Section 1503(d) of the Code and the regulations thereunder provide that a dual consolidated loss of a corporation cannot reduce the taxable income of any other member of the affiliated group (“domestic affiliate”). A dual consolidated loss is a net operating loss of a domestic corporation that is subject to an income tax of a foreign country on its income without regard to the source of its income, or is subject to tax on a residence basis. Except as discussed below, when section 1503(d) of the Code applies, a dual consolidated loss may only be used to offset income earned by the domestic corporation.

Similar rules apply to any loss of a separate unit of a domestic corporation. A separate unit includes activities of a domestic corporation that constitute a permanent establishment under the terms of a treaty between the United States and the country in which the activities are conducted. For purposes of the dual consolidated loss rules, a separate unit is treated as a domestic corporation and therefore is a domestic affiliate.

Notwithstanding the general rule, a dual consolidated loss may offset income of a domestic affiliate, provided that a taxpayer makes an election and enters into an agreement pursuant to regulations (“(g)(2)(i) agreement”) whereby the taxpayer certifies that, inter alia, no portion of the loss has been or will be used to offset the income of any other person under the income tax laws of a foreign country. This election is an annual election made separately with respect to dual consolidated losses incurred in each taxable year. If a (g)(2)(i) agreement is entered into, and a subsequent “triggering event” occurs (and no exception applies), the taxpayer must generally recapture and report as gross income the total amount of the dual consolidated loss on its U.S. Federal income tax return for the taxable year in which the triggering event occurs, plus an applicable interest charge. Triggering events include, but are not limited to, the use of any portion of the dual consolidated loss by any means to offset the income of any other person under the income tax laws of a foreign country.

The regulations under section 1503(d) of the Code also contain a “mirror legislation” rule that denies the ability to elect to use a dual consolidated loss to offset the income of a domestic affiliate in certain cases. The mirror legislation rule generally applies when a foreign jurisdiction has enacted legislation that operates in a manner similar to the U.S. dual consolidated loss rules and, as a result, prohibits the taxpayer from claiming the dual consolidated loss in the foreign jurisdiction. Section 403D(6) ICTA 88 is mirror legislation within the meaning of the regulations under section 1503(d) of the Code. The mirror legislation rule does not apply, however, to the extent an election is made under Treas. Reg. §1.1503-2(g)(1) to use the loss in the United States pursuant to an agreement entered into between the United States and a foreign country that puts into place an elective procedure through which losses offset income in only one country. The competent authority agreement set forth in this document is an agreement described in Treas. Reg. §1.1503-2(g)(1).

Section 403D ICTA1988 generally allows for the surrender of the trading losses of UK permanent establishments of foreign companies, but not where that loss is deductible or allowable in any period against profits that are outside the corporation tax jurisdiction of the United Kingdom. No surrender is possible other than in the circumstances permitted. (Section 403D(1)(c) ICTA1988).

The UK legislation also contains a rule (section 403D(6)) that requires any overseas rule which prevents that overseas deduction or allowance by virtue of relief that may be available in the United Kingdom to be disregarded in deciding whether a loss is ‘deductible or allowable outside the United Kingdom’. The regulations under section 1503(d) of the Code constitute such a rule. So no surrender of the loss as group relief in the UK is possible.

Section 403D(6) is effective in relation to losses in accounting periods ending on or after April 1, 2000.

As mentioned, the interaction of the rules described above may result in no relief for a loss in either Contracting State, thereby producing double taxation inconsistent with the aims of Article 7 (Business Profits) and Article 24 (Relief of Double Taxation) of the Treaty and with the intentions of the Contracting States in passing domestic laws to prevent the same loss from being used more than once.

Therefore, to resolve the issue regarding the interaction of the legislation and regulations referred to above, the competent authorities of the Contracting States agree that certain taxpayers may, subject to the terms and conditions of the competent authority agreement set forth in this document, elect to use, or relieve, losses in either the United States or the United Kingdom to the extent permitted by the rules of the Contracting State, as modified by this agreement.

1. The competent authorities of the United States of America and the United Kingdom hereby enter into the following agreement (“Agreement”) regarding, in the case of the United States, dual consolidated losses under section 1503(d) of the Code and, in the case of the United Kingdom, trading losses disallowed under 403D(1)(c) ICTA1988 by the action of S403D(6) ICTA 88, under the Treaty. Except as provided in this paragraph 1, the Agreement applies in cases where a consolidated group of which a domestic owner is a member, or an unaffiliated domestic owner (as such terms are defined in Treas. Reg. §1.1503-2(c)(8), (9) and (11), respectively) (“Taxpayer”), has a permanent establishment in the United Kingdom as defined in Article 5 (Permanent Establishment) of the Treaty (“UK permanent establishment”) that incurs losses which, for UK tax purposes, relate to accounting periods ending on or after April 1, 2000, and are otherwise subject to section 1503(d) of the Code and the regulations thereunder, including Treas. Reg. §1.1503-2(b) and (c)(15)(iv), and S403D(6) ICTA 88.^[1] This agreement shall not apply where losses are incurred by:

2. The Agreement is entered into under paragraph 3 of Article 26 (Mutual Agreement Procedure) of the Treaty.

3. With respect to the United States, and except as provided in paragraph 4 and Annex A of the Agreement, a dual consolidated loss of a UK permanent establishment cannot offset the taxable income of any domestic affiliate as provided under section 1503(d)(1) of the Code and Treas. Reg. §1.1503-2(b) and (c)(15)(iv). With respect to the United Kingdom, and except as provided in paragraph 4 and Annex B of the Agreement, no loss or other amount of a UK permanent establishment shall be treated as available for surrender by way of group relief pursuant to section 403D(1)(c) ICTA 1988.

4. Subject to the terms and conditions of the Agreement, a Taxpayer may elect to:

but may not elect for both treatments. Further, and except as provided in paragraph 4 of each of Annex A and Annex B with respect to losses incurred in certain prior taxable years, no election may be made under this Agreement with respect to a loss unless both the statute of limitations (in the case of the United States) and the time limit for claimant company provided by paragraph 74 of Schedule 18 to FA1998 (in the case of the United Kingdom) have not closed or passed, respectively, with respect to the taxable year or taxable period, respectively, in which such loss was incurred.

5. The election must be made in accordance with the procedures and conditions set out in Annex A or Annex B, as applicable.

6. The use of a loss pursuant to an election under this Agreement must be consistent with the domestic law generally applicable to the relief of losses of the Contracting State in which relief for such loss is sought.

7. In the case of an election for a loss to be used in the United States pursuant to the Agreement and Annex A, the election shall only apply to dual consolidated losses within the meaning of section 1503(d)(2) of the Code and Treas. Reg. §1.1503-2(c)(5). The fact that a particular item taken into account in computing the dual consolidated loss is not taken into account in computing the Taxpayer’s taxable income (or loss) in the United Kingdom shall not cause such item to be excluded from the calculation of the dual consolidated loss.

8. In the case of an election for a loss to be used in the United Kingdom, pursuant to the Agreement and Annex B, the election shall apply only to amounts within the terms of S403D ICTA 88. The fact that a particular item taken into account for the purposes of S403D is not taken into account in computing the Taxpayer’s taxable income (or loss) in the United States shall not cause such item to be excluded from the calculation of the S403D amount.

9. The election provided under this Agreement is an annual election, applicable with respect to losses incurred in a specific taxable year. A Taxpayer may make only one election under this Agreement with respect to a loss incurred in a particular taxable year. Once made, an election may not be revoked. Taxable year for this purpose refers to the U.S. taxable year of the entity for which a UK permanent establishment exists and which is the subject of this Agreement. If for UK CT purposes, the accounting period of the UK permanent establishment is different from that of the U.S. taxable year for the entity, then an election for a taxable year shall correspond to each accounting period, or part of an accounting period, to which that tax year relates.

10. No part of a loss which has been relieved, used, or claimed in a Contracting State following an election under this Agreement may be utilized for loss relief purposes in the other Contracting State in a manner inconsistent with the domestic law of the first-mentioned Contracting State. Where a loss (or any item composing such loss) has been used in a manner inconsistent with the domestic law of the first-mentioned Contracting State, any loss relief given in the first-mentioned Contracting State will be recoverable or recaptured, where appropriate, in accordance with the domestic laws of the first-mentioned Contracting State and Annex A or Annex B, as applicable.

11. This Agreement shall be applied taking into account the domestic law of the Contracting States in effect on or before October 6, 2006. In addition, any reference to the domestic law of either Contracting State shall incorporate, when effective, any successor provision of domestic law provided such provision is not materially inconsistent with this Agreement. In the case of the United States, the proposed regulations contained in the notice of proposed rulemaking (REG-102144-04, 2005-25 I.R.B. 1297), that was published in the Federal Register on Tuesday, May 24, 2005 (70 FR 29868), shall, when finalized, be treated as a successor provision that is not materially inconsistent with this Agreement.

12. This Agreement may not be unilaterally terminated by the competent authority of either Contracting State until after December 31, 2011. Prior to such date, this Agreement may only be terminated by the joint agreement of the competent authorities. After December 31, 2011, this Agreement may be unilaterally terminated by the competent authority of either Contracting State providing written notice of such termination to the competent authority of the other Contracting State. If this Agreement is unilaterally terminated by the competent authority of a Contracting State, then such termination will take effect 3 months after the date of the notice of termination. In such event, any election made under this Agreement prior to such termination shall remain valid and in effect with respect to losses covered by such election.

13. It is understood that the competent authorities shall consult together at regular intervals regarding the terms and operation of the Agreement. In addition, the competent authorities may consult regarding the application of specific elections made in accordance with the Agreement. The Agreement will be reviewed in detail in parallel with the arrangements for the Treaty outlined in the Exchange of Notes of July 24, 2001.