Reg. § 1.965-3 Section 965(c) deductions.
(a) Scope This section provides rules regarding section deductions and section deduction amounts. of this section provides rules for disregarding certain assets for purposes of determining the aggregate foreign cash position of a section U.S. shareholder. of this section provides rules for determining the aggregate foreign cash position for a section U.S. shareholder inclusion year. of this section provides a rule regarding certain expatriated entities. of this section provides a rule for the treatment of section deductions in connection with an election under section . of this section provides rules regarding the treatment of a section deduction under certain provisions of the Internal Revenue Code. of this section provides a rule for domestic pass-through entities.
(b) Rules for disregarding certain assets for determining aggregate foreign cash position
(1) Disregard of certain obligations between related specified foreign corporations In determining the aggregate foreign cash position of a section U.S. shareholder, any account receivable, account payable, short-term obligation, or derivative financial instrument between a specified foreign corporation with respect to which the section U.S. shareholder owns section stock and a related specified foreign corporation on corresponding cash measurement dates is disregarded to the extent of the smallest of the product of the amount of the item on such corresponding cash measurement dates of each specified foreign corporation and the section U.S. shareholder's ownership percentage of section stock of the specified foreign corporation owned by the section U.S. shareholder on such dates. For purposes of this , a specified foreign corporation is treated as a related specified foreign corporation with respect to another specified foreign corporation if, as of the cash measurement date referred to in the preceding sentence of each specified foreign corporation, the specified foreign corporations are related persons within the meaning of section , substituting the term “specified foreign corporation” for “controlled foreign corporation” in each place that it appears.
(2) Disregard of other assets upon demonstration of double-counting For purposes of determining the aggregate foreign cash position of a section U.S. shareholder, the section U.S. shareholder's pro rata share of the cash position of a specified foreign corporation on a cash measurement date is reduced by amounts of net accounts receivable, actively traded property, and short-term obligations to the extent such amounts are attributable to amounts taken into account in determining the section U.S. shareholder's pro rata share of the cash position of another specified foreign corporation on the corresponding cash measurement date of such other specified corporation and to the extent not disregarded pursuant to of this section. However, the preceding sentence applies only if the section U.S. shareholder attaches a statement containing the information outlined in through of this section to its timely filed return (taking into account extensions, if any) for the section U.S. shareholder inclusion year, or, if the section U.S. shareholder has multiple section U.S. shareholder inclusion years, the later of such years. Relief is not available under or to allow late filing of the statement. The statement must contain the following information with respect to each specified foreign corporation for which the cash position is reduced under this —
(i) A description of the asset that would be taken into account with respect to both specified foreign corporations,
(ii) A statement of the amount by which its pro rata share of the cash position of one specified foreign corporation is reduced,
(iii) A detailed explanation of why there would otherwise be double-counting, including the computation of the amount taken into account with respect to the other specified foreign corporation, and
(iv) An explanation of why of this section does not apply to disregard such amount.
(3) Disregard of portion of cash position of noncorporate entities treated as specified foreign corporations If an entity is treated as a specified foreign corporation of a section U.S. shareholder pursuant to section , for purposes of determining the aggregate foreign cash position of the section U.S. shareholder, the section U.S. shareholder's pro rata share of the cash position of the entity (determined taking into account and of this section) is reduced by the amount of the pro rata share attributable to deemed stock of the entity not owned (within the meaning of section , applied by treating domestic pass-through entities as foreign) by a specified foreign corporation of the section U.S. shareholder (determined without taking into account section ).
(4) Examples The following examples illustrate the application of this .
(i) Example 1
(A) Facts USP, a domestic corporation, owns all of the stock of CFC1, a foreign corporation. CFC1 owns 95% of the only class of stock of CFC2, also a foreign corporation, and 40% of the only class of stock of CFC3, also a foreign corporation. The remaining 5% of the only class of stock of CFC2 is owned by a person unrelated to USP, CFC1, and CFC2; and the remaining 60% of the only class of stock of CFC3 is owned by a person unrelated to USP and CFC1. USP, CFC1, and CFC3 have calendar year taxable years. CFC2 has a taxable year ending on November 30. On November 15, 2015, CFC1 makes a loan of $100x to CFC2, which is required to be and is, in fact, repaid on January 1, 2016. On November 15, 2016, CFC2 sells inventory to CFC1 in exchange for an account receivable of $200x, which is required to be and is, in fact, repaid on December 15, 2016. On August 1, 2017, CFC1 makes a loan of $300x to CFC3, which is required to be and is, in fact, repaid on January 31, 2018.
