T.D. 9315

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Internal Revenue Bulletin:

2007-15 April 9, 2007

T.D. 9315

Dual Consolidated Loss Regulations

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations.

SUMMARY:

This document contains final regulations under section 1503(d) of the Internal Revenue Code (Code) regarding dual consolidated losses. Section 1503(d) generally provides that a dual consolidated loss of a dual resident corporation cannot reduce the taxable income of any other member of the affiliated group unless, to the extent provided in regulations, the loss does not offset the income of any foreign corporation. Similar rules apply to losses of separate units of domestic corporations. These final regulations address various dual consolidated loss issues, including exceptions to the general prohibition against using a dual consolidated loss to reduce the taxable income of any other member of the affiliated group.

DATES:

Effective Date: These regulations are effective on March 19, 2007.

Applicability Dates: For dates of applicability, see §1.1503(d)-8.

FOR FURTHER INFORMATION CONTACT:

Jeffrey P. Cowan, (202) 622-3860 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-1946.

The collections of information in these final regulations are in §§1.1503(d)-1(c), 1.1503(d)-3(e), 1.1503(d)-4(e), 1.1503(d)-6(c), 1.1503(d)-6(d), 1.1503(d)-6(e), 1.1503(d)-6(f), 1.1503(d)-6(g), 1.1503(d)-6(h), and 1.1503(d)-6(j). This information is required for various reasons. The information under §1.1503(d)-1(c) notifies the IRS when a taxpayer asserts that it had reasonable cause for failing to comply with certain filing requirements under the regulations. The information under §1.1503(d)-4(e) indicates when the taxpayer attempts to rebut the amount of presumed tainted income. The information under the other provisions provides the IRS with various information regarding domestic use elections, exceptions to the domestic use limitation, triggering events, new domestic use agreements, original elector statements, annual certifications, and terminations of existing domestic use elections.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number.

Books or records relating to a collection of information must be retained as long as their contents might become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Background

Congress enacted section 1503(d), as part of the Tax Reform Act of 1986, to prevent a dual resident corporation from using a single economic loss once to offset income that was subject to U.S. tax, but not foreign tax, and a second time to offset income subject to foreign tax, but not U.S. tax (double dip). In 1988, Congress extended the application of section 1503(d), by adding section 1503(d)(3) and (4), to apply the provisions to separate units of domestic corporations and to grant the Secretary authority to promulgate regulations to prevent the avoidance of section 1503(d) through the contribution of assets to a corporation with a dual consolidated loss after the loss was sustained. The IRS and Treasury Department issued temporary regulations under section 1503(d) in 1989 (T.D. 8261, 1989-2 C.B. 220) and final regulations in 1992 (T.D. 8434, 1992-2 C.B. 240), see §601.601(d)(2)(ii)(b). These final regulations were updated and amended over the next 11 years (current regulations).

On May 24, 2005, the IRS and Treasury Department published in the Federal Register a notice of proposed rulemaking (REG-102144-04, 2005-1 C.B. 1297 [70 FR 29868]). The proposed regulations addressed the following fundamental concerns arising under the current regulations: (1) the potential over- and under-application of the current regulations; (2) various issues arising in the application of the current regulations, particularly in light of the adoption of the entity classification regulations under §§301.7701-1 through 301.7701-3 (check-the-box regulations); and (3) the administrative burden of the current regulations. The public hearing with respect to the 2005 proposed regulations was cancelled because no request to speak was received. However, the IRS and Treasury Department received a number of written comments which are discussed in this preamble.

Summary of Comments and Explanation of Provisions

A. Application of Section 1503(d) to Regulated Investment Companies and Real Estate Investment Trusts Under the current regulations, a dual resident corporation is a domestic corporation that is subject to an income tax of a foreign country on its worldwide income or on a residence basis. As a result, unless specifically exempted, certain entities that are domestic corporations, but not generally taxed at the entity level, may be subject to the current regulations. The current regulations provide that an S corporation, which is a domestic corporation, is not treated as a dual resident corporation. The proposed regulations, and these final regulations, provide that an S corporation is not treated as a domestic corporation and thus cannot be a dual resident corporation or own a separate unit.

Under the current regulations, as a domestic corporation, a regulated investment company (as defined in section 851) or a real estate investment trust (as defined in section 856) could be a dual resident corporation or own a separate unit. In the preamble to the proposed regulations, however, the IRS and Treasury Department requested comments as to whether regulated investment companies or real estate investment trusts should, like S corporations, be excluded from the application of the dual consolidated loss rules. One commentator suggested that regulated investment companies and real estate investment trusts should be subject to the dual consolidated loss rules, but would limit recapture pursuant to a domestic use agreement to situations where there was a foreign use and a section 381 transaction occurred.

The IRS and Treasury Department believe that subjecting regulated investment companies and real estate investment trusts to the dual consolidated loss rules is inappropriate. Section 1503(d) was intended to apply to domestic corporations that are subject to entity-level tax. Although regulated investment companies and real estate investment trusts are domestic corporations under the Code, unlike most domestic corporations these entities often do not pay tax at the entity level because they may deduct the amount of dividends paid to their shareholders from their own taxable income. Thus, under the final regulations regulated investment companies and real estate investment trusts are excluded from the definition of a domestic corporation and, as a result, are not subject to the dual consolidated loss rules.

B. Separate Units

(1) Separate unit combination rule Section 1.1503-2(c)(3)(ii) of the current regulations provides that if two or more foreign branches located in the same foreign country are owned by a single domestic corporation and the losses of each branch are available to offset the income of the other branches under the tax laws of the foreign country, then the branches are treated as a single separate unit.

In response to comments that the current combination rule was unnecessarily limited and did not appropriately address the check-the-box regulations, the proposed regulations adopt a broader combination rule that, subject to certain requirements, combines all separate units of a single domestic corporation. One requirement for combining separate units, both under the current regulations and the proposed regulations, is that the losses of each separate unit are made available to offset the income of the other separate units under the tax laws of a single foreign country.

The combination rule in the proposed regulations does not combine dual resident corporations that are members of the same consolidated group, or separate units of multiple domestic corporations that are members of the same consolidated group. However, in the preamble to the proposed regulations, the IRS and Treasury Department requested comments as to whether combination was appropriate in these cases.

Numerous comments were received on the scope and application of the combination rule. Commentators uniformly recommended that the combination rule be expanded to include separate units that are located in or subject to tax in the same foreign country (same-country separate units) and that are owned by multiple domestic corporations that are members of the same consolidated group. The IRS and Treasury Department believe that combining same-country separate units of domestic corporations that are members of the same consolidated group is consistent with the policies underlying section 1503(d) because, in general, all of the items of income, gain, deduction, and loss of such combined separate units are taken into account in both the United States and the foreign country. Therefore, these final regulations expand the combination rule to apply to same-country separate units of multiple domestic corporations that are members of the same consolidated group.

Two commentators recommended that the combination rule be expanded to combine dual resident corporations that are members of the same consolidated group. The IRS and Treasury Department do not believe that Congress intended that multiple dual resident corporations be treated as a single domestic corporation for purposes of section 1503(d). Combining dual resident corporations and separate units would also add complexity because certain rules apply differently to dual resident corporations and separate units. As a result, the combination rule in these final regulations does not apply to dual resident corporations.

Nevertheless, it is important to note that a dual resident corporation will often carry on its activities through a foreign branch (as defined in §1.367(a)-6T(g)(1)) and, as a result, will be a domestic owner of a foreign branch separate unit. In these cases, the foreign branch separate unit through which it carries on its activities in the foreign country will be eligible for combination. In addition, in many cases, a significant number of the items of income, gain, deduction, and loss of a dual resident corporation that owns a foreign branch separate unit will be attributable to the foreign branch separate unit (and therefore will not be items of the dual resident corporation itself). As a result, not extending the combination rule to dual resident corporations should, as a practical matter, have limited effect.

One commentator recommended eliminating the proposed regulations’ requirement that losses of each separate unit must be available to offset the income of other separate units under the tax laws of a single foreign country in order for them to combine. The IRS and Treasury Department believe that it is appropriate to remove this requirement, provided that the individual separate units are located, or subject to income tax on a worldwide or residence basis, in the same foreign country. This is the case because it is likely that all of the items of the combined separate unit will be recognized in both the United States and the foreign jurisdiction, without regard to whether such items are available for offset under the income tax laws of the foreign country. In addition, the IRS and Treasury Department believe that eliminating this requirement will reduce complexity, and will further refine the application of the rules. As a result, these final regulations eliminate this requirement from the combination rule.

Commentators also recommended making combination elective in certain situations. The IRS and Treasury Department believe that elective combination would add complexity and create administrative burdens. Therefore, this comment is not adopted.

The IRS and Treasury Department recognize that the expanded combination rule may necessitate that the basis of the stock of multiple domestic corporations, which are members of the same consolidated group, be adjusted to reflect the items of income, gain, deduction, and loss entering into the computation of the dual consolidated loss of a combined separate unit. These regulations provide guidance on the manner of such basis adjustments.

These final regulations also clarify that the separate unit combination rule generally applies for all purposes of section 1503(d). As a result, except as specifically provided in these regulations, any individual separate unit composing a combined separate unit loses its character as an individual separate unit. For example, in determining whether there is a triggering event as a result of the transfer of the assets of a combined separate unit, all of the assets of the combined separate unit are taken into account (rather than only the assets of any individual separate unit within the combined separate unit).

(2) Definition of a foreign branch by reference to §1.367(a)-6T(g) One commentator stated that the reference in the current and proposed regulations to §1.367(a)-6T(g) for the definition of a foreign branch, which implicitly includes references to §1.367(a)-6T(g)(1) through (3), creates needless complexity. The IRS and Treasury Department generally agree with this comment. Accordingly, these final regulations clarify that a foreign branch is defined, in part, by reference to §1.367(a)-6T(g)(1), rather than by reference to §1.367(a)-6T(g).

(3) Treaty exception to the definition of a foreign branch separate unit One commentator suggested that the definition of a foreign branch separate unit should not include a branch that would not be subject to income tax in a foreign jurisdiction either as a result of an income tax convention or because of the passive nature of the activities. This commentator explained that such an exclusion is appropriate because in these cases there would be no potential use of a branch loss for foreign tax purposes.

The IRS and Treasury Department agree that it is appropriate to exclude from the definition of a foreign branch separate unit certain business operations that, under an applicable income tax convention, would not be considered a permanent establishment. As a result, these final regulations include an exception to the definition of a foreign branch separate unit. The IRS and Treasury Department do not, however, believe an exception is appropriate where the business operations are not subject to tax in the foreign jurisdiction because of the passive nature of the activities. Such an exception would require the analysis of foreign law which, to the extent possible, should not be required under these rules.

(4) Activities owned by a dual resident corporation or a hybrid entity One commentator requested clarification that home-country activities of a dual resident corporation or hybrid entity separate unit can qualify as a foreign branch separate unit. The IRS and Treasury Department agree that this clarification is warranted and these final regulations are modified accordingly.

