1.1503(d)-7—Examples.
(a) In general.
This section provides examples that illustrate the application of §§ 1.1503(d)-1 through 1.1503(d)-6. This section also provides facts that are presumed for such examples.
(b) Presumed facts for examples.
For purposes of the examples in this section, unless otherwise indicated, the following facts are presumed:
(1)
Each entity has only a single class of equity outstanding, all of which is held by a single owner.
(2)
P, a domestic corporation and the common parent of the P consolidated group, owns S, a domestic corporation and a member of the P consolidated group.
(3)
DRCX, a domestic corporation, is subject to Country X tax on its worldwide income or on a residence basis, and is a dual resident corporation.
(4)
DE1X and DE2X are both Country X entities, subject to Country X tax on their worldwide income or on a residence basis, and disregarded as entities separate from their owners for U.S. tax purposes. DE3Y is a Country Y entity, subject to Country Y tax on its worldwide income or on a residence basis, and disregarded as an entity separate from its owner for U.S. tax purposes. All the interests in DE1X, DE2X, and DE3Y constitute hybrid entity separate units.
(5)
FBX is a Country X business operation that, if carried on by a U.S. person, would constitute a foreign branch, as defined in § 1.367(a)-6T(g)(1), and is a Country X foreign branch separate unit.
(6)
Neither the assets nor the activities of an entity constitute a foreign branch separate unit.
(7)
FSX is a Country X entity that is subject to Country X tax on its worldwide income or on a residence basis and is classified as a foreign corporation for U.S. tax purposes.
(8)
The applicable foreign country has a consolidation regime that—
(i)
Includes as members of a consolidated group any commonly controlled branches and permanent establishments in such jurisdiction, and entities that are subject to tax in such jurisdiction on their worldwide income or on a residence basis; and
(ii)
Allows the losses of members of consolidated groups to offset income of other members.
(9)
There is no mirror legislation, within the meaning of § 1.1503(d)-3(e)(1), in the applicable foreign country.
(10)
There is no elective agreement described in § 1.1503(d)-6(b) between the United States and the applicable foreign country.
(11)
There is no income tax convention between the United States and the applicable foreign country.
(12)
If a domestic use election, within the meaning of § 1.1503(d)-6(d), is made, all the necessary filings related to such election are properly completed on a timely basis.
(13)
If there is a triggering event requiring recapture of a dual consolidated loss, the amount of recapture is not reduced pursuant to § 1.1503(d)-6(h)(2).
(14)
There are no other items of income, gain, deduction, and loss. In addition, the United States and the applicable foreign country recognize the same items of income, gain, deduction, and loss in each taxable year.
(15)
All taxpayers use the calendar year as their taxable year.
(c) Examples.
The following examples illustrate the application of §§ 1.1503(d)-1 through 1.1503(d)-6:
Code of Federal Regulations
Example 1. Separate unit combination rule.
(i) Facts. P owns DE3Y which, in turn, owns DE1X. DE1X owns FBX. PRS, an entity treated as a partnership for both U.S. and Country X tax purposes, is owned 50 percent by P and 50 percent by an unrelated foreign person. PRS carries on a business operation in Country X that, if carried on by a U.S. person, would constitute a foreign branch within the meaning of § 1.367(a)-6T(g)(1)
. In addition, P owns DRCX, a member of the consolidated group of which P is the parent, which carries on business operations in Country X that constitute a foreign branch within the meaning of § 1.367(a)-6T(g)(1)
. S owns DE2X.
(ii) Result. Pursuant to § 1.1503(d)-1(b)(4)(ii)
, the interest in DE1X, the interest in DE2X, FBX, P's share of the Country X business operations carried on by PRS (which is owned by P indirectly through its interest in PRS), and DRCX's Country X business operations are combined and treated as a single separate unit of the consolidated group of which P is the parent. This is the case regardless of whether the losses of each individual separate unit are made available to offset the income of the other individual separate units under Country X tax laws. Because DRCX is a dual resident corporation, it is not combined and treated as part of this combined separate unit and, as a result, DRCX's income or dual consolidated loss is not taken into account in determining the income or dual consolidated loss of the combined separate unit. In addition, P's interest in DE3Y is not combined and is another separate unit because it is subject to tax in Country Y, rather than Country X.
