Allocation and Apportionment of Expenses for Sec. 199 Purposes — footnotes

¹DPGR is defined as gross receipts received from (1) lease, rental, license, sale, exchange or other disposition of certain qualifying production property that is manufactured, produced, grown or extracted by the taxpayer in whole or in significant part within the U.S.; qualified film produced by the taxpayer; or electricity, natural gas or potable water produced by the taxpayer in the U.S.; (2) construction performed in the U.S.; or (3) engineering or architectural services performed in the U.S. for construction projects in the U.S. (Prop. Regs. Sec. 1.199-3(a)).

²See Prop. Regs. Sec. 1.199-4(e) and (f). The qualification requirements for both alternative methods under Notice 2005-14 are slightly different. According to the preamble of the proposed regulations, taxpayers may rely on the eligibility requirements under either the proposed Sec. 199 regulations or Notice 2005-14 until final regulations are published.

³See Prop. Regs. Sec. 1.199-4(c)(1).

⁴See Regs. Sec. 1.861-8(f)(1), which provides, in part, that the operative sections of the Code which require the determination of taxable income of the taxpayer from specific sources or activities and which give rise to statutory groupings to which this section is applicable include the overall limitation to the FTC, effectively connected taxable income, etc.

⁵See Prop. Regs. Sec. 1.199-4(d).

⁶See Regs. Sec. 1.861-8(a)(4), under which “statutory grouping” means the gross income from a specific source or activity that must first be determined to arrive at taxable income from such specific source or activity under an operative section. Gross income from other sources or activities is referred to as the “residual grouping of gross income” or “residual grouping.”

⁷See Temp. Regs. Secs. 1.861-11T(c) and -14T(c).

⁸See Regs. Sec. 1.199-7(d)(4).

⁹In the proposed Sec. 199 regulations, the Service is requesting comments regarding whether additional guidance is needed to clarify how the affiliated group rules in the Sec. 861 regulations apply under the Sec. 861 method to allocate and apportion interest and other expenses, such as R&E expenses, in computing QPAI of the members of such affiliated groups in which otherwise includible corporations are owned indirectly through foreign corporations and partnerships.

¹⁰Thus, for example, a taxpayer may change from using gross income as a factor to the use of units sold as a factor to apportion deductions, without such a change giving rise to a change in method of accounting under Sec. 446.

¹¹These special rules, including the controlled foreign corporation netting rule, are outlined in Regs. Secs. 1.861-10 and Temp. Regs. Sec. 1.861-10T, but are not discussed further in this article.

¹²Sec. 864(e)(2) provides that all allocations and apportionments of interest expense must be made on the basis of asset values. For example, for purposes of computing the FTC limitation, interest expense is allocated to all gross income and must be apportioned in proportion to the value of the assets used to produce the various categories of foreign-source income and U.S.-source income. Similarly, under Sec. 199, interest expense must be apportioned in proportion to the value of assets used to produce gross income attributable to DPGR and gross income attributable to non-DPGR.

¹³See Temp. Regs. Sec. 1.861-9T(g)(1)(ii).

¹⁴See Temp. Regs. Sec. 1.861-9T(g)(2)(2)(i).

¹⁵See Temp. Regs. Sec. 1.861-9T(g)(3).

¹⁶See Prop. Regs. Sec. 1.199-7(a) and (b).

¹⁷See Prop. Regs. Sec. 1.199-7(d)(4).

¹⁸See Prop. Regs. Sec. 1.199-4(d)(3).

¹⁹Regs. Sec. 1.861-8(e)(8) provides that an NOL deduction is allocated and apportioned in the same manner as the deductions giving rise to the NOL. Thus, an NOL deduction is definitely related and allocable to the class of gross income that generated the NOL. For FTC purposes, the loss is apportioned between the statutory and residual groupings of gross income on the basis of the relative amount of the NOL arising in the loss year, which is attributable to each of these groupings of income. The NOL retains its character when either it is carried back or carried forward.

²⁰See Regs. Sec. 1.861-8(e)(7)(i).

²¹See Prop. Regs. Sec. 1.199-4(d)(2).

²²See Prop. Regs. Sec. 1.199-4(c)(2)(iii).

²³See Temp. Regs. Sec. 1.861-9T(g)(1)(ii).

²⁴See Temp. Regs. Sec. 1.861-8T(c)(2), -9T(i)(2) and -17(e). For example, once a taxpayer uses the FMV to apportion interest expense, the taxpayer and all related persons must continue to use such method unless expressly authorized by the Commissioner.