Title 26
SECTION 1.960-1
1.960-1 Overview, definitions, and computational rules for determining foreign income taxes deemed paid under section 960(a), (b), and (d).
§ 1.960-1 Overview, definitions, and computational rules for determining foreign income taxes deemed paid under section 960(a), (b), and (d).(a) Overview - (1) Scope of §§ 1.960-1 through 1.960-3. This section and §§ 1.960-2 and 1.960-3 provide rules to associate foreign income taxes of a controlled foreign corporation with the income that a domestic corporation that is a United States shareholder of the controlled foreign corporation takes into account in determining a subpart F inclusion or GILTI inclusion amount of the domestic corporation, as well as to associate foreign income taxes of a controlled foreign corporation with distributions of previously taxed earnings and profits. This section and §§ 1.960-2 and 1.960-3 provide the exclusive rules for determining the foreign income taxes deemed paid by a domestic corporation under section 960. Therefore, only foreign income taxes of a controlled foreign corporation that are associated under these rules with a subpart F inclusion or GILTI inclusion amount of a domestic corporation that is a United States shareholder of the controlled foreign corporation, or with previously taxed earnings and profits, are eligible to be deemed paid. This section provides definitions and computational rules for determining foreign income taxes deemed paid under section 960(a), (b), and (d). Section 1.960-2 provides rules for computing the amount of foreign income taxes deemed paid by a domestic corporation that is a United States shareholder of a controlled foreign corporation under section 960(a) and (d). Section 1.960-3 provides rules for computing the amount of foreign income taxes deemed paid by a domestic corporation that is a United States shareholder of a controlled foreign corporation, or by a controlled foreign corporation, under section 960(b). This section and §§ 1.960-2 and 1.960-3 also apply for purposes of any provision that treats a taxpayer as a domestic corporation that is deemed to pay foreign income taxes or treats a foreign corporation as a controlled foreign corporation for purposes of section 960. See, for example, sections 962(a)(2) and 1293(f).
(2) Scope of this section. Paragraph (b) of this section provides definitions for purposes of this section and §§ 1.960-2 and 1.960-3. Paragraph (c) of this section provides computational rules to coordinate the various calculations under this section and §§ 1.960-2 and 1.960-3. Paragraph (d) of this section provides rules for computing the income in an income group within a section 904 category, and for associating foreign income taxes with an income group. Paragraph (e) of this section provides a rule for the treatment of taxes associated with the residual income group. Paragraph (f) of this section provides an example illustrating the application of this section.
(b) Definitions. The following definitions apply for purposes of this section and §§ 1.960-2 and 1.960-3.
(1) Annual PTEP account. The term annual PTEP account has the meaning set forth in § 1.960-3(c)(1).
(2) Controlled foreign corporation. The term controlled foreign corporation means a foreign corporation described in section 957(a).
(3) Current taxable year. The term current taxable year means the U.S. taxable year of a controlled foreign corporation that is an inclusion year, or during which the controlled foreign corporation receives a section 959(b) distribution or makes a section 959(a) distribution or a section 959(b) distribution.
(4) Current year tax. The term current year tax means a foreign income tax 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)). A foreign income tax accrues when 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) (economic performance exception for certain foreign taxes). Withholding taxes described in section 901(k)(1)(B) that are withheld from a payment accrue when the payment is made. A foreign income tax calculated on the basis of net income (or a base in lieu of net income) for a foreign taxable year accrues on the last day of the foreign taxable year. Accordingly, current year taxes include foreign withholding taxes that are withheld from payments made to the controlled foreign corporation during the current taxable year, and foreign income taxes that accrue in the controlled foreign corporation's current taxable year in which or with which its foreign taxable year ends. Additional payments of foreign income taxes resulting from a redetermination of foreign tax liability, including contested taxes that accrue when the contest is resolved, “relate back” and are considered to accrue as of the end of the foreign taxable year to which the taxes relate.