(B) Analysis
(1) Loan from CFC1 to CFC2 For purposes of determining the aggregate foreign cash position of USP, a section U.S. shareholder of CFC1, under of this section, because CFC1 and CFC2 are related within the meaning of of this section, the short-term obligation of CFC2 held by CFC1 outstanding on the first cash measurement date of each specified foreign corporation, November 30, 2015, and December 31, 2015, respectively, is disregarded to the extent of 95%, the smallest ownership percentage of section stock of CFC1 and CFC2 owned by USP on such first cash measurement dates. Accordingly, USP only takes into account $5 ($100−95% of $100) of the short-term obligation in determining CFC1's cash position for purposes of determining its aggregate foreign cash position.
(2) Account receivable of CFC1 held by CFC2 Because the account receivable of CFC1 held by CFC2 on its second cash measurement date, November 30, 2016, is not outstanding on CFC1's second cash measurement date, December 31, 2016, of this section does not apply to disregard any portion of such account receivable.
(3) Loan from CFC1 to CFC3 Because CFC3 is not related to CFC1 within the meaning of of this section, of this section does not apply to disregard any portion of such short-term obligation.
(ii) Example 2
(A) Facts The facts are the same as in of this section (the facts in Example 1), except that on December 1, 2015, CFC1 sells 5% of the stock of CFC2 to an unrelated person.
(B) Analysis The analysis is the same as in of this section (the analysis in Example 1), except that the short-term obligation of CFC2 held by CFC1 outstanding on both of their first cash measurement dates, November 30, 2015, and December 31, 2015, respectively, is disregarded under of this section to the extent of 90%, the smallest ownership percentage of section stock of CFC1 and CFC2 by USP on such first cash measurement dates. Accordingly, USP takes into account $10 ($100−90% of $100) of the short-term obligation in determining CFC1's cash position for purposes of determining its aggregate foreign cash position.
(iii) Example 3
(A) Facts USP, a domestic corporation, owns all of the stock of CFC1, a foreign corporation, which owns 45% of the only class of stock of CFC2, also a foreign corporation. The remainder of the CFC2 stock is actively traded on an established financial market but is not owned by any person related to USP or CFC1. USP, CFC1, and CFC2 have calendar year taxable years. The value of the CFC2 stock owned by CFC1 is $500x on each of the cash measurement dates. Also on each of the cash measurement dates, CFC2 has $300x of assets described in section and that are taken into account in determining its cash position.
(B) Analysis For purposes of determining USP's aggregate foreign cash position, USP's pro rata share of the cash position of CFC1 on each cash measurement date may be reduced by the amount of the stock of CFC2 to the extent attributable to amounts taken into account in determining USP's pro rata share of the cash position of CFC2 on such cash measurement date (that is, to the extent of the $135x taken into account with respect to CFC2), provided USP attaches a statement to its timely filed return (taking into account extensions, if any) containing the following: A description of the CFC2 stock and the assets of CFC2 taken into account in determining its cash position; a statement that USP's pro rata share of the cash position of CFC1 is being reduced by $135x; the computation of the $135x taken into account with respect to CFC2; and an explanation of why of this section does not apply to disregard such amount.
(iv) Example 4
(A) Facts USP, a domestic corporation, owns all of the stock of CFC1 and CFC2, each a foreign corporation. USP, CFC1, and CFC2 have calendar year taxable years. CFC1 buys goods on credit from a third party for $100x and thus has an account payable of $100x. CFC1 modifies the goods and sells to CFC2 for $105x in exchange for an account receivable of $105x. CFC2 modifies the goods and sells to another third party for $110x in exchange for an account receivable of $110x. All of the accounts payable and accounts receivable are outstanding on the final cash measurement date.
(B) Analysis For purposes of determining USP's aggregate foreign cash position, on the final cash measurement date, CFC1 has net accounts receivable of $0 because, pursuant to of this section, CFC1's account receivable from CFC2 is disregarded, and CFC2 has net accounts receivable of $110x because, pursuant to of this section, CFC2's account payable to CFC1 is disregarded. USP cannot rely on the rule in of this section because no amounts attributable to CFC2's net accounts receivable are taken into account with respect to another specified foreign corporation.