C. Elimination of the Consistency Rule As a result of the expansion of the separate unit combination rule in these final regulations, the IRS and Treasury Department believe that the consistency rule would have only limited application. Therefore, the consistency rule has been eliminated from these final regulations. The IRS and Treasury Department believe that eliminating the consistency rule will simplify the application of the dual consolidated loss rules and will eliminate various issues that arise under the rule.

D. Domestic Reverse Hybrid Entities One commentator noted that the application of the current and proposed regulations to certain structures involving domestic reverse hybrid entities appears inconsistent with the underlying policies of section 1503(d). In a typical structure, a foreign corporation owns the majority of the interests in a partnership or limited liability company that elects to be treated as a corporation for U.S. tax purposes and, therefore, is subject to tax on its worldwide income in the United States, but is treated as a pass-through entity under foreign law (domestic reverse hybrid). The domestic reverse hybrid is the parent of a consolidated group, is the obligor on group indebtedness, and holds stock of other group members. This structure allows the interest expense of the domestic reverse hybrid to offset income of the foreign corporation, which is not subject to U.S. tax, and to offset income of the other members of the consolidated group, which is not subject to foreign tax.

The commentator noted that because the domestic reverse hybrid is neither a dual resident corporation (because it is not subject to tax on a residence basis or on its worldwide income in the foreign country, but is instead treated as a pass-through entity) nor a separate unit of a domestic corporation, the current and proposed regulations do not apply to the losses of the domestic reverse hybrid. The commentator asserted that this result is inconsistent with the policies underlying section 1503(d), which was adopted, in part, to ensure that domestic corporations were not put at a competitive disadvantage as compared to foreign corporations through the use of certain inbound acquisition structures. See S. Rep. No. 99-313, 1986-3 C.B. Vol. 3 at 420, see §601.601(d)(2)(ii)(b). The commentator suggested that the scope of the final regulations be broadened to treat such entities as separate units, the losses of which are subject to the restrictions of section 1503(d). This change would, in effect, apply the provisions of section 1503(d) to a separate unit of a foreign corporation.

The IRS and Treasury Department recognize that this type of structure results in a double dip similar to that which Congress intended to prevent through the adoption of section 1503(d). However, the IRS and Treasury Department believe that a domestic reverse hybrid is neither a dual resident corporation nor a separate unit and, therefore, is not subject to section 1503(d). As a result, this comment is not adopted. However, the IRS and Treasury Department continue to study these and similar structures.

E. Transparent Entities Section 1.1503-2(c)(3) and 1.1503-2(c)(4) of the current regulations define a separate unit of a domestic corporation as a foreign branch (within the meaning of §1.367(a)-6T(g)), and an interest in a partnership, trust, or hybrid entity. As a result, the current regulations potentially apply not only to entities that are subject to tax in a foreign country (for example, hybrid entities), but also to entities that are not subject to tax in a foreign country, and otherwise have no connection to a foreign jurisdiction (for example, a domestic partnership engaged in a U.S. trade or business).

The proposed regulations modify the definition of a separate unit to exclude interests in non-hybrid entity partnerships and non-hybrid entity grantor trusts. These interests were excluded because the IRS and Treasury Department believe that it is unlikely that losses and deductions attributable to these interests could be put to a foreign use (as that term is defined in the proposed regulations). However, the proposed regulations retain the rule that a domestic corporation can own a separate unit through a non-hybrid entity partnership or non-hybrid entity grantor trust.

Commentators noted that, as a result of this change, the proposed regulations may not sufficiently and consistently address the treatment of certain entities. Such an entity is a pass-through entity for U.S. tax purposes (for example, a disregarded entity, a partnership or a grantor trust), but is not a hybrid entity because it is not subject to tax on its worldwide income or on a residence basis in a foreign country. In addition, the entity would not be treated as a pass-through entity under the laws of the applicable foreign country. One example of such an entity (transparent entity) is a limited liability company organized in the United States that for U.S. tax purposes is a partnership or disregarded entity, but, for purposes of the applicable foreign country, is not viewed as a pass-through entity. Another example is a foreign entity that is a pass-through entity for U.S. tax purposes, is not subject to income tax in a foreign country as a corporation (or otherwise at the entity level) either on its worldwide income or on a residence basis (because, for example, it is organized in a foreign country that does not impose an income tax), and is not treated as a pass-through entity under the laws of the applicable foreign country.

The commentators noted that under the proposed regulations items of income, gain, deduction, and loss of a transparent entity that is a partnership for U.S. tax purposes would be taken into account in computing the dual consolidated loss of a dual resident corporation or hybrid entity separate unit that owns an interest in such entity, even though it is unlikely that the items are taken into account by the jurisdiction in which the dual resident corporation or hybrid entity is subject to tax. As a result, items of deduction or loss which are unlikely to be available for a double dip (because they are not taken into account by the foreign country in which the dual resident corporation or hybrid entity is subject to tax) could inappropriately result in a dual consolidated loss. The commentators further noted that items of income or gain which are unlikely to be taken into account by the foreign country could inappropriately reduce (or eliminate) a dual consolidated loss of the dual resident corporation or hybrid entity separate unit that owns an interest in such entity.

The IRS and Treasury Department believe that losses attributable to interests in transparent entities should not be subject to section 1503(d), but also believe that items attributable to these interests should not influence the calculation or use of a dual consolidated loss of a dual resident corporation or separate unit in a manner that is inconsistent with the purposes of section 1503(d). Accordingly, these final regulations provide four new rules that address transparent entities (and interests therein).

First, these final regulations provide a definition of a transparent entity that is consistent with the description and examples in the preceding discussion.

Second, rules are provided for attributing items of income, gain, deduction, and loss to interests in transparent entities. The rules applicable for attributing items to these interests are consistent with the rules for attributing items to hybrid entity separate units.

Third, these final regulations provide that items of income, gain, deduction, and loss attributable to interests in transparent entities are not considered when calculating whether a dual resident corporation that holds an interest in such entity has income or a dual consolidated loss. This modification ensures that in cases where the foreign country in which the dual resident corporation is subject to tax is unlikely to take into account items of the transparent entity, such items do not inappropriately affect the computation of income or a dual consolidated loss of the dual resident corporation. Similar rules apply for purposes of calculating the income or dual consolidated loss of a separate unit through which an interest in a transparent entity is owned (directly or indirectly).

Finally, an interest in a transparent entity will be treated as a domestic affiliate for purposes of determining whether there is a domestic use of a dual consolidated loss. This change prevents a dual consolidated loss from being used to offset the income of a transparent entity such that there is no inappropriate domestic use of the loss.

These final regulations do not treat transparent entities, or interests therein, as dual resident corporations or separate units and, as a result, do not cause such entities (or interests therein) to be subject to the limitations of section 1503(d). Instead, the rules aim to appropriately take into account such entities when applying the dual consolidated loss rules to dual resident corporations and separate units.

F. Reasonable Cause Exception The current regulations require various filings to be included on a timely filed income tax return. In addition, taxpayers that fail to include these filings must request an extension of time to file under §§301.9100-1 through 301.9100-3. The proposed regulations eliminate the requirement that a taxpayer obtain an extension of time under §§301.9100-1 through 301.9100-3 and instead adopt a reasonable cause standard.

On January 31, 2006, the IRS and Treasury Department published Notice 2006-13, 2006-8 I.R.B. 496, see §601.601(d)(2)(ii)(b), announcing that taxpayers that must file agreements, statements, and other information under section 1503(d) may cure any late filings by applying a reasonable cause exception similar to the standard contained in the proposed regulations, until such time as the proposed regulations become final. In addition to allowing the use of the reasonable cause exception prior to the proposed regulations being published as final regulations in the Federal Register, the notice modifies the procedures for obtaining reasonable cause relief to ensure that requests for reasonable cause relief are handled in a timely and efficient manner.

These final regulations adopt the reasonable cause standard contained in the proposed regulations and Notice 2006-13, with certain modifications. See paragraph S(3) of this preamble for the application of the reasonable cause exception to losses that are subject to the current regulations.

G. Foreign Use

(1) In general Section 1.1503-2(g)(2)(i) of the current regulations provides that, in order to elect relief from the general limitation on the use of a dual consolidated loss to offset income of a domestic affiliate ((g)(2)(i) election), the taxpayer must, among other things, certify that no portion of the losses, expenses, or deductions taken into account in computing the dual consolidated loss has been, or will be, used to offset the income of any other person under the income tax laws of a foreign country. If, contrary to this certification, there is such a use, the dual consolidated loss subject to the (g)(2)(i) election generally must be recaptured and reported as gross income.

The proposed regulations modify the definition of “use” and provide a rule based on “foreign use” in order to minimize the potential over- and under-application of the current regulations. The proposed regulations provide that a foreign use is deemed to occur only if two conditions are satisfied. The first condition is satisfied if any portion of a deduction or loss taken into account in computing the dual consolidated loss is made available under the income tax laws of a foreign country to offset or reduce, directly or indirectly, any item that is recognized as income or gain under such laws (including items of income or gain generated by the dual resident corporation or separate unit itself), regardless of whether income or gain is actually offset, and regardless of whether these items are recognized under U.S. tax principles. The second condition is satisfied if items that are (or could be) offset pursuant to the first condition are considered, under U.S. tax principles, to be items of: (1) a foreign corporation; or (2) a direct or indirect (for example, through a partnership) owner of an interest in a hybrid entity, provided such interest is not a separate unit.

(2) Indirect foreign use As noted, the proposed regulations provide that a foreign use of a dual consolidated loss will occur when any item of deduction or loss, entering into the computation of the dual consolidated loss, is made available, directly or indirectly, to offset under foreign law, income of a foreign corporation or an owner of an interest in a hybrid entity that is not a separate unit. The proposed regulations do not provide comprehensive examples illustrating when an indirect use of a dual consolidated loss occurs. However, the provision was included in the proposed regulations to address transactions that are structured to avoid the application of section 1503(d) through, for example, the use of a back-to-back lending or conduit financing-type arrangements, or through the use of one or more hybrid instruments.

Commentators requested additional guidance regarding an indirect foreign use. In response to these comments, these final regulations clarify when an indirect foreign use is deemed to occur, include an exception to the general indirect foreign use rule for certain ordinary course transactions, and provide related examples.

The indirect foreign use rules are designed to limit an indirect use to situations in which taxpayers have engaged in transactions which have the effect of transferring an item of deduction or loss composing a dual consolidated loss to another entity for foreign tax purposes, so that it is made available to offset the income of a foreign corporation or the owner of an interest in an entity which is not a separate unit. In general, these rules are intended to target structured transactions that are designed to achieve a double dip that is contrary to the policies of section 1503(d), and are not intended to apply to ordinary business transactions.