Code of Federal Regulations
Example 2. Definition of a separate unit and application of domestic use limitation—foreign branch separate unit.
(i) Facts. P carries on business operations in Country X that constitute a permanent establishment under the U.S.-Country X income tax convention. In year 1, a loss is attributable to P's Country X permanent establishment, as determined under § 1.1503(d)-5
.
(ii) Result. Under §§ 1.1503(d)-1(b)(4)(i)(A) and 1.367(a)-6T(g)(1)
, P's Country X permanent establishment constitutes a foreign branch separate unit. Therefore, the year 1 loss attributable to the foreign branch separate unit constitutes a dual consolidated loss pursuant to § 1.1503(d)-1(b)(5)(ii)
. The dual consolidated loss rules apply to the dual consolidated loss even though there is no affiliate of the foreign branch separate unit in Country X, because it is still possible that all or a portion of the dual consolidated loss can be put to a foreign use. For example, there may be a foreign use with respect to a Country X affiliate acquired in a year subsequent to the year in which the dual consolidated loss was incurred. See § 1.1503(d)-6(a)(2)
. Accordingly, unless an exception under § 1.1503(d)-6
applies (such as a domestic use election), the year 1 dual consolidated loss attributable to P's Country X permanent establishment is subject to the domestic use limitation rule of § 1.1503(d)-4(b)
. As a result, pursuant to § 1.1503(d)-4(c)
, the year 1 dual consolidated loss cannot offset income of P that is not attributable to its Country X foreign branch separate unit, nor can it offset income of any other domestic affiliate. The loss can, however, offset income of the Country X foreign branch separate unit, subject to the application of § 1.1503(d)-4(c)
. The result would be the same even if Country X did not have a consolidation regime that includes as members of consolidated groups Country X branches or permanent establishments of nonresident corporations. The dual consolidated loss rules apply even in the absence of a consolidation regime in the foreign country because it is possible that all or a portion of a dual consolidated loss can be put to a foreign use by other means, such as through a sale, merger, or similar transaction. See § 1.1503(d)-6(a)(2)
.
(iii) Alternative facts. The facts are the same as in paragraph (i) of this Example 2,except that P's Country X business operations constitute a foreign branch as defined in § 1.367(a)-6T(g)(1)
, but do not constitute a permanent establishment under the U.S.-Country X income tax convention. Although the activities carried on by P in Country X would otherwise constitute a foreign branch separate unit as described in § 1.1503(d)-1(b)(4)(i)(A)
, the exception under § 1.1503(d)-1(b)(4)(iii)
applies because the activities do not constitute a permanent establishment under the U.S.-Country X income tax convention. Thus, the Country X business operations do not constitute a foreign branch separate unit, and the year 1 loss is not subject to the dual consolidated loss rules. If P instead carried on its Country X business operations through DE1X, then the exception under § 1.1503(d)-1(b)(4)(iii)
would not apply because P carries on the business operations through a hybrid entity and, as a result, the business operations would constitute a foreign branch separate unit. Thus, in such a case the year 1 loss would be subject to the dual consolidated loss rules.
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Example 3. Domestic use limitation—foreign branch separate unit owned through a partnership.
(i) Facts. P and S organize a partnership, PRSX, under the laws of Country X. PRSX is treated as a partnership for both U.S. and Country X tax purposes. PRSX owns FBX. PRSX earns U.S. source income that is unconnected with its FBX branch operations, and such income is not subject to tax by Country X. In addition, such U.S. source income is not attributable to FBX under § 1.1503(d)-5
.
(ii) Result. Under § 1.1503(d)-1(b)(4)(i)(A)
, P's and S's shares of FBX owned indirectly through their interests in PRSX are individual foreign branch separate units. Pursuant to § 1.1503(b)-1(b)(4)(ii)
, these individual separate units are combined and treated as a single separate unit of the consolidated group of which P is the parent. Unless an exception under § 1.1503(d)-6
applies, any dual consolidated loss attributable to FBX cannot offset income of P or S (other than income attributable to FBX, subject to the application of § 1.1503(d)-4(c)
), including their distributive share of the U.S. source income earned through their interests in PRSX, nor can it offset income of any other domestic affiliates.
