350x of income that is an
intercompany item. The payment is not
a disregarded payment because the
transaction is regarded for Federal
income tax purposes.
(2) Timing and attributes under
§ 1.1502–13—(i) Separate entity versus
single entity analysis. Under a separate
entity analysis, the result is the same as
in paragraph (f)(4)(xiv)(B) of this section
(the analysis in Example 14), whereby P
has $600x of foreign source passive
category income and $50x of U.S. source
general category income, and USS has
$350x of foreign source foreign branch
category income. In contrast, under a
single entity analysis, the result is the
same as in paragraph (f)(4)(xiii)(B) of
this section (the analysis in Example
13), whereby P has $600x of foreign
source passive category income, $50x of
U.S. source general category income,
and $350x of U.S. source foreign branch
category income.
(ii) Application of the matching rule.
Under the matching rule in § 1.1502–
13(c), the timing, character, source, and
other attributes of USS’s $350x
intercompany item and P’s $350x
corresponding item are redetermined to
produce the effect of transactions

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between divisions of a single
corporation, as if the services payment
had been made to a foreign branch of
that corporation. Accordingly, all of
USS’s foreign source income of $350x is
redetermined to be U.S. source, rather
than foreign source, income. Therefore,
for purposes of § 1.1502–4(c)(1), the P
group has $600x of foreign passive
category income, $50x of U.S. source
general category income, and $350x of
U.S. source foreign branch category
income.
(xvi) Example 16: Disregarded
payment made from non-branch taxable
unit—(A) Facts. The facts are the same
as those in paragraph (f)(4)(xiii)(A) of
this section (the facts in Example 13),
except that P also wholly owns FDE1, a
disregarded entity that is a non-branch
taxable unit. In addition, FDE1 (rather
than P) is the entity that properly
accrues and records on its books and
records the $400x of U.S. source general
category income from the license of
intellectual property and the $600x of
foreign source passive category interest
income, and FDE1 (rather than P) is the
entity that makes the $350x payment,
which is disregarded for Federal income
tax purposes, to FDE in compensation
for services.
(B) Analysis. Under paragraph
(f)(2)(vi)(G) of this section, the rules of
paragraph (f)(2) of this section apply to
attribute gross income to FDE1, a nonbranch taxable unit, as though FDE1
were a foreign branch. Under these
rules, the $400x of licensing income and
the $600 of interest income are initially
attributable to FDE1. This income is
adjusted in Year 1 to account for the
$350x disregarded payment, which is
allocable to the $400x of licensing
income of FDE1. Accordingly, $50x of
the $400x of U.S. source general
category licensing income is attributable
to FDE1 and $350x of this income is
attributable to the FDE foreign branch.
To determine the income that is
attributable to P, the foreign branch
owner, and FDE, the foreign branch, the
income that is attributed to FDE1, after
taking into account all of the
disregarded payments that it makes and
receives, must be further attributed to
one or more foreign branches or a
foreign branch owner under paragraph
(f)(2)(vi)(G) of this section. Under
paragraph (f)(2)(vi)(G) of this section,
the income of FDE1 is attributed to the
foreign branch group or foreign branch
owner group of which it is a member.
Because FDE1 is wholly owned by P,
FDE is a member solely of the foreign
branch owner group that is owned by P.
See definition of ‘‘foreign branch owner
group’’ in § 1.904–4(f)(3). All the income
that is attributed to FDE1 under

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paragraph (f)(2) of this section, namely,
the $50x of U.S. source general category
licensing income and the $600x of
foreign source passive category interest
income, is further attributed to P. See
§ 1.904–4(f)(2)(vi)(G)(3). Therefore, the
result is the same as in paragraph
(f)(4)(xiii)(B) of this section (the analysis
in Example 13).
*
*
*
*
*
(q) * * *
(3) Paragraph (f) of this section
applies to taxable years that begin after
December 31, 2019, and end on or after
November 2, 2020.
■ Par. 27. Section 1.904–6 is amended
by adding paragraph (b)(2) and revising
paragraph (g) to read as follows:
§ 1.904–6 Allocation and apportionment of
foreign income taxes.

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*

*
*
*
*
(b) * * *
(2) Disregarded payments—(i) In
general—(A) Assignment of foreign
gross income. Except as provided in
paragraph (b)(2)(ii) of this section, if a
taxpayer that is an individual or a
domestic corporation includes an item
of foreign gross income by reason of the
receipt of a disregarded payment by a
foreign branch or foreign branch owner
(as those terms are defined in § 1.904–
4(f)(3)), or a non-branch taxable unit, the
foreign gross income item is assigned to
a separate category under § 1.861–
20(d)(3)(v).
(B) Definition of non-branch taxable
unit. The term non-branch taxable unit
means a person or interest that is
described in paragraph (b)(2)(i)(B)(1) or
(2) of this section, respectively.
(1) Persons. A non-branch taxable unit
described in this paragraph
(b)(2)(i)(B)(1) means a person that is not
otherwise a foreign branch owner and
that is a U.S. individual, a domestic
corporation, or a foreign or domestic
partnership (or other pass-through
entity, as defined in § 1.904–5(a)(4)) an
interest in which is owned, directly or
indirectly through one or more other
partnerships (or other pass-through
entities), by a U.S. individual or a
domestic corporation.
(2) Interests. A non-branch taxable
unit described in this paragraph
(b)(2)(i)(B)(2) means an interest of a
foreign branch owner or an interest of a
person described in paragraph
(b)(2)(i)(B)(1) of this section that is not
otherwise a foreign branch, and that is
either a disregarded entity or a branch,
as defined in § 1.267A–5(a)(2),
including a branch described in
§ 1.951A–2(c)(7)(iv)(A)(3) (modified by
substituting the term ‘‘person’’ for
‘‘controlled foreign corporation’’).

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(ii) Foreign branch group
contributions—(A) In general. If a
taxpayer includes an item of foreign
gross income by reason of a foreign
branch group contribution, the foreign
gross income is assigned to the foreign
branch category, or, in the case of a
foreign branch owner that is a
partnership, to the partnership’s general
category income that is attributable to
the foreign branch. See, however,
§§ 1.861–20(d)(3)(v)(C)(2), 1.960–
1(d)(3)(ii)(A), and 1.960–1(e) for rules
providing that foreign income tax on a
disregarded payment that is a
contribution from a controlled foreign
corporation to a taxable unit is assigned
to the residual grouping and cannot be
deemed paid under section 960.
(B) Foreign branch group
contribution. A foreign branch group
contribution is a contribution (as
defined in § 1.861–20(d)(3)(v)(E)) made
by a member of a foreign branch owner
group to a member of a foreign branch
group that the payor owns, made by a
member of a foreign branch group to
another member of that group that the
payor owns, or made by a member of a
foreign branch group to a member of a
different foreign branch group that the
payor owns. For purposes of this
paragraph (b)(2)(ii)(B), the terms foreign
branch group and foreign branch owner
group have the meanings provided in
§ 1.904–4(f)(3).
*
*
*
*
*
(g) Applicability dates. Except as
otherwise provided in this paragraph
(g), this section applies to taxable years
that begin after December 31, 2019.
Paragraph (b)(2) of this section applies
to taxable years that begin after
December 31, 2019, and end on or after
November 2, 2020.
■ Par. 28. Revise 1.905–1 to read as
follows:
§ 1.905–1 When credit for foreign income
taxes may be taken.

(a) Scope. This section provides rules
regarding when the credit for foreign
income taxes (as defined in § 1.901–2(a))
may be taken, based on a taxpayer’s
method of accounting for such taxes.
Paragraph (b) of this section provides
the general rule. Paragraph (c) of this
section sets forth rules for determining
the taxable year in which taxpayers
using the cash receipts and
disbursement method of accounting for
income (‘‘cash method’’) may claim a
foreign tax credit. Paragraph (d) of this
section sets forth rules for determining
the taxable year in which taxpayers
using the accrual method of accounting
for income (‘‘accrual method’’) may
claim a foreign tax credit. Paragraph (e)
of this section provides rules for

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taxpayers using the cash method to
claim foreign tax credits on the accrual
basis pursuant to the election provided
under section 905(a). Paragraph (f) of
this section provides rules for when
foreign income tax expenditures of a
pass-through entity can be taken as a
credit by the entity’s partners,
shareholders, or owners. Paragraph (g)
of this section provides rules for when
a foreign tax credit can be taken with
respect to blocked income. Paragraph
(h) provides the applicability dates for
this section.
(b) General rule. The credit for foreign
income taxes provided in subpart A,
part III, subchapter N, chapter 1 of the
Code (the ‘‘foreign tax credit’’) may be
taken either on the return for the year
in which the foreign income taxes
accrued or on the return for the year in
which the foreign income taxes were
paid (that is, remitted), depending on
whether the taxpayer uses the accrual or
the cash receipts and disbursements
method of accounting for purposes of
computing taxable income and filing
returns. However, regardless of the year
in which the credit is claimed under the
taxpayer’s method of accounting for
foreign income taxes, the foreign tax
credit is allowed only to the extent the
foreign income taxes are ultimately both
owed and remitted to the foreign
country (in the case of a taxpayer
claiming the foreign tax credit on the
accrual basis, within the time prescribed
by section 905(c)(2)). See section 905(b)
and §§ 1.901–1(a) and 1.901–2(e).
Because the taxpayer’s liability for
foreign income tax may accrue (that is,
become fixed and determinable) in a
different taxable year than that in which
the tax is paid (that is, remitted), the
taxpayer’s entitlement to the credit may
be perfected, or become subject to
adjustment, by reason of events that
occur in a taxable year after the taxable
year in which the credit is allowed. See
section 905(c) and § 1.905–3(a) for rules
relating to changes to the taxpayer’s
foreign income tax liability that require
a redetermination of the allowable
foreign tax credit and the taxpayer’s
U.S. tax liability.
(c) Rules for cash method taxpayers—
(1) Credit allowed in year paid. Except
as provided in paragraph (e) of this
section, a taxpayer who uses the cash
method of accounting may claim a
foreign tax credit only in the taxable
year in which the foreign income taxes
are paid. Generally, foreign income
taxes are considered paid in the taxable
year in which the taxes are remitted to
the foreign country. However, foreign
withholding taxes described in section
901(k)(1)(B), as well as foreign net
income taxes described in § 1.901–

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2(a)(3)(i) that are withheld from the
taxpayer’s gross income by the payor,
are treated as paid in the year in which
they are withheld. Foreign income taxes
that have been withheld or remitted but
which are not considered an amount of
tax paid for purposes of section 901
under the rules of § 1.901–2(e) (for
example, because the amount withheld
or remitted was not a compulsory
payment), however, are not eligible for
a foreign tax credit. See §§ 1.901–2(e)
and 1.905–3(b)(1)(ii)(B) (Example 2).
(2) Payment of contested foreign tax
liability. Under § 1.901–2(e)(2)(i), a
foreign income tax liability that is
contested by the taxpayer is not a
reasonable approximation of the
taxpayer’s final foreign income tax
liability and, therefore, is not
considered an amount of tax paid for
purposes of section 901 until the contest
is resolved. Thus, except as provided in
paragraph (c)(3) of this section, a foreign
tax credit for a contested foreign income
tax liability (or portion thereof) that has
been remitted to the foreign country
cannot be claimed until such time as the
contest is resolved and the tax is
considered paid. Once the contest is
resolved and the foreign income tax
liability is finally determined, the tax
liability is treated as paid in the taxable
year in which the foreign tax was
remitted. See paragraph (c)(1) of this
section; see also section 6511(d)(3) and
§ 301.6511(d)–3 of this chapter for a
special 10-year period of limitations for
claiming a credit or refund of U.S. tax
that is attributable to foreign income
taxes for which a credit is allowed
under section 901, which for taxpayers
claiming credits on the cash basis runs
from the unextended due date of the
return for the taxable year in which the
foreign income taxes are paid (within
the meaning of paragraph (c) of this
section).
(3) Election to claim a provisional
credit for contested taxes remitted
before contest is resolved. A taxpayer
claiming foreign tax credits on the cash
basis may, under the conditions
provided in this paragraph (c)(3), elect
to claim a foreign tax credit for a
contested foreign income tax liability (or
a portion thereof) in the year the
contested amount (or a portion thereof)
is remitted to the foreign country,
notwithstanding that the liability is not
finally determined and so is not
considered an amount of tax paid. Such
election applies only for contested
foreign income taxes that are remitted in
a taxable year in which the taxpayer
elects under section 901(a) to claim a
credit, instead of a deduction under
section 164(a)(3), for taxes paid in such
year. To make the election, a taxpayer