(v) Example 5
(A) Facts USP, a domestic corporation, owns all of the stock of CFC1 and CFC2, each a foreign corporation. USP and CFC1 own 60% and 40%, respectively, of the interests in the capital and profits of PS1, a partnership. PS1 and CFC2 own 70% and 30%, respectively, of the interests in the capital and profits of PS2, a partnership. On each cash measurement date, PS1's cash position of $100x consists entirely of cash, and PS2's cash position of $200x includes a $50x short-term obligation of CFC2.
(B) Analysis
(1) Treatment of PS1 Because an interest in PS1 is held by CFC1, a specified foreign corporation of USP, and PS1 would be a specified foreign corporation of USP if it were a foreign corporation, PS1 is treated as a specified foreign corporation of USP for purposes of determining USP's aggregate foreign cash position. Without regard to of this section, USP must take into account $100x, its pro rata share of PS1's cash position, for purposes of determining its aggregate foreign cash position. However, 60% of that amount is attributable to deemed stock of PS1 that is not owned (within the meaning of section ) by a specified foreign corporation of USP. Accordingly, pursuant to of this section, the amount of PS1's cash position that USP must take into account for purposes of determining its aggregate foreign cash position is reduced by $60x (60% of $100x) to $40x ($100x−$60x).
(2) Treatment of PS2 Because an interest in PS2 is held by CFC2, a specified foreign corporation of USP, and PS2 would be a specified foreign corporation of USP if it were a foreign corporation, PS2 is treated as a specified foreign corporation of USP for purposes of determining USP's aggregate foreign cash position. USP, CFC1, CFC2, PS1, and PS2 all have calendar year taxable years. For purposes of determining the aggregate foreign cash position of USP, a section U.S. shareholder of PS2, under of this section, the short-term obligation of CFC2 held by PS2 outstanding on each cash measurement date of each specified foreign corporation is disregarded on such cash measurement dates. Accordingly, without regard to of this section, USP must take into account $150x ($200x−$50x) of PS2's cash position for purposes of determining its aggregate foreign cash position. However, 42% (60% × 70%) of that amount is attributable to deemed stock of PS2 that is not owned (within the meaning of section , applied by treating PS1 as foreign if it is a domestic pass-through entity) by a specified foreign corporation of USP (determined without taking into account section ). Accordingly, pursuant to of this section, the amount of PS2's cash position that USP must take into account for purposes of determining its aggregate foreign cash position is reduced by $63x (42% of $150x) to $87x ($150x−$63x).
(c) Determination of aggregate foreign cash position for a section 958(a) U.S. shareholder inclusion year
(1) Single section 958(a) U.S. shareholder inclusion year If a section U.S. shareholder has a single section U.S. shareholder inclusion year, then the section U.S. shareholder's aggregate foreign cash position for the section U.S. shareholder inclusion year is equal to the aggregate foreign cash position of the section U.S. shareholder.
(2) Multiple section 958(a) U.S. shareholder inclusion years If a section U.S. shareholder has multiple section U.S. shareholder inclusion years, then the section U.S. shareholder's aggregate foreign cash position for each section U.S. shareholder inclusion year is determined by allocating the aggregate foreign cash position to a section U.S. shareholder inclusion year under and of this section.
(i) Allocation to first section 958(a) U.S. shareholder inclusion year A portion of the aggregate foreign cash position of the section U.S. shareholder is allocated to the first section U.S. shareholder inclusion year in an amount equal to the lesser of the section U.S. shareholder's aggregate foreign cash position or the section U.S. shareholder's aggregate section inclusion amount for the section U.S. shareholder inclusion year.
(ii) Allocation to succeeding section 958(a) U.S. shareholder inclusion years The amount of the section U.S. shareholder's aggregate foreign cash position allocated to any succeeding section U.S. shareholder inclusion year equals the lesser of the excess, if any, of the section U.S. shareholder's aggregate foreign cash position over the aggregate amount of its aggregate foreign cash position allocated to preceding section U.S. shareholder inclusion years under of this section and this or the section U.S. shareholder's aggregate section inclusion amount for such succeeding section U.S. shareholder inclusion year.