Code of Federal Regulations
Example 4. Definition of a separate unit and domestic use limitation—interest in hybrid entity partnership and indirectly owned foreign branch separate unit.
(i) Facts. HPSX is a Country X entity that is subject to Country X tax on its worldwide income. HPSX is classified as a partnership for Federal tax purposes. P, S, and FSX, are the sole partners of HPSX. For U.S. tax purposes, P, S, and FSX each has an equal interest in each item of HPSX's profit or loss. HPSX carries on operations in Country Y that, if carried on by a U.S. person, would constitute a foreign branch within the meaning of § 1.367(a)-6T(g)(1)
.
(ii) Result. Under § 1.1503(d)-1(b)(4)(i)(B)
, the partnership interests in HPSX held by P and S are individual hybrid entity separate units. These individual separate units are combined into a single separate unit under § 1.1503(d)-1(b)(4)(ii)
. In addition, P's and S's share of the Country Y operations owned indirectly through their interests in HPSX are individual foreign branch separate units under § 1.1503(d)-1(b)(4)(i)(B)
. These individual separate units are also combined into a single separate unit under § 1.1503(d)-1(b)(4)(ii)
. Unless an exception under § 1.1503(d)-6
applies, dual consolidated losses attributable to P's and S's combined interests in HPSX can only be used to offset income attributable to their combined interests in HPSX (other than income attributable to P's and S's combined interests in the Country Y foreign branch separate unit), subject to the application of § 1.1503(d)-4(c)
. Similarly, dual consolidated losses attributable to P's and S's combined interests in the Country Y operations of HPSX can only be used to offset income attributable to their combined interests in such Country Y operations, subject to the application of § 1.1503(d)-4(c)
. Neither FSX's interest in HPSX, nor its share of the Country Y operations owned by HPSX, is a separate unit because FSX is not a domestic corporation.
Code of Federal Regulations
Example 5. Foreign use—general rule and de minimis reduction exception.
(i) Facts. P owns DE1X. DE1X owns FSX. In year 1, there is a $100x loss attributable to P's interest in DE1X that is a dual consolidated loss. Also in year 1, FSX earns $200x of income. DE1X and FSX file a Country X consolidated tax return. For Country X tax purposes, the year 1 $100x loss of DE1X is used to offset $100x of year 1 income generated by FSX. Under Country X tax law, unused losses are carried forward and available to offset income in subsequent taxable years.
(ii) Result. The $100x loss attributable to P's interest in DE1X is available to, and in fact does, offset FSX's income under the laws of Country X. In addition, under U.S. tax principles, such income is considered to be an item of FSX, a foreign corporation. As a result, under § 1.1503(d)-3(a)
, there has been a foreign use of the year 1 dual consolidated loss attributable to P's interest in DE1X. Therefore, P cannot make a domestic use election with respect to the loss as provided under § 1.1503(d)-6(d)(2)
, and such loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b)
. The result would be the same even if FSX, under Country X tax law, had no income against which the dual consolidated loss of DE1X could be offset (unless FSX's ability to use the loss under Country X tax law requires an election, and no such election is made).
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(iii) Alternative facts. The facts are the same as in paragraph (i) of this Example 5, except that FSX cannot use the loss of DE1X under Country X tax law without an election, and no such election is made. Pursuant to the exception in § 1.1503(d)-3(c)(2)
, there is no foreign use of the year 1 dual consolidated loss attributable to P's interest in DE1X. In addition, P files a domestic use election with respect to the year 1 dual consolidated loss attributable to its interest in DE1X and, at the beginning of year 3, P sells its interest in DE1X to F, a Country Y entity that is a foreign corporation. The sale of the interest in DE1X to F results in a foreign use triggering event pursuant to § 1.1503(d)-6(e)(1)(i)
because, immediately after the sale, the loss attributable to the interest in DE1X carries over under Country X law and, therefore, is available under U.S. tax principles to offset income of the owner of the interest in DE1X which, in the hands of F, is not a separate unit. It is also a foreign use because the loss is available under U.S. tax principles to offset the income of F, a foreign corporation. See § 1.1503(d)-3(a)(1)
. Finally, the transfer is a triggering event pursuant to § 1.1503(d)-6(e)(1)(iv) and (v)
.