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must file a Form 1116 (Foreign Tax
Credit (Individual, Estate, or Trust)) or
Form 1118 (Foreign Tax Credit—
Corporations), and the agreement
described in paragraphs (d)(4)(ii) and
(iii) of this section. In addition, the
taxpayer must, for each subsequent
taxable year up to and including the
taxable year in which the contest is
resolved, file the annual notice
described in paragraph (d)(4)(iv) of this
section. Any portion of a contested
foreign income tax liability for which a
provisional credit is claimed under this
paragraph (c)(3) that is subsequently
refunded by the foreign country results
in a foreign tax redetermination under
§ 1.905–3(a).
(4) Adjustments to taxes claimed as a
credit in the year paid. A refund of
foreign income taxes for which a foreign
tax credit has been claimed on the cash
basis, or a subsequent determination
that the amount paid exceeds the
taxpayer’s liability for foreign income
tax, requires a redetermination of
foreign income taxes paid and the
taxpayer’s U.S. tax liability pursuant to
section 905(c) and § 1.905–3. See
§ 1.905–3(a) and 1.905–3(b)(1)(ii)(G)
(Example 7). Additional foreign income
taxes paid that relate back to a prior year
in which foreign income taxes were
claimed as a credit on the cash basis,
including by reason of the settlement of
a dispute with the foreign tax authority,
may be claimed as a credit only in the
year the additional taxes are paid
(within the meaning of paragraph (c) of
this section). The payment of such
additional taxes does not result in a
redetermination pursuant to section
905(c) or § 1.905–3 of the foreign
income taxes paid in any prior year,
although a redetermination of U.S. tax
liability may be required due, for
example, to a carryback of unused
foreign tax under section 904(c) and
§ 1.904–2.
(d) Rules for accrual method
taxpayers—(1) Credit allowed in year
accrued—(i) In general. A taxpayer who
uses the accrual method of accounting
may claim a foreign tax credit only in
the taxable year in which the foreign
income taxes are considered to accrue
for foreign tax credit purposes under the
rules of this paragraph (d). Foreign
income taxes accrue in the taxable year
in which all the events have occurred
that establish the fact of the liability and
the amount of the liability can be
determined with reasonable accuracy.
See §§ 1.446–1(c)(1)(ii)(A) and 1.461–
4(g)(6)(iii)(B). For purposes of the
preceding sentence, a foreign income
tax that is contingent on a future
distribution of earnings does not meet
the all events test until the earnings are

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distributed. A foreign income tax
liability determined on the basis of a
foreign taxable year becomes fixed and
determinable at the close of the
taxpayer’s foreign taxable year.
Therefore, foreign income taxes that are
computed based on items of income,
deduction, and loss that arise in a
foreign taxable year accrue in the United
States taxable year with or within which
the taxpayer’s foreign taxable year ends.
Foreign withholding taxes that are paid
with respect to a foreign taxable year
and that represent advance payments of
a foreign net income tax liability
determined on the basis of that foreign
taxable year accrue at the close of the
foreign taxable year. Foreign
withholding taxes imposed on a
payment giving rise to an item of foreign
gross income accrue on the date the
payment from which the tax is withheld
is made (or treated as made under
foreign tax law).
(ii) Relation-back rule for adjustments
to taxes claimed as a credit in year
accrued. Additional tax paid as a result
of a change in the foreign tax liability,
including additional tax paid when a
contest with a foreign tax authority is
resolved, relates back and is considered
to accrue at the end of the foreign
taxable year with respect to which the
tax is imposed (the ‘‘relation-back
year’’). Additional withholding tax paid
as a result of a change in the amount of
an item of foreign gross income (such as
pursuant to a foreign transfer pricing
adjustment) also relates back and is
considered to accrue in the year in
which the payment from which the
additional tax is withheld is made (or
considered to have been made under
foreign tax law). Foreign income taxes
that are not paid within 24 months after
the close of the taxable year in which
they were accrued are treated as
refunded pursuant to § 1.905–3(a); when
subsequently paid, the foreign income
taxes are allowed as a credit in the
relation-back year. See § 1.905–
3(b)(1)(ii)(E) (Example 5). For special
rules that apply to determine when
foreign income tax is considered to
accrue in the case of certain ownership
and entity classification changes, see
§§ 1.336–2(g)(3)(ii), 1.338–9(d), 1.901–
2(f)(5), and 1.1502–76.
(2) Special rule for 52–53 week U.S.
taxable years. If a taxpayer has elected
pursuant to section 441(f) to use a U.S.
taxable year consisting of 52–53 weeks,
and such U.S. taxable year closes within
six calendar days of the end of the
taxpayer’s foreign taxable year, the
determination of when foreign income
taxes accrue under paragraph (d)(1) of
this section is made by deeming the

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taxpayer’s U.S. taxable year to end on
the last day of its foreign taxable year.
(3) Accrual of contested foreign tax
liability. A contested foreign income tax
liability is finally determined and
accrues for purposes of paragraph (d)(1)
of this section when the contest is
resolved. However, pursuant to section
905(c)(2), no credit is allowed for any
accrued tax that is not paid within 24
months of the close of the relation-back
year until the tax is actually remitted
and considered paid. Thus, except as
provided in paragraph (d)(4) of this
section, a foreign tax credit for a
contested foreign income tax liability
cannot be claimed until such time as
both the contest is resolved and the tax
is considered paid, even if the contested
liability (or portion thereof) has
previously been remitted to the foreign
country. Once the contest is resolved
and the foreign income tax liability is
finally determined and paid, the tax
liability accrues, and is considered to
accrue in the relation-back year for
purposes of the foreign tax credit. See
paragraph (d)(1) of this section; see also
section 6511(d)(3) and § 301.6511(d)–3
of this chapter for a special 10-year
period of limitations for claiming a
credit or refund of U.S. tax that is
attributable to foreign income taxes for
which a credit is allowed under section
901, which for taxpayers claiming
credits on the accrual basis runs from
the unextended due date of the return
for the taxable year in which the foreign
income taxes accrued (within the
meaning of this paragraph (d)).
(4) Election to claim a provisional
credit for contested taxes remitted
before accrual—(i) Conditions of
election. A taxpayer may, under the
conditions provided in this paragraph
(d)(4), elect to claim a foreign tax credit
for a contested foreign income tax
liability (or a portion thereof) in the
relation-back year when the contested
amount (or a portion thereof) is remitted
to the foreign country, notwithstanding
that the liability is not finally
determined and so has not accrued. This
election is available only for contested
foreign income taxes that relate to a
taxable year in which the taxpayer has
elected under section 901(a) to claim a
credit, instead of a deduction under
section 164(a)(3), for foreign income
taxes that accrue in such year. If the
election is made by a taxpayer with
respect to contested foreign income
taxes of a controlled foreign corporation,
such taxes are treated as deemed paid in
the relation-back year and the controlled
foreign corporation may deduct the
taxes in computing its taxable income in
the relation-back year. To make the
election, a taxpayer must file an

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amended return for the taxable year to
which the contested tax relates, together
with a Form 1116 (Foreign Tax Credit
(Individual, Estate, or Trust)) or Form
1118 (Foreign Tax Credit—
Corporations), and the agreement
described in paragraph (d)(4)(ii) of this
section. In addition, the taxpayer must,
for each subsequent taxable year up to
and including the taxable year in which
the contest is resolved, file the annual
notice described in paragraph (d)(4)(iii)
of this section. Any portion of a
contested foreign income tax liability for
which a provisional credit is claimed
under this paragraph (d)(4) that is
subsequently refunded by the foreign
country results in a foreign tax
redetermination under § 1.905–3(a).
(ii) Contents of provisional foreign tax
credit agreement. The provisional
foreign tax credit agreement must
contain the following:
(A) A statement that the document is
an election and an agreement under the
provisions of paragraph (d)(4) of this
section;
(B) A description of the contested
foreign income tax liability, including
the name (or other identifier) of the
foreign tax or taxes being contested, the
name of the country imposing the tax,
the name and identifying number of the
payor of the contested tax, the amount
of the contested tax, and the U.S.
taxable year(s) and the income to which
the contested foreign income tax
liability relates;
(C) The amount of the contested
foreign income tax liability in paragraph
(d)(4)(ii)(B) of this section that has been
remitted to the foreign country and the
date of the remittance(s);
(D) An agreement by the taxpayer, for
a period of three years from the later of
the filing or the due date (with
extensions) of the return for the taxable
year in which the taxpayer notifies the
Internal Revenue Service of the
resolution of the contest, not to assert
the statute of limitations on assessment
as a defense to the assessment of
additional taxes or interest related to the
contested foreign income tax liability
described in paragraph (d)(4)(ii)(B) of
this section that may arise from a
determination that the taxpayer failed to
exhaust all effective and practical
remedies to minimize its foreign income
tax liability, so that the amount of the
contested foreign income tax is not a
compulsory payment and is not
considered paid within the meaning of
§ 1.901–2(e)(5);
(E) A statement that the taxpayer
agrees to comply with all the conditions
and requirements of paragraph (d)(4) of
this section, including to provide notice

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365

to the Internal Revenue Service upon
the resolution of the contest; and
(F) Any additional information as may
be prescribed by the Commissioner of
Internal Revenue in Internal Revenue
Service forms or instructions.
(iii) Signatory. The provisional foreign
tax credit agreement must be signed
under penalties of perjury by a person
authorized to sign the return of the
taxpayer.
(iv) Annual notice. For each taxable
year following the year in which an
election pursuant to paragraph (d)(4) of
this section is made up to and including
the taxable year in which the contest is
resolved, the taxpayer must include
with its timely-filed return the
information described in paragraphs
(d)(4)(iii)(A) through (C) of this section
on Form 1116 or Form 1118 or in such
other form or manner prescribed by the
Commissioner of Internal Revenue in
Internal Revenue Service forms or
instructions.
(A) A description of the contested
foreign income tax liability, including
the name (or other identifier) of the
foreign tax or taxes, the name of the
country imposing the tax, the name and
identifying number of the payor of the
contested tax, the amount of the
contested tax, and a description of the
status of the contest.
(B) With the return for the taxable
year in which the contest is resolved,
notification that the contest has been
resolved. Such notification must
include the date of final resolution and
the amount of the finally determined
foreign income tax liability.
(C) Any additional information,
which may include a copy of the final
judgment, order, settlement, or other
documentation of the contest resolution,
as may be prescribed by the
Commissioner of Internal Revenue in
Internal Revenue Service forms or
instructions.
(5) Correction of improper accruals—
(i) In general. The accrual of a foreign
income tax expense generally involves
the determination of the proper timing
for recognizing the expense for Federal
income tax purposes. Thus, foreign
income tax expense is a material item
within the meaning of section 446. See
§ 1.446–1(e)(2)(ii). As a material item, a
change in the timing of accruing a
foreign income tax expense is generally
a change in method of accounting. See
section 446(e). A change from an
improper method of accruing foreign
income taxes to the proper method of
accrual described in this paragraph (d)
is treated as a change in a method of
accounting, regardless of whether the
taxpayer (or a partner or beneficiary
taking into account a distributive share