(3) Exceptions to foreign use The proposed regulations contain three exceptions to the definition of a foreign use, including an exception where there is no dilution of an interest in a separate unit. In the preamble to the proposed regulations, the IRS and Treasury Department request comments as to whether a de minimis exception should be provided to the dilution limitation. The preamble also states that a revenue procedure would be issued, in conjunction with the proposed regulations being published as final regulations in the Federal Register, that would provide additional exceptions (safe harbors) under which a triggering event would be deemed rebutted if various conditions were satisfied, including, in certain cases, a demonstration that there can be no foreign use of a significant portion of the dual consolidated loss.

The IRS and Treasury Department received a number of comments on transactions and situations that could be included in the list of safe harbors. One commentator suggested an exception whereby recapture would not be required following transactions outside the taxpayer’s control. For example, this commentator suggested that a recapture of a dual consolidated loss should not occur following the conveyance or relinquishment of assets of a separate unit, or interests in a separate unit, to a foreign government.

Commentators also suggested that relief should be provided following certain transactions, similar to those mentioned in the preamble to the proposed regulations, where there is a de minimis potential for foreign use, a de minimis carryover of asset basis, and for which rebuttal would otherwise be difficult or impossible. According to these commentators, this safe harbor would apply to many common business transactions in which the policies underlying section 1503(d) would not be violated because of only a de minimis potential for foreign use.

Another commentator stated that an exception to foreign use would be appropriate where the taxpayer enters into a binding and irrevocable agreement with the tax authorities of a foreign country which ensures that no portion of the dual consolidated loss can be put to a foreign use in the foreign country. The commentator explained that, pursuant to such an arrangement, the taxpayer and the foreign tax authorities would agree that the foreign tax attributes of a dual resident corporation or separate unit (for example, loss carryforwards and asset basis) would be eliminated such that there would be no opportunity for a foreign use.

After considering these comments, the IRS and Treasury Department believe that it is appropriate to include certain safe harbors where a foreign use will be deemed not to occur. As a result, these final regulations (rather than a revenue procedure) set forth additional exceptions to the definition of a foreign use. These exceptions generally apply in cases where the potential for foreign use is de minimis, or where the transaction giving rise to a foreign use occurs as a result of events largely outside of the taxpayer’s control.

These new exceptions to foreign use include a de minimis rule and rules that apply to certain transactions involving the carry over of asset basis and the assumption of liabilities. Another new exception applies to a transaction that qualifies for the multiple-party event exception to a triggering event (referred to as successor elector events under the proposed regulations) where the acquiring unaffiliated domestic owner or consolidated group owns, immediately after the transaction, less than 100 percent of the acquired assets or interests. Without this exception to foreign use, many transactions that would qualify for the multiple-party event exception would immediately result in a foreign use triggering event when the unaffiliated domestic corporation or consolidated group acquires between 90 and 100 percent of the assets or interests. Finally, these regulations modify the “no dilution” exception contained in the proposed regulations to, among other things, incorporate a de minimis exception.

These final regulations provide that the exceptions may be supplemented through subsequent guidance published in the Internal Revenue Bulletin, as appropriate. As a result, the IRS and Treasury Department request comments on additional transactions or situations that should be added as safe harbors. For example, additional comments are requested on arrangements with foreign tax authorities whereby foreign tax attributes could be eliminated to ensure that no portion of the dual consolidated loss can be put to a foreign use.

(4) Ordering rules for determining a foreign use The current and proposed regulations provide rules for determining the order in which dual consolidated losses are used in cases where the laws of a foreign country provide for the foreign use of such loss, but do not provide applicable rules for determining the order in which these losses are used in a taxable year.

A commentator noted that in certain cases involving dual consolidated losses incurred in different taxable years, the ordering rules may result in losses being deemed to be made available for a foreign use resulting in recapture, even though there are other losses which, if deemed to be used, would not result in recapture. This commentator recommended that in these situations the losses be deemed to first be used in a manner that will not result in the recapture of a dual consolidated loss. The commentator also noted that this approach is consistent with the exception to foreign use contained in §1.1503(d)-1(b)(14)(iii)(B) of the proposed regulations where there is no foreign country rule for determining use. Finally, the commentator stated that losses that do give rise to a foreign use should be deemed to be used on a “last-in/first-out” basis. The IRS and Treasury Department believe these rules are appropriate and, as a result, these comments are adopted.

(5) Mirror legislation The current regulations contain a mirror legislation rule that denies a taxpayer the ability to make an election to use a dual consolidated loss to offset the income of a domestic affiliate where the foreign country has enacted legislation that operates in a manner similar to section 1503(d), and, as a result, prohibits the taxpayer from claiming the dual consolidated loss in the foreign country. The mirror legislation rule was designed to prevent the revenue gain resulting from the disallowance of a double dip from inuring solely to the foreign country. Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, at 1065 - 66 (J. Comm. Print 1987), see §601.601(d)(2)(ii)(b); see also British Car Auctions, Inc. v. United States, 35 Fed. Cl. 123 (1996), aff’d without op., 116 F.3d 1497 (Fed. Cir. 1997) (upholding the validity of the mirror legislation rule). The effect of the mirror legislation rule is that a dual consolidated loss may be disallowed in the United States and in the foreign country. In such cases, Congress intended for the Treasury Department to pursue a bilateral agreement with the foreign jurisdiction so that the loss could offset income of an affiliate in only one country.

The proposed regulations retain the mirror legislation rule and modify it to better take into account the policies underlying its adoption.

A number of comments were received on the scope and utility of the mirror legislation rule. Several commentators encouraged the IRS and the Treasury Department to pursue bilateral agreements where the dual consolidated loss is disallowed in both the United States and the foreign country.

The IRS and Treasury Department agree that such agreements are necessary and recently concluded a competent authority agreement on such matters with the United Kingdom on October 6, 2006 (the Agreement). For the text of the Agreement, see Announcement 2006-86, 2006-45 I.R.B. 842; see §601.601(d)(2)(ii)(b). The Agreement applies to dual consolidated losses attributable to certain UK permanent establishments that are otherwise subject to both section 1503(d) and mirror legislation enacted by the United Kingdom. In general, the Agreement provides that taxpayers can elect to use or relieve the loss in either the United Kingdom or the United States, but not both.

The IRS and Treasury Department believe that these final regulations and the Agreement appropriately refine and limit the scope of the mirror rule. In addition, the IRS and Treasury Department believe that the provisions of the Agreement can serve as a model for future competent authority agreements, if necessary, between the United States and its treaty partners which would further the Congressional intent with respect to the application of the mirror legislation rule. Accordingly, comments are requested on the provisions of the Agreement and on specific jurisdictions and considerations that should be taken into account in future agreements.

Commentators also suggested that a “stand-alone” exception to the mirror legislation rule be adopted. This exception would apply where filing a domestic use election with respect to a dual consolidated loss otherwise subject to the mirror legislation rule would not violate the policies of section 1503(d). According to the commentators, this is the case because the mirror legislation in the foreign country would not have the effect of forcing taxpayers to use the losses in the United States. The commentators suggested that the mirror legislation rule would not apply provided there is not a foreign affiliate to which the separate unit or dual resident corporation could put the dual consolidated loss to a foreign use. The commentators noted that in these situations, the mirror legislation does not result in the revenue loss inuring solely to the United States, because it is factually impossible for the loss to offset taxable income in the foreign country that is not also taken into account in the United States.

The IRS and Treasury Department generally agree with this comment. As a result, these final regulations contain a stand-alone exception to the mirror legislation rule.

H. Elimination of a Dual Consolidated Loss After Certain Transactions Both the current and proposed regulations contain rules that eliminate a dual consolidated loss that is subject to the general restrictions under section 1503(d)(1) following certain transactions. In the case of a dual resident corporation, the dual consolidated loss is generally eliminated in transactions described in section 381(a) because the dual resident corporation ceases to exist. In the case of a separate unit, the dual consolidated loss is generally eliminated in transactions where the separate unit ceases to be a separate unit of its domestic owner (either through a transaction described in section 381(a) or otherwise). In these cases, and subject to the exceptions discussed in this preamble, after the transaction it is no longer possible for the dual resident corporation or separate unit to generate income that can be offset by the dual consolidated loss. As a result, any unused dual consolidated loss is eliminated.

Both the current and the proposed regulations provide exceptions to the general elimination rule in the case of certain transactions to which section 381(a) applies. These exceptions generally apply in cases where it is possible that income that is generated by the transferee corporation after the transaction is subject to tax in both the United States and the foreign country such that it is appropriate for the income to be offset by the dual consolidated loss that carries over to the transferee.

These final regulations make certain modifications to the elimination rules. For example, the rules are modified to reflect the expansion of the separate unit combination rule. Thus, these final regulations take into account transactions involving combined separate units that have more than one domestic owner. For example, a dual consolidated loss of a domestic owner that is attributable to a separate unit will not be eliminated under these final regulations if the separate unit continues to be a separate unit of any member of its domestic owner’s consolidated group.

I. Application of SRLY Limitation to a Former Dual Resident Corporation Section 1.1503(d)-3(c)(3) of the proposed regulations provides that a dual consolidated loss is treated as a loss incurred by a dual resident corporation or separate unit in a separate return limitation year (SRLY) and is generally subject to all the limitations of §1.1502-21(c). The proposed regulations provide that when determining the general SRLY limitation with respect to a dual resident corporation, the calculation of aggregate consolidated taxable income only includes income, gain, deduction, and loss generated in years in which the dual resident corporation is a resident (or is taxed on its worldwide income) in the same foreign country in which it was a resident (or was taxed on its worldwide income) during the year in which the dual consolidated loss was generated. See proposed §1.1503(d)-3(c)(3)(iii).

One commentator noted that this rule prevents the dual consolidated loss of a dual resident corporation from being taken into account by its consolidated group after the dual resident corporation ceases to be subject to tax on a residence basis (or on its worldwide income), regardless of whether the former dual resident corporation contributes taxable income to the consolidated taxable income of the group. The commentator stated that this result is inappropriate because it does not merely limit the use of a dual consolidated loss from offsetting the income of a domestic affiliate, but has the effect of limiting the use of a dual consolidated loss from offsetting the domestic corporation’s own taxable income.

The IRS and Treasury Department agree with this comment. Section 1503(d)(1) provides that a dual consolidated loss of a corporation shall not reduce the taxable income of any other member of the affiliated group for the taxable year or for any other taxable year. However, the limitations of section 1503(d)(1) do not prevent the use of a dual consolidated loss to offset the income of the dual resident corporation that incurred the loss, even where the dual resident corporation ceases to be subject to tax in the foreign country. As a result, this rule is not contained in these final regulations. But see section 1503(d)(4) (relating to tainted assets contributed to a dual resident corporation).

J. Effect of Section 1503(d) on Foreign Tax Credits Section 1503(d)(2) generally defines a dual consolidated loss to mean any net operating loss of a dual resident corporation or a separate unit. Section 172(c) generally defines a net operating loss as the excess of deductions over gross income. Section 164(a)(3) generally provides that foreign taxes are allowed as a deduction for the taxable year in which paid or accrued. However, section 275(a)(4) provides that no deduction is allowed for any such taxes, to the extent the taxpayer chooses to take to any extent the benefits of section 901 (which permits taxpayers to claim a credit for certain taxes paid or accrued during the taxable year to any foreign country or any possession of the United States).