(iv) Alternative facts. The facts are the same as in paragraph (iii), of this Example 5, except that P only sells 5 percent of its interest in DE1X to F. Pursuant to Rev. Rul. 99-5 (1999-1 CB 434), see § 601.601(d)(2)(ii)
(b) of this chapter, the transaction is treated as if P sold 5 percent of its interest in each of DE1X's assets to F, and then immediately thereafter P and F transferred their interests in the assets of DE1X to a partnership in exchange for an ownership interest therein. The sale of the 5 percent interest in DE1X generally results in a foreign use triggering event because a portion of the dual consolidated loss carries over under Country X tax law and is available under U.S. tax principles to offset income of the owner of the interest in DE1X, a hybrid entity, which in the hands of F is not a separate unit. It is also a foreign use because the loss is available under U.S. tax principles to offset the income of F, a foreign corporation. See § 1.1503(d)-3(a)(1)
. However, pursuant to the exception under § 1.1503(d)-3(c)(5)
(relating to a de minimis reduction of an interest in a separate unit), such availability does not result in a foreign use. In addition, pursuant to § 1.1503(d)-6(f)(1) and (3)
, the deemed transfers pursuant to Rev. Rul. 99-5 as a result of the sale are not treated as triggering events described in § 1.1503(d)-6(e)(1)(iv) or (v)
.
Code of Federal Regulations
Example 6. Foreign use and indirect foreign use—foreign reverse hybrid structure and disregarded payments.
(i) Facts. P owns DE1X. DE1X owns 99 percent and S owns 1 percent of FRHX, a Country X partnership that elected to be treated as a corporation for U.S. tax purposes. FRHX conducts a trade or business in Country X. In year 1, DE1X incurs interest expense on a third-party loan, which constitutes a dual consolidated loss attributable to P's interest in DE1X. In year 1, for Country X tax purposes, DE1X takes into account its distributive share of income generated by FRHX and offsets such income with its interest expense.
(ii) Result. In year 1, the dual consolidated loss attributable to P's interest in DE1X is available to, and in fact does, offset income recognized in Country X and, under U.S. tax principles, the income is considered to be income of FRHX, a foreign corporation. Accordingly, pursuant to § 1.1503(d)-3(a)(1)
, there is a foreign use of the dual consolidated loss. Therefore, P cannot make a domestic use election with respect to the year 1 dual consolidated loss attributable to its interest in DE1X, as provided under § 1.1503(d)-6(d)(2)
, and such loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b)
.
(iii) Alternative facts. (A) The facts are the same as in paragraph (i) of this Example 6, except as follows. Instead of owning DE1X, P owns DE3Y which, in turn, owns DE1X. In addition, DE3Y, rather than DE1X, is the obligor on the third-party loan and therefore incurs the interest expense on such loan. Finally, DE3Y on-lends the loan proceeds from the third-party loan to DE1X, and DE1X pays interest to DE3Y on such loan that is generally disregarded for U.S. tax purposes.
(B) Pursuant to § 1.1503(d)-5(c)(1)(ii)
, for purposes of calculating income or a dual consolidated loss, DE3Y and DE1X do not take into account interest income or interest expense, respectively, with respect to amounts paid on the disregarded loan from DE3Y to DE1X. As a result, such items neither create a dual consolidated loss with respect to the interest in DE1X, nor do they reduce (or eliminate) the dual consolidated loss attributable to the interest in DE3Y. Thus, in year 1, there is a dual consolidated loss attributable to P's interest in DE3Y, but not to P's indirect interest in DE1X.