(3) Estimation of aggregate foreign cash position For purposes of determining the aggregate foreign cash position of a section U.S. shareholder, the section U.S. shareholder may assume that its pro rata share of the cash position of any specified foreign corporation whose last taxable year beginning before January 1, 2018, ends after the date the return for such section U.S. shareholder inclusion year (the estimated section U.S. shareholder inclusion year) is timely filed (taking into account extensions, if any) is zero as of the cash measurement date with which the taxable year of such specified foreign corporation ends. If a section U.S. shareholder's pro rata share of the cash position of a specified foreign corporation is treated as zero pursuant to the preceding sentence, the amount described in with respect to such section U.S. shareholder in fact exceeds the amount described in with respect to such section U.S. shareholder, and the aggregate section inclusion amount for the estimated section U.S. shareholder inclusion year exceeds the amount described in with respect to such section U.S. shareholder, interest and penalties will not be imposed if such section U.S. shareholder amends the return for the estimated section U.S. shareholder inclusion year to account for the correct aggregate foreign cash position for the year. The amended return must be filed by the due date (taking into account extensions, if any) for the return for the year after the estimated section U.S. shareholder inclusion year.
(4) Examples The following examples illustrate the application of this .
(i) Example 1. Estimation of aggregate foreign cash position for a section 958(a) U.S. shareholder inclusion year
(A) Facts USP, a domestic corporation, owns all of the stock of CFC1, a foreign corporation, which owns all of the stock of CFC2, also a foreign corporation. USP is a calendar year taxpayer. CFC1 has a taxable year ending on December 31, and CFC2 has a taxable year ending on November 30. The cash position of CFC1 on each of December 31, 2015, December 31, 2016, and December 31, 2017, is $100x. The cash position of CFC2 on each of November 30, 2015, and November 30, 2016, is $200x. USP has a section inclusion amount of $300x with respect to CFC1.
(B) Analysis In determining its aggregate foreign cash position for its 2017 taxable year, USP may assume that its pro rata share of the cash position of CFC2 will be zero as of November 30, 2018, for purposes of filing its return due on April 18, 2018 (or due on October 15, 2018, with extension). Therefore, USP's aggregate foreign cash position is treated as $300x, which is the greater of (a) $300x, 50% of the sum of USP's pro rata shares of the cash position of CFC1 as of December 31, 2015, and December 31, 2016, and of the cash position of CFC2 as of November 30, 2015, and November 30, 2016, and (b) $100x, USP's pro rata share of the cash position of CFC1 as of December 31, 2017. If USP's pro rata share of the cash position of CFC2 as of November 30, 2018, in fact exceeds $200x, USP must amend its return for its 2017 taxable year to reflect the correct aggregate foreign cash position by the due date for its return for its 2018 taxable year, April 15, 2019 (or October 15, 2019, with extension).
(ii) Example 2. Allocation of aggregate foreign cash position among section 958(a) U.S. shareholder inclusion years
(A) Facts The facts are the same as in of this section (the facts in Example 1), except that the cash position of each of CFC1 and CFC2 on all relevant cash measurement dates is $200x, with the result that USP has an aggregate foreign cash position determined under of $400x. For its 2017 taxable year, USP has a section inclusion amount with respect to CFC1 of $300x, and for its 2018 taxable year, USP has a section inclusion amount with respect to CFC2 of $300x.
(B) Analysis Under of this section, USP's aggregate foreign cash position for 2017 is $300x, which is the lesser of USP's aggregate foreign cash position determined under ($400x) or the section inclusion amount ($300x) that USP takes into account in 2017. Under of this section, the amount of USP's aggregate foreign cash position for 2018 is $100x, USP's aggregate foreign cash position determined under ($400x) reduced by the amount of its aggregate foreign cash position for 2017 ($300x) under of this section.
(d) Increase of income by section 965(c) deduction of an expatriated entity
(1) In general If a person is allowed a section deduction and the person (or a successor) first becomes an expatriated entity, with respect to a surrogate foreign corporation, at any time during the 10-year period beginning on December 22, 2017, then the tax imposed by chapter 1 of the Internal Revenue Code is increased for the first taxable year in which such person becomes an expatriated entity by an amount equal to 35 percent of the person's section deductions, and no credits are allowed against such increase in tax. The preceding sentence applies only if the surrogate foreign corporation first becomes a surrogate foreign corporation on or after December 22, 2017.