Commentators asked whether a creditable foreign tax expenditure incurred by a dual resident corporation or separate unit, for which an election is made to claim a credit pursuant to section 901, may be subject to the limitations of section 1503(d)(1).

The IRS and Treasury Department recognize that policy concerns arise in certain transactions in which two or more parties claim a credit for the same foreign taxes. Although these policy concerns are similar to those arising under section 1503(d), the IRS and Treasury Department do not believe that Congress intended the limitations of section 1503(d) to apply to foreign taxes, so long as the foreign taxes do not enter into the computation of a net operating loss (that is, so long as an election is made to claim a credit for such taxes, in lieu of deducting them). As a result, under the terms of the statute, the limitations of section 1503(d) do not apply to creditable foreign tax expenditures incurred by a dual resident corporation or a separate unit, provided an election is made to claim a credit with respect to such expenditures in accordance with section 901 and the related regulations.

Even though section 1503(d) does not apply to foreign tax credits that are claimed by more than one person, the IRS and Treasury Department continue to study these transactions and, as appropriate, intend to address them in future published guidance under other provisions.

K. Tainted Income Rule Section 1503(d)(4) grants the Secretary authority to prescribe such regulations as may be necessary or appropriate to prevent the avoidance of the purposes of section 1503(d) by contributing assets to the corporation with the dual consolidated loss after such loss is incurred. Section 1.1503-2(e) of the current regulations prevents the dual consolidated loss of a dual resident corporation that ceases being a dual resident corporation from offsetting the income from assets that are acquired by the dual resident corporation in a nonrecognition transaction, or as a contribution to capital, at any time during the three taxable years immediately preceding the taxable year in which the corporation ceases to be a dual resident corporation, or any time thereafter. The proposed regulations retained the tainted income rule, with certain modifications.

One commentator noted that the tainted income rule of the current and proposed regulations applies with respect to assets acquired by a dual resident corporation, regardless of whether such tainted assets were received from a member of the dual resident corporation’s affiliated group. According to this commentator, because section 1503(d) was intended to prevent the use of a dual consolidated loss from offsetting the taxable income of any other member of the affiliated group, applying the tainted income rule where the tainted assets were not received from a member of the dual resident corporation’s affiliated group is inconsistent with the policies underlying section 1503(d).

Section 1503(d)(4) grants the Secretary broad regulatory authority to implement the tainted income rule. In addition, the IRS and Treasury Department believe that adopting the rule suggested by the commentator would require the IRS to trace the source of tainted assets received (for example, to ensure that the rule cannot be avoided through the imposition of an intermediary entity, such as a partnership, or through indirect transfers of assets). Moreover, such a rule would be difficult for both taxpayers and the IRS to apply, and would increase complexity. Accordingly, the IRS and Treasury Department believe that the tainted income rule should continue to apply without regard to the source of the tainted assets. As a result, this comment is not adopted.

L. Items Taken into Account in Computing Income or a Dual Consolidated Loss

(1) In general Section 1503(d)(2)(A) generally defines a dual consolidated loss to mean any net operating loss of a domestic corporation which is subject to an income tax of a foreign country on its income without regard to whether such income is from sources inside or outside such foreign country, or is subject to such a tax on a residence basis. Section 1503(d)(3) grants the Secretary broad authority to subject any loss of a separate unit of a domestic corporation to the limitations of section 1503(d). Because separate units are not themselves taxpayers, it is necessary to determine which items of income, gain, deduction, and loss of the domestic owner of the separate unit should be taken into account for purposes of calculating a dual consolidated loss.

Section 1.1503-2(d)(1)(ii) of the current regulations provides a limited rule for attributing items of a domestic owner to a separate unit. Under this rule, a separate unit must compute its income as if it were a separate domestic corporation that is a dual resident corporation, using only those items of income, expense, deduction, and loss that are otherwise attributable to such separate unit. For this purpose, only items of the domestic owner that are recognized for U.S. tax purposes are taken into account.

In response to requests for additional guidance in this area, the proposed regulations provide more detailed rules for determining the amount of income or dual consolidated loss of a separate unit. This determination depends on various factors, including the type of separate unit, the ownership structure, and the nature of the item. The determination generally turns on whether it is likely that the relevant foreign country would take into account the item (assuming the item is recognized) for tax purposes. This determination is solely for purposes of section 1503(d) and does not apply for any other purpose, such as attributing items under an applicable income tax treaty or under other Code sections such as section 884 or 987.

These final regulations adopt the attribution rules contained in the proposed regulations, with modifications.

(2) Books and records The proposed regulations provide that, in general, the items of income, gain, deduction, and loss that are attributable to a hybrid entity (and, therefore, attributable to interests in the hybrid entity) are those that are properly reflected on its books and records, as adjusted to conform to U.S. tax principles. The proposed regulations further provide that the principles of §1.988-4(b)(2) apply for purposes of making this determination.

One commentator asked whether §1.988-4(b)(2) is a strict booking rule, or whether it would instead permit taxpayers to take positions contrary to how items are reflected on the books and records if, under the facts and circumstances, the items were not appropriately reflected on the books and records. Another commentator stated that the clause “to the extent consistent with U.S. tax principles” in the proposed regulations created uncertainty.

In response to these comments, the final regulations clarify that only the Commissioner, and not the taxpayer, may make adjustments to the books and records where the booking practices are employed with a principle purpose of avoiding the principles of section 1503(d), including inconsistently treating the same or similar items of income, gain, deduction, and loss. In addition, these final regulations clarify that, in general, a domestic owner’s items of income, gain, deduction, and loss are attributable to the domestic owner’s hybrid entity separate unit, or interest in a transparent entity, to the extent such items are reflected on the hybrid entity or transparent entity’s books and records (as defined in §1.989(a)-1(d)), as adjusted to conform to U.S. tax principles.

The books and records standard set forth in these final regulations is intended to be consistent with the more detailed approach for attributing items that was adopted in proposed §1.987-2(b) that was published on September 7, 2006 (REG-208270-86, 2006-42 I.R.B. 698 [71 FR 52875]). It is anticipated that when those regulations are published as final regulations in the Federal Register, that approach will, as appropriate, be incorporated into these regulations. The IRS and Treasury Department believe that applying consistent standards under these two provisions, where appropriate, would make the rules more administrable. Comments are requested as to whether the standard contained in the section 987 proposed regulations is appropriate for purposes of section 1503(d).

(3) Attributing interest expense under the principles of §1.882-5 The proposed regulations provide that the principles of §1.882-5, as modified, apply for purposes of determining the interest expense that is attributable to a foreign branch separate unit. In making this determination, and solely for this purpose, the domestic owner is treated as a foreign corporation, the foreign branch separate unit is treated as a trade or business within the United States, and assets other than those of the foreign branch separate unit are treated as assets that are not U.S. assets.

Two comments were received on the application of this rule. First, commentators stated that adopting the principles of §1.882-5 results in unnecessary complexity. These commentators suggested that, in lieu of using the principles of §1.882-5, the interest expense of a foreign branch separate unit be determined by reference to its books and records. Another commentator noted the rationale of using the principles of §1.882-5 as a general matter, but suggested that where the foreign country looks to the books and records of the foreign branch separate unit for purposes of computing the interest expense of the separate unit, it would be appropriate to use the books and records for purposes of section 1503(d).

The IRS and Treasury Department continue to believe that the principles of §1.882-5, as modified, serve as a reasonable proxy for determining the items of interest expense recognized for U.S. tax purposes that, if recognized by the foreign country, would be taken into account by the foreign country. Therefore, the principles of §1.882-5, as modified, are retained as the general rule for purposes of determining the interest expense that is attributable to a foreign branch separate unit.

However, to minimize complexity, the IRS and Treasury Department believe it is appropriate to use a books and records approach, where possible. Therefore, these final regulations provide an exception to the general rule such that interest expense is attributable to a foreign branch separate unit to the extent it is reflected on its books and records. This exception only applies if the foreign country in which the foreign branch is located determines, for purposes of computing the taxable income (or loss) under the laws of the foreign country, the interest expense of the foreign branch separate unit by taking into account only the items of interest expense reflected on the foreign branch separate unit’s books and records. This rule will not apply, however, in cases where the foreign country does not use a strict booking approach for interest expense.

Finally, it is important to note that in all cases only items of interest expense, as determined for U.S. tax purposes, are taken into account. The treatment of interest expense in the foreign country is only relevant for purposes of determining the method under which items of interest expense (determined for U.S. tax purposes) is attributed to the foreign branch separate unit.

(4) Treaty-based methods The proposed regulations provide that for purposes of determining the items of income, gain, deduction (other than interest), and loss that are taken into account in determining the taxable income or loss of a foreign branch separate unit, the principles of sections 864(c)(2) and (c)(4) as set forth in §§1.864-4(c) and 1.864-6 shall apply.

One commentator stated that domestic corporations operating foreign branch separate units should be allowed to attribute items to the foreign branch separate unit based on the method provided under an income tax treaty between the United States and the foreign country (or between two foreign countries if foreign branch operations are conducted by a hybrid entity outside its home country). The IRS and Treasury Department believe that this approach is inappropriate for two reasons. First, it would have the effect of attributing items recognized by the foreign jurisdiction, which may not be recognized as items for U.S. tax purposes. This would be inconsistent with section 1503(d), which defines a dual consolidated loss solely based on U.S. tax rules. Second, this approach would require the interpretation of foreign law, which the IRS and Treasury Department believe should be avoided, to the extent possible. Accordingly, this comment is not adopted.

(5) Gain or loss recognized under section 987 The proposed regulations do not provide whether gain or loss of a domestic owner recognized under section 987 as a result of a remittance or transfer is attributable to a separate unit for purposes of calculating income or dual consolidated loss, but instead request comments.

Commentators stated that gain or loss recognized under section 987 should not be attributable to a separate unit because in most cases the foreign country would not recognize such items since the income of the separate unit will be computed in the local currency. The IRS and Treasury Department agree with this comment. As a result, these final regulations provide that gain or loss recognized under section 987, as a result of a remittance or transfer, will not be taken into account for purposes of computing the income or dual consolidated loss of a separate unit.

(6) Attributable to or taken into account The proposed regulations generally provide that items are attributable to a hybrid entity separate unit, but are taken into account by a foreign branch separate unit. The IRS and Treasury Department believe that the use of these different terms is unnecessary and may lead to confusion. As a result, these final regulations provide that items are attributable to a separate unit, regardless of whether the separate unit is a foreign branch separate unit or a hybrid entity separate unit.