(C) In year 1, interest expense paid by DE1X to DE3Y on the disregarded loan is taken into account as a deduction in computing DE1X's taxable income for Country X tax purposes, but does not give rise to a corresponding item of income or gain for U.S. tax purposes (because it is generally disregarded). In addition, such interest has the effect of making an item of deduction or loss composing the dual consolidated loss attributable to P's interest in DE3Y available for a foreign use. This is the case because it may reduce or offset items of deduction or loss composing the dual consolidated loss for foreign tax purposes, and creates another deduction or loss that may reduce or offset income of DE1X for foreign tax purposes that, under U.S. tax principles, is treated as income of FRHX, a foreign corporation. Moreover, because the disregarded item is incurred or taken into account as interest for foreign tax purposes, it is deemed to have been incurred or taken into account with a principal purpose of avoiding the provisions of section 1503(d). Accordingly, there is an indirect foreign use of the year 1 dual consolidated loss attributable to P's interest in DE3Y, and P cannot make a domestic use election with respect to such loss as provided under § 1.1503(d)-6(d)(2)
. Thus, the loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b)
.
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Example 7. Indirect foreign use—hybrid instrument.
(i) Facts. P owns DE1X which, in turn, owns FSX. DE1X borrows cash from an unrelated lender and transfers the cash to FSX in exchange for an instrument (hybrid instrument). The hybrid instrument is treated as equity for U.S. tax purposes and debt for Country X tax purposes. Interest expense on the loan from the unrelated lender results in a dual consolidated loss being attributable to P's interest in DE1X in year 1. DE1X does not elect under Country X law to consolidate with FSX. In year 1, FSX distributes its stock as a payment on the hybrid instrument to DE1X. For U.S. tax purposes, such payment is excluded from P's gross income under section 305. However, for Country X tax purposes, such payment is treated as interest and gives rise to a deduction taken into account in computing FSX's Country X tax liability; the payment also gives rise to interest income to DE1X for Country X tax purposes.
(ii) Result. The payment on the hybrid instrument does not give rise to an item of income or gain for U.S. tax purposes and therefore does not reduce (or eliminate) the dual consolidated loss attributable to P's interest in DE1X. In addition, such payment is taken into account as a deduction in computing FSX's taxable income for Country X tax purposes. Moreover, such payment has the effect of making an item of deduction or loss composing the dual consolidated loss attributable to P's interest in DE1X available for a foreign use. This is the case because it may reduce or offset items of deduction or loss composing the dual consolidated loss for foreign tax purposes, and creates a deduction that reduces or offsets income of FSX for foreign tax purposes that, under U.S. tax principles, is income of a foreign corporation. Further, because the item is incurred, or taken into account, using an instrument that is treated as equity for U.S. tax purposes and debt for foreign tax purposes, it is deemed to have been engaged in with the principal purpose of avoiding the provisions of section 1503(d). As a result, there has been an indirect foreign use of the year 1 dual consolidated loss, and P cannot make a domestic use election with respect to such loss, as provided under § 1.1503(d)-6(d)(2)
. Thus, the year 1 dual consolidated loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b)
.
Code of Federal Regulations
Example 8. No indirect foreign use—transaction entered into in the ordinary course of business.
(i) Facts. P owns DE1X and FBY. FBY is a foreign branch separate unit located in Country Y. DE1X owns FBX and FSX. P's interest in DE1X and FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii)
. Under Country X tax laws, DE1X elects to consolidate with FSX. FBY engages in the business of providing services and, in connection with its ordinary course of business, provides services to unrelated third parties and to DE1X. As compensation for services, DE1X makes a payment to FBY. Under Country X tax law, the payment is deductible. However, the payment is generally disregarded for U.S. tax purposes and, pursuant to § 1.1503(d)-5(c)(1)(ii)
, is not taken into account in calculating the income or dual consolidated loss attributable to the Country X separate unit or FBY. In year 1, the Country X separate unit and FBY each has a dual consolidated loss. The dual consolidated loss attributable to the Country X separate unit is subject to the domestic use limitation under § 1.1503(d)-4(b)
because DE1X and FSX elect to consolidate and, as a result, the dual consolidated loss is put to a foreign use.
