Reg. § 1.960-5 Credit for taxable year of inclusion binding for taxable year of exclusion.

(1) Chooses to claim a foreign tax credit as provided in section 901 for the taxable year for which he is required to include in gross income under section 951(a) or 951A(a) an amount attributable to the earnings and profits of a controlled foreign corporation; and

(2) Does not choose to claim a foreign tax credit as provided in section 901 for a taxable year in which he receives an amount which is excluded from gross income under section 959(a)(1) and which is attributable to such earnings and profits of such controlled foreign corporation,

No deduction shall be allowed under section 164 for the taxable year of such exclusion for any foreign income taxes paid or accrued on or with respect to such excluded amount.

(1) Facts USP, a domestic corporation, owns all the one class of stock of CFC, a controlled foreign corporation. Both corporations use the calendar year as the taxable year and the functional currency of CFC is the U.S. dollar. All of CFC's earnings and profits of $80x for Year 1 (after payment of foreign income taxes of $20x on its total income of $100x for such year) are attributable to amounts required under section 951(a) to be included in USP's gross income for Year 1 because such income is general category foreign base company services income of CFC. For Year 1, USP chooses to claim a foreign tax credit for the $20x of foreign income taxes which for such year are paid by CFC and deemed paid by USP under section 960(a) and § 1.960-2(b). In Year 2, CFC distributes the entire $80x of Year 1 previously taxed earnings and profits, from which a foreign income tax of $8x is withheld. Also in Year 2, CFC pays $40x of interest to USP, from which a foreign income tax of $4x is withheld. For Year 2, USP chooses to claim deductions for its creditable foreign income taxes under section 164 rather than a foreign tax credit under section 901.

(2) Analysis Although USP does not choose to claim a foreign tax credit for Year 2, under section 960(c)(4) and paragraph (a) of this section it may not deduct the $8x of foreign income taxes under section 164. USP may, however, deduct under such section the foreign income tax of $4x which is withheld from the interest paid by CFC in Year 2.