Forms of Overseas Operations (Part I) — footnotes

¹ Under Sec. 904(a), the FTC limit is: U.S. income tax x (foreign-source taxable income/total taxable income). In effect, the FTC limit equals the taxpayer’s U.S. effective tax rate multiplied by its foreign- source taxable income.

² Passive income generally includes dividends, interest, rents, royalties, annuities, net gains from the sale of assets that produce passive (or no) income, and net gains from certain commodity and currency transactions; see Sec. 904(d)(2)(A)(i) and Regs. Secs. 1.904-4(b)(1) and 1.954-2(a)(1). Passive income also includes income reported under the foreign personal holding company (FPHC) and passive foreign investment company (PFIC) rules; see Sec. 904(d)(2)(A)(ii). It does not include high-taxed income, export financing interest and income included in another basket (e.g., high-withholding-tax interest). High-taxed income is passive income subject to an aggregate foreign income tax (including deemed-paid taxes) greater than the highest applicable U.S. tax rate. The high-taxed income test is applied to net passive income (i.e., after the allocation of expense of the U.S. taxpayer to such income); such high-taxed income is excluded from the passive income basket and included in the general limitation basket. Passive income items are segregated into groups in determining whether they are high-taxed income; see Sec. 904(d)(2)(A)(iii) and Regs. Sec. 1.904-4(c).

³ High-withholding-tax interest is any interest income subject to 5% foreign withholding tax or more. Under Regs. Sec. 1.904-4(d), all such interest is included in the high-withholding-tax-interest basket, except for export financing interest.

⁴ A noncontrolled Sec. 902 corporation is any foreign corporation in which a U.S. taxpayer owns at least 10%, but no more than 50%, of the voting stock. Prior to 2003, a separate limitation basket was required for dividends from each noncontrolled Sec. 902 corporation. For tax years beginning after 2002, AJCA Section 403 amends Sec. 904(d)(4), and retroactively provides that dividends from noncontrolled Sec. 902 corporations are subject to lookthrough rules.

⁵ This basket includes income items not included in another basket. Most active trade or business income should fall within this basket. Export financing interest and high-taxed passive income are also included. This basket can have both high- and low-taxed income; see Regs. Sec. 1.904-4(h).

⁶ For details, see Zink, Tax Clinic, “FTC Baskets Reduced to Two,” 36 The Tax Adviser 76 (February 2005).

⁷ See Regs. Sec. 1.861-8(b) and Temp. Regs. Sec. 1.861-8T(c).

⁸ See Sec. 864(e) and Temp. Regs. Sec. 1.861-9T(a) and (f)(1).

⁹ Notice 2003-69, IRB 2003-42, 851.

¹⁰ For tax years of foreign corporations beginning before 2005, dividends from FPHCs, foreign investment companies (FICs) and PFICs do not qualify for the 15% rate. For tax years beginning after 2004, it appears that only dividends from PFICs will not qualify, because both the FPHC and FIC rules were repealed by AJCA Section 413(a).

¹¹ Under Regs. Sec. 1.1503-2(c)(2), an S corporation is not a dual-resident corporation. Further, any “separate unit” of a domestic corporation is treated as a dual-resident corporation. A separate unit includes a foreign branch under Regs. Sec. 1.1503-2(c)(3). Thus, the proper interpretation is that an S corporation should not be subject to the DCL rules.

¹² See Regs. Sec. 1.1503-2(b) and (c).

¹³ If a foreign country (e.g., the U.K.) has a law that mirrors the DCL rules and disallows the foreign branch loss from offsetting another person’s income, Regs. Sec. 1.1503-2(c)(15)(iv) treats the loss as if it had actually offset that income. Thus, the election to deduct a branch loss cannot be made for losses generated in foreign countries with legislation that mirrors the DCL rules.

¹⁴ Before amendment by AJCA Section 402(a), a U.S.-source loss offsetting foreign-source income would not be subject to recapture by recharacterizing subsequent U.S.-source income as foreign income. Effective for losses in tax years beginning after 2006, U.S.-source loss will be subject to recharacterization under Sec. 904(g).

¹⁵ See Sec. 904(f)(1) and (5)(C). If a taxpayer has a loss in a separate limitation basket that offsets U.S.-source income or income in another limitation basket, the taxpayer must establish and maintain an account for that loss. If the loss offsets U.S.-source income, the taxpayer must establish an “overall loss account” for the separate limitation basket that incurred the loss. If the loss offsets income in another limitation basket, the taxpayer must establish a “separate limitation loss account” for the separate limitation basket that generated the loss (Regs. Sec. 1.904(f)-1(b)). Additions and subtractions are made to the account each year. The balance in the account represents the amount to be recharacterized or resourced.

¹⁶ The dividends are not subpart F income if both CFCs are incorporated in the same country and the lower-tier CFC uses a substantial part of its assets in a trade or business in the country of incorporation (Regs. Sec. 1.954-2(b)(4)). Also, the dividends can be excluded as subpart F income if the foreign country taxes them at an effective tax rate greater than 90% of the maximum U.S. income tax rate; see Sec. 954(b)(4).

¹⁷ REG-113909-98 (7/13/99).

¹⁸ Pre-June 19, 1998, arrangements are grandfathered; see Prop. Regs. Sec. 1.954-9(c).

¹⁹ Notice 2000-20, 2000-1 CB 851.