M. Basis Adjustments Section 1.1503-2(d)(3) of the current regulations contains special basis adjustment rules that override the normal investment adjustment rules under §1.1502-32 for stock of affiliated dual resident corporations and affiliated domestic owners owned by other members of the consolidated group. Similar rules apply to separate units arising from the ownership of an interest in a partnership. These special basis adjustment rules were included in the current regulations to prevent the indirect deduction of a dual consolidated loss. Although the proposed regulations retain these rules, the IRS and Treasury Department requested comments on whether the special basis adjustment rules should be retained.

A number of commentators recommended that the special basis adjustment rules be removed for several reasons. For example, the commentators noted that an indirect use, which the special basis rules were intended to prevent, may not occur for many years after the dual consolidated loss was incurred. In response to these comments, the special basis rules are not contained in these final regulations. Thus, the basis adjustment rules under §1.1502-32 shall apply without modification for purposes of determining the adjusted basis in the stock of a dual resident corporation or the stock of an affiliated domestic owner owned by other members of the consolidated group. These final regulations also contain rules to ensure consistent treatment for a partner’s basis in a partnership interest that is a separate unit, or through which a separate unit is owned indirectly.

N. Losses of a Foreign Insurance Company Treated as a Domestic Corporation

(1) In general Section 953(d) generally provides that a foreign corporation that would qualify to be taxed as an insurance company if it were a domestic corporation may, under certain circumstances, elect to be treated as a domestic corporation (section 953(d) company). Section 953(d)(3) provides that if a section 953(d) company is treated as a member of an affiliated group, any loss of such corporation is treated as a dual consolidated loss for purposes of section 1503(d), without regard to section 1503(d)(2)(B) (grant of regulatory authority to exclude losses which do not offset the income of foreign corporations from the definition of a dual consolidated loss).

The current regulations do not address the application of section 953(d)(3). In the proposed regulations, however, the definition of a dual resident corporation includes a section 953(d) company that is a member of an affiliated group. In addition, the proposed regulations clarify that a section 953(d) company may not make a domestic use election. These rules are consistent with section 953(d)(3).

In response to comments, these final regulations provide additional guidance on the application of the dual consolidated loss rules to section 953(d)(3) companies, including the treatment of separate units owned by such companies.

(2) Transactions intended to avoid the limitations of sections 953(d)(3) and 1503(d) The IRS and Treasury Department understand that taxpayers may be implementing structures that result in the same overall tax consequences as structures that Congress intended to be subject to the loss limitation rules provided under sections 953(d)(3) and 1503(d). However, taxpayers may be taking the position that the structures are not subject to these loss limitation rules. For example, a foreign insurance company may, in lieu of making an election under section 953(d) and thus being subject to the limitations of sections 953(d)(3) and 1503(d), file a certificate of domestication in a state as a limited liability company. As a business entity with multiple charters, this entity would be treated as a domestic corporation for U.S. tax purposes under §301.7701-2(b)(9). Taxpayers may take the position that this entity would be entitled to the same benefits of a company that makes an election under section 953(d), without being subject to the limitations on the use of its losses that are imposed under sections 953(d)(3) and 1503(d).

The IRS and Treasury Department disagree with the taxpayer’s characterization of these structures under current law. In addition, the IRS and Treasury Department believe the taxpayers’ characterization of the structures is contrary to the policies underlying section 953(d). Accordingly, the IRS and Treasury Department are considering issuing regulations, which may be retroactive, that would clarify the application of section 953(d)(3) to these structures. These regulations would provide that if a foreign insurance company is eligible to make an election to be treated as a domestic corporation pursuant to section 953(d), but in lieu of making such election becomes a domestic corporation through other means (for example, by filing a certificate of domestication in a state as a limited liability company), then such company shall be subject to the limitations under sections 953(d)(3) and 1503(d) (without regard to paragraph (2)(B) thereof). The IRS and Treasury Department request comments regarding appropriate rules to address these structures and other structures that are intended to avoid the purposes of section 953(d)(3).

O. All or Nothing Rule Under the current regulations a triggering event (other than a foreign use) generally can be rebutted only if no portion of the dual consolidated loss can be used by (or carries over to) another person under foreign law. See §1.1503-2(g)(2)(iii)(A)(2) through (7). Thus, even a de minimis foreign use will cause the entire amount of the dual consolidated loss to be recaptured and reported as income.

The proposed regulations retain this so-called all or nothing principle because the IRS and Treasury Department recognize that departing from it would lead to significant administrative burdens for the Commissioner and taxpayers. Although the all or nothing principle was retained, the IRS and Treasury Department requested comments regarding administrable alternatives that would not involve substantial analysis of foreign law.

Several comments were received with respect to this issue. A number of commentators stated that the final regulations should remove the all or nothing principle and allow for a pro-rata recapture such that, for example, the disposition of an individual separate unit, which is part of a combined separate unit, would not result in the entire recapture of the combined separate unit’s dual consolidated loss, but only the portion of the loss attributable to the individual separate unit. Another commentator suggested removing the all or nothing rule and allowing a taxpayer to establish that the losses otherwise subject to recapture were not, in fact, used under foreign law. The commentator suggested that any concerns regarding an analysis of foreign law could be mitigated by requiring the taxpayer to provide certified copies of foreign tax returns and, in addition, where the foreign tax base differs substantially from the U.S. tax base, by adopting an apportionment methodology.

The IRS and Treasury Department continue to believe that, even under the approaches suggested by these commentators, departing from the all or nothing principle would lead to substantial administrative complexity. As a result, these comments are not adopted.

Another commentator suggested that the final regulations include a general de minimis rule for purposes of applying the triggering and recapture provisions. Under this approach, if a taxpayer could establish that less than a specific percentage of the dual consolidated loss is available for a foreign use, the taxpayer could avoid recapture altogether. However, in situations where the potential loss available for a foreign use exceeds the de minimis amount, the dual consolidated loss would be recaptured to the extent it was actually put to a foreign use.

The IRS and Treasury Department do not believe that a de minimis rule as described would be meaningful given that the Commissioner and taxpayers would be required to determine the actual amount of the dual consolidated loss available for foreign use, which poses the same administrative concerns as generally departing from the all or nothing principle (that is, a complex analysis of foreign law or complicated ordering, stacking, or tracing rules). As a result, this suggestion is not adopted.

Finally, commentators suggested that following certain events otherwise requiring recapture, a taxpayer should be allowed to reduce the amount of recapture by establishing that a portion of the dual consolidated loss is attributable to items of deduction or loss that, due to permanent differences between the U.S. and foreign tax law, do not give rise to a corresponding item of deduction or loss in the foreign country. The commentators cited items of deduction or loss composing the dual consolidated loss attributable to a basis step-up following a section 338 election, or attributable to a deduction arising from the amortization of goodwill or certain intangibles under section 197, as examples of such items.

The IRS and Treasury Department recognize that items of deduction or loss that are never taken into account in the foreign country cannot be put to a foreign use. However, the IRS and Treasury Department believe that the suggested approach would, in most situations, involve many items of deduction and loss and, as a result, would present the same concerns as are present in the other approaches discussed above. For example, if the deductions giving rise to a dual consolidated loss were the result of a step-up in basis following a section 338 election, but the various assets to which such basis attached had, prior to the election, a basis for foreign tax purposes, complex ordering and stacking rules would be required to determine that, in fact, no portion of the dual consolidated loss is attributable to the pre-existing foreign tax basis. In addition, this approach would require rules to distinguish a permanent (or base) difference from a timing difference, in order to ensure that the portion of the dual consolidated loss that is not being recaptured would not be available for a foreign use at some point in the future. As a result, such rules would add complexity and would be administratively burdensome. Accordingly, this comment is not adopted.

Although these comments are not adopted in the final regulations, the IRS and Treasury Department believe that the application of the all or nothing rule will be significantly reduced under these regulations as a result of the new exceptions to foreign use and the further reduction of the term of the certification period.

P. Triggering Events and Related Rules

(1) Modification of exceptions to triggering events The proposed regulations contain exceptions to triggering events that generally apply where assets or interests sold or disposed of are acquired, directly or through certain wholly-owned pass-through entities, by members of the consolidated group that includes the dual resident corporation or separate unit, or by the unaffiliated domestic owner.

The final regulations generally retain these exceptions, but modify them to take into account the new exceptions to foreign use. For example, the exceptions are modified to include certain acquisitions by pass-through entities that are more than 90-percent owned (rather than wholly owned) by the consolidated group or unaffiliated domestic owner. These rules also address certain deemed transactions (for example, pursuant to Rev. Rul. 99-5, 1999-1 C.B. 434) to minimize the likelihood that they result in triggering events, where appropriate, see §601.601(d)(2)(ii)(b).

Finally, in response to comments discussed in section G(3) of this preamble, these regulations contain a new exception to triggering events that occur as a result of certain compulsory transfers.

(2) Rebuttal Under the current regulations, taxpayers may rebut all but two of the triggering events such that there is no recapture of a certified dual consolidated loss (or related interest charge) as a result of a putative triggering event. In general, under the current regulations, a triggering event is rebutted if the taxpayer demonstrates to the satisfaction of the Commissioner that, depending on the triggering event, either: (1) the losses, expenses, or deductions of the dual resident corporation (or separate unit) cannot be used to offset income of another person under the laws of a foreign country; or (2) the transfer of assets did not result in a carryover under foreign law of the losses, expenses, or deductions of the dual resident corporation (or separate unit). See §1.1503-2(g)(2)(iii)(A)(2) through 1.1503-2(g)(2)(iii)(A)(7). The dual consolidated loss rules do not require recapture or an interest charge in such cases because there is no opportunity for any portion of the dual consolidated loss to be used to offset income of any other person under the income tax laws of a foreign country.

The proposed regulations generally retain the rebuttal standard contained in the current regulations, with modifications. Taxpayers may rebut a triggering event under the proposed regulations if it can be demonstrated, to the satisfaction of the Commissioner, that there can be no foreign use of the dual consolidated loss. However, unlike the current regulations that have different standards for different triggering events, the proposed regulations apply the same standard to all triggering events (other than a foreign use triggering event, which cannot be rebutted).

One commentator noted that the rebuttal standard of the proposed regulations is unnecessarily broad with respect to certain asset transfers. For example, according to this commentator, a triggering event cannot be rebutted under this standard where a separate unit transfers over 50 percent of its assets in a transaction that does not result in a loss carryover to the transferee under foreign law. This is the case because the separate unit would not be able to establish that the dual consolidated loss, which did not carry over to the transferee, could never be put to a foreign use. Accordingly, this commentator requested that the rebuttal standard for asset transfers contained in the current regulations be adopted in the final regulations.

The IRS and Treasury Department agree with this comment and these final regulations are modified accordingly.

Another commentator noted that neither the proposed nor current regulations specify how taxpayers must demonstrate that there can be no foreign use during the remaining certification period by any means. The commentator stated that this lack of specificity creates uncertainty and, as a result, requested additional guidance as to how the determination is to be made.