(ii) Result. The payment made by DE1X to FBY in connection with the performance of services is taken into account as a deduction in computing DE1X's taxable income for Country X tax purposes, but does not give rise to an item of income or gain for U.S. tax purposes. In addition, such payment has the effect of making an item of deduction or loss composing the dual consolidated loss attributable to FBY available for a foreign use. This is the case because it may reduce or offset items of deduction or loss composing the dual consolidated loss of FBY for foreign tax purposes, and creates another deduction that reduces or offsets income of FSX for foreign tax purposes (because DE1X and FSX elect to file a consolidated return) that, under U.S. tax principles, is income of a foreign corporation. However, the transaction between DE1X and FBY was entered into in the ordinary course of FBY's trade or business. As a result, if P can demonstrate to the satisfaction of the Commissioner that the transaction was not entered into with a principal purpose of avoiding the provisions of section 1503(d), FBY's year 1 dual consolidated loss will not be treated as having been made available for an indirect foreign use. In such a case, P would be entitled to make a domestic use election with respect to such loss.
Code of Federal Regulations
Example 9. Foreign use—dual resident corporation with hybrid entity joint venture.
(i) Facts. P owns DRCX, a member of the P consolidated group. DRCX owns 80 percent of HPSX, a Country X entity that is subject to Country X tax on its worldwide income. HPSX is classified as a partnership for U.S. tax purposes. FSX owns the remaining 20 percent of HPSX. In year 1, DRCX generates a $100x net operating loss (without regard to items attributable to DRCX's interest in HPSX). Also in year 1, HPSX generates $100x of income, $80x of which is attributable to DRCX's interest in HPSX. DRCX and HPSX file a consolidated tax return for Country X tax purposes, and HPSX offsets its $100x of income with the $100x loss generated by DRCX.
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(ii) Result. DRCX and its interest in HPSX are not combined because DRCX is a dual resident corporation and the combination rule under § 1.1503(d)-1(b)(4)(ii)
only applies to separate units. The $100x year 1 net operating loss incurred by DRCX (without regard to items attributable to DRCX's interest in HPSX) is a dual consolidated loss. In addition, HPSX is a hybrid entity and DRCX's interest in HPSX is a hybrid entity separate unit; however, there is no dual consolidated loss attributable to such separate unit in year 1 (instead, there is $80x of income attributable to such separate unit). DRCX's year 1 dual consolidated loss offsets $100x of income for Country X purposes, and $20x of such income is, under U.S. tax principles, income of FSX, which owns an interest in HPSX that is not a separate unit (in addition, FSX is a foreign corporation). As a result, pursuant to § 1.1503(d)-3(a)
, there is a foreign use of the year 1 dual consolidated loss of DRCX, and P cannot make a domestic use election with respect to such loss pursuant to § 1.1503(d)-6(d)(2)
. Therefore, such loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b)
. The result would be the same even if HPSX, under Country X laws, had no income against which the dual consolidated loss could be offset (unless the ability to use the loss under Country X laws required an election, and no such election is made).
Code of Federal Regulations
Example 10. Foreign use—foreign parent corporation.
(i) Facts. F1 and F2, nonresident alien individuals, each owns 50 percent of FPX, a Country X entity that is subject to Country X tax on its worldwide income. FPX is classified as a foreign corporation for U.S. tax purposes. FPX owns DRCX. DRCX is the parent of a consolidated group that includes as a member DS, a domestic corporation. In year 1, DRCX incurs a dual consolidated loss of $100x and, for Country X tax purposes, FPX generates $100x of income. In year 1, FPX elects to consolidate with DRCX for Country X tax purposes, and the $100x year 1 loss of DRCX is used to offset the income of FPX under the laws of Country X. For U.S. tax purposes, the items of FPX do not constitute items of income in year 1.
