Final Regulations on Dual Consolidated Losses: A Practical Guide (Part I)— footnotes

Authors’ note: The authors wish to thank Maria Martinez and John Karasek for their assistance with this article.

¹ P.L. 99-514, 99th Congress, HR 3838, JCS-10-87 (Part 14 of 19 Parts), General Explanation of the Tax Reform Act of 1986 at E.9.

² For purposes of the 2007 DCL regulations, “domestic owner” generally means a U.S. corporation (including a DRC) that owns one or more separate units or transparent entities; Regs. Sec. 1.1503(d)-1(b)(9).

³ The 1992 DCL regulations provided that a separate unit was treated as a DRC or domestic corporation for certain parts of the regulations, but not for others. The 2007 DCL regulations do not carry forward this rule, but rather explicitly refer to separate units and DRCs when the rules are applicable to those entities.

⁴ A DRC also includes foreign insurance corporations treated as U.S. corporations under Sec. 953(d) that are also members of an affiliated group, regardless of whether such corporations are subject to foreign income tax.

⁵ Indirect ownership means through a partnership, disregarded entity, or grantor trust, regardless of whether such entities are U.S. persons. This definition of indirect ownership is the same throughout the 2007 DCL regulations; see Regs. Sec. 1.1503 (d )-1(b)(19).

⁶ The definition of a U.S. corporation here is the same as described above. Thus, not only are S corporations, RICs, and REITs not DRCs, they also cannot own a separate unit. Thus, the DCL rules are not applicable to those entities.

⁷ In general, a foreign branch is an integral business operation carried on by a U.S. person outside the U.S.

⁸ Separate units of a foreign insurance company treated as a DRC are not combined with separate units of any other U.S. corporation.

⁹ A grantor trust is defined under Regs. Sec. 1.1503 (d )-1( b)(15) as “a trust, any portion of which is treated as being owned by the grantor or another person under subpart E or subchapter J” of the Code.

¹⁰ This is a change from the 1992 DCL regulations, which included non-hybrid-entity partnerships and non-hybrid-entity grantor trusts in the definition of separate unit. See Regs. Sec. 1.1503-2(c)(3)(i)(B) and (C) of the 1992 DCL regulations.

¹¹ Preamble to TD 9315 (3/9/07).

¹² Regs. Sec. 1.1503(d )-5( b)(1). Items recognized by the DRC in the current year by virtue of an election under Sec. 338 will also be taken into account.

¹³ Regs. Sec. 1.1503(d)-5(c)(4)(vi). Recapture income and the determination of this amount are discussed in Part II of this article.

¹⁴ If the foreign branch is in a jurisdiction where taxable income or loss of a permanent establishment or branch are determined only with reference to the items recorded in its books and records, the principles in Regs. Sec. 1.882-5 will not apply. In that case, only items of the domestic owner’s interest expense reflected on the foreign branch’s books and records, adjusted to conform to U.S. tax principles, are attributed to the foreign-branch separate unit; see Regs. Sec. 1.1503(d)-5(c)(2)(iii). Regs. Sec. 1.882-5 provides a three-step process for allocating the interest expense of a foreign corporation to the effectively connected income of its U.S. trade or business. Those steps include (1) determining the total value of U.S. assets of the foreign corporation; (2) determining the U.S.-connected liabilities; and (3) adjusting the interest paid or accrued on U.S.-booked liabilities for interest expense attributable to the difference between U.S.-connected liabilities and U.S.-booked liabilities. When applying the principles of Sec. 864(c) and Regs. Sec. 1.882-5, the foreign-branch separate unit’s U.S. owner should be treated as a foreign corporation, the foreign-branch separate unit should be treated as a trade or business within the U.S., and the other assets of the U.S. owner should be treated as assets that are not U.S. assets.

¹⁵ The term “books and records” is defined in Regs. Sec. 1.989(a)-1(d).

¹⁶ Sec. 367(a)(3)(C) requires gain recognition on certain transfers of foreign-branch assets to a foreign corporation.

¹⁷ Regs. Sec. 1.1503(d)-5(c)(4)(iii)(A). Sec. 904(f )(3) provides rules for determining gain and source of income on the disposal of property predominantly used outside the U.S.

¹⁸ Regs. Sec. 1.1503(d)-4( b). A domestic use of a DCL occurs “when the dual consolidated loss is made available to offset, directly or indirectly, the income of a domestic affiliate (other than the dual resident corporation or separate unit that, in each case, incurred the dual consolidated loss) in the taxable year in which the dual consolidated loss is recognized, or in any other taxable year,” even if the DCL does not offset foreign taxable income and even if the foreign taxable income is or will not be subject to U.S. tax; see Regs. Sec. 1.1503(d)-2. A domestic use occurs in the year the DCL is included in the consolidated group, unaffiliated DRC, or unaffiliated domestic owner’s taxable income, even if there is no tax benefit resulting from such inclusion in the current year. A domestic affiliate is a member of an affiliated group, without consideration of the exceptions in Sec. 1504( b) (other than Sec. 1504( b)(3)). A domestic affiliate also includes a domestic owner, a separate unit, and a transparent entity; see Regs. Sec. 1.1503(d)-1( b)(12).

¹⁹ The loss is subject to all of the SRLY limitations under Regs. Sec. 1.1502-21(c), with certain modifications; see Regs. Sec. 1.1503(d )-4(c)(3).

²⁰ Regs. Sec. 1.1503(d)-4(c)(1) and (2). The DCL is treated as a pro-rata portion of each item of deduction and loss of the DRC or separate unit taken into account in calculating the DCL.

²¹ Id. For this purpose, the DCL rules adopt the SRLY cumulative register concepts of Regs. Sec. 1.1502-21(c).

²² The exceptions do not apply to losses incurred or carried over under a Sec. 381(a) transaction for a foreign insurance company that is a DRC or for a separate unit of such foreign insurance company; see Regs. Sec. 1.1503(d)-6(a)(3).

²³ The certification period has been reduced from the 15-year period in the 1992 DCL regulations; see Regs. Sec. 1.1503(d )-1(b)(20) under the 1992 DCL regulations.

²⁴ United Kingdom/United States Dual Consolidated Loss Competent Authority Agreement, Convention between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains, October 6, 2006 (2006 TNT 196-24).

²⁵ Regs. Sec. 1.1503(d)-7(c), Example (6)(i) and (ii).

²⁶ Regs. Sec. 1.1503(d)-7(c), Example (6)(iii).