|Treasury Decision 9251
||March 13, 2006
Special Rules Regarding Certain Section 951
Pro Rata Share Allocations
Internal Revenue Service (IRS), Treasury.
This document contains final regulations under section 951(a) of the
Internal Revenue Code (Code) regarding a United States shareholder’s pro
rata share of a controlled foreign corporation’s (CFC’s)
subpart F income, previously excluded subpart F income withdrawn from investment
in less developed countries, and previously excluded subpart F income withdrawn
from foreign base country shipping operations. These regulations are intended
to ensure that a CFC’s earnings and profits for a taxable year attributable
to a section 304 transaction will not be allocated in a manner that results
in the avoidance of Federal income tax. These regulations are also intended
to ensure that earnings and profits of a CFC are not allocated to certain
preferred stock in a manner inconsistent with the economic interest that such
Effective Date: These regulations are effective
February 22, 2006.
Applicability Date: For dates of applicability,
see §1.951-1(e)(3)(v), (e)(4)(ii) and (e)(7).
FOR FURTHER INFORMATION CONTACT:
Jefferson VanderWolk, (202) 622-3810 (not a toll-free number).
On August 6, 2004, the IRS published in the Federal
Register a notice of proposed rulemaking (REG-129771-04, 2004-2
C.B. 453) under section 951 of the Code. After consideration of comments
received, the proposed regulations were modified and adopted as final with
the publication of T.D. 9222, 2005-40 I.R.B. 614, on August 25, 2005 (70
FR 49864). In response to comments, the IRS published at the same time in
the Federal Register a notice of proposed rulemaking (REG-129782-05, 2005-40
I.R.B. 675 [70 FR 49894]) under section 951 of the Code. No written comments
were received in response to that notice of proposed rulemaking. No public
hearing was requested or held on the notice of proposed rulemaking. The proposed
regulations are adopted as final regulations with the modifications discussed
Section 1.951-1(e) defines pro rata share for purposes
of section 951(a) of the Code. The general rule, set forth in §1.951-1(e)(3)(i),
provides for the allocation of current earnings and profits to different classes
of stock on the basis of the respective amounts of such earnings and profits
that would be distributed with respect to each class if such earnings and
profits were distributed on the last day of the CFC’s taxable year on
which it is a CFC.
Section 1.951-1(e)(3)(v) provides a special rule that modifies the general
rule regarding the allocation of a CFC’s current earnings and profits
to more than one class of stock. The special rule applies where a CFC has
earnings and profits and subpart F income for its taxable year attributable
to a transaction described in section 304 of the Code and that transaction
is part of a plan a principal purpose of which is to avoid Federal income
taxation by allocating the subpart F income resulting from the section 304
transaction disproportionately to a tax-indifferent party. Pursuant to the
rule, such earnings and profits are allocated to each class of stock of the
CFC in accordance with the value of such class relative to all other classes.
Several practitioners noted in oral comments that proposed §1.951-1(e)(6), Example
9, which illustrates the application of proposed §1.951-1(e)(3)(v),
presented facts whose characterization under other Code sections could be
unclear under the circumstances. In response to these comments, the IRS and
Treasury Department have revised the example in order to limit the issues
A comment on the rules originally proposed on August 6, 2004, requested
guidance to eliminate inappropriate distortions between subpart F inclusions
and economic realization that taxpayers may achieve if accumulated but unpaid
dividends with respect to preferred stock are not discounted to present value
for purposes of determining the hypothetical distribution. As a partial response
to that comment, proposed §1.951-1(e)(4)(ii) provided a special rule
requiring accumulated but unpaid dividends with respect to mandatorily redeemable
cumulative preferred stock be taken into account at present value for purposes
of the hypothetical distribution. Comments were requested regarding the treatment
of cumulative preferred stock that does not have a mandatory redemption date
or that is subject to a shareholder-level agreement, such as a purchase option.
In addition, the preamble stated that the IRS and the Treasury Department
anticipated that any such rules would be effective for taxable years of a
controlled foreign corporation beginning on or after January 1, 2006. No
further comments were received beyond the original comment.
The IRS and Treasury Department agree with the commentator that accrued
but unpaid dividends generally present possibilities for distortion between
subpart F income inclusions and economic income realization. These distortions
are similar to those that can arise from stock with discretionary distribution
rights. Accordingly, §1.951-1(e)(4)(ii) adds a rule that generally treats
cumulative preferred stock with accrued but unpaid dividends in the same manner
as stock with discretionary distribution rights (as defined in §1.951-1(e)(3)(ii)).
Earnings and profits are allocated to such stock on the basis of the value
of such stock relative to the value of other classes of stock outstanding.
There are two exceptions to this general rule. First, to the extent
that dividends are paid with respect to such stock during the year, earnings
and profits equal to the amount of such dividends are first allocated to that
class of stock. Additional earnings and profits are allocated to that class
of stock only in the amount (if any) by which the value-based allocation of
earnings and profits to that class of stock exceeds the amount of such dividends.
Second, the final regulations preserve the special present-value rule (with
technical modifications) for certain mandatorily redeemable cumulative preferred
Consistent with the comment received, and as provided in the preamble
to the proposed regulations, these rules are effective for taxable years of
a controlled foreign corporation beginning on or after January 1, 2006.