(ii) Result. The year 1 dual consolidated loss of DRCX offsets the income of FPX under the laws of Country X. Pursuant to § 1.1503(d)-3(a)
, the offset constitutes a foreign use because the items constituting such income are considered under U.S. tax principles to be items of a foreign corporation. This is the case even though the United States does not recognize such items as income in year 1. Therefore, DRCX cannot make a domestic use election with respect to its year 1 dual consolidated loss pursuant to § 1.1503(d)-6(d)(2)
. As a result, such loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b)
.
(iii) Alternative facts. The facts are the same as in paragraph (i) of this Example 10, except that FPX is classified as a partnership for U.S. tax purposes. The result would be the same as in paragraph (ii) of this Example 10, because the offset of the income generated by FPX is a foreign use pursuant to § 1.1503(d)-3(a)
. This is the case because the items constituting such income are considered under U.S. tax principles to be items of F1 and F2, the owners of interests in FPX (a hybrid entity), that are not separate units. Moreover, the result would be the same if F1 and F2 owned their interests in FPX indirectly through another partnership.
Code of Federal Regulations
Example 11. No foreign use—absence of foreign loss allocation rules.
(i) Facts. P owns DE1X and DRCX. DRCX is a member of the P consolidated group and owns FSX. DE1X owns FBX. P's interest in DE1X and P's indirect interest in FBX are individual separate units that are combined into a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii)
. In year 1, DRCX incurs a $200x net operating loss and $200x of income is attributable to P's Country X separate unit. The $200x net operating loss incurred by DRCX is a dual consolidated loss. FSX also earns $200x of income in year 1. DRCX, DE1X, and FSX file a Country X consolidated tax return. However, Country X has no applicable rules for determining which income is offset by DRCX's year 1 $200x loss.
(ii) Result. Under § 1.1503(d)-3(c)(3)
, DRCX's $200x loss shall be treated as having been made available to offset the $200x of income attributable to P's Country X separate unit. P's Country X separate unit is not, under U.S. tax principles, a foreign corporation, and there is no interest in DE1X (which is a hybrid entity) that is not a separate unit. As a result, DRCX's loss being made available to offset the income attributable to P's Country X separate unit is not considered a foreign use of such loss. Therefore, P can make a domestic use election with respect to DRCX's year 1 dual consolidated loss.
(iii) Alternative facts. The facts are the same as in paragraph (i) of this Example 11, except that in year 1 only $150x of income is attributable to P's Country X separate unit. Because only $150x of income is attributed to P's Country X separate unit, $50x of DRCX's year 1 dual consolidated loss is treated as being made available to offset the income of FSX, a foreign corporation, and therefore constitutes a foreign use. As a result, DRCXcannot make a domestic use election with respect to its year 1 dual consolidated loss pursuant to § 1.1503(d)-6(d)(2)
, and such loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b)
.
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Example 12. No foreign use—absence of foreign loss usage ordering rules.
(i) Facts. (A) P owns DRCX, a member of the P consolidated group. DRCX owns FSX. Under the Country X consolidation regime, a consolidated group may elect in any given year to use all or a portion of the losses of one consolidated group member to offset income of other consolidated group members. If no such election is made in a year in which losses are generated by a consolidated member, such losses carry forward and are available, at the election of the consolidated group, to offset income of consolidated group members in subsequent taxable years. Country X law does not provide ordering rules for determining when a loss from a particular taxable year is used because, under Country X law, losses never expire. In addition, Country X law does not provide ordering rules for determining when a particular type of loss (for example, capital or ordinary) is used.
(B) In year 1, DRCX incurs a capital loss of $80x which, under § 1.1503(d)-5(b)(2)
, is not a dual consolidated loss. DRCX also incurs a net operating loss of $80x in year 1 which is a dual consolidated loss. FSX generates $60x of capital gain in year 1 which, for Country X purposes, can be offset by capital losses and net operating losses. Under the laws of Country X, DRCX elects to use $60x of its total year 1 loss of $160x to offset the $60x of capital gain generated by FSX in year 1; the remaining $100x of year 1 loss carries forward. In both year 2 and year 3, DRCX incurs a net operating loss of $100x, while FSX incurs no income or loss in years 2 and 3. DRCX's $100x losses incurred in year 2 and year 3 are dual consolidated losses. Because DRCX does not elect under the laws of Country X to use all or a portion of its year 2 or year 3 net operating losses of $100x to offset the income of other members of the Country X consolidated group, P is permitted to make (and in fact does make) a domestic use election with respect to both the year 2 and year 3 dual consolidated losses of DRCX. In year 4, DRCX has a net operating loss of $10x and FSX generates $125x of income. Country X law permits, upon an election, FSX's $125x of income generated in year 4 to be offset by losses (including carryover losses from prior years) of other group members. Accordingly, in year 4, DRCX elects to use $125x of its accumulated losses to offset the $125x of year 4 income generated by FSX.