The IRS and Treasury Department believe that this demonstration can be made in a number of ways, including based on the taxpayer’s interpretation of foreign law, on an opinion from local advisors, or on assurance from the local country tax authorities. In all cases, however, the determination must be made to the satisfaction of the Commissioner. These final regulations are modified accordingly.

(3) Reduction of recapture amount The proposed regulations permit the elector to reduce the amount of the dual consolidated loss that must be recaptured upon a triggering event. The recapture amount can be reduced to the extent the elector demonstrates that the dual consolidated loss would have offset other income of the dual resident corporation or separate unit reported on a timely filed U.S. income tax return for any taxable year up to and including the taxable year of the triggering event if such loss had been subject to the limitation under §1.1503(d)-2(b) of the proposed regulations.

Commentators questioned the requirements for the reduction of the recapture amount. One commentator suggested that recapture should be reduced by the amount of subsequent income attributable to the dual resident corporation or separate unit, irrespective of the income or loss of other group members.

The IRS and Treasury Department recognize that the policies underlying the SRLY rules differ from those underlying section 1503(d). Although the SRLY rules do not provide for a reduction in recapture in all cases consistent with the views of this commentator, the IRS and Treasury Department continue to believe that the SRLY rules are a reasonable and appropriate mechanism for implementing the restrictions of section 1503(d)(1) in the vast majority of cases. Further, the IRS and Treasury Department believe that deviating from the SRLY mechanism would add considerable complexity to the rules and could lead to unintended consequences. As a result, this comment is not adopted. The IRS and Treasury Department will consider addressing the interaction of the SRLY rules with the recapture provisions in future guidance. Comments are requested as to alternative mechanisms that are more consistent with dual consolidated loss policy and that are not unduly complicated.

(4) Interest due on recapture Under both the current regulations and these final regulations, taxpayers must pay an interest charge in connection with recapture that is computed under the rules of section 6601. In response to comments, these final regulations clarify that this interest charge is deductible to the same extent as interest under section 6601.

(5) Treatment of recapture income under section 384 One commentator requested clarification regarding a subsequent elector’s agreement to treat potential recapture amounts as unrealized built-in gain for purposes of section 384(a). The commentator stated that it may be unclear as to whether section 384 must otherwise apply to the transaction, whether the thresholds of section 384 apply, and whether potential recapture income treated as unrealized built-in gain is subject to reduction for income earned by a separate unit or dual resident corporation.

The IRS and Treasury Department believe that potential recapture amounts should be treated as unrealized built-in gains for purposes of determining whether section 384 applies, but that the requirements and exceptions of section 384 otherwise apply. In addition, the potential recapture amount treated as unrealized built-in gain may be reduced by potential offset, as permitted under the regulations. These final regulations have been modified accordingly.

(6) Reconstituted dual consolidated loss Both the current and proposed regulations contain a reconstituted loss provision. This rule generally provides that if a dual consolidated loss is recaptured as a result of a triggering event, the dual resident corporation or separate unit that incurred the loss is treated as having a net operating loss in an amount equal to the amount recaptured. The loss is reconstituted in the taxable year immediately following the year of the recapture and is subject to the general restrictions of section 1503(d). This rule is intended to put the taxpayer in the same approximate position it would have been in had it never made an election to use the dual consolidated loss.

These final regulations modify the proposed regulations’ reconstituted loss rule to reflect the expansion of the separate unit combination rule and the rules that eliminate dual consolidated losses following certain transactions. In addition, the rule was modified to better take into account the interaction of the dual consolidated loss rules with the general loss carryover rules. For example, these final regulations provide that, other than with respect to the multiple-party event exception, a transfer of an interest in a separate unit by its domestic owner to another corporation cannot cause all or a portion of the dual consolidated loss of such separate unit to carry over to the acquiring corporation, absent the application of section 381.

Q. Certification Period Section 1.1503-2(g)(2)(vi)(B) of the current regulations provides that if a (g)(2)(i) election is made with respect to a dual consolidated loss of a dual resident corporation or a hybrid entity separate unit, the consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner, as the case may be, must file with its tax return an annual certification during the 15 year certification period. This filing permits the dual consolidated loss to be used in the United States to offset the income of a domestic affiliate but certifies that the losses or deductions that make up the dual consolidated loss have not been used to offset the income of another person under the tax laws of a foreign country. The current regulations do not require annual certifications for (g)(2)(i) agreements entered into with respect to dual consolidated losses of foreign branch separate units. The current regulations also provide that if there is a triggering event during the 15 year period following the year in which the dual consolidated loss was incurred (certification period), the taxpayer must recapture and report as income the amount of the dual consolidated loss, and pay an interest charge. §1.1503-2(g)(2)(iii)(A).

The proposed regulations reduce the certification period from 15 years to seven years, and expand the annual certification requirement to include dual consolidated losses of foreign branch separate units.

Commentators recommended that the certification period in the proposed regulations be further reduced to five years, because such five-year period would be sufficient to deter the types of double dips with which section 1503(d) is concerned, and would be consistent with time periods used under similar provisions (for example, the term of gain recognition agreements entered into under section 367(a)). The IRS and Treasury Department agree with this comment, and, as a result, the certification period in these final regulations is five years.

Another commentator asserted that extending the annual certification requirement to foreign branch separate units is both unnecessary and administratively burdensome and, as a result, such certification should not be included in these final regulations.

The IRS and Treasury Department continue to believe that the annual certification requirement improves taxpayer compliance and is beneficial in monitoring and deterring inappropriate double dips. In addition, the IRS and Treasury Department believe that, where appropriate, treating foreign branch separate units, hybrid entity separate units, and dual resident corporations consistently for purposes of section 1503(d) will reduce the administrative complexity of these regulations. As a result, this comment is not adopted.

R. Other Comments and Modifications

(1) Information provided with domestic use election One commentator recommended that certain information provided with the domestic use election should not bind a taxpayer if the information is provided in good faith, but subsequently is determined to be erroneous. The IRS and Treasury Department believe that adopting this recommendation would be administratively burdensome. Accordingly, this comment is not adopted.

(2) No possibility of foreign use One commentator noted that taxpayers may be eligible to demonstrate no possibility of foreign use, but still choose to enter into a domestic use agreement. The commentator explained that taxpayers may do so to avoid the cost and effort required to satisfy the no possibility of foreign use standard, recognizing that this demonstration would only be beneficial if there is a triggering event during the certification period. The commentator further stated that the taxpayer should nonetheless retain the ability to argue at a later time, when a foreign use may occur after a change in foreign law, that no dual consolidated loss existed in the year in which the loss was actually incurred. Thus, if there was a change in foreign law, taxpayers would not be penalized for being unable to rebut the triggering event in the current year (due to a change in foreign law) but could instead rely on the foreign law in effect for the year in which the loss was incurred.

The IRS and Treasury Department recognize that taxpayers may simply choose to file a domestic use election, rather than engage in additional efforts to demonstrate no possibility of foreign use. The IRS and Treasury Department believe that these final regulations provide ample opportunities for taxpayers willing to demonstrate no possibility of foreign use. Taxpayers have three opportunities to demonstrate no possibility of foreign use under the final regulations: first under §1.1503(d)-6(c) to be excepted from the domestic use limitation, second under §1.1503(d)-6(e)(2) to rebut a triggering event, and third under §1.1503(d)-6(j)(2) to terminate a domestic use agreement. Because of these opportunities and the administrative burdens that would ensue from taking into account changes in foreign law, this comment is not adopted.

S. Effective Dates

(1) General rule Except as provided in this preamble, these final regulations apply to dual consolidated losses incurred in taxable years beginning on or after April 18, 2007. However, a taxpayer may apply these regulations, in their entirety, to dual consolidated losses incurred in taxable years beginning on or after January 1, 2007.

(2) Certification period A number of commentators requested that the reduced certification period of these final regulations apply with respect to dual consolidated losses that are subject to the current regulations. The commentators asserted that the policies underlying the reduced certification period should apply equally to dual consolidated losses that are subject to the current regulations. Commentators also recommended that the reduced certification period contained in these final regulations apply to closing agreements entered into between taxpayers and the IRS pursuant to §1.1503-2(g)(2)(iv)(B)(3)(i) and Rev. Proc. 2000-42, 2000-2 C.B. 394, see §601.601(d)(2)(ii)(b).

The IRS and Treasury Department generally agree with these comments and these final regulations are modified accordingly.

(3) Reasonable cause exception These final regulations adopt the reasonable cause procedure for purposes of curing all late filings as introduced in the proposed regulations, and subsequently modified by Notice 2006-13, 2006-8 I.R.B. 496, see §601.601(d)(2)(ii)(b). Moreover, these final regulations provide that the reasonable cause procedures supplant the current procedures for all untimely filings with respect to dual consolidated losses incurred under the current regulations as well, except with respect to requests for closing agreements. Taxpayers requiring relief to cure a late request for a closing agreement must continue to seek extensions of time under §§301.9100-1 through 301.9100-3 and Rev. Proc. 2000-42, 2000-2 C.B. 394, see §601.601(d)(2)(ii)(b). Taxpayers seeking relief for other late filings required in connection with such closing agreements must, however, use the reasonable cause procedure of these final regulations. Therefore, as a result of these changes, untimely filings under section 1503(d) and these regulations will no longer be eligible for the relief provided by §§301.9100-1 through 301.9100-3, regardless of whether such filings were required under the current regulations (except for certain closing agreements) or these final regulations.

(4) Multiple-party event exception to triggering events These final regulations provide an exception to certain triggering events involving multiple parties. In general, the exceptions provided under these final regulations with respect to multiple-party events are similar to those provided under §1.1503-2(g)(2)(iv)(B)(1). The procedures required to satisfy these multiple-party event exceptions are also similar to those found in §1.1503-2(g)(2)(iv)(B)(3). One important difference is that these final regulations do not require (or permit) taxpayers to obtain closing agreements. These final regulations also provide a special effective date provision with respect to events described in §1.1503-2(g)(2)(iv)(B)(1) that occur after April 18, 2007, that are with respect to dual consolidated losses subject to the current regulations. Such events are not eligible for the exception described in §1.1503-2(g)(2)(iv)(B)(1) and thus are not eligible for a closing agreement as described in §1.1503-2(g)(2)(iv)(B)(3)(i). Instead, such events are eligible for the multiple-party event exception described in these final regulations and as modified by the special effective date provision of §1.1503(d)-8(b)(4). Taxpayers may, however, choose to apply the multiple-party exception to events described in §1.1503-2(g)(2)(iv)(B)(1)(i) through (iii) that occur after March 19, 2007 and on or before April 18, 2007.

(5) Basis adjustments One commentator requested that the elimination of the special basis adjustments described in paragraph M of this preamble be applied retroactively. The commentator further requested that such retroactive application apply to adjustments that occurred in closed taxable years if the basis of the stock is relevant in an open taxable year.

The IRS and Treasury Department agree with this comment. As a result, these regulations provide that taxpayers may apply the basis adjustment rules of these final regulations for all taxable years if such adjustments affected tax basis that is relevant in an open taxable year.