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of foreign income taxes paid by a
partnership or other pass-through
entity) chooses to claim a deduction or
a credit for such taxes in any taxable
year. For purposes of this paragraph
(d)(5), an improper method of accruing
foreign income taxes includes a method
under which foreign income tax is
accrued in a taxable year other than the
taxable year in which the requirements
of the all events test in §§ 1.446–
1(c)(1)(ii)(A) and 1.461–4(g)(6)(iii)(B) are
met, or which fails to apply the relationback rule in paragraph (d)(1) of this
section that applies for purposes of the
foreign tax credit, but does not include
corrections to estimated accruals or
errors in computing the amount of
foreign income tax that is allowed as a
deduction or credit in any taxable year.
Taxpayers must file a Form 3115,
Application for Change in Accounting
Method, in accordance with Revenue
Procedure 2015–13 (or any successor
administrative procedure prescribed by
the Commissioner) to obtain the
Commissioner’s permission to change
from an improper method of accruing
foreign income taxes to the proper
method described in this paragraph (d).
In order to prevent a duplication or
omission of a benefit for foreign income
taxes that accrue in any taxable year
(whether through the double allowance
or double disallowance of either a
deduction or a credit, the allowance of
both a deduction and a credit, or the
disallowance of either a deduction or a
credit, for the same amount of foreign
income tax), the rules in paragraphs
(d)(5)(ii) through (iv) of this section,
describing a modified cut-off approach,
apply if the Commissioner grants
permission for the taxpayer to change to
the proper method of accrual. Under the
modified cut-off approach, a section
481(a) adjustment is neither required
nor permitted with respect to the
amounts of foreign income tax that were
improperly accrued (or improperly not
accrued) under the taxpayer’s improper
method in taxable years before the
taxable year of change.
(ii) Adjustments required to
implement a change in method of
accounting for accruing foreign income
taxes. A change from an improper
method of accruing foreign income taxes
to the proper method described in this
paragraph (d) is made under the
modified cut-off approach described in
this paragraph (d)(5)(ii). Under the
modified cut-off approach, the amount
of foreign income tax in a statutory or
residual grouping (such as a separate
category as defined in § 1.904–5(a)(4))
that properly accrues in the taxable year
of change (accounted for in the currency

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in which the foreign tax liability is
denominated) is first adjusted upward
by the amount of foreign income tax in
the same grouping that properly accrued
in a taxable year before the taxable year
of change but which, under the
taxpayer’s improper method of
accounting, the taxpayer failed to accrue
and claim as either a credit or a
deduction in any taxable year before the
taxable year of change, and next,
adjusted downward (but not below zero)
by the amount of foreign income tax in
the same grouping that the taxpayer
improperly accrued in a taxable year
before the year of change and for which
the taxpayer claimed a credit or a
deduction in such prior taxable year,
but only if the improperly-accrued
amount of foreign income tax did not
properly accrue in a taxable year before
the taxable year of change. The modified
cut-off approach is applied separately
with respect to amounts of foreign
income tax for which the foreign tax
credit is disallowed and to which
section 275 does not apply. See, for
example, section 901(m)(6). For
purposes of the foreign tax credit, the
adjusted amounts of accrued foreign
income taxes, including any upward
adjustment, are translated into U.S.
dollars under § 1.986(a)–1 as if those
amounts properly accrued in the taxable
year of change. To the extent that the
downward adjustment in any grouping
required under this modified cut-off
approach exceeds the amount of foreign
income tax properly accruing in that
grouping in the year of change, as
increased by the upward adjustment, if
any, such excess will carry forward to
each subsequent taxable year and
reduce properly-accrued amounts of
foreign income tax in the same grouping
to the extent of those properly-accrued
amounts, until all improperly-accrued
amounts included in the downward
adjustment are accounted for. See
§ 1.861–20 for rules that apply to assign
foreign income taxes to statutory and
residual groupings. See paragraphs
(d)(6)(v) through (d)(6)(ix) of this section
for examples illustrating the application
of the modified cut-off approach.
(iii) Application of section 905(c)—(A)
Two-year rule. Except as otherwise
provided in this paragraph (d)(5)(iii), if
the taxpayer claimed a credit for
improperly-accrued amounts in a
taxable year before the taxable year of
change, no adjustment is required under
section 905(c)(2) and § 1.905–3(a) solely
by reason of the improper accrual. For
purposes of applying section 905(c)(2)
and § 1.905–3(a) to improperly-accrued
amounts of foreign income tax that were
claimed as a credit in any taxable year

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before the taxable year of change, the
24-month period runs from the close of
the U.S. taxable year(s) in which those
amounts were accrued under the
taxpayer’s improper method and
claimed as a credit. To the extent any
improperly-accrued amounts remain
unpaid as of the date 24 months after
the close of the taxable year in which
the amounts were improperly accrued
and claimed as a credit, an adjustment
is required under section 905(c)(2) and
§ 1.905–3(a) as if the improperlyaccrued amounts were refunded as of
the date 24 months after the close of
such taxable year. See § 1.986(a)–1(c) (a
refund or other downward adjustment
to foreign income taxes paid or accrued
on more than one date reduces the
foreign income taxes paid or accrued on
a last-in, first-out basis, starting with the
amounts most recently paid or accrued).
(B) Application of payments.
Amounts of foreign income tax that a
taxpayer accrued and claimed as a
credit or a deduction in a taxable year
before the taxable year of change under
the taxpayer’s improper method, but
that had properly accrued either in the
taxable year the credit or deduction was
claimed or in a different taxable year
before the taxable year of change, are
not included in the downward
adjustment required by paragraph
(d)(5)(ii) of this section. Remittances to
the foreign country of such amounts
(accounted for in the currency in which
the foreign tax liability is denominated)
are treated first as payments of the
amounts of tax that had properly
accrued in the taxable year claimed as
a credit or deduction to the extent
thereof, and then as payments of the
amounts of tax that were improperly
accrued in a different taxable year, on a
last-in, first-out basis, starting with the
most recent improperly-accrued
amounts. Remittances to the foreign
country of amounts of foreign income
tax that properly accrue in or after the
taxable year of change (accounted for in
the foreign currency in which the
foreign tax liability is denominated) but
that are offset by the amounts included
in the downward adjustment required
by paragraph (d)(5)(ii) of this section are
treated as payments of the amounts of
tax that were improperly accrued before
the taxable year of change and included
in the downward adjustment on a lastin, first-out basis, starting with the most
recent improperly-accrued amounts.
Additional amounts of foreign income
tax that first accrue in or after the
taxable year of change but that relate to
a taxable year before the taxable year of
change are taken into account in the
earlier of the taxable year of change or

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the taxable year or years in which they
would have been considered to accrue
based upon the taxpayer’s improper
method. Additional amounts of foreign
income tax that first accrue in or after
the taxable year of change and that
relate to the taxable year of change or a
taxable year after the year of change are
taken into account in the proper
relation-back year, but may then be
subject to the downward adjustment
required by paragraph (d)(5)(ii) of this
section.
(iv) Foreign income tax expense
improperly accrued by a foreign
corporation, partnership, or other passthrough entity. Foreign income tax
expense of a foreign corporation reduces
both the corporation’s taxable income
and its earnings and profits, and may
give rise to an amount of foreign taxes
deemed paid under section 960 that
may be claimed as a credit by a United
States shareholder that is a domestic
corporation or that is a person that
makes an election under section 962. If
the Commissioner grants permission for
a foreign corporation to change its
method of accounting for foreign
income tax expense, the duplication or
omission of those expenses (accounted
for in the functional currency of the
foreign corporation) and the associated
foreign income taxes (translated into
dollars in accordance with § 1.986(a)-1)
are accounted for by applying the rules
in paragraph (d)(5)(ii) of this section as
if the foreign corporation were itself
eligible to, and did, claim a credit under
section 901 for such amounts. In the
case of a partnership or other passthrough entity that is granted
permission to change its method of
accounting for accruing foreign income
taxes to a proper method as described in
this paragraph (d), such partnership or
other pass-through entity must provide
its partners or other owners with the
information needed for the partners or
other owners to properly account for the
improperly-accrued or unaccrued
amounts under the rules in paragraph
(d)(5)(ii) of this section as if their
proportionate shares of foreign income
tax expense were directly paid or
accrued by them.
(6) Examples. The following examples
illustrate the application of paragraph
(d) of this section. Unless otherwise
stated, the local currency of Country X
and Country Y, and the functional
currency of any foreign branch, is the
Euro (Ö), and at all relevant times the
exchange rate is $1:Ö1.
(i) Example 1: Accrual of foreign
income tax—(A) Facts. A, a U.S. citizen,
resides and works in Country X. A uses
the calendar year as the U.S. taxable
year and has made an election under

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paragraph (e) of this section to claim
foreign tax credits on an accrual basis.
Country X has a tax year that begins on
April 1 and ends on March 31. A’s
wages are subject to net income tax, at
graduated rates, under Country X tax
law and are subject to withholding on
a monthly basis by A’s employer in
Country X. In the period between April
1, Year 1, and March 31, Year 2, A earns
$50,000x in Country X wages, from
which A’s employer withholds $10,000x
in tax. On December 1, Year 1, A
receives a dividend distribution from a
Country Y corporation, from which the
corporation withheld $500x of tax.
Country Y imposes withholding tax on
dividends paid to nonresidents solely
based on the gross amount of the
dividend payment; A is not required to
file a tax return in Country Y.
(B) Analysis. Under paragraph (d)(1)
of this section, A’s liability for Country
X net income tax accrues on March 31,
Year 2, the last day of the Country X
taxable year. The Country X net income
tax withheld by A’s employer from A’s
wages is a reasonable approximation of,
and represents an advance payment of,
A’s final net income tax liability for the
year, which becomes fixed and
determinable only at the close of the
Country X taxable year. Thus, A cannot
claim a credit for any portion of the
Country X net income tax on A’s
Federal income tax return for Year 1,
and may claim a credit for the entire
Country X net income tax that accrues
on March 31, Year 2, on A’s Federal
income tax return for Year 2. A may
claim a credit for the Country Y
withholding tax on A’s Federal income
tax return for Year 1, because the
withholding tax accrued on December 1,
Year 1.
(ii) Example 2: 52–53 week taxable
year—(A) Facts. U.S.C., an accrual
method taxpayer, is a domestic
corporation that operates in branch form
in Country X. U.S.C. uses the calendar
year for Country X tax purposes. For
Federal income tax purposes, U.S.C.
elects pursuant to § 1.441–2(a) to use a
52–53 week taxable year that ends on
the last Friday of December. In Year 1,
U.S.C.’s U.S. taxable year ends on
Friday, December 25; in Year 2, U.S.C.’s
U.S. taxable year ends Friday, December
31. For its foreign taxable year ending
December 31, Year 1, U.S.C. earns
$10,000x of foreign source income
through its Country X branch and incurs
Country X foreign income tax of $500x;
for Year 2, U.S.C. earns $12,000x and
incurs Country X foreign income tax of
$600x.
(B) Analysis. Under paragraph (d)(1)
of this section, the $500x of Country X
foreign income tax becomes fixed and