(ii) Result. (A) Under the ordering rules of § 1.1503(d)-3(d)(3)
, a pro rata amount of DRCX's year 1 net operating loss ($30x) and capital loss ($30x) is considered to be used to offset FSX's year 1 $60x capital gain. As a result, P cannot make a domestic use election with respect to DRCX's year 1 $80x dual consolidated loss because a portion of such loss is put to a foreign use.
(B) DRCX's $10x year 4 net operating loss is also a dual consolidated loss. Under the ordering rules of § 1.1503(d)-3(d)(1)
, such loss is considered to be used to offset $10x of FSX's year 4 $125x of income. Consequently, P cannot make a domestic use election with respect to such loss. Under the ordering rules of § 1.1503(d)-3(d)(2)
, $50x of capital loss carryover and $50x of ordinary loss from year 1 will be considered to offset $100x of FSX's year 4 income because the income is first deemed to have been offset by losses the use of which would not constitute a triggering event that would result in the recapture of a dual consolidated loss. The remaining $15x of FSX's year 4 income is considered to be offset by losses from year 3 because it is the most recent taxable year from which a loss may be carried forward. Thus, a portion of the year 3 dual consolidated loss has been put to a foreign use and the entire year 3 dual consolidated loss is recaptured. However, none of DRCX's $100x year 2 net operating loss will be deemed to offset FSX's year 4 income. As a result, DRCX's year 2 dual consolidated loss will not be recaptured.
Code of Federal Regulations
Example 13. Exception to foreign use through partnership interest.
(i) Facts. (A) P owns 80 percent of HPSX, a Country X entity subject to Country X tax on its worldwide income. FSZ, an unrelated foreign corporation, owns the remaining 20 percent of HPSX. HPSX is classified as a partnership for Federal tax purposes and carries on operations in Country X that, if carried on by a U.S. person, would constitute a foreign branch within the meaning of § 1.367(a)-6T(g)(1)
. P's interest in HPSX and P's indirect interest in the Country X branch are individual separate units that are combined into a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii)
.
(B) In year 1, HPSX incurs a loss of $100x, $80x of which is attributable to P's Country X separate unit. The $80x of loss attributable to P's Country X separate unit constitutes a dual consolidated loss and P makes a domestic use election with respect to such loss. In year 2, HPSX generates $50x of income, $40x of which is attributable to P's interest in the Country X separate unit. Under Country X income tax laws, the $100x of year 1 loss incurred by HPSX is carried forward and offsets the $50x of income generated by HPSX in year 2; the remaining $50x of loss is carried forward and is available to offset income generated by HPSX in subsequent years. P and FSZ maintain their ownership interests in HPSX throughout years 1 and 2.
(ii) Result. In year 2, under the laws of Country X, the $100x of year 1 loss, which includes the $80x dual consolidated loss attributable to P's Country X separate unit, is made available to offset income of HPSX. Such income is attributable to P's interest in HPSX, which is a separate unit. Such income also is income of FSZ, a foreign corporation that is an owner of an interest in HPSX, which is not a separate unit. However, pursuant to § 1.1503(d)-3(c)(4)
, there is no foreign use of the year 1 dual consolidated loss in year 2. This is the case because P's interest in HPSX as of the end of year 1 has not been reduced by more than a de minimis amount, and the portion of the $80x dual consolidated loss was made available for a foreign use in year 2 solely as a result of FSZ's ownership in HPSX and the allocation or carry forward of the dual consolidated loss as a result of such ownership.