Section III—Branch Profits Tax — 2025 Inst 1120-F (PDF)

Part I—Branch Profits Tax Section 884(a) imposes a 30% branch profits tax on the after-tax earnings of a foreign corporation’s U.S. trade or business (that is,

Instructions for Form 1120-F (2025) 31

effectively connected earnings and profits (ECEP)) that are not reinvested in a U.S. trade or business by the close of the tax year, or are disinvested in a later tax year. Changes in the value of the equity of the foreign corporation’s U.S. trade or business (that is, U.S. net equity) are used as a measure of whether earnings have been reinvested in, or disinvested from, a U.S. trade or business. An increase in U.S. net equity during the tax year is generally treated as a reinvestment of earnings for the current tax year. A decrease in U.S. net equity is generally treated as a disinvestment of prior year’s earnings that have not previously been subject to the branch profits tax.

The amount subject to the branch profits tax for the tax year is the dividend equivalent amount. See Regulations section 1.884-1(b).

Other entities subject to the branch profits tax.

A foreign corporate partner of a partnership engaged in a U.S. trade or business is subject to the branch profits tax on its ECEP attributable to its distributive share of ECI.
A foreign government is subject to both the branch profits tax and the branch-level interest tax. However, no branch profits tax or branch-level interest tax will be imposed on ECEP and interest accrued prior to September 11, 1992. See Regulations section 1.884-0.

Line 2

Attach a statement showing the following adjustments (based on the principles of section 312) to the corporation’s line 1 effectively connected taxable income (ECTI) (before the NOL deduction and special deductions) to get ECEP.

Positive adjustments for certain ECI items that are excluded from ECTI but that must be included in computing ECEP (such as tax-exempt interest income).
Positive adjustments for certain items deducted in computing ECTI but that may not be deducted in computing ECEP. Include adjustments for certain deductions claimed in computing ECTI, such as:

Excess of percentage depletion over cost depletion,
Excess of accelerated depreciation over straight line depreciation (but only if 20% or more of the foreign corporation’s gross income from all sources is U.S. source), and
Capital loss carrybacks and carryovers.

Negative adjustments for certain deductible items (that are allocable to ECI) that may not be deducted in computing ECTI but that must be deducted in computing ECEP (for example, federal income taxes, capital losses in excess of capital gains, and interest and expenses that are not deductible under section 265).

Note: Do not reduce ECEP by any dividends or other distributions made by the foreign corporation to its shareholders during the year.

See Temporary Regulations section 1.884-2T for any adjustments to ECEP due to a reorganization, liquidation, or incorporation.

Exceptions. Do not include the following types of income when computing ECEP.

Related person insurance company income that a taxpayer elects to treat as ECI under section 953(c)(3)(C) if the income is not otherwise ECI.
Income that is exempt from tax under section 892.
Interest income derived by a possession bank from U.S. obligations if the interest is treated as ECI under section 882(e) and is not otherwise ECI.

Note: Deductions and other adjustments attributable (under the principles of Regulations section 1.861-8) to the types of income not includible in ECEP listed above do not reduce ECEP.

Lines 4a and 4b. U.S. Net Equity

U.S. net equity is U.S. assets reduced by U.S. liabilities. U.S. net equity may be less than zero. See Temporary Regulations section 1.884-2T for specific rules regarding the computation of the foreign corporation’s U.S. net equity due to a reorganization, liquidation, or incorporation.

U.S. assets. In general, property is a U.S. asset if all income from its use and all gain from its disposition (if used or sold on the last day of the tax year) are or would be ECI. The amount of property taken into account as a U.S. asset is the adjusted basis (for purposes of computing earnings and profits) of the property. Special rules exist for specific types of property, such as depreciable property, inventory, and installment obligations. Special rules also exist to determine the amount of a partnership interest that is treated as a U.S. asset. See Regulations section 1.884-1(d).

U.S. liabilities. In general, U.S. liabilities are U.S.-connected liabilities of a foreign corporation (determined under Regulations section 1.882-5), computed as of the end of the tax year, rather than as an average, as required under Regulations section 1.882-5. Special rules may apply to foreign insurance companies. For more details, see Regulations section 1.884-1(e). If the corporation is electing to reduce liabilities under Regulations section 1.884-1(e)(3), attach a statement that it is making the election and indicate the amount of the reduction of U.S. liabilities and the corresponding reduction in interest expense. The aggregate amount of the corporation’s liability reduction elections is also required to be reported on Schedule I (Form 1120-F), line 7b.

Reporting requirements. In the statements required for lines 4a and 4b, report U.S. assets according to the categories of U.S. assets in Regulations section 1.884-1(d). For U.S. liabilities, show the formula used to calculate the U.S. liabilities figure.

Line 6. Branch Profits Tax

Qualification for treaty benefits. In general, a foreign corporation must be a qualified resident (see definition later) in the tax year in which it has a dividend equivalent amount to obtain treaty benefits for the branch profits tax. It must also meet the requirements of any limitation on benefits article in the treaty. However, a foreign corporation is not required to be a qualified resident if it meets the requirements of a limitation on benefits article of an income tax treaty that entered into force after December 31, 1986. Treaties other than income tax treaties do not exempt a foreign corporation from the branch profits tax.

Foreign corporations that meet the requirements of the limitation on benefits article of an income tax treaty that entered into force after December 31, 1986. Most limitation on benefits articles of treaties that entered into force after December 31, 1986, include a series of objective tests including ownership tests (generally describing the circumstances under which individuals, publicly traded corporations, subsidiaries of

Income from the operation of ships or aircraft exempt from taxation under section 883(a)(1) or (2).
FSC income and distributions treated as ECI under section 921(d) or 926(b), as in effect before their repeal, that are not otherwise ECI.
Gain on the disposition of an interest in a domestic corporation that is a U.S. real property interest under section 897(c)(1)(A)(ii) if the gain is not otherwise ECI.

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publicly traded corporations, etc., will be treated as qualified residents under a treaty), a base erosion test, and a trade or business test. These tests are self-executing. A person that does not meet these objective tests may still be granted benefits under the treaty (and may be treated as a qualified resident for branch profits tax purposes) at the discretion of the Competent Authority. See Rev. Proc. 2015-40, 2015-35 I.R.B. 236, available at IRS.gov/irb/2015-35_IRB#RP-2015-40 , or its successor.

Foreign corporations that do not meet the requirements of a limitation on benefits article of an income tax treaty that entered into force after December 31, 1986. A foreign corporation that does not meet the requirements of a limitation on benefits article of an income tax treaty that entered into force after December 31, 1986, is a qualified resident of a country if it meets one of the three tests explained in the regulations under section 1.884-5. See these regulations for details on these tests and certain circumstances in which a foreign corporation that does not meet these tests may request a ruling to be treated as a qualified resident.

Rate of tax. If treaty benefits apply, the rate of tax is the rate on branch profits specified in the treaty. If the treaty does not specify a rate for branch profits, the rate of tax is the rate specified in the treaty for dividends paid by a wholly owned domestic corporation to the foreign corporation. See Regulations section 1.884-1(g) for applicable rates of tax. Benefits other than a rate reduction may be available under certain treaties, such as the Canadian income tax treaty.

Note: Many treaties listed in Regulations section 1.884-1(g)(3) and (g)(4) are no longer in force and have been replaced by more recently ratified treaty agreements. The corporation should use the applicable rate of tax specified in the treaty agreement currently in force with the United States.

Effect of complete termination. If the foreign corporation has completely terminated its U.S. trade or business (within the meaning of Temporary Regulations section 1.884-2T(a)) during the tax year, enter zero on line 6 and complete line 11 at the bottom of page 7 of Form 1120-F.

In general, a foreign corporation has terminated its U.S. trade or business if it no longer has any U.S. assets, except those retained to pay off liabilities. The foreign corporation (or a related corporation) may not use assets from the terminated U.S. trade or business or the proceeds from their sale in a U.S. trade or business within 3 years after the complete termination. The foreign corporation must also attach Form 8848 extending the period for assessment for the year of complete termination to a date not earlier than the close of the sixth year following the close of that tax year.

Effect of complete liquidation or reorganization. If a foreign corporation transfers its U.S. assets in a liquidation or reorganization described in section 381(a