(6) Other provisions A number of commentators requested that the IRS and Treasury Department provide that taxpayers be allowed to electively apply other provisions of these regulations to dual consolidated losses that are subject to the current regulations.

The IRS and Treasury Department do not believe that it would be appropriate to allow taxpayers to selectively apply provisions of these regulations (other than those that the IRS and Treasury Department view as clarifications) retroactively, because it would lead to administrative complexity for the IRS and could lead to unintended results.

Effect on Other Documents

These final regulations obsolete Notice 2006-13, 2006-8 I.R.B. 496, see §601.601(d)(2)(ii)(b). These final regulations also obsolete Rev. Proc. 2000-42, 2000-2 C.B. 394, see §601.601(d)(2)(ii)(b), with respect to triggering events occurring after April 18, 2007.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that these regulations will primarily affect affiliated groups of corporations that also have a foreign affiliate, which tend to be larger businesses. Moreover, the number of taxpayers affected and the average burden are minimal. Therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding this regulation was submitted to the Chief Counsel for Advocacy of the Small Business for comment on its impact on small business.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read in part as follows:

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

Section 1.1503(d) also issued under 26 U.S.C. 953(d) and 26 U.S.C. 1502.

§1.1502-21 [Amended]

Par. 2. In §1.1502-21, paragraph (c)(2)(v) is amended by removing the language “§1.1503-2” and adding “§§1.1503(d)-1 through 1.1503(d)-8” in its place.

§1.1503-2A [Removed]

Par. 3. Section 1.1503-2A is removed.

Par. 4. New §§1.1503(d)-0 through 1.1503(d)-8 are added to read as follows:

§1.1503(d)-0 Table of contents. This section lists the captions contained in §§1.1503(d)-1 through 1.1503(d)-8.

§1.1503(d)-1 Definitions and special rules for filings under section 1503(d). (a) In general.

(b) Definitions.

(1) Domestic corporation.

(2) Dual resident corporation.

(3) Hybrid entity.

(4) Separate unit.

(i) In general.

(ii) Separate unit combination rule.

(iii) Business operations that do not constitute a permanent establishment.

(iv) Foreign branch separate units held by dual resident corporations or hybrid entities in the same foreign country.

(5) Dual consolidated loss.

(6) Subject to tax.

(7) Foreign country.

(8) Consolidated group.

(9) Domestic owner.

(10) Affiliated dual resident corporation and affiliated domestic owner.

(11) Unaffiliated dual resident corporation, unaffiliated domestic corporation, and unaffiliated domestic owner.

(12) Domestic affiliate.

(13) Domestic use.

(14) Foreign use.

(15) Grantor trust.

(16) Transparent entity.

(i) In general.

(ii) Example.

(17) Disregarded entity.

(18) Partnership.

(19) Indirectly.

(20) Certification period.

(c) Special rules for filings under section 1503(d).

(1) Reasonable cause exception.

(2) Requirements for reasonable cause relief.

(i) Time of submission.

(ii) Notice requirement.

(3) Signature requirement.

§1.1503(d)-2 Domestic use.

§1.1503(d)-3 Foreign use. (a) Foreign use.

(1) In general.

(2) Indirect use.

(i) General rule.

(ii) Exception.

(iii) Examples.

(3) Deemed use.

(b) Available for use.

(c) Exceptions.

(1) In general.

(2) Election or merger required to enable foreign use.

(3) Presumed use where no foreign country rule for determining use.

(4) Certain interests in partnerships or grantor trusts.

(i) General rule.

(ii) Combined separate unit.

(iii) Reduction in interest.

(5) De minimis reduction of an interest in a separate unit.

(i) General rule.

(ii) Limitations.

(iii) Reduction in interest.

(iv) Examples and coordination with exceptions to other triggering events.

(6) Certain asset basis carryovers.

(7) Assumption of certain liabilities.

(i) In general.

(ii) Ordinary course limitation.

(8) Multiple-party events.

(9) Additional guidance.

(d) Ordering rules for determining the foreign use of losses.

(e) Mirror legislation rule.

(1) In general.

(2) Stand-alone exception.

(i) In general.

(ii) Stand-alone domestic use agreement.

(iii) Termination of stand-alone domestic use agreement.

§1.1503(d)-4 Domestic use limitation and related operating rules. (a) Scope.

(b) Limitation on domestic use of a dual consolidated loss.

(c) Effect of a dual consolidated loss on a consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner.

(1) Dual resident corporation.

(2) Separate unit.

(3) SRLY limitation.

(4) Items of a dual consolidated loss used in other taxable years.

(5) Reconstituted net operating losses.

(d) Elimination of a dual consolidated loss after certain transactions.

(1) General rule.

(i) Transactions described in section 381(a).

(ii) Cessation of separate unit status.

(2) Exceptions.

(i) Certain section 368(a)(1)(F) reorganizations.

(ii) Acquisition of a dual resident corporation by another dual resident corporation.

(iii) Acquisition of a separate unit by a domestic corporation.

(A) Acquisition by a corporation that is not a member of the same consolidated group.

(B) Acquisition by a member of the same consolidated group.

(iv) Special rules for foreign insurance companies.

(e) Special rule denying the use of a dual consolidated loss to offset tainted income.

(1) In general.

(2) Tainted income.

(i) Definition.

(ii) Income presumed to be derived from holding tainted assets.

(3) Tainted assets defined.

(4) Exceptions.

(f) Computation of foreign tax credit limitation.

§1.1503(d)-5 Attribution of items and basis adjustments. (a) In general.

(b) Determination of amount of income or dual consolidated loss of a dual resident corporation.

(1) In general.

(2) Exceptions.

(c) Determination of amount of income or dual consolidated loss attributable to a separate unit, and income or loss attributable to an interest in a transparent entity.

(1) In general.

(i) Scope and purpose.

(ii) Only items of domestic owner taken into account.

(iii) Separate application.

(2) Foreign branch separate unit.

(i) In general.

(ii) Principles of §1.882-5.

(iii) Exception where foreign country attributes interest expense solely by reference to books and records.

(3) Hybrid entity separate unit and an interest in a transparent entity.

(i) General rule.

(ii) Interests in certain disregarded entities, partnerships, and grantor trusts owned by a hybrid entity or transparent entity.

(4) Special rules.

(i) Allocation of items between certain tiered separate units and interests in transparent entities.

(A) Foreign branch separate unit.

(B) Hybrid entity separate unit or interest in a transparent entity.

(ii) Combined separate unit.

(iii) Gain or loss on the direct or indirect disposition of a separate unit or an interest in a transparent entity.

(A) In general.

(B) Multiple separate units or interests in transparent entities.

(iv) Inclusions on stock.

(v) Foreign currency gain or loss recognized under section 987.

(vi) Recapture of dual consolidated loss.

(d) Foreign tax treatment disregarded.

(e) Items generated or incurred while a dual resident corporation, a separate unit, or a transparent entity.

(f) Assets and liabilities of a separate unit or an interest in a transparent entity.

(g) Basis adjustments.

(1) Affiliated dual resident corporation or affiliated domestic owner.

(2) Interests in hybrid entities that are partnerships or interests in partnerships through which a separate unit is owned indirectly.

(i) Scope.

(ii) Determination of basis of partner’s interest.

(3) Combined separate units.

§1.1503(d)-6 Exceptions to the domestic use limitation rule. (a) In general.

(1) Scope and purpose.

(2) Absence of foreign affiliate or foreign consolidation regime.

(3) Foreign insurance companies treated as domestic corporations.

(b) Elective agreement in place between the United States and a foreign country.

(1) In general.

(2) Application to combined separate units.

(c) No possibility of foreign use.

(1) In general.

(2) Statement.

(d) Domestic use election.

(1) In general.

(2) No domestic use election available if there is a triggering event in the year the dual consolidated loss is incurred.

(e) Triggering events requiring the recapture of a dual consolidated loss.

(1) Events.

(i) Foreign use.

(ii) Disaffiliation.

(iii) Affiliation.

(iv) Transfer of assets.

(v) Transfer of an interest in a separate unit.

(vi) Conversion to a foreign corporation.

(vii) Conversion to a regulated investment company, a real estate investment trust, or an S corporation.

(viii) Failure to certify.

(ix) Cessation of stand-alone status.

(2) Rebuttal.

(i) General rule.

(ii) Certain asset transfers.

(iii) Reporting.

(iv) Examples.

(f) Triggering event exceptions.

(1) Continuing ownership of assets or interests.

(i) Disaffiliation as a result of a transaction described in section 381.

(ii) Continuing ownership by consolidated group.

(iii) Continuing ownership by unaffiliated dual resident corporation or unaffiliated domestic owner.

(2) Transactions requiring a new domestic use agreement.

(i) Multiple-party events.

(ii) Events resulting in a single consolidated group.

(iii) Requirements.

(A) New domestic use agreement.

(B) Statement filed by original elector.

(3) Certain transfers qualifying for the de minimis exception to foreign use.

(4) Deemed transactions as a result of certain transfers that do not result in a foreign use.

(5) Compulsory transfers.

(6) Subsequent triggering events.

(g) Annual certification reporting requirement.

(h) Recapture of dual consolidated loss and interest charge.

(1) Presumptive rules.

(i) Amount of recapture.

(ii) Interest charge.

(2) Reduction of presumptive recapture amount and presumptive interest charge.

(i) Amount of recapture.

(ii) Interest charge.

(3) Rules regarding multiple-party event exceptions to triggering events.

(i) Scope.

(ii) Original elector and prior subsequent electors not subject to recapture or interest charge.

(iii) Recapture tax amount and required statement.

(A) In general.

(B) Recapture tax amount.

(iv) Tax assessment and collection procedures.

(A) In general.

(B) Collection from original elector and prior subsequent electors; joint and several liability.

(C) Allocation of partial payments of tax.

(D) Refund.

(v) Definition of income tax liability.

(vi) Example.

(4) Computation of taxable income in year of recapture.

(i) Presumptive rule.

(ii) Exception to presumptive rule.

(5) Character and source of recapture income.

(6) Reconstituted net operating loss.

(i) General rule.

(ii) Exception.

(iii) Special rule for recapture following multiple-party event exception to a triggering event.

(i) [Reserved].

(j) Termination of domestic use agreement and annual certifications.

(1) Rebuttals, exceptions to triggering events, and recapture.

(2) Termination of ability for foreign use.

(i) In general.

(ii) Statement.

(3) Agreements filed in connection with stand-alone exception.

§1.1503(d)-7 Examples. (a) In general.

(b) Presumed facts for examples.

(c) Examples.

§1.1503(d)-8 Effective dates. (a) General rule.

(b) Special rules.

(1) Reduction of term of agreements filed under §§1.1503-2(g)(2)(i) or 1.1503-2T(g)(2)(i).

(2) Reduction of term of closing agreements entered into pursuant to §1.1503-2(g)(2)(iv)(B)(3)(i).