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determinable at the close of U.S.C.’s
foreign taxable year, on December 31,
Year 1, which is after the close of its
U.S. taxable year (December 25, Year 1).
The $600x of Country X foreign income
tax becomes fixed and determinable on
December 31, Year 2. Thus, both the
Year 1 and Year 2 Country X foreign
income taxes accrue in U.S.C.’s U.S.
taxable year ending December 31, Year
2. However, pursuant to paragraph
(d)(2) of this section, for purposes of
determining the amount of foreign
income taxes accrued in each taxable
year for foreign tax credit purposes,
U.S.C.’s U.S. taxable year is deemed to
end on December 31, the end of U.S.C.’s
Country X taxable year. U.S.C. may
therefore claim a foreign tax credit for
$500x of Country X foreign income tax
on its Federal income tax return for Year
1 and a credit for $600x of Country X
foreign income tax on its Federal
income tax return for Year 2.
(iii) Example 3: Contested tax—(A)
Facts. U.S.C. is a domestic corporation
that operates in branch form in Country
X. U.S.C. uses an accrual method of
accounting and uses the calendar year
as its U.S. and Country X taxable year.
In Year 1, when the average exchange
rate described in § 1.986(a)–1(a)(1) is
$1:Ö1, U.S.C. earns Ö20,000x = $20,000x
through its Country X branch for U.S.
and Country X tax purposes and accrues
Country X foreign income taxes of
Ö500x = $500x, which U.S.C. claims as
a credit on its Federal income tax return
for Year 1. In Year 3, when the average
exchange rate is $1:Ö1.2, Country X
asserts that U.S.C. owes additional
foreign income taxes of Ö100x with
respect to U.S.C.’s Year 1 income. U.S.C.
contests the liability but remits Ö40x to
Country X with respect to the contested
liability in Year 3. U.S.C. does not make
an election under paragraph (d)(4) of
this section to claim a provisional credit
with respect to the Ö40x. In Year 6, after
exhausting all effective and practical
remedies, it is finally determined that
U.S.C. is liable for Ö50x of additional
Country X foreign income taxes with
respect to its Year 1 income. U.S.C. pays
an additional Ö10x to Country X on
September 15, Year 6, when the spot
rate described in § 1.986(a)–1(a)(2)(i) is
$1:Ö2.
(B) Analysis. Pursuant to paragraph
(d)(3) of this section, the additional
liability asserted by Country X with
respect to U.S.C.’s Year 1 income does
not accrue until the contest is resolved
in Year 6. U.S.C.’s remittance of Ö40x of
contested tax in Year 3 is not a payment
of accrued tax, and so is not a foreign
tax redetermination. Both the Ö40x of
Country X taxes paid in Year 3 and the
Ö10x of Country X taxes paid in Year 6

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accrue in Year 6, when the contest is
resolved. Once accrued and paid, the
Ö50x relates back for foreign tax credit
purposes to Year 1, and can be claimed
as a credit by U.S.C. on a timely-filed
amended return for Year 1. Under
§ 1.986(a)–1(a), for foreign tax credit
purposes the Ö40x paid in Year 3 is
translated into dollars at the average
exchange rate for Year 1 (Ö40x × $1/Ö1
= $40x), and the Ö10x paid in Year 6 is
translated into dollars at the spot rate on
the date paid (Ö10x × $1/Ö2 = $5x).
Accordingly, after the Ö50x of Country
X income tax is paid in Year 6 U.S.C.
may claim an additional foreign tax
credit of $45x for Year 1.
(iv) Example 4: Provisional credit for
contested tax—(A) Facts. The facts are
the same as those in paragraph
(d)(6)(iii)(A) of this section (the facts in
Example 3), except that U.S.C. pays the
entire contested tax liability of Ö100x to
Country X in Year 3 and elects under
paragraph (d)(4) of this section to claim
a provisional foreign tax credit on an
amended return for Year 1. In Year 6,
upon resolution of the contest, U.S.C.
receives a refund of Ö50x from Country
X.
(B) Analysis. In Year 3, U.S.C. may
claim a provisional foreign tax credit for
$100x (Ö100x translated at the average
exchange rate for Year 1) of contested
foreign tax paid to Country X by filing
an amended return for Year 1, with
Form 1118 attached, and a provisional
foreign tax credit agreement described
in paragraph (d)(4)(ii) of this section. In

each year for Years 4 through 6, U.S.C.
must attach the certification described
in paragraph (d)(4)(iii) of this section to
its timely-filed Federal income tax
return. In Year 6, as a result of the Ö50x
refund, U.S.C. must redetermine its U.S.
tax liability for Year 1 and for any other
affected year pursuant to § 1.905–3,
reducing the Year 1 foreign tax credit by
$50x (from $600x to $550x), and comply
with the notification requirements in
§ 1.905–4. See § 1.986(a)–1(c) (refunds
of foreign income tax translated into
U.S. dollars at the rate used to claim the
credit).
(v) Example 5: Improperly accelerated
accrual—(A) Facts—(1) Foreign income
tax accrued and paid. U.S.C. is a
domestic corporation that operates a
foreign branch in Country X. All of
U.S.C.’s gross and taxable income is
foreign source foreign branch category
income, and all of its foreign income
taxes are properly allocated and
apportioned under § 1.861–20 to the
foreign branch category. U.S.C. uses the
accrual method of accounting and uses
the calendar year as its U.S. taxable
year. For Country X tax purposes, U.S.C.
uses a fiscal year that ends on March 31.
U.S.C. accrued Ö200x of Country X net
income tax (as defined in § 1.901–
2(a)(3)) for its foreign taxable year
ending March 31, Year 2, for which the
average exchange rate was $1:Ö1. It
timely filed its Country X tax return and
paid the Ö200x on January 15, Year 3.
U.S.C. accrued and paid with its timely
filed Country X tax returns Ö280x and

Ö240x of Country X net income tax for
its foreign taxable years ending on
March 31 of Year 3 and Year 4,
respectively, on January 15 of Year 4
and Year 5, respectively.
(2) Improper accrual. On its Federal
income tax return for Year 1, U.S.C.
improperly pro-rated and accelerated
the accrual of Country X net income tax
and claimed a credit for $150x, equal to
three-fourths of the Country X net
income tax of $200x that relates to
U.S.C.’s foreign taxable year ending
March 31, Year 2. Continuing with this
improper method of accruing foreign
income taxes, U.S.C. claimed a foreign
tax credit of $260x on its U.S. tax return
for Year 2, comprising $50x (one-fourth
of the $200x of net income tax relating
to its foreign taxable year ending March
31, Year 2) plus $210x (three-fourths of
the $280x of net income tax relating to
its foreign taxable year ending March
31, Year 3). Similarly, U.S.C. improperly
accrued and claimed a foreign tax credit
on its U.S. tax return for Year 3 for
$250x of Country X net income tax,
comprising $70x (one-fourth of the
$280x that properly accrued in Year 3)
plus $180x (three-fourths of the $240x
that properly accrued in Year 4). In Year
4, U.S.C. realizes its mistake and, as
provided in paragraph (d)(5)(i) of this
section, files Form 3115 with the IRS to
seek permission to change from an
improper method to a proper method of
accruing foreign income taxes.

TABLE 1 TO PARAGRAPH (d)(6)(V)(A)(2)
Country X taxable year ending in U.S. calendar taxable year

tkelley on DSK125TN23PROD with RULES 2

3/31/Y1
3/31/Y2
3/31/Y3
3/31/Y4

ends
ends
ends
ends

in
in
in
in

Year
Year
Year
Year

1
2
3
4

..............................................................
..............................................................
..............................................................
..............................................................

(B) Analysis—(1) Downward
adjustment. Under paragraph (d)(5)(ii)
of this section, in Year 4, the year of
change, U.S.C. must reduce (but not
below zero) the amount (in Euros) of
Country X net income tax in the foreign
branch category that properly accrues in
Year 4, Ö240x, by the amount of foreign
income tax that was accrued and
claimed as either a deduction or a credit
in a year before the year of change, and
that had not properly accrued in either
the year in which the tax was accrued
under U.S.C.’s improper method or in
any other taxable year before the taxable
year of change. For all taxable years

VerDate Sep<11>2014

Net income
tax properly
accrued
($1 = Ö1))

19:19 Jan 03, 2022

Jkt 256001

0
200x
280x
240x

Net income tax accrued under
improper method
($1 = Ö1))
⁄ (200x) = 150x.
⁄ (200x) + 3⁄4 (280x) = 260x.
1⁄4 (280x) + 3⁄4 (240x) = 250x.
[year of change].
34
14

before the taxable year of change, under
its improper method U.S.C. had accrued
and claimed as a credit a total of Ö660x
= $660x of foreign income tax, of which
only Ö480x = $480x had properly
accrued. Therefore, the downward
adjustment required by paragraph
(d)(5)(ii) of this section is Ö180x (Ö660x
¥ Ö480x = Ö180x). In Year 4, U.S.C.’s
foreign tax credit in the foreign branch
category is reduced by $180x (Ö180x
downward adjustment translated into
dollars at $1:Ö1, the average exchange
rate for Year 4), from $240x to $60x.
(2) Application of section 905(c)—(i)
Year 1. Under paragraph (d)(5)(iii) of
this section, the Ö200x U.S.C. paid on

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January 15, Year 3, that relates to its
Country X taxable year ending on March
31, Year 2, is first treated as a payment
of the Ö50x of that Country X net
income tax liability that properly
accrued and was claimed as a credit by
U.S.C. in Year 2, and next as a payment
of the Ö150x of that Country X net
income tax liability that U.S.C.
improperly accrued and claimed as a
credit in Year 1. Because all Ö150x of
the Country X net income tax that was
improperly accrued and claimed as a
credit in Year 1 was paid within 24
months of December 31, Year 1, no
foreign tax redetermination occurs, and

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tkelley on DSK125TN23PROD with RULES 2

Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
no redetermination of U.S. tax liability
is required, for Year 1.
(ii) Year 2. Under paragraph (d)(5)(iii)
of this section, the Ö280x U.S.C. paid on
January 15, Year 4, that relates to its
Country X taxable year ending on March
31, Year 3, is first treated as a payment
of the Ö70x = $70x of that Country X net
income tax liability that properly
accrued and was claimed as a credit by
U.S.C. in Year 3, and next as a payment
of the Ö210x = $210x of that Country X
net income tax liability that U.S.C.
improperly accrued and claimed as a
credit in Year 2. Together with the Ö50x
= $50x of U.S.C.’s Country X net income
tax liability that properly accrued and
was claimed as a credit in Year 2, all
Ö260x of the Country X net income tax
that was accrued and claimed as a credit
in Year 2 under U.S.C.’s improper
method was paid within 24 months of
December 31, Year 2. Accordingly, no
foreign tax redetermination occurs, and
no redetermination of U.S. tax liability
is required, for Year 2.
(iii) Year 3. Under paragraph (d)(5)(iii)
of this section, the Ö240x U.S.C. paid on
January 15, Year 5, that relates to its
Country X taxable year ending on March
31, Year 4, is first treated as a payment
of the Ö60x = $60x of that Country X net
income tax liability that properly
accrued and was claimed as a credit by
U.S.C. in Year 4, and next as a payment
of the Ö180x = $180x of that Country X
net income tax liability that U.S.C.
improperly accrued and claimed as a
credit in Year 3. Together with the Ö70x
= $70x of U.S.C.’s Country X net income
tax liability that properly accrued and
was claimed as a credit by U.S.C. in
Year 3, all Ö250x of the Country X net
income tax that was accrued and
claimed as a credit in Year 3 under
U.S.C.’s improper method was paid
within 24 months of December 31, Year
3. Accordingly, no foreign tax
redetermination occurs, and no
redetermination of U.S. tax liability is
required, for Year 3.
(iv) Year 4. Under paragraph (d)(5)(iii)
of this section, Ö60x = $60x of U.S.C.’s
January 15, Year 5 payment of Ö240x
with respect to its Country X net income
tax liability for Year 4 is treated as a
payment of Ö60x = $60x of Country X
net income tax that, after application of
the downward adjustment required by
paragraph (d)(5)(ii) of this section, was
accrued and claimed as a credit in Year
4, the year of change.
(vi) Example 6: Failure to pay
improperly-accrued tax within 24
months—(A) Facts. The facts are the
same as those in paragraph (d)(6)(v) of
this section (the facts in Example 5),
except that U.S.C. does not pay its
Ö240x tax liability for its Country X