(5) Foreign income tax. The term foreign income tax means each separate levy (as defined in § 1.901-2(d)) that is an income, war profits, and excess profits tax as defined in § 1.901-2(a), and tax included in the term income, war profits, and excess profits tax by reason of section 903 and § 1.903-1(a), that is imposed by a foreign country or a possession of the United States, including any such tax that is deemed paid by a controlled foreign corporation under section 960(b)(2). Income, war profits, and excess profits taxes do not include amounts excluded from the definition of those taxes under section 901. See, for example, section 901(f), (g), and (i). Foreign income tax also does not include taxes paid by a controlled foreign corporation for which a credit is disallowed at the level of the controlled foreign corporation. See, for example, sections 245A(e)(3), 901(k)(1), (l), and (m), 909, and 6038(c)(1)(B). Foreign income tax, however, includes 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 taxable year. The term foreign taxable year has the meaning set forth in section 7701(a)(23), applied by substituting “under foreign law” for the phrase “under subtitle A.”
(7) Foreign taxable income. The term foreign taxable income means the base upon which a current year tax is imposed that comprises the items included in gross income under foreign law and the deductions allowed under foreign law. In the case of a current year tax that is imposed with respect to a taxable period, foreign taxable income includes all of the items taken into account under foreign law with respect to that period. See paragraph (d)(3)(ii)(A) of this section for rules for apportioning current year tax to section 904 categories or income groups on the basis of foreign taxable income.
(8) GILTI inclusion amount. The term GILTI inclusion amount has the meaning set forth in § 1.951A-1(c)(1) (or, in the case of a member of a consolidated group, § 1.1502-51(b)).
(9) Gross tested income. The term gross tested income has the meaning set forth in § 1.951A-2(c)(1).
(10) Inclusion percentage. The term inclusion percentage has the meaning set forth in § 1.960-2(c)(2).
(11) Inclusion year. The term inclusion year means the U.S. taxable year of a controlled foreign corporation which ends during or with the taxable year of a United States shareholder of the controlled foreign corporation in which the United States shareholder includes an amount in income under section 951(a)(1) or 951A(a) with respect to the controlled foreign corporation.
(12) Income group. The term income group means a group of income described in paragraph (d)(2)(ii) of this section.
(13) Partnership CFC. The term partnership CFC means, with respect to a U.S. shareholder partnership, a controlled foreign corporation stock of which is owned (within the meaning of section 958(a)) by the U.S. shareholder partnership.
(14) Passive category. The term passive category means the separate category of income described in section 904(d)(1)(C) and § 1.904-4(b).
(15) Previously taxed earnings and profits. The term previously taxed earnings and profits means earnings and profits described in section 959(c)(1) or (2), including earnings and profits described in section 959(c)(2) by reason of section 951A(f)(1) and § 1.951A-5(b)(1).
(16) PTEP group. The term PTEP group has the meaning set forth in § 1.960-3(c)(2).
(17) PTEP group taxes. The term PTEP group taxes has the meaning set forth in § 1.960-3(d)(1).
(18) Recipient controlled foreign corporation. The term recipient controlled foreign corporation has the meaning set forth in § 1.960-3(b)(2).
(19) Reclassified previously taxed earnings and profits. The term reclassified previously taxed earnings and profits has the meaning set forth in § 1.960-3(c)(4).
(20) Reclassified PTEP group. The term reclassified PTEP group has the meaning set forth in § 1.960-3(c)(4).
(21) Residual income group. The term residual income group has the meaning set forth in paragraph (d)(2)(ii)(D) of this section.
(22) Section 904 category. The term section 904 category means a separate category of income described in § 1.904-5(a)(4)(v).
(23) Section 951A category. The term section 951A category means the separate category of income described in section 904(d)(1)(A) and § 1.904-4(g).
(24) Section 959 distribution. The term section 959 distribution means a section 959(a) distribution or a section 959(b) distribution.
(25) Section 959(a) distribution. The term section 959(a) distribution means a distribution excluded from the gross income of a United States shareholder under section 959(a).
(26) Section 959(b) distribution. The term section 959(b) distribution means a distribution excluded from the gross income of a controlled foreign corporation for purposes of section 951(a) under section 959(b).