(2) Definition of expatriated entity For purposes of of this section, the term expatriated entity has the same meaning given such term under section , except that such term does not include an expatriated entity if the surrogate foreign corporation with respect to the expatriated entity is treated as a domestic corporation under section .
(3) Definition of surrogate foreign corporation For purposes of of this section, the term surrogate foreign corporation has the meaning given such term in section .
(e) Section 962 election
(1) In general In the case of an individual (including a trust or estate) that makes an election under section , any section deduction taken into account under in determining taxable income as used in section is not taken into account for purposes of determining the individual's taxable income under section .
(2) Example The following example illustrates the application of the rule in this .
(i) Facts USI, a United States citizen, owns 10% of the capital and profits of USPRS, a domestic partnership that has a calendar year taxable year, the remainder of which is owned by foreign persons unrelated to USI or USPRS. USPRS owns all of the stock of FS, a foreign corporation that is a controlled foreign corporation with a calendar year taxable year. USPRS has a section inclusion amount with respect to FS of $1,000x and has a section deduction amount of $700x. FS has no post-1986 foreign income taxes. USI makes a valid election under section for 2017.
(ii) Analysis USI's “taxable income” described in equals $100x (USI's domestic pass-through owner share of USPRS's section inclusion amount) minus $70x (USI's domestic pass-through owner share of USPRS's section deduction amount), or $30x. No other deductions are allowed in determining this amount. USI's tax on the $30x section inclusion will be equal to the tax that would be imposed on such amount under section if USI were a domestic corporation. Under of this section, USI cannot deduct $70x for purposes of determining USI's taxable income that is subject to tax under section .
(f) Treatment of section 965(c) deduction under certain provisions of the Internal Revenue Code
(1) Sections 62(a) and 63(d) A section deduction is treated as a deduction described in section and is not treated as an itemized deduction for any purpose of the Internal Revenue Code.
(2) Sections 705, 1367, and 1368
(i) Adjustments to basis In the case of a domestic partnership or S corporation—
(A) The aggregate amount of its section inclusions net of the aggregate amount of its section deductions is treated as a separately stated item of net income solely for purposes of calculating basis under section and and section and , and
(B) The aggregate amount of its section inclusions equal to the aggregate amount of its section deductions is treated as income exempt from tax solely for purposes of calculating basis under sections , , and .
(ii) S corporation accumulated adjustments account In the case of an S corporation, the aggregate amount of its section inclusions equal to the aggregate amount of its section deductions is treated as income not exempt from tax solely for purposes of determining whether an adjustment is made to an accumulated adjustments account under section and .
(iii) Example The following example illustrates the application of this .
(A) Facts USI, a United States citizen, owns all of the stock of S Corp, an S corporation, which owns all of the stock of FS, a foreign corporation. S Corp has a section inclusion of $1,000x with respect to FS and has a $700x section deduction.
(B) Analysis As a result of the application of of this section, solely for purposes of calculating basis under section and , USI treats as a separately stated item of net income $300x (its pro rata share of the net of S Corp's $1,000x aggregate section inclusion and S Corp's $700x aggregate section deduction). Accordingly, USI's basis in S Corp is increased under section by $300x. As a result of the application of of this section, an amount of S Corp's aggregate section inclusion equal to its aggregate section deduction, $700x, is treated as tax exempt income solely for purposes of calculating basis under section and , and accordingly, USI's basis in S Corp is further increased by its pro rata share of such amount, $700x. S Corp's accumulated adjustments account (“AAA”) is increased under section by the $1,000x section inclusion taken into account and reduced by the $700x section deduction taken into account. In addition, as a result of the application of of this section, S Corp's AAA is further increased by an amount of S Corp's aggregate section inclusion equal to its aggregate section deduction, $700x, which is not treated as tax-exempt income for purposes of .
(3) Section 1411 For purposes of section and , a section deduction is not treated as being properly allocable to any section inclusion.
(4) Section 4940 For purposes of section , a section deduction is not treated as an ordinary and necessary expense paid or incurred for the production or collection of gross investment income.
(g) Domestic pass-through entities For purposes of determining a domestic pass-through owner share, a section deduction amount of a domestic pass-through entity must be allocated to a domestic pass-through owner in the same proportion as an aggregate section inclusion amount of the domestic pass-through entity for a section U.S. shareholder inclusion year is allocated to the domestic pass-through owner.
[T.D. 9846, 84 FR 1875, Feb. 5, 2019]