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taxable year ending on March 31, Year
4, until January 15 of Year 6, when the
spot rate described in § 1.986(a)–
1(a)(2)(i) is $1:Ö1.5.
(B) Analysis. The results are the same
as in paragraphs (d)(6)(v)(B)(2)(i) and (ii)
of this section (the analysis in Example
5 for Year 1 and Year 2). With respect
to Year 3, because the Ö180x = $180x of
Year 4 foreign income tax that was
improperly accrued and credited in
Year 3 was not paid within 24 months
of the end of Year 3, under section
905(c)(2) and § 1.905–3(a) that Ö180x =
$180x is treated as refunded on
December 31, Year 5, requiring a
redetermination of U.S.C.’s Federal
income tax liability for Year 3 (to
reverse out the credit claimed). In Year
6, when U.S.C. pays the Ö240x of
Country X income tax liability for Year
4, under paragraph (d)(5)(iii) of this
section that payment is first treated as
a payment of the Ö60x = $60x that was
properly accrued and claimed as a
credit in Year 4, and then as a payment
of the Ö180x that was improperly
accrued and claimed as a credit in Year
3 and that was treated as refunded in
Year 5. Under section 905(c)(2)(B) and
§ 1.905–3(a), that Year 6 payment of
accrued but unpaid tax is a second
foreign tax redetermination for Year 3
that also requires a redetermination of
U.S.C.’s U.S. tax liability. Under
§ 1.986(a)–1(a)(2), the Ö180x of
redetermined tax for Year 3 is translated
into dollars at the spot rate on January
15, Year 6, when the tax is paid (Ö180x
× $1/Ö1.5 = $120x). Under § 1.905–
4(b)(1)(iv), U.S.C. may file one amended
return accounting for both foreign tax
redeterminations (which occur in two
consecutive taxable years) with respect
to Year 3, which taken together result in
a reduction in U.S.C.’s foreign tax credit
for Year 3 from $250x to $190x ($250x
originally accrued ¥ $180x unpaid after
24 months + $120x paid in Year 6).
(vii) Example 7: Additional payment
of improperly-accrued tax—(A) Facts.
The facts are the same as those in
paragraph (d)(6)(v)(A) of this section
(the facts in Example 5), except that in
Year 6, Country X assessed additional
net income tax of Ö100x with respect to
U.S.C.’s Country X taxable year ending
March 31, Year 3, and after exhausting
all effective and practical remedies to
reduce its liability for Country X income
tax, U.S.C. pays the additional assessed
tax on September 15, Year 7, when the
spot rate described in § 1.986(a)–
1(a)(2)(i) is $1:Ö0.5.
(B) Analysis. Under paragraph (d)(3)
of this section, the additional Ö100x of
Country X income tax U.S.C. paid in
Year 7 with respect to its foreign taxable
year that ended March 31, Year 3,

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369

relates back and is considered to accrue
in Year 3. However, under its improper
method of accounting U.S.C. had
accrued and claimed foreign tax credits
for Country X net income tax that
related to Year 3 on its Federal income
tax returns for both Year 2 and Year 3.
Accordingly, under paragraph
(d)(5)(iii)(B) of this section U.S.C. must
redetermine its U.S. tax liability for both
Year 2 and Year 3 (and any other
affected years) to account for the
additional Ö100x of Country X net
income tax liability, using the improper
method it used to accrue foreign income
taxes before the year of change.
Therefore, three-fourths of the Ö100x of
additional tax, or Ö75x, is treated as if
it accrued in Year 2, and one-fourth of
the additional tax, or Ö25x, is treated as
if it accrued in Year 3. Pursuant to
§ 1.986(a)–1(a)(2)(i), the Ö75x of tax
treated as if it accrued in Year 2 and the
Ö25x of tax treated as if it accrued in
Year 3 are converted into dollars using
the September 15, Year 7, spot rate of
$1:Ö0.5, to $150x and $50x,
respectively. Under § 1.905–4(b)(1)(iii),
U.S.C. may claim a refund for any
resulting overpayment of U.S. tax for
Year 2 or Year 3 or any other affected
year by filing an amended return within
the period provided in section 6511.
(viii) Example 8: Tax improperly
accrued before year of change exceeds
tax properly accrued in year of
change—(A) Facts. U.S.C. owns all of
the stock in CFC, a controlled foreign
corporation organized in Country X.
Country X imposes net income tax on
Country X corporations at a rate of 10%
only in the year its earnings are
distributed to its shareholders, rather
than in the year the income is earned.
Both U.S.C. and CFC use the calendar
year as their taxable year for both
Federal and Country X income tax
purposes and CFC uses the Euro as its
functional currency. In each of Years 1–
3, CFC earns Ö1,000x for both Federal
and Country X income tax purposes of
general category foreign base company
sales income (before reduction for
foreign income taxes). CFC improperly
accrues Ö100x of Country X net income
tax with respect to Ö1,000x of income at
the end of each of Years 1 and 2, even
though no distribution is made in those
years. In Year 1, for which the average
exchange rate is $1:Ö1, U.S.C. computes
and includes in income with respect to
CFC $900x of subpart F income, claims
a deemed paid foreign tax credit of
$100x under section 960(a), and has a
section 78 dividend of $100x. In Year 2,
for which the average exchange rate is
$1:Ö0.5, U.S.C. computes and includes
in income with respect to CFC $1,800x

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370

Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations

of subpart F income, claims a deemed
paid foreign tax credit of $200x under
section 960(a), and has a section 78
dividend of $200x. In Year 2, CFC
makes a distribution to U.S.C. of Ö400x
of earnings and pays Ö40x of net income
tax to Country X. In Year 3, for which

the average exchange rate is $1:Ö1, CFC
makes another distribution to U.S.C. of
Ö500x of earnings and pays Ö50x in net
income tax to Country X. In Year 3,
U.S.C. realizes its mistake and seeks
permission from the IRS for CFC to
change to a proper method of accruing

foreign income taxes. In Year 4, for
which the average exchange rate is
$1:Ö2, CFC makes a distribution of
Ö700x of earnings and pays Ö70x of net
income tax to Country X.

TABLE 2 TO PARAGRAPH (d)(6)(viii)(A)
Foreign
income tax
properly
accrued

Taxable year ending

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12/31/Y1
12/31/Y2
12/31/Y3
12/31/Y4

($1:Ö1) .........................................................................
($1:Ö0.5) ......................................................................
($1:Ö1) .........................................................................
($1:Ö2) .........................................................................

(B) Analysis—(1) Downward
adjustment. Under paragraph (d)(5)(iv)
of this section, CFC applies the rules of
paragraph (d)(5) of this section as if it
claimed a foreign tax credit under
section 901 for Country X taxes. Under
paragraph (d)(5)(ii) of this section, in
Year 3, the year of change, CFC must
reduce (but not below zero) the amount
(in Euros) of Country X net income tax
allocated and apportioned to its general
category foreign base company sales
income group that properly accrues in
Year 3, Ö50x, by the amount of foreign
income tax (in Euros) that was
improperly accrued in that statutory
grouping in a year before the year of
change, and that had not properly
accrued in either the year accrued or in
another taxable year before the year of
change. For all taxable years before the
year of change, under its improper
method CFC had accrued a total of
Ö200x of foreign income tax with
respect to its general category foreign
base company sales income group, of
which only Ö40x had properly accrued.
Therefore, the downward adjustment
required by paragraph (d)(5)(ii) of this
section is Ö160x (Ö200x—Ö40x =
Ö160x). In Year 3, CFC’s Ö50x of eligible
foreign income taxes in the general
category foreign base company sales
income group is reduced by Ö50x to
zero. The Ö110x balance of the
downward adjustment carries forward
to Year 4, and reduces CFC’s Ö70x of
eligible foreign income taxes in the
general category foreign base company
sales income group by Ö70x to zero. The
remaining Ö40x balance of the
downward adjustment carries forward
to later years and will reduce CFC’s
eligible foreign income taxes in the
general category foreign base company
sales income group until all improperlyaccrued amounts are accounted for.

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0
Ö40x = $80x
Ö50x = $50x
Ö70x = $35x

Foreign income tax accrued under improper method

Ö100x = $100x.
Ö100x = $200x.
[year of change].

(2) Application of section 905(c)—(i)
Year 2. Under paragraph (d)(5)(iii) of
this section, CFC’s payment in Year 2 of
the Ö40x of Country X net income tax
that properly accrued in Year 2, before
the year of change, is treated as a
payment of Ö40x of foreign income tax
that CFC properly accrued in Year 2.
The Ö60x of foreign income tax that CFC
improperly accrued in Year 2 that
remains unpaid at the end of Year 2 is
not adjusted in Year 2. Under paragraph
(d)(5)(iii) of this section, CFC’s payment
in Year 3 of Ö50x of Country X net
income tax that properly accrued but
was offset by the downward adjustment
in Year 3 is treated as a payment of Ö50x
of the remaining Ö60x of Country X net
income tax that CFC improperly accrued
in Year 2, the most recent improper
accrual. In addition, CFC’s payment in
Year 4 of Ö70x of Country X net income
tax that properly accrued but was offset
by the downward adjustment in Year 4
is treated first as a payment of the
remaining Ö10x of Country X net
income tax that CFC improperly accrued
in Year 2. Because all Ö100x of foreign
income tax accrued in Year 2 under
CFC’s improper method of accounting is
treated as paid within 24 months of
December 31, Year 2, no foreign tax
redetermination occurs, and no
redetermination of CFC’s foreign base
company sales income, earnings and
profits, and eligible foreign income
taxes or of U.S.C.’s $1,800x subpart F
inclusion, $200x deemed paid credit,
$200x section 78 dividend and U.S. tax
liability is required, for Year 2.
(ii) Year 1. Because all Ö100x of the
tax CFC improperly accrued in Year 1
remained unpaid as of December 31,
Year 3, the date 24 months after the end
of Year 1, under section 905(c)(2) and
§ 1.905–3(a) that Ö100x is treated as
refunded on December 31, Year 3.
Under § 1.905–3(b)(2)(ii), U.S.C. must

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Fmt 4701

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redetermine its Federal income tax
liability for Year 1 to account for the
foreign tax redetermination, increasing
CFC’s foreign base company sales
income and earnings and profits by
Ö100x, and decreasing its eligible
foreign income taxes by $100x.
However, under paragraph (d)(5)(iii)(B)
of this section Ö60x of CFC’s payment
in Year 4 of Ö70x of Country X net
income tax that properly accrued but
was offset by the downward adjustment
in Year 4 is treated as a payment of Ö60x
of the Ö100x of Country X net income
tax that was improperly accrued in Year
1 and treated as refunded in Year 3.
Under § 1.905–4(b)(1)(iv), U.S.C. may
account for the two foreign tax
redeterminations that occurred in Years
3 and 4 on a single amended Federal
income tax return for Year 1. CFC’s
foreign base company sales income
(taking into account the reduction for
foreign income taxes) and earnings and
profits for Year 1 are recomputed as
Ö1,000x of foreign base company sales
income—Ö100x foreign income tax
improperly accrued in Year 1 + Ö100x
improperly accrued foreign income tax
treated as refunded on December 31,
Year 3—Ö60x improperly accrued
foreign income tax treated as paid in
Year 4 = Ö940x. CFC’s eligible foreign
income taxes for Year 1 are translated
into dollars at the applicable exchange
rate and recomputed as $100x foreign
income tax improperly accrued in Year
1—$100x improperly accrued foreign
income tax treated as refunded on
December 31, Year 3 + $30x improperly
accrued foreign income tax treated as
paid in Year 4 = $30x. U.S.C.’s subpart
F inclusion with respect to CFC for Year
1 (translated at the average exchange
rate for Year 1 of $1:Ö1) is increased
from $900x to $940x (Ö940x x $1/Ö1),
and the amount of foreign taxes deemed
paid under section 960(a) and the

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
amount of the section 78 dividend are
reduced from $100x to $30x.
(iii) Summary. As of the end of Year
4, CFC and U.S.C. have been allowed a
$30x foreign tax credit for Year 1, and
a $200x foreign tax credit for Year 2. If
in a later taxable year CFC distributes
additional earnings to U.S.C. and
accrues Ö40x of additional Country X
net income tax that is offset by the
balance of the Ö40x downward
adjustment, CFC’s payment of that Ö40x
Country X net income tax liability will
be treated as a payment of the remaining
Ö40x of Country X net income tax that
was improperly accrued in Year 1 and
treated as refunded as of the end of Year
3.
(ix) Example 9: Improperly deferred
accrual—(A) Facts—(1) Foreign income
tax accrued and paid. U.S.C. is a
domestic corporation that operates a

foreign branch in Country X. All of
U.S.C.’s gross and taxable income is
foreign source foreign branch category
income, and all of its foreign income
taxes are properly allocated and
apportioned under § 1.861–20 to the
foreign branch category. U.S.C. uses the
accrual method of accounting and uses
the calendar year as its taxable year for
both Federal and Country X income tax
purposes. U.S.C. accrued Ö160x of
Country X net income tax (as defined in
§ 1.901–2(a)(3)) with respect to Year 1.
U.S.C. filed its Country X tax return and
paid the Ö160x on June 30, Year 2.
U.S.C. accrued Ö180x, Ö240x, and Ö150x
of Country X tax for Years 2, 3, and 4,
respectively, and paid with its timely
filed Country X tax returns these tax
liabilities on June 30 of Years 3, 4, and
5, respectively. The average exchange
rate described in § 1.986(a)–1(a)(1) is

371

$1:Ö0.5 in Year 1, $1:Ö1 in Year 2,
$1:Ö1.25 in Year 3, and $1:Ö1.5 in Year
4.
(2) Improper accrual. On its Federal
income tax return for Year 1, U.S.C.
claimed no foreign tax credit. On its
Federal income tax return for Year 2,
U.S.C. improperly accrued and claimed
a credit for $160x (Ö160x of Country X
tax for Year 1 that it paid in Year 2,
translated into dollars at the average
exchange rate for Year 2). Continuing
with this improper method of
accounting, U.S.C. improperly accrued
and claimed a credit in Year 3 for $144x
(Ö180x of Country X tax for Year 2 that
it paid in Year 3, translated into dollars
at the average exchange rate for Year 3).
In Year 4, U.S.C. realizes its mistake and
seeks permission from the IRS to change
to a proper method of accruing foreign
income taxes.