(27) Section 959(c)(2) PTEP group. The term section 959(c)(2) PTEP group has the meaning set forth in § 1.960-3(c)(4).
(28) Subpart F inclusion. The term subpart F inclusion has the meaning set forth in § 1.960-2(b)(1).
(29) Subpart F income. The term subpart F income has the meaning set forth in section 952 and § 1.952-1(a).
(30) Subpart F income group. The term subpart F income group has the meaning set forth in paragraph (d)(2)(ii)(B)(1) of this section.
(31) Tested foreign income taxes. The term tested foreign income taxes has the meaning set forth in § 1.960-2(c)(3).
(32) Tested income. The term tested income means the amount with respect to a controlled foreign corporation that is described in section 951A(c)(2)(A) and § 1.951A-2(b)(1).
(33) Tested income group. The term tested income group has the meaning set forth in paragraph (d)(2)(ii)(C) of this section.
(34) United States shareholder. The term United States shareholder has the meaning set forth in section 951(b).
(35) U.S. shareholder partner. The term U.S. shareholder partner means, with respect to a U.S. shareholder partnership and a partnership CFC of the U.S. shareholder partnership, a United States person that is a partner in the U.S. shareholder partnership and that is also a United States shareholder (as defined in section 951(b)) of the partnership CFC.
(36) U.S. shareholder partnership. The term U.S. shareholder partnership means a domestic partnership (within the meaning of section 7701(a)(4)) that is a United States shareholder of one or more controlled foreign corporations.
(37) U.S. taxable year. The term U.S. taxable year has the same meaning as that of the term taxable year set forth in section 7701(a)(23).
(c) Computational rules - (1) In general. For purposes of computing foreign income taxes deemed paid by either a domestic corporation that is a United States shareholder with respect to a controlled foreign corporation under § 1.960-2 or § 1.960-3 or by a controlled foreign corporation under § 1.960-3 for the current taxable year, the following rules apply in the following order, beginning with the lowest-tier controlled foreign corporation in a chain with respect to which the domestic corporation is a United States shareholder:
(i) First, items of gross income of the controlled foreign corporation for the current taxable year other than a section 959(b) distribution are assigned to section 904 categories and included in income groups within those section 904 categories under the rules in paragraph (d)(2) of this section. The receipt of a section 959(b) distribution by the controlled foreign corporation is accounted for under § 1.960-3(c)(3).
(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. Additionally, the functional currency amounts of 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, and to reduce earnings and profits in any PTEP groups that were increased as provided in paragraph (c)(1)(i) of this section. See paragraph (d)(3)(ii) of this section. For purposes of computing foreign taxes deemed paid, current year taxes 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). See paragraph (c)(3) of this section.
(iii) Third, current year taxes deemed paid under section 960(a) and (d) by the domestic corporation with respect to income of the controlled foreign corporation are computed under the rules of § 1.960-2. In addition, foreign income taxes deemed paid under section 960(b)(2) with respect to the receipt of a section 959(b) distribution by the controlled foreign corporation are computed under the rules of § 1.960-3(b).
(iv) Fourth, any previously taxed earnings and profits of the controlled foreign corporation resulting from subpart F inclusions and GILTI inclusion amounts with respect to the controlled foreign corporation's current taxable year are separated from other earnings and profits of the controlled foreign corporation and added to an annual PTEP account, and a PTEP group within the PTEP account, under the rules of § 1.960-3(c).
(v) Fifth, paragraphs (c)(1)(i) through (iv) of this section are repeated for each next higher-tier controlled foreign corporation in the chain.
(vi) Sixth, with respect to the highest-tier controlled foreign corporation in a chain that is owned directly (or indirectly through a partnership) by the domestic corporation, foreign income taxes that are deemed paid under section 960(b)(1) in connection with the receipt of a section 959(a) distribution by the domestic corporation are computed under the rules of § 1.960-3(b).
(2) Inclusion of current year items. For a current taxable year, the items of income and deductions (including for taxes), and the U.S. dollar amounts of current year taxes, that are included in the computations described in this section and assigned to income groups and PTEP groups for the taxable year are the items that the controlled foreign corporation accrues and takes into account during the current taxable year. An item of income with respect to a current taxable year does not include an amount included as subpart F income of a controlled foreign corporation by reason of the recharacterization of a recapture account established in a prior U.S. taxable year (and the corresponding earnings and profits) of the controlled foreign corporation under section 952(c)(2) and § 1.952-1(f).
(3) Functional currency and translation. The computations described in this paragraph (c) that relate to income and earnings and profits are made in the functional currency of the controlled foreign corporation (as determined under section 985), and references to taxes deemed paid are to U.S. dollar amounts (translated in accordance with section 986(a)).
(d) Computing income in a section 904 category and an income group within a section 904 category - (1) Scope. This paragraph (d) provides rules for assigning gross income (including gains) of a controlled foreign corporation for the current taxable year to a section 904 category and income group within a section 904 category, and for allocating and apportioning deductions (including losses and current year taxes) and the U.S. dollar amount of current year taxes of the controlled foreign corporation for the current taxable year among the section 904 categories, income groups within a section 904 category, and PTEP groups. For rules regarding maintenance of previously taxed earnings and profits in an annual PTEP account, and assignment of those previously taxed earnings and profits to PTEP groups, see § 1.960-3.
(2) Assignment of gross income to section 904 categories and income groups within a category - (i) Assigning items of gross income to section 904 categories. Items of gross income of the controlled foreign corporation for the current taxable year are first assigned to a section 904 category of the controlled foreign corporation under §§ 1.904-4 and 1.904-5, and under § 1.960-3(c)(1) in the case of gross income relating to a section 959(b) distribution received by the controlled foreign corporation. Income of a controlled foreign corporation, other than gross income relating to a section 959(b) distribution, cannot be assigned to the section 951A category. See § 1.904-4(g).
(ii) Grouping gross income within a section 904 category - (A) In general. Gross income within a section 904 category is assigned to an income group under the rules of this paragraph (d)(2)(ii), or to a PTEP group under the rules of § 1.960-3(c)(3). Gross income other than a section 959(b) distribution is assigned to a subpart F income group, tested income group, or residual income group.
(B) Subpart F income groups - (1) In general. The term subpart F income group means an income group within a section 904 category that consists of income that is described in paragraph (d)(2)(ii)(B)(2) of this section. Gross income that is treated as a single item of income under § 1.954-1(c)(1)(iii) is in a separate subpart F income group under paragraph (d)(2)(ii)(B)(2)(i) of this section. Items of gross income that give rise to income described in paragraph (d)(2)(ii)(B)(2)(ii) of this section are aggregated and treated as gross income in a separate subpart F income group. Similarly, items of gross income that give rise to income described in each one of paragraphs (d)(2)(ii)(B)(2)(iii) through (v) of this section are aggregated and treated as gross income in a separate subpart F income group.
(2) Income in subpart F income groups. The income included in subpart F income groups is:
(i) Items of foreign base company income treated as a single item of income under § 1.954-1(c)(1)(iii);
(ii) Insurance income described in section 952(a)(1);
(iii) Income subject to the international boycott factor described in section 952(a)(3);
(iv) Income from certain bribes, kickbacks and other payments described in section 952(a)(4); and
(v) Income subject to section 901(j) described in section 952(a)(5).
(C) Tested income groups. The term tested income group means an income group that consists of tested income within a section 904 category. Items of gross tested income in each section 904 category are aggregated and treated as gross income in a separate tested income group.
(D) Residual income group. The term residual income group means the income group within a section 904 category that consists of income that is not in a subpart F income group, tested income group, or PTEP group.
(E) Examples. The following examples illustrate the application of this paragraph (d)(2)(ii).
(1) Example 1: Subpart F income groups - (i) Facts. CFC, a controlled foreign corporation, is incorporated in Country X. CFC uses the “u” as its functional currency. At all relevant times, 1u = $1x. CFC earns from sources outside of Country X portfolio dividend income of 100,000u, portfolio interest income of 1,500,000u, and 70,000u of royalty income that is not derived from the active conduct of a trade or business. CFC also earns 50,000u from the sale of personal property to a related person for use outside of Country X that gives rise to foreign base company sales income under section 954(d). Finally, CFC earns 45,000u for performing consulting services outside of Country X for related persons that gives rise to foreign base company services income under section 954(e). None of the income is taxed by Country X. The dividend income is subject to a 15 percent third-country withholding tax after application of the applicable income tax treaty. The interest income and the royalty income are subject to no third-country withholding tax. CFC incurs no expenses.
(ii) Analysis. Under paragraph (d)(2)(i) of this section and § 1.904-4, the interest income, dividend income, and royalty income are passive category income and the sales and consulting income are general category income. Under paragraph (d)(2)(ii)(B) of this section, CFC has a separate subpart F income group within the passive category with respect to the 100,000u of dividend income, which is foreign personal holding company income described in § 1.954-1(c)(1)(iii)(A)(1)(i) (dividends, interest, rents, royalties and annuities) that falls within a single group of income under § 1.904-4(c)(3)(i) for passive income that is subject to withholding tax of fifteen percent or greater. CFC also has a separate subpart F income group within the passive category with respect to the 1,500,000u of interest income and the 70,000u of royalty income (in total 1,570,000u) which together are foreign personal holding company income described in § 1.954-1(c)(1)(iii)(A)(1)(i) (dividends, interest, rents, royalties and annuities) that falls within a single group of income under § 1.904-4(c)(3)(iii) for passive income that is subject to no withholding tax or other foreign tax. With respect to its 50,000u of sales income, CFC has a separate subpart F income group with respect to foreign base company sales income described in § 1.954-1(c)(1)(iii)(A)(2)(i) within the general category. With respect to its 45,000u of services income, CFC has a separate subpart F income group with respect to foreign base company services income described in § 1.954-1(c)(1)(iii)(A)(2)(ii) within the general category.
(2) Example 2: Tested income groups - (i) Facts. CFC, a controlled foreign corporation, is incorporated in Country X. CFC uses the “u” as its functional currency. At all relevant times, 1u = $1x. CFC earns 500u from the sale of goods to unrelated parties. CFC also earns 75u for performing consulting services for unrelated parties. All of its income is gross tested income. CFC incurs no deductions.
(ii) Analysis. Under paragraph (d)(2)(i) of this section and section 904 and § 1.904-4, the sales income and services income are both general category income. Under paragraph (d)(2)(ii)(C) of this section, with respect to the 500u of sales income and 75u services income (in total 575u), CFC has one tested income group within the general category.
(3) Allocation and apportionment of deductions among section 904 categories, income groups within a section 904 category, and certain PTEP groups - (i) In general. Gross income of the controlled foreign corporation in each income group within each section 904 category is reduced by deductions (including losses) of the controlled foreign corporation for the current taxable year under the rules in this paragraph (d)(3)(i). No deductions of the controlled foreign corporation for the current taxable year other than a deduction for current year taxes imposed solely by reason of the receipt of a section 959(b) distribution are allocated or apportioned to reduce earnings and profits in a PTEP group.
(A) First, the rules of sections 861 through 865 and 904(d) (taking into account the rules of section 954(b)(5) and § 1.954-1(c), and section 951A(c)(2)(A)(ii) and § 1.951A-2(c)(3), as appropriate) apply to allocate and apportion to reduce gross income (or create a loss) in each section 904 category and income group within a section 904 category any deductions of the controlled foreign corporation that are definitely related to less than all of the controlled foreign corporation's gross income as a class. See paragraph (d)(3)(ii) of this section for special rules for allocating and apportioning current year taxes to section 904 categories, income groups, and PTEP groups.
(B) Second, related person interest expense is allocated to and apportioned among the subpart F income groups within the passive category under the principles of §§ 1.904-5(c)(2) and 1.954-1(c)(1)(i).
(C) Third, any remaining deductions are allocated and apportioned to reduce gross income (or create a loss) in the section 904 categories and income groups within each section 904 category under the rules referenced in paragraph (d)(3)(i)(A) of this section.
(ii) Allocation and apportionment of a current year tax - (A) In general. A current year tax is allocated and apportioned among the section 904 categories under the rules of § 1.904-6. An amount of the current year tax that is allocated and apportioned to a section 904 category is then allocated and apportioned among the income groups within the section 904 category under § 1.861-20 (as modified by § 1.904-6(c)) by treating each income group as a statutory grouping and treating the residual income group as the residual grouping. Therefore, foreign gross income attributable to a base difference is assigned to the residual income grouping under § 1.861-20(d)(2)(ii)(B). See, however, paragraph (d)(3)(ii)(B) of this section for special rules for applying § 1.861-20 in the case of PTEP groups. 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 a current year tax 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 current year tax is allocated and apportioned.
(B) Foreign taxable income that includes previously taxed earnings and profits. For purposes of allocating and apportioning a current year tax under this paragraph (d)(3)(ii), a PTEP group that is increased under § 1.960-3(c)(3) as a result of the receipt of a section 959(b) distribution in the current taxable year of the controlled foreign corporation is treated as an income group within the section 904 category. In such case, under § 1.861-20, the portion of the foreign gross income (as defined in § 1.861-20(b)(5)) that is characterized under Federal income tax principles as a distribution of previously taxed earnings and profits that results in the increase in the PTEP group in the current taxable year is assigned to that PTEP group. If a PTEP group is not treated as an income group under the first sentence of this paragraph (d)(3)(ii)(B), and the rules of § 1.861-20 would otherwise apply to assign foreign gross income to a PTEP group, that foreign gross income is instead assigned to the subpart F income group or tested income group to which the income that gave rise to the previously taxed earnings and profits would be assigned if the income were recognized by the recipient controlled foreign corporation under Federal income tax principles in the current taxable year. For example, a net basis or withholding tax imposed on a controlled foreign corporation's receipt of a section 959(b) distribution is allocated or apportioned to a PTEP group. In contrast, a withholding tax imposed on a disregarded payment from a disregarded entity to its controlled foreign corporation owner is never treated as related to a PTEP group, even if all of the controlled foreign corporation's earnings are previously taxed earnings and profits, because the payment that gives rise to the foreign gross income from which the tax was withheld does not constitute a section 959(b) distribution in the current taxable year. That foreign gross income, however, may be assigned to a subpart F income group or tested income group.
(e) No deemed paid credit for current year taxes related to residual income group. Current year taxes paid or accrued by a controlled foreign corporation that are allocated and apportioned under paragraph (d)(3)(ii) of this section to a residual income group cannot be deemed paid under section 960 for any taxable year.
(f) Example. The following example illustrates the application of this section and § 1.960-3.
(1) Facts - (i) Income of CFC1 and CFC2. CFC1, a controlled foreign corporation, conducts business in Country X. CFC1 uses the “u” as its functional currency. At all relevant times, 1u=$1x. CFC1 owns all of the stock of CFC2, a controlled foreign corporation. CFC1 and CFC2 both use the calendar year as their U.S. and foreign taxable years. In 2019, CFC1 earns 2,000,000u of gross income that is foreign oil and gas extraction income, within the meaning of section 907(c)(1), and 2,000,000u of interest income from unrelated persons, for both U.S. and Country X tax law purposes. Country X exempts interest income from tax. In 2019, CFC1 also receives a section 959(b) distribution from CFC2 of 4,000,000u of previously taxed earnings and profits attributable to an inclusion under section 965(a) for CFC2's 2017 U.S. taxable year. The inclusion under section 965(a) was income in the general category. There are no PTEP group taxes associated with the previously taxed earnings and profits distributed by CFC2 at the level of CFC2. The section 959(b) distribution is treated as a dividend taxable to CFC1 under Country X law. In 2019, CFC2 earns no gross income and receives no distributions.
(ii) Pre-tax deductions of CFC1 and CFC2. For both U.S. and Country X tax purposes, in 2019, CFC1 incurs 1,500,000u of deductible expenses other than current year taxes that are allocable to all gross income. For U.S. tax purposes, under §§ 1.861-8 through 1.861-14T, 750,000u of such deductions are apportioned to each of CFC1's foreign oil and gas extraction income and interest income. Under Country X law, 1,000,000u of deductions are allocated and apportioned to the 4,000,000u treated as a dividend, and 500,000u of deductions are allocated and apportioned to the 2,000,000u of foreign oil and gas extraction income. Under Country X law, no deductions are allocable to the interest income. Country X imposes tax of 900,000u on a base of 4,500,000u (6,000,000u gross income−1,500,000u deductions) consisting of 3,000,000u (4,000,000u−1,000,000u) attributable to CFC1's section 959(b) distribution and 1,500,000u (2,000,000u−500,000u) attributable to CFC1's foreign oil and gas extraction income. In 2019, CFC2 has no expenses (including current year taxes).
(iii) United States shareholders of CFC1. All of the stock of CFC1 is owned (within the meaning of section 958(a)) by corporate United States shareholders that use the calendar year as their U.S. taxable year. In 2019, the United States shareholders of CFC1 include in gross income subpart F inclusions in the passive category totaling $1,250,000x with respect to 1,250,000u of subpart F income of CFC1.
(2) Analysis - (i) CFC2. Under paragraph (c)(1) of this section, the computational rules of paragraph (c)(1) of this section are applied beginning with CFC2. However, CFC2 has no gross income or expenses in 2019 (the “current taxable year”). Accordingly, the computational rules described in paragraphs (c)(1)(i) through (iv) of this section are not relevant with respect to CFC2. Under paragraph (c)(1)(v) of this section, the rules in paragraph (c)(1)(i) through (iv) of this section are then applied to CFC1.
(ii) CFC1 - (A) Step 1. Under paragraph (c)(1)(i) of this section, CFC1's items of gross income for the current taxable year are assigned to section 904 categories and included in income groups within those section 904 categories. In addition, CFC1's receipt of a section 959(b) distribution is assigned to a PTEP group. Under paragraph (d)(2)(i) of this section and § 1.904-4, the interest income is passive category income and the foreign oil and gas extraction income is general category income. Under paragraph (d)(2)(ii) of this section, the 2,000,000u of interest income is assigned to a subpart F income group (the “subpart F income group”) within the passive category because it is foreign personal holding company income described in § 1.954-1(c)(1)(iii)(A)(1)(i) that falls within a single group of income under § 1.904-4(c)(3)(iii) for passive income that is subject to no withholding tax or other foreign tax. The 2,000,000u of foreign oil and gas extraction income is assigned to the residual income group within the general category. Under § 1.960-3(c), the 4,000,000u section 959(b) distribution is assigned to the PTEP group described in § 1.960-3(c)(2)(vii) within the 2017 annual PTEP account (the “PTEP group”) within the general category.
(B) Step 2 - (1) Allocation and apportionment of deductions for expenses other than taxes. Under paragraph (c)(1)(ii) of this section, CFC1's deductions for the current taxable year are allocated and apportioned among the section 904 categories, income groups within a section 904 category, and any PTEP groups that were increased as provided in paragraph (c)(1)(i) of this section. Under paragraph (d)(3)(i) of this section and §§ 1.861-8 through 1.861-14T, 750,000u of deductions are allocated and apportioned to the residual income group within the general category, and 750,000u of deductions are allocated and apportioned to the subpart F income group within the passive category. Therefore, CFC1 has 1,250,000u (2,000,000u−750,000u) of pre-tax income attributable to the residual income group within the general category and 1,250,000u (2,000,000u−750,000u) of pre-tax income attributable to the subpart F income group within the passive category. For U.S. tax purposes, no deductions other than current year taxes are allocated and apportioned to the 4,000,000u in CFC1's PTEP group.
(2) Allocation and apportionment of current year taxes. Under paragraph (c)(1)(ii) of this section, CFC1's current year taxes are allocated and apportioned among the section 904 categories, income groups within a section 904 category, and any PTEP groups that were increased as provided in paragraph (c)(1)(i) of this section. Under paragraphs (d)(3)(i) and (ii) of this section, for purposes of allocating and apportioning taxes to reduce the income in a section 904 category, an income group, or PTEP group, § 1.904-6(a)(1) and (ii) are applied to determine the amount of foreign taxable income, computed under Country X law but characterized under Federal income tax law, in each section 904 category, income group, and PTEP group that is included in the Country X tax base. For Country X purposes, 1,000,000u of deductions are apportioned to CFC1's PTEP group within the general category, 500,000u of deductions are apportioned to the residual income group within the general category, and no deductions are apportioned to the subpart F income group in the passive category. Therefore, for Country X purposes, CFC1 has 3,000,000u of foreign taxable income attributable to the PTEP group within the general category, 1,500,000u of foreign taxable income attributable to the residual income group within the general category, and no income attributable to the subpart F income group within the passive category. Under paragraph (d)(3)(ii) of this section, 600,000u (3,000,000u/4,500,000u × 900,000u) of the 900,000u current year taxes paid by CFC1 are related to the PTEP group within the general category, and 300,000u (1,500,000u/4,500,000u × 900,000u) are related to the residual income group within the general category. No current year taxes are allocated or apportioned to the subpart F income group within the passive category because the interest expense is exempt from Country X tax. Thus, for U.S. tax purposes, CFC1 has 3,400,000u of previously taxed earnings and profits (4,000,000u−600,000u) in the PTEP group within the general category, 1,250,000u of income in the subpart F income group within the passive category, and 950,000u of income (1,250,000u−300,000u) in the residual income group within the general category. For purposes of determining 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.
(C) Step 3. Under paragraph (c)(1)(iii) of this section, the United States shareholders of CFC1 compute current year taxes deemed paid under section 960(a) and (d) and the rules of § 1.960-2. None of the Country X tax is allocated to CFC1's subpart F income group. Therefore, there are no current year taxes deemed paid by CFC1's United States shareholders with respect to their passive category subpart F inclusions. See § 1.960-2(b)(5) and (c)(7) for examples of the application of section 960(a) and (d) and the rules in § 1.960-2. Additionally, under paragraph (c)(1)(iii) of this section, foreign income taxes deemed paid under section 960(b)(2) by CFC1 are determined with respect to the section 959(b) distribution from CFC2 under the rules of § 1.960-3. There are no PTEP group taxes associated with the previously taxed earnings and profits distributed by CFC2 in the hands of CFC2. Therefore, there are no foreign income taxes deemed paid by CFC1 under section 960(b)(2) with respect to the section 959(b) distribution from CFC2. See § 1.960-3(e) for examples of the application of section 960(b) and the rules in § 1.960-3.
(D) Step 4. Under paragraph (c)(1)(iv) of this section, previously taxed earnings and profits resulting from subpart F inclusions and GILTI inclusion amounts with respect to CFC1's current taxable year are separated from CFC1's other earnings and profits and added to an annual PTEP account and PTEP group within the PTEP account, under the rules of § 1.960-3(c). The United States shareholders of CFC1 include in gross income subpart F inclusions totaling $1,250,000x with respect to 1,250,000u of subpart F income of CFC1, and the subpart F inclusions are passive category income. Therefore, under § 1.960-3(c)(2), 1,250,000u of previously taxed earnings and profits resulting from the subpart F inclusions is added to CFC1's section 951(a)(1)(A) PTEP within the 2019 annual PTEP account within the passive category.
(E) Step 5. Paragraph (c)(1)(v) of this section does not apply because CFC1 is the highest-tier controlled foreign corporation in the chain.
(F) Step 6. Paragraph (c)(1)(vi) of this section does not apply because CFC1 did not make a section 959(a) distribution.
[T.D. 9882, 84 FR 69107, Dec. 17, 2019, as amended by T.D. 9922, 85 FR 72071, Nov. 12, 2020]