(3) Relief for untimely filings.

(i) General rule.

(ii) Closing agreements.

(iii) Pending requests for relief.

(4) Multiple-party event exception to triggering events.

(5) Basis adjustment rules.

§1.1503(d)-1 Definitions and special rules for filings under section 1503(d). (a) In general. This section and §§1.1503(d)-2 through 1.1503(d)-8 provide rules concerning the determination and use of dual consolidated losses pursuant to section 1503(d). Paragraph (b) of this section provides definitions that apply for purposes of this section and §§1.1503(d)-2 through 1.1503(d)-8. Paragraph (c) of this section provides a reasonable cause exception and a signature requirement for filings.

(b) Definitions. The following definitions apply for purposes of this section and §§1.1503(d)-2 through 1.1503(d)-8:

(1) Domestic corporation means an entity classified as a domestic corporation under section 7701(a)(3) and (4) or otherwise treated as a domestic corporation by the Internal Revenue Code, including, but not limited to, sections 269B, 953(d), 1504(d), and 7874. However, solely for purposes of section 1503(d), the term domestic corporation shall not include a regulated investment company as defined in section 851, a real estate investment trust as defined in section 856, or an S corporation as defined in section 1361.

(2) Dual resident corporation means—

(i) A domestic corporation that is subject to an income tax of a foreign country on its worldwide income or on a residence basis. A corporation is taxed on a residence basis if it is taxed as a resident under the laws of the foreign country; and

(ii) A foreign insurance company that makes an election to be treated as a domestic corporation pursuant to section 953(d) and is treated as a member of an affiliated group for purposes of chapter 6, even if such company is not subject to an income tax of a foreign country on its worldwide income or on a residence basis. See section 953(d)(3).

(3) Hybrid entity means an entity that is not taxable as an association for Federal tax purposes, but is subject to an income tax of a foreign country as a corporation (or otherwise at the entity level) either on its worldwide income or on a residence basis.

(4) Separate unit—(i) In general. The term separate unit means either of the following that is carried on or owned, as applicable, directly or indirectly, by a domestic corporation (including a dual resident corporation):

(A) Except to the extent provided in paragraph (b)(4)(iii) of this section, a business operation outside the United States that, if carried on by a U.S. person, would constitute a foreign branch as defined in §1.367(a)-6T(g)(1) (foreign branch separate unit).

(B) An interest in a hybrid entity (hybrid entity separate unit).

(ii) Separate unit combination rule. Except as otherwise provided in this paragraph, if a domestic owner, or two or more domestic owners that are members of the same consolidated group, have two or more separate units (individual separate units), then all such individual separate units that are located (in the case of a foreign branch separate unit) or subject to an income tax either on their worldwide income or on a residence basis (in the case of a hybrid entity an interest in which is a hybrid entity separate unit) in the same foreign country shall be treated as one separate unit (combined separate unit). See §1.1503(d)-7(c) Example 1. Separate units of a foreign insurance company that is a dual resident corporation under paragraph (b)(2)(ii) of this section, however, shall not be combined with separate units of any other domestic corporation. Except as specifically provided in this section or §§1.1503(d)-2 through 1.1503(d)-8, any individual separate unit composing a combined separate unit loses its character as an individual separate unit.

(iii) Business operations that do not constitute a permanent establishment. A business operation carried on by a domestic corporation that is not a dual resident corporation shall not constitute a foreign branch separate unit, provided the business operation:

(A) Is not carried on indirectly through a hybrid entity or a transparent entity; and

(B) Is conducted in a country with which the United States has entered into an income tax convention and is not treated as a permanent establishment pursuant to that convention, or is not otherwise subject to tax on a net basis under that convention. See §1.1503(d)-7(c) Example 2.

(iv) Foreign branch separate units held by dual resident corporations or hybrid entities in the same foreign country. A foreign branch separate unit may be owned by a dual resident corporation, or through a hybrid entity (an interest in which is a separate unit), even where the foreign branch is located in the same foreign country that subjects such dual resident corporation or hybrid entity to tax on its worldwide income or on a residence basis. But see the rule under paragraph (b)(4)(ii) of this section that combines certain same-country hybrid entity separate units and foreign branch separate units. See also §1.1503(d)-7(c) Example 1.

(5) Dual consolidated loss means—

(i) In the case of a dual resident corporation, and except to the extent provided in §1.1503(d)-5(b), the net operating loss (as defined in section 172(c) and the related regulations) incurred in a year in which the corporation is a dual resident corporation; and

(ii) In the case of a separate unit, the net loss attributable to the separate unit under §1.1503(d)-5(c) through (e).

(6) Subject to tax. For purposes of determining whether a domestic corporation or another entity is subject to an income tax of a foreign country on its income, the fact that it has no actual income tax liability to the foreign country for a particular taxable year shall not be taken into account.

(7) Foreign country includes any possession of the United States.

(8) Consolidated group has the meaning provided in §1.1502-1(h).

(9) Domestic owner means—

(i) A domestic corporation (including a dual resident corporation) that has one or more separate units or interests in a transparent entity; and

(ii) In the case of a combined separate unit, a domestic corporation (including a dual resident corporation) that has one or more individual separate units that are treated as part of the combined separate unit under paragraph (b)(4)(ii) of this section.

(10) Affiliated dual resident corporation and affiliated domestic owner mean a dual resident corporation and a domestic owner, respectively, that is a member of a consolidated group.

(11) Unaffiliated dual resident corporation, unaffiliated domestic corporation, and unaffiliated domestic owner mean a dual resident corporation, domestic corporation, and domestic owner, respectively, that is not a member of a consolidated group.

(12) Domestic affiliate means—

(i) A member of an affiliated group, without regard to the exceptions contained in section 1504(b) (other than section 1504(b)(3)) relating to includible corporations;

(ii) A domestic owner;

(iii) A separate unit; or

(iv) An interest in a transparent entity, as defined in paragraph (b)(16) of this section.

(13) Domestic use. See §1.1503(d)-2.

(14) Foreign use. See §1.1503(d)-3.

(15) Grantor trust means a trust, any portion of which is treated as being owned by the grantor or another person under subpart E of subchapter J of this chapter.

(16) Transparent entity—(i) In general. The term transparent entity means an entity described in this paragraph (b)(16) where all or a portion of its interests are owned, directly or indirectly, by a domestic corporation. An entity is described in this paragraph (b)(16) if the entity—

(A) Is not taxable as an association for Federal tax purposes;

(B) Is not subject to income tax in a foreign country as a corporation (or otherwise at the entity level) either on its worldwide income or on a residence basis; and

(C) Is not a pass-through entity under the laws of the applicable foreign country. For purposes of applying the preceding sentence, the applicable foreign country is the foreign country in which the relevant foreign branch separate unit is located, or the foreign country that subjects the relevant hybrid entity (an interest in which is a separate unit) or dual resident corporation to an income tax either on its worldwide income or on a residence basis.

(ii) Example. A U.S. limited liability company (LLC) does not elect to be taxed as an association for Federal tax purposes and is not subject to income tax in a foreign country as a corporation (or otherwise at the entity level) either on its worldwide income or on a residence basis. The LLC is owned by a hybrid entity (an interest in which is a separate unit) that is the relevant hybrid entity. Provided the LLC is not treated as a pass-through entity by the applicable foreign country that subjects the relevant hybrid entity to an income tax either on its worldwide income or on a residence basis, the LLC would qualify as a transparent entity. See also §1.1503(d)-7(c) Example 26.

(17) Disregarded entity means an entity that is disregarded as an entity separate from its owner, under §§301.7701-1 through 301.7701-3 of this chapter, for Federal tax purposes.

(18) Partnership means an entity that is classified as a partnership, under §§301.7701-1 through 301.7701-3 of this chapter, for Federal tax purposes.

(19) Indirectly, when used in reference to ownership, means ownership through a partnership, a disregarded entity, or a grantor trust, regardless of whether the partnership, disregarded entity, or grantor trust is a U.S. person.

(20) Certification period means the period of time up to and including the fifth taxable year following the year in which the dual consolidated loss that is the subject of a domestic use agreement (as described in §1.1503(d)-6(d)(1)) was incurred.

(c) Special rules for filings under section 1503(d)—(1) Reasonable cause exception. A person that is permitted or required to file an election, agreement, statement, rebuttal, computation, or other information pursuant to section 1503(d) and these regulations, that fails to make such filing in a timely manner, shall be considered to have satisfied the timeliness requirement with respect to such filing if the person is able to demonstrate, to the Area Director, Field Examination, Small Business/Self Employed or the Director of Field Operations, Large and Mid-Size Business (Director) having jurisdiction of the taxpayer’s tax return for the taxable year, that such failure was due to reasonable cause and not willful neglect. In determining whether the taxpayer has reasonable cause, the Director shall consider whether the taxpayer acted reasonably and in good faith. In general, the taxpayer must demonstrate that it exercised ordinary care and prudence in meeting its tax obligations but nonetheless did not comply with the prescribed duty within the prescribed time. Whether the taxpayer acted reasonably and in good faith will be determined after considering all the facts and circumstances. The Director shall notify the person in writing within 120 days of the filing if it is determined that the failure to comply was not due to reasonable cause, or if additional time will be needed to make such determination. For this purpose, the 120-day period shall begin on the date the taxpayer is notified in writing that the request has been received and assigned for review. If, once such period commences, the taxpayer is not again notified within 120 days, then the taxpayer shall be deemed to have established reasonable cause. The reasonable cause exception of this paragraph (c) shall only apply if, once the person becomes aware of its failure to file the election, agreement, statement, rebuttal, computation or other information in a timely manner, the person complies with the requirements of paragraph (c)(2) of this section.

(2) Requirements for reasonable cause relief—(i) Time of submission. Requests for reasonable cause relief will only be considered if once the person becomes aware of the failure to file the election, agreement, statement, rebuttal, computation or other information, the person attaches all the documents that should have been filed, as well as a written statement setting forth the reasons for the failure to timely comply, to an amended return that amends the return to which the documents should have been attached pursuant to the rules of section 1503(d) and these regulations.

(ii) Notice requirement. In addition to the requirements of paragraph (c)(2)(i) of this section, the taxpayer must provide a copy of the amended return and all required attachments to the Director as follows:

(A) If the taxpayer is under examination for any taxable year when the taxpayer requests relief, the taxpayer must provide a copy of the amended return and attachments to the personnel conducting the examination.

(B) If the taxpayer is not under examination for any taxable year when the taxpayer requests relief, the taxpayer must provide a copy of the amended return and attachments to the Director having jurisdiction of the taxpayer’s return.

(3) Signature requirement. When an election, agreement, statement, rebuttal, computation, or other information is required pursuant to section 1503(d) and these regulations to be attached to and filed by the due date (including extensions) of a U.S. tax return and signed under penalties of perjury by the person who signs the return, the attachment and filing of an unsigned copy is considered to satisfy such req