TABLE 3 TO PARAGRAPH (d)(6)(ix)(A)(2)
Foreign
income tax
properly
accrued

Taxable year ending

tkelley on DSK125TN23PROD with RULES 2

12/31/Y1
12/31/Y2
12/31/Y3
12/31/Y4

($1:Ö0.5) .............................................
($1:Ö1) ................................................
($1:Ö1.25) ...........................................
($1:Ö1.5) .............................................

(B) Analysis—(1) Upward adjustment.
Under paragraph (d)(5)(ii) of this
section, in Year 4, the year of change,
U.S.C. increases the amount of Country
X net income tax allocated and
apportioned to its foreign branch
category that properly accrues in Year 4,
Ö150x, by the amount of foreign income
tax in that same grouping that properly
accrued in a taxable year before the
taxable year of change, but which, under
its improper method of accounting,
U.S.C. failed to accrue and claim as
either a credit or deduction before the
taxable year of change. For all taxable
years before the taxable year of change,
under a proper method, U.S.C. would
have accrued a total of Ö580x of foreign
income tax, of which it accrued and
claimed a credit for only Ö340x under
its improper method. Thus, in Year 4,
U.S.C. increases its Ö150x of properly
accrued foreign income taxes in the
foreign branch category by Ö240x
(Ö580x ¥ Ö340x), and may claim a
credit in that year for the total, Ö390x,
or $260x (translated into dollars at the
average exchange rate for Year 4, as if
the total amount properly accrued in
Year 4).
(2) Application of section 905(c).
Under paragraph (d)(5)(iii) of this
section, U.S.C.’s payment in Year 2 of

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Jkt 256001

Ö160x
Ö180x
Ö240x
Ö150x

=
=
=
=

$320x
$180x
$192x
$100x

Foreign income tax accrued under
improper method

.................................................
.................................................
.................................................
.................................................

Ö160x of Country X net income tax that
properly accrued in Year 1 but that
U.S.C. accrued and claimed as a credit
in Year 2 under its improper method of
accounting is first treated as a payment
of the amount of the Year 1 tax liability
that properly accrued in Year 2. Since
none of the Ö160x properly accrued in
Year 2, the Ö160x is treated as a
payment of the Year 1 tax liability that
U.S.C. improperly accrued and claimed
as a credit in Year 2, Ö160x. Because all
Ö160x of the Country X net income tax
that was improperly accrued and
claimed as a credit in Year 2 was paid
within 24 months of the end of Year 2,
no foreign tax redetermination occurs,
and no redetermination of U.S.C.’s
$160x foreign tax credit and U.S. tax
liability is required, for Year 2.
Similarly, because all Ö180x of the Year
2 Country X net income tax that was
improperly accrued and claimed as a
credit in Year 3 was paid within 24
months of the end of Year 3, no foreign
tax redetermination occurs, and no
redetermination of U.S.C.’s $144x
foreign tax credit and U.S. tax liability
is required, for Year 3.
(e) Election by cash method taxpayer
to take credit on the accrual basis—(1)
In general. A taxpayer who uses the
cash method of accounting for income

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0.
Ö160x = $160x.
Ö180x = $144x.
[year of change].

may elect to take the foreign tax credit
in the taxable year in which the taxes
accrue in accordance with the rules in
paragraph (d) of this section. Except as
provided in paragraph (e)(2) of this
section, an election pursuant to this
paragraph (e)(1) must be made on a
timely-filed original return, by checking
the appropriate box on Form 1116
(Foreign Tax Credit (Individual, Estate,
or Trust)) or Form 1118 (Foreign Tax
Credit—Corporations) indicating the
cash method taxpayer’s choice to claim
the foreign tax credit in the year the
foreign income taxes accrue. Once
made, the election is irrevocable and
must be followed for purposes of
claiming a foreign tax credit for all
subsequent years. See section 905(a).
(2) Exception for cash method
taxpayers claiming a foreign tax credit
for the first time. If the year with respect
to which an election pursuant to
paragraph (e)(1) of this section to claim
the foreign tax credit on an accrual basis
is made (the ‘‘election year’’) is the first
year for which a taxpayer has ever
claimed a foreign tax credit, the election
to claim the foreign tax credit on an
accrual basis can also be made on an
amended return filed within the period
permitted under § 1.901–1(d)(1). The
election is binding in the election year

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and all subsequent taxable years in
which the taxpayer claims a foreign tax
credit.
(3) Treatment of taxes that accrued in
a prior year. In the election year and
subsequent taxable years, a cash method
taxpayer that claimed foreign tax credits
on the cash basis in a prior taxable year
may claim a foreign tax credit not only
for foreign income taxes that accrue in
the election year, but also for foreign
income taxes that accrued (or are
considered to accrue) in a taxable year
preceding the election year but that are
paid in the election year or a subsequent
taxable year, as applicable. Under
paragraph (c) of this section, foreign
income taxes paid with respect to a
taxable year that precedes the election
year may be claimed as a credit only in
the year the taxes are paid and do not
require a redetermination under section
905(c) or § 1.905–3 of U.S. tax liability
in any prior year.
(4) Examples. The following examples
illustrate the application of paragraph
(e) of this section.
(i) Example 1—(A) Facts. A, a U.S.
citizen who is a resident of Country X,
is a cash method taxpayer who uses the
calendar year as the taxable year for
both U.S. and Country X tax purposes.
In Year 1 through Year 5, A claims
foreign tax credits for Country X foreign
income taxes on the cash method, in the
year the taxes are paid. For Year 6, A
makes a timely election to claim foreign
tax credits on the accrual basis. In Year
6, A accrues $100x of Country X foreign
income taxes with respect to Year 6.
Also in Year 6, A pays $80x in foreign
income taxes that had accrued in Year
5.
(B) Analysis. Pursuant to paragraph
(e)(3) of this section, A can claim a
foreign tax credit in Year 6 for the $100x
of Country X taxes that accrued in Year
6 and for the $80x of Country X taxes
that accrued in Year 5 but that are paid
in Year 6.
(ii) Example 2—(A) Facts. The facts
are the same as those in paragraph
(e)(4)(i)(A) of this section (the facts in
Example 1), except that in Year 7, A is
assessed an additional $10x of foreign
income tax by Country X with respect
to A’s income in Year 3. After
exhausting all effective and practical
remedies, A pays the additional $10x to
Country X in Year 8.
(B) Analysis. Pursuant to paragraph
(e)(3) of this section, A can claim a
foreign tax credit in Year 8 for the
additional $10x of foreign income tax
paid to Country X in Year 8 with respect
to Year 3.
(f) Rules for creditable foreign tax
expenditures of partners, shareholders,
or beneficiaries of a pass-through

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entity—(1) Effect of pass-through
entity’s method of accounting on when
foreign tax credit or deduction can be
claimed. Each partner that elects to
claim the foreign tax credit for a
particular taxable year may treat its
distributive share of the creditable
foreign tax expenditures (as defined in
§ 1.704–1(b)(4)(viii)(b)) of the
partnership that are paid or accrued by
the partnership, under the partnership’s
method of accounting, during the
partnership’s taxable year ending with
or within the partner’s taxable year, as
foreign income taxes paid or accrued (as
the case may be, according to the
partner’s method of accounting for such
taxes) by the partner in that particular
taxable year. See §§ 1.702–1(a)(6) and
1.703–1(b)(2). Under §§ 1.905–3(a) and
1.905–4(b)(2), additional creditable
foreign tax expenditures of the
partnership that result from a change in
the partnership’s foreign tax liability for
a prior taxable year, including
additional taxes paid when a contest
with a foreign tax authority is resolved,
must be identified by the partnership as
a prior year creditable foreign tax
expenditure in the information reported
to its partners for its taxable year in
which the additional tax is actually
paid. Subject to the rules in paragraphs
(c) and (e) of this section, a partner
using the cash method of accounting for
foreign income taxes may claim a credit
(or a deduction) for its distributive share
of such additional taxes in the partner’s
taxable year with or within which the
partnership’s taxable year ends. Subject
to the rules in paragraph (d) of this
section, a partner using the accrual
method of accounting for foreign
income taxes may claim a credit for the
partner’s distributive share of such
additional taxes in the relation-back
year, or may claim a deduction in its
taxable year with or within which the
partnership’s taxable year ends. The
principles of this paragraph (f)(1) apply
to determine the year in which a
shareholder of a S corporation, or the
grantor or beneficiary of an estate or
trust, may claim a foreign tax credit (or
a deduction) for its proportionate share
of foreign income taxes paid or accrued
by the S corporation, estate or trust. See
sections 642(a), 671, 901(b)(5), and
1373(a) and §§ 1.1363–1(c)(2)(iii) and
1.1366–1(a)(2)(iv). See §§ 1.905–3 and
1.905–4 for notifications and
adjustments of U.S. tax liability that are
required if creditable foreign tax
expenditures of a partnership or S
corporation, or foreign income taxes
paid or accrued by a trust or estate, are
refunded or otherwise reduced.