It has been determined that this notice of proposed rulemaking is not
a significant regulatory action as defined in Executive Order 12866. Therefore,
a regulatory assessment is not required. It has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does
not apply to these regulations and because these regulations do not impose
a collection of information on small entities, a Regulatory Flexibility Analysis
under the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking
preceding these regulations was submitted to the Chief Counsel for Advocacy
of the Small Business Administration for comment on its impact on small business.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
Paragraph 1. The authority citation for part 1 continues to read, in
part, as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.951-1 is amended by revising paragraphs (e)(3)(v),
(e)(4)(ii), and the first sentence of paragraph (e)(7), and adding paragraph
(e)(6) Example 9.
The revisions and addition read as follows:
§1.951-1 Amounts included in gross income of United
* * * * *
(e) * * *
(3) * * *
(v) Earnings and profits attributable to certain section 304
transactions. For taxable years of a controlled foreign corporation
beginning on or after January 1, 2006, if a controlled foreign corporation
has more than one class of stock outstanding and the corporation has earnings
and profits and subpart F income for a taxable year attributable to a transaction
described in section 304, and such transaction is part of a plan a principal
purpose of which is the avoidance of Federal income taxation, the amount of
such earnings and profits allocated to any one class of stock shall be that
amount which bears the same ratio to the remainder of such earnings and profits
as the value of all shares of such class of stock, determined on the hypothetical
distribution date, bears to the total value of all shares of all classes of
stock of the corporation, determined on the hypothetical distribution date.
(4) * * * (i) * * *
(ii) Certain cumulative preferred stock. For
taxable years of a controlled foreign corporation beginning on or after January
1, 2006, if a controlled foreign corporation has one or more classes of preferred
stock with cumulative dividend rights, such stock shall be considered for
the purposes of this section as stock with discretionary distribution rights.
As a result, the provisions of paragraph (e)(3)(ii) of this section shall
apply for purposes of allocating earnings and profits to such stock, except
that earnings and profits shall first be allocated to the stock under paragraph
(e)(3)(i) of this section to the extent of any dividends paid with respect
to the stock during the taxable year. Additional earnings and profits will
be allocated to the stock only in an amount equal to the excess (if any) of
the amount of earnings and profits allocated to the stock under paragraph
(e)(3)(ii) of this section over the amount of such dividends. Notwithstanding
the foregoing, if a class of redeemable preferred stock with cumulative dividend
rights has a mandatory redemption date, and all dividend arrearages with respect
to such stock compound at least annually at a rate that is not lower than
the applicable Federal rate (as defined in section 1274(d)(1)) (AFR) that
applies on the date the stock is issued for the term from such issue date
to the mandatory redemption date, based on a comparable compounding assumption,
such stock shall not be considered for purposes of this section as stock with
discretionary distribution rights.
* * * * *
(6) * * *
Example 9. (i) Facts. In
2006, FC10, a controlled foreign corporation within the meaning of section
957(a), has outstanding 100 shares of common stock and 100 shares of 6-percent,
voting, preferred stock with a par value of $10x per share. All of the common
stock is held by Corp H, a foreign corporation, which invested $1000x in FC10
in exchange for the common stock. All of the preferred stock is held by Corp
J, a domestic corporation, which invested $5000x in FC10 in exchange for the
preferred stock. Corp H is unrelated to Corp J. In 2006, FC10 borrows $3000x
from a bank and invests $5000x in preferred stock issued by FC11, a foreign
corporation the common stock of which is owned by Corp J. Corp J’s
adjusted basis in its FC11 common stock is $5000x. FC11, which has no current
or accumulated earnings and profits, distributes the $5000x to Corp J. Subsequently,
in 2007, FC10 sells the FC11 preferred stock to FC12, a wholly-owned foreign
subsidiary of FC11 that has $5000x of accumulated earnings and profits, for
$5000x in a transaction described in section 304. FC10 repays the bank loan
in full. For 2007, FC10 has $5000x of earnings and profits, all of which
is subpart F income attributable to a section 304 dividend arising from FC10’s
sale of the FC11 preferred stock to FC12. At all relevant times, the value
of the common stock of FC10 is $1000x and the value of the preferred stock
of FC10 is $5000x.
(ii) Analysis. The acquisition and sale of the
FC11 preferred stock by FC10 was part of a plan a principal purpose of which
was the avoidance of Federal income tax by depleting the earnings and profits
of FC12 and allowing FC11 to make a distribution to Corp J that it characterizes
entirely as a return of basis. FC10 has $5000x of earnings and profits for
2007 attributable to a dividend from a section 304 transaction which was part
of such plan. Under paragraph (e)(3)(v) of this section, these earnings and
profits are allocated to the common and preferred stock of FC10 in accordance
with the relative value of each class of stock ($1000x and $5000x, respectively).
Thus, for taxable year 2007, $833x (1/6 x $5000x = $833x) of these earnings
and profits is allocated to FC10’s common stock and $4167x (5/6 x $5000x
= $4167x) is allocated to its preferred stock.
(7) Effective dates. Except as provided in paragraphs
(e)(3)(v) and (e)(4)(ii) of this section, this paragraph (e) applies for taxable
years of a controlled foreign corporation beginning on or after January 1,
2005. * * *
* * * * *
Mark E. Matthews,
Services and Enforcement.
Approved February 8, 2006.
Secretary of the Treasury (Tax Policy).
(Filed by the Office of the Federal Register on February 21, 2006, 8:45
a.m., and published in the issue of the Federal Register for February 22,
2006, 71 F.R. 8943)
The principal author of these regulations is Jeffrey Vinnik of the Office
of the Associate Chief Counsel (International). However, other personnel
from the IRS and Treasury Department participated in their development.
* * * * *
Internal Revenue Bulletin 2006-11
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