Reg. § 1.904(b)-3 Disregard of certain dividends and deductions under section 904(b)(4).
(a) Disregard of certain dividends and deductions
(1) In general For purposes of section , in the case of a domestic corporation which is a United States shareholder with respect to a specified 10-percent owned foreign corporation (as defined in section ), the domestic corporation's foreign source taxable income in a separate category and entire taxable income is determined without regard to the following items:
(i) Any dividend for which a deduction is allowed under section ;
(ii) Deductions properly allocable or apportioned to gross income in the section subgroup as determined under and of this section; and
(iii) Deductions properly allocable or apportioned to stock of specified 10-percent owned foreign corporations in the section subgroup as determined under and of this section.
(2) Deductions properly allocable or apportioned to the residual grouping Deductions that are properly allocable or apportioned to gross income or stock in the section subgroup of the residual grouping (consisting of U.S. source income) are disregarded solely for purposes of determining entire taxable income under section .
(b) Determining properly allocable or apportioned deductions The amount of deductions properly allocable or apportioned to gross income or stock described in and of this section is determined by subdividing the United States shareholder's gross income and assets in each separate category described in into a section subgroup and a non-section subgroup. Gross income and assets in the residual grouping for U.S. source income are also subdivided into a section subgroup and a non-section subgroup. Each section subgroup is treated as a statutory grouping under . Deductions properly allocable or apportioned to dividends or stock described in and of this section only include those deductions that are allocated and apportioned under through and to the section subgroups. The deduction allowed under section for dividends is allocated and apportioned solely among the section subgroups on the basis of the relative amounts of gross income from such dividends in each section subgroup.
(c) Income and assets in the 245A subgroups
(1) In general For purposes of applying the section regulations (as defined in ) to the deductions of a United States shareholder, the only gross income included in a section subgroup is dividend income for which a deduction is allowed under section . The only asset included in a section subgroup is the portion of the value of stock of each specified 10-percent owned foreign corporation that is assigned to the section subgroup determined under of this section.
(2) Assigning stock to a subgroup The value of stock of a specified 10-percent owned foreign corporation is characterized as an asset in a separate category described in or the residual grouping for U.S. source income under the rules of . If the specified 10-percent owned foreign corporation is not a controlled foreign corporation, all of the value of its stock (other than the portion of stock assigned to the statutory groupings for gross section income under and -13) in each separate category and in the residual grouping for U.S. source income is assigned to the section subgroup in such separate category or residual grouping. If the specified 10-percent owned foreign corporation is a controlled foreign corporation, a portion of the value of stock in each separate category and in the residual grouping for U.S. source income is subdivided between a section and non-section subgroup under .
(d) Coordination with OFL and ODL rules
(1) In general Section and this section apply before the operation of the overall foreign loss rules in section and the overall domestic loss rules in section . See .
(2) Net operating losses If the taxpayer has a net operating loss in the current taxable year, then solely for purposes of determining the source and separate category of the net operating loss, the overall foreign loss rules in section and the overall domestic loss rules in section are applied without taking into account the adjustments required under section and this section.
(e) Example The following example illustrates the application of this section.
(1) Facts
(i) Income and assets of USP USP is a domestic corporation. USP owns a factory in the United States with a tax book value of $27,000x. USP also directly owns all of the stock of each of the following three controlled foreign corporations: CFC1, CFC2, and CFC3. USP's tax book value in each of CFC1, CFC2, and CFC3 is $10,000x. USP incurs $1,500x of interest expense and earns $1,600x of U.S. source gross income. Under section and the section regulations (as defined in ), USP's GILTI inclusion amount is $2,200x. USP's deduction under section is $1,100x (“section deduction”), all of which is by reason of section . No portion of USP's section deduction is reduced by reason of section . None of the CFCs makes any distributions.
(ii) Characterization of CFC stock After application of , USP determined that $8,000x of the stock of each of CFC1, CFC2, and CFC3 is assigned to the section category (“section category stock”) in the non-section subgroup and the remaining $2,000x of the stock of each of CFC1, CFC2, and CFC3 is assigned to the general category (“general category stock”) in the section subgroup. Additionally, under , $4,000x of the stock of each of CFC1, CFC2, and CFC3 that is section category stock is an exempt asset. Accordingly, with respect to the stock of its controlled foreign corporations in the aggregate, USP has $12,000x of section category stock in a non-section subgroup; $6,000x of general category stock in a section subgroup; and $12,000x of stock that is an exempt asset.
(iii) Apportioning of expenses Taking into account USP's factory and its stock in CFC1, CFC2, and CFC3, the tax book value of USP's assets for purposes of apportioning expenses is $45,000x (excluding the $12,000x of exempt assets). Under , USP's $1,500 of interest expense is apportioned as follows: $400x ($1,500x × $12,000x/$45,000x) to section category income, $200x ($1,500x × $6,000x/$45,000x) to general category income, and the remaining $900x ($1,500 × $27,000x/$45,000x) to the residual U.S. source grouping. Under , all of USP's section deduction is allocated and apportioned to section category income.
(2) Analysis
(i) USP's pre-credit U.S. tax USP's worldwide taxable income is $1,200x, which equals its GILTI inclusion amount of $2,200x plus its U.S. source gross income of $1,600x, less its deduction under section of $1,100 and its interest expense of $1,500x. For purposes of applying section , before taking into account any foreign tax credit under section , USP's Federal income tax liability is 21% of $1,200x, or $252x.
(ii) Application of section 904(b)(4) Under section , USP applies section separately to each separate category of income.
(A) General category income Before application of section and the rules in this section, USP's foreign source taxable income in the general category is a loss of $200x, which equals $0 (USP's foreign source general category income) less $200x (interest expense apportioned to general category income), and USP's worldwide taxable income is $1,200. Under of this section, the rules in section and (g) apply after section and the rules in this section. Under and of this section, USP has no deductions properly allocable or apportioned to gross income in the section subgroup because USP has no dividend income in the general category for which a deduction is allowed under section . Under and of this section, USP has $200x of deductions for interest expense that are properly allocable or apportioned to stock of specified 10-percent owned foreign corporations in the section subgroup because USP's only general category assets are the general category stock of CFC1, CFC2, and CFC3, all of which are in the section subgroup. Therefore, under of this section, USP's foreign source taxable income in the general category and its worldwide taxable income are determined without regard to the $200x of deductions for interest expense. Accordingly, USP's foreign source taxable income in the general category is $0 and its worldwide taxable income is $1,400x, and therefore, there is no separate limitation loss for purposes of section . Under section and (d)(1) USP's foreign tax credit limitation for the general category is $0.
(B) Section 951A category income Before application of section and the rules in this section, USP's foreign source taxable income in the section category is $700x, which equals $2,200x (USP's GILTI inclusion amount) less $1,100x (USP's section deduction) less $400x (interest apportioned to section category income). Under and of this section, USP has no deductions properly allocable and apportioned to gross income in a section subgroup of the section category. Under and of this section, USP has no deductions properly allocable and apportioned to stock of specified 10-percent owned foreign corporations in a section subgroup of section category stock because no portion of section category stock is assigned to a section subgroup. See . Therefore, under of this section no adjustment is made to USP's foreign source taxable income in the section category. However, the adjustments to USP's worldwide taxable income described in of this section apply for purposes of calculating USP's foreign tax credit limitation for the section category. Accordingly, USP's foreign source taxable income in the section category is $700x and its worldwide taxable income is $1,400x. Under section and (d)(1), USP's foreign tax credit limitation for the section category is $126x ($252x × $700x/$1,400x).
(f) Applicability dates
(1) Except as provided in of this section, this section applies to taxable years beginning after December 31, 2017.
(2) of this section applies to taxable years ending on or after December 16, 2019.
[T.D. 9882, 84 FR 69099, Dec. 17, 2019, as amended by T.D. 9922, 85 FR 72060, Nov. 12, 2020]