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(2) Provisional credit for contested
taxes. Under paragraph (d)(3) of this
section, a contested foreign tax liability
does not accrue until the contest is
resolved and the amount of the liability
has been finally determined. In
addition, under section 905(c)(2), a
foreign income tax that is not paid
within 24 months of the close of the
taxable year to which the tax relates
may not be claimed as a credit until the
tax is actually paid. Thus, a partnership
or other pass-through entity cannot take
the contested tax into account as a
creditable foreign tax expenditure until
both the contest is resolved and the tax
is actually paid. However, to the extent
that a partnership or other pass-through
entity remits a contested foreign tax
liability to a foreign country, a partner
or other owner of such pass-through
entity that claims foreign tax credits
may, by complying with the rules in
paragraph (c)(3) or (d)(4) of this section,
as applicable, elect to claim a
provisional credit for its distributive
share of such contested tax liability in
the year the pass-through entity remits
the tax (for owners claiming foreign tax
credits on the cash basis) or in the
relation-back year (for owners claiming
foreign tax credits on the accrual basis).
(3) Example. The following example
illustrates the application of paragraph
(f) of this section.
(i) Facts. ABC is a U.S. partnership
that is engaged in a trade or business in
Country X. ABC has two U.S. partners,
A and B. For Federal income tax
purposes, ABC and partner A both use
the accrual method of accounting and
utilize a taxable year ending on
September 30. ABC uses a taxable year
ending on September 30 for Country X
tax purposes. B is a calendar year
taxpayer that uses the cash method of
accounting. For its taxable year ending
September 30, Year 1, ABC accrues
$500x in foreign income tax to Country
X; each partner’s distributive share of
the foreign income tax is $250x. In its
taxable year ending September 30, Year
5, ABC settles a contest with Country X
with respect to its Year 1 tax liability
and, as a result of such settlement,
accrues an additional $100x in foreign
income tax for Year 1. ABC remits the
additional tax to Country X in January
of Year 6. A and B both elect to claim
foreign tax credits for their respective
taxable Years 1 through 6.
(ii) Analysis. For its taxable year
ending September 30, Year 1, A can
claim a credit for its $250x distributive
share of foreign income taxes paid by
ABC with respect to ABC’s taxable year
ending September 30, Year 1. Pursuant
to paragraph (f)(1) of this section, B can
claim its distributive share of $250x of

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
foreign income tax for its taxable year
ending December 31, Year 1, even if
ABC does not remit the Year 1 taxes to
Country X until Year 2. Although the
additional $100x of Country X foreign
income tax owed by ABC with respect
to Year 1 accrued in its taxable year
ending September 30, Year 5, upon
conclusion of the contest, because ABC
uses the accrual method of accounting,
it does not take the additional tax into
account until the tax is actually paid, in
its taxable year ending September 30,
Year 6. See section 905(c)(2)(B) and
paragraph (f)(1) of this section. Pursuant
to § 1.905–4(b)(2), ABC is required to
notify the IRS and its partners of the
foreign tax redetermination. A’s
distributive share of the additional tax
relates back, is considered to accrue,
and may be claimed as a credit for Year
1; however, A cannot claim a credit for
the additional tax until Year 6, when
ABC remits the tax to Country X. See
§ 1.905–3(a). B’s distributive share of the
additional tax does not relate back to
Year 1 and is creditable in B’s taxable
year ending December 31, Year 6.
(g) Blocked income. If, under the
provisions of the regulations under
section 461, an amount otherwise
constituting gross income for the taxable
year from sources without the United
States is, owing to monetary, exchange,
or other restrictions imposed by a
foreign country, not includible in gross
income of the taxpayer for such year,
the credit for foreign income taxes
imposed by such foreign country with
respect to such amount shall be taken
proportionately in any subsequent
taxable year in which such amount or
portion thereof is includible in gross
income.
(h) Applicability dates. This section
applies to foreign income taxes paid or
accrued in taxable years beginning on or
after December 28, 2021. In addition,
the election described in paragraphs
(c)(3) and (d)(4) of this section may be
made (including by a partner or other
owner of a pass-through entity
described in paragraph (f)(2) of this
section) with respect to amounts of
contested tax that are remitted in
taxable years beginning on or after
December 28, 2021 and that relate to a
taxable year beginning before December
28, 2021.
■ Par. 29. Section 1.905–3 is amended:
■ 1. In paragraph (a), by revising the
first two sentences.
■ 2. In paragraph (b)(1)(ii)(B)(1), by
removing the language ‘‘U.S.C.
Effective’’ and adding the language
‘‘U.S.C.. Effective’’ in its place.
■ 3. By adding paragraph (b)(4).
■ 4. By revising paragraph (d).

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The revisions and addition read as
follows:
§ 1.905–3 Adjustments to U.S. tax liability
and to current earnings and profits as a
result of a foreign tax redetermination.

(a) * * * For purposes of this section
and § 1.905–4, the term foreign tax
redetermination means a change in the
liability for foreign income taxes (as
defined in § 1.901–2(a)) or certain other
changes described in this paragraph (a)
that may affect a taxpayer’s U.S. tax
liability, including by reason of a
change in the amount of its foreign tax
credit, a change to claim a foreign tax
credit for foreign income taxes that it
previously deducted, a change to claim
a deduction for foreign income taxes
that it previously credited, a change in
the amount of its distributions or
inclusions under sections 951, 951A, or
1293, a change in the application of the
high-tax exception described in section
954(b)(4) (including for purposes of
determining amounts excluded from
gross tested income under section
951A(c)(2)(A)(i)(III) and § 1.951A–
2(c)(1)(iii)), or a change in the amount
of tax determined under sections
1291(c)(2) and 1291(g)(1)(C)(ii). In the
case of a taxpayer that claims the credit
in the year the taxes are paid, a foreign
tax redetermination occurs if any
portion of the tax paid is subsequently
refunded, or if the taxpayer’s liability is
subsequently determined to be less than
the amount paid and claimed as a
credit. * * *
(b) * * *
(4) Change in election to claim a
foreign tax credit. A redetermination of
U.S. tax liability is required to account
for the effect of a timely change by the
taxpayer to claim a foreign tax credit or
a deduction for foreign income taxes
paid or accrued in any taxable year as
permitted under § 1.901–1(d).
*
*
*
*
*
(d) Applicability dates. Except as
provided in this paragraph (d), this
section applies to foreign tax
redeterminations occurring in taxable
years ending on or after December 16,
2019, and to foreign tax
redeterminations of foreign corporations
occurring in taxable years that end with
or within a taxable year of a United
States shareholder ending on or after
December 16, 2019 and that relate to
taxable years of foreign corporations
beginning after December 31, 2017. The
first two sentences of paragraph (a) of
this section, and paragraph (b)(4) of this
section, apply to foreign tax
redeterminations occurring in taxable
years beginning on or after December
28, 2021.

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373

Par. 30. Section 1.951A–2 is
amended:
■ 1. In paragraph (c)(7)(iii)(A), by
adding the language ‘‘and the rules of
§ 1.861–20’’ at the end of the first
sentence.
■ 2. By removing paragraph
(c)(7)(iii)(B).
■ 3. By redesignating paragraph
(c)(7)(iii)(C) as paragraph (c)(7)(iii)(B).
■ 4. In newly redesignated paragraph
(c)(7)(iii)(B), by removing the language
‘‘(c)(7)(iii)(C)’’ from the first sentence
and adding the language ‘‘(c)(7)(iii)(B)’’
in its place.
■ 5. By adding paragraph (c)(8)(ii)(M).
■ 6. By revising paragraph
(c)(8)(iii)(A)(2)(ii).
■ 7. By removing and reserving
paragraph (c)(8)(iii)(B).
■ 8. In paragraph (c)(8)(iii)(C)(2)(iii):
■ i. By removing the language ‘‘the
principles of §§ 1.960–1(d)(3)(ii) and
1.904–6(a)(1)’’ from the first and second
sentences and adding the language
‘‘§ 1.861–20’’ in its place.
■ ii. By removing the language ‘‘Under
these principles, the’’ from the third
sentence and adding the language
‘‘Under § 1.861–20,’’ in its place.
The additions and revisions read as
follows:
■

§ 1.951A–2

*

Tested income and tested loss.

*
*
*
*
(c) * * *
(8) * * *
(ii) * * *
(M) The same amounts of regarded
items of income and deduction that are
accrued under federal income tax law
are also accrued under foreign law.
(iii) * * *
(A) * * *
(2) * * *
(ii) * * * Under paragraph
(c)(7)(iii)(A) of this section, CFC1X’s
tentative tested income items are
computed by treating the CFC1X
tentative gross tested income item and
the FDE1Y tentative gross tested income
item each as income in a separate tested
income group (the ‘‘CFC1X income
group’’ and the ‘‘FDE1Y income group’’)
and by allocating and apportioning
CFC1X’s deductions for current year
taxes under § 1.861–20 (CFC1X has no
other deductions to allocate and
apportion). Under paragraph
(c)(7)(iii)(A) of this section and § 1.861–
20(d)(3)(v), the Ö20x deduction for
Country Y income taxes is allocated and
apportioned solely to the FDE1Y income
group (the ‘‘FDE1Y group tax’’) and
none of the Country Y taxes are
allocated and apportioned to the CFC1X
income group.
*
*
*
*
*
■ Par. 31. Section 1.951A–7(b) is
amended:

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1. By removing the language
‘‘Section’’ from the first sentence and
adding the language ‘‘Except as
otherwise provided in this paragraph
(b), section,’’ in its place.
■ 2. Adding three sentences after the
second sentence.
The addition reads as follows:
■

§ 1.951A–7

Applicability dates.

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*

*
*
*
*
(b) * * * Section 1.951A–
2(c)(7)(iii)(B), (c)(8)(ii),
(c)(8)(iii)(A)(2)(ii), and (c)(8)(iii)(B)
apply to taxable years of foreign
corporations beginning on or after
December 28, 2021, and to taxable years
of United States shareholders in which
or with which such taxable years of the
foreign corporations end. In addition,
taxpayers may choose to apply the rules
in § 1.951A–2(c)(7)(iii)(B),
(c)(8)(iii)(A)(2)(ii), and
(c)(8)(iii)(B)(2)(iii) to taxable years of
foreign corporations that begin after
December 31, 2019, and before
December 28, 2021, and to taxable years
of U.S. shareholders in which or with
which such taxable years of the foreign
corporations end. For taxable years of
foreign corporations beginning before
December 28, 2021, see § 1.951A–
2(c)(7)(iii)(B), (c)(8)(iii)(A)(2)(ii), and
(c)(8)(iii)(B)(2)(iii) as contained in 26
CFR part 1 revised as of April 1, 2021.
■ Par. 32. Section 1.960–1 is amended:
■ 1. By revising paragraph (b)(4).
■ 2. By redesignating paragraphs (b)(5)
through (37) as paragraphs (b)(6)
through (38), respectively.
■ 3. By adding a new paragraph (b)(5).
■ 4. By revising newly redesignated
paragraphs (b)(6) and (c)(1)(ii).
■ 5. By redesignating paragraphs
(c)(1)(iii) through (vi) as paragraphs
(c)(1)(iv) through (vii).
■ 6. By adding a new paragraph
(c)(1)(iii).
■ 7. In newly redesignated paragraph
(c)(1)(iv), by removing the language
‘‘Third, current year taxes’’ in the first
sentence and adding the language
‘‘Fourth, eligible current year taxes’’ in
its place.
■ 8. In newly redesignated paragraph
(c)(1)(v), by removing the language
‘‘Fourth,’’ from the first sentence and
adding the language ‘‘Fifth,’’ in its
place.
■ 9. In newly redesignated paragraph
(c)(1)(vi), by removing the language
‘‘Fifth,’’ from the first sentence and
adding the language ‘‘Sixth,’’ in its
place.
■ 10. In newly redesignated paragraph
(c)(1)(vii), by removing the language
‘‘Sixth,’’ from the first sentence and
adding the language ‘‘Seventh,’’ in its
place.

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11. In paragraph (d)(1), by removing
the language ‘‘the U.S. dollar amount of
current year taxes’’ from the first
sentence and adding the language ‘‘the
U.S. dollar amount of eligible current
year taxes’’ in its place.
■ 12. In paragraph (d)(3)(i) introductory
text, by removing the language ‘‘current
year taxes’’ from the second sentence
and adding the language ‘‘eligible
current year taxes’’ in its place.
■ 13. In paragraph (d)(3)(ii)(A), by
revising the last sentence.
■ 14. In paragraph (d)(3)(ii)(B), by
removing the language ‘‘a current year
tax’’ from the first sentence and adding
the language ‘‘an eligible current year
tax’’ in its place.
■ 15. In paragraph (f)(1)(ii), by removing
the language ‘‘tax’’ from the fifth
sentence and adding the language
‘‘eligible current year tax’’ in its place.
■ 16. In paragraph (f)(2)(i):
■ i. By removing the language
‘‘paragraphs (c)(1)(i) through (iv)’’ from
the third sentence and adding the
language ‘‘paragraphs (c)(1)(i) through
(v)’’ in its place.
■ ii. By removing the language ‘‘Under
paragraph (c)(1)(v) of this section, the
rules in paragraph (c)(1)(i) through (iv)’’
from the fourth sentence and adding the
language ‘‘Under paragraph (c)(1)(vi) of
this section, the rules in paragraph
(c)(1)(i) through (v)’’ in its place.
■ 17. In paragraph (f)(2)(ii)(B)(1), by
removing the language ‘‘current year
taxes’’ from the last sentence and adding
the language ‘‘eligible current year
taxes’’ in its place.
■ 18. In paragraph (f)(2)(ii)(B)(2):
■ i. By removing the language ‘‘current
year taxes’’ from the fifth sentence and
adding the language ‘‘eligible current
year taxes’’ in its place.
■ ii. By removing the last two sentences.
■ 19. By redesignating paragraphs
(f)(2)(ii)(C) through (F) as paragraphs
(f)(2)(ii)(D) through (G), respectively.
■ 20. By adding a new paragraph
(f)(2)(ii)(C).
■ 21. In newly-redesignated paragraph
(f)(2)(ii)(D):
■ i. By removing the language ‘‘Step 3.
Under paragraph (c)(1)(iii)’’ from the
first sentence and adding the language
‘‘Step 4. Under paragraph (c)(1)(iv)’’ in
its place.
■ ii. By removing the language
‘‘paragraph (c)(1)(iii)’’ from the fifth
sentence and adding the language
‘‘paragraph (c)(1)(iv)’’ in its place.
■ 21. In newly-redesignated paragraph
(f)(2)(ii)(E), by removing the language
‘‘Step 4. Under paragraph (c)(1)(iv)’’
from the first sentence and adding the
language ‘‘Step 5. Under paragraph
(c)(1)(v)’’ in its place.
■ 22. In newly-redesignated paragraph
(f)(2)(ii)(F), by removing the language
■

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‘‘Step 5. Paragraph (c)(1)(v)’’ and adding
the language ‘‘Step 6. Paragraph
(c)(1)(vi)’’ in its place.
■ 23. In newly-redesignated paragraph
(f)(2)(ii)(G), by removing the language
‘‘Step 6. Paragraph (c)(1)(vi)’’ and
adding the language ‘‘Step 7. Paragraph
(c)(1)(vii)’’ in its place.
The additions and revisions read as
follows:
§ 1.960–1 Overview, definitions, and
computational rules for determining foreign
income taxes deemed paid under section
960(a), (b), and (d).

*

*
*
*
*
(b) * * *
(4) Current year tax. The term current
year tax means a foreign income tax that
is paid or accrued by a controlled
foreign corporation in a current taxable
year (taking into account any
adjustments resulting from a foreign tax
redetermination (as defined in § 1.905–
3(a)). See § 1.905–1 for rules on when
foreign income taxes are considered
paid or accrued for foreign tax credit
purposes; see also § 1.367(b)-7(g) for
rules relating to foreign income taxes
associated with foreign section 381
transactions and hovering deficits.
(5) Eligible current year tax. The term
eligible current year tax means a current
year tax, other than a current year tax
for which a credit is disallowed or
suspended at the level of the controlled
foreign corporation. See, for example,
section 245A(e)(3) and § 1.245A(d)1(a)(2) and sections 901(k)(1), (l), and
(m), 909, and 6038(c)(1)(B). An eligible
current year tax, however, includes a
current year tax that may be deemed
paid but for which a credit is reduced
or disallowed at the level of the United
States shareholder. See, for example,
sections 901(e), 901(j), 901(k)(2), 908,
965(g), and 6038(c)(1)(A).
(6) Foreign income tax. The term
foreign income tax has the meaning
provided in § 1.901–2(a).
*
*
*
*
*
(c) * * *
(1) * * *
(ii) Second, deductions (other than for
current year taxes) of the controlled
foreign corporation for the current
taxable year are allocated and
apportioned to reduce gross income in
the section 904 categories and the
income groups within a section 904
category. See paragraph (d)(3)(i) of this
section. Deductions for current year
taxes (other than eligible current year
taxes) of the controlled foreign
corporation for the current taxable year
are allocated and apportioned to reduce
gross income in the section 904
categories and the income groups within
a section 904 category. Additionally, the

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Federal Register / Vol. 87, No. 2 / Tuesday, January 4, 2022 / Rules and Regulations
functional currency amounts of eligible
current year taxes are allocated and
apportioned to reduce gross income in
the section 904 categories and the
income groups within a section 904
category, and to reduce earnings and
profits in the PTEP groups that were
increased as provided in paragraph
(c)(1)(i) of this section. No deductions
other than eligible current year taxes are
allocated and apportioned to PTEP
groups. See paragraph (d)(3)(ii) of this
section.
(iii) Third, for purposes of computing
foreign taxes deemed paid, eligible
current year taxes that were allocated
and apportioned to income groups and
PTEP groups in the section 904
categories are translated into U.S.
dollars in accordance with section
986(a).
*
*
*
*
*
(d) * * *
(3) * * *
(ii) * * *
(A) * * * For purposes of
determining foreign income taxes
deemed paid under the rules in
§§ 1.960–2 and 1.960–3, the U.S. dollar
amount of eligible current year taxes is
assigned to the section 904 categories,
income groups, and PTEP groups (to the
extent provided in paragraph
(d)(3)(ii)(B) of this section) to which the
eligible current year taxes are allocated
and apportioned.
*
*
*
*
*
(f) * * *
(2) * * *
(ii) * * *
(C) Step 3. Under paragraph (c)(1)(iii)
of this section, for purposes of
computing foreign taxes deemed paid
under section 960, CFC1 has $600,000x
of foreign income taxes in the PTEP
group within the general category and
$300,000x of current year taxes in the
residual income group within the
general category. Under paragraph (e) of
this section, the United States
shareholders of CFC1 cannot claim a
credit with respect to the $300,000x of
taxes on CFC1’s income in the residual
income group.
*
*
*
*
*
■ Par. 33. Section 1.960–2 is amended:
■ 1. In paragraph (b)(2), by removing the
language ‘‘current year taxes’’ and
adding the language ‘‘eligible current
year taxes’’ in its place.
■ 2. In paragraph (b)(3)(i), by removing
the language ‘‘current year taxes’’ each
place it appears and adding the
language ‘‘eligible current year taxes’’ in
its place.
■ 3. In paragraph (b)(5)(i), by revising
the seventh sentence.
■ 4. In paragraph (b)(5)(ii)(A), by
revising the first and second sentences.

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5. In paragraph (b)(5)(ii)(B), by
revising the first and second sentences.
■ 6. In paragraph (c)(4), by removing the
language ‘‘current year taxes’’ and
adding the language ‘‘eligible current
year taxes’’ in its place.
■ 7. In paragraph (c)(5), by removing the
language ‘‘current year taxes’’ each
place it appears and adding the
language ‘‘eligible current year taxes’’ in
its place.
■ 8. In paragraph (c)(7)(i)(A), by revising
the fifth sentence.
■ 9. In paragraph (c)(7)(i)(B), by revising
the first and second sentences.
■ 10. In paragraph (c)(7)(ii)(A)(1), by
revising the ninth and eleventh
sentences.
■ 11. In paragraph (c)(7)(ii)(B)(1)(i), by
revising the first and second sentences.
■ 12. In paragraph (c)(7)(ii)(B)(1)(ii), by
removing the language ‘‘foreign income
taxes’’ in the first sentence and adding
the language ‘‘eligible current year
taxes’’ in its place.
The additions and revisions read as
follows:
■

§ 1.960–2 Foreign income taxes deemed
paid under sections 960(a) and (d).

*

*
*
*
*
(b) * * *
(5) * * *
(i) * * * CFC has current year taxes,
all of which are eligible current year
taxes, translated into U.S. dollars, of
$740,000x that are allocated and
apportioned as follows: $50,000x to
subpart F income group 1; $240,000x to
subpart F income group 2; and
$450,000x to subpart F income group 3.
* * *
(ii) * * *
(A) * * * Under paragraphs (b)(2)
and (3) of this section, the amount of
CFC’s foreign income taxes that are
properly attributable to items of income
in subpart F income group 1 to which
a subpart F inclusion is attributable
equals USP’s proportionate share of the
eligible current year taxes that are
allocated and apportioned under
§ 1.960–1(d)(3)(ii) to subpart F income
group 1, which is $40,000x ($50,000x ×
800,000u/1,000,000u). Under
paragraphs (b)(2) and (3) of this section,
the amount of CFC’s foreign income
taxes that are properly attributable to
items of income in subpart F income
group 2 to which a subpart F inclusion
is attributable equals USP’s
proportionate share of the eligible
current year taxes that are allocated and
apportioned under § 1.960–1(d)(3)(ii) to
subpart F income group 2, which is
$192,000x ($240,000x × 1,920,000u/
2,400,000u). * * *
(B) * * * Under paragraphs (b)(2) and
(3) of this section, the amount of CFC’s

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375

foreign income taxes that are properly
attributable to items of income in
subpart F income group 3 to which a
subpart F inclusion is attributable
equals USP’s proportionate share of the
eligible current year taxes that are
allocated and apportioned under
§ 1.960–1(d)(3)(ii) to subpart F income
group 3, which is $360,000x ($450,000x
× 1,440,000u/1,800,000u). CFC has no
other subpart F income groups within
the general category. * * *
(c) * * *
(7) * * *
(i) * * *
(A) * * * CFC1 has current year
taxes, all of which are eligible current
year taxes, translated into U.S. dollars,
of $400x that are all allocated and
apportioned to the tested income group.
* * *
(B) * * * Under paragraph (c)(5) of
this section, USP’s proportionate share
of the eligible current year taxes that are
allocated and apportioned under
§ 1.960–1(d)(3)(ii) to CFC1’s tested
income group is $400x ($400x × 2,000u/
2,000u). Therefore, under paragraph
(c)(4) of this section, the amount of
foreign income taxes that are properly
attributable to tested income taken into
account by USP under section 951A(a)
and § 1.951A–1(b) is $400x. * * *
(ii) * * *
(A) * * *
(1) * * * CFC1 has current year taxes,
all of which are eligible current year
taxes, translated into U.S. dollars, of
$100x that are all allocated and
apportioned to CFC1’s tested income
group. * * * CFC2 has current year
taxes, all of which are eligible current
year taxes, translated into U.S. dollars,
of $20x that are allocated and
apportioned to CFC2’s tested income
group.
*
*
*
*
*
(B) * * *
(1) * * *
(i) * * * Under paragraphs (c)(5) and
(6) of this section, US1’s proportionate
share of the eligible current year taxes
that are allocated and apportioned
under § 1.960–1(d)(3)(ii) to CFC1’s
tested income group is $95x ($100x ×
285u/300u). Therefore, under paragraph
(c)(4) of this section, the amount of the
foreign income taxes that are properly
attributable to tested income taken into
account by US1 under section 951A(a)
and § 1.951A–1(b) is $95x. * * *
*
*
*
*
*
■ Par. 34. Section 1.960–7 is amended
by revising paragraph (b) to read as
follows:
§ 1.960–7

*

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(b) Section 1.960–1(c)(2) and (d)(3)(ii)
apply to taxable years of a foreign
corporation beginning after December
31, 2019, and to each taxable year of a
domestic corporation that is a United
States shareholder of the foreign
corporation in which or with which
such taxable year of such foreign
corporation ends. For taxable years of a
foreign corporation that end on or after
December 4, 2018, and also begin before
January 1, 2020, see § 1.960–1(c)(2) and
(d)(3)(ii) as in effect on December 17,
2019. Paragraphs (b)(4), (5), and (6),

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(c)(1)(ii), (iii), and (iv), and (d)(3)(ii)(A)
and (B) of § 1.960–1, and paragraphs
(b)(2), (b)(3)(i), (b)(5)(i), (b)(5)(iv)(A),
and (c)(4), (5), and (7) of § 1.960–2,
apply to taxable years of foreign
corporations beginning on or after
December 28, 2021, and to each taxable
year of a domestic corporation that is a
United States shareholder of the foreign
corporation in which or with which
such taxable year of such foreign
corporation ends. For taxable years of
foreign corporations beginning before
December 28, 2021, with respect to the

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paragraphs described in the preceding
sentence, see §§ 1.960–1 and 1.960–2 as
in effect on November 12, 2020.
Douglas W. O’Donnell,
Deputy Commissioner for Services and
Enforcement.
Approved: December 9, 2021
Lily Batchelder,
Assistant Secretary of the Treasury (Tax
Policy).
[FR Doc. 2021–27887 Filed 12–28–21; 4:15 pm]
BILLING CODE 4830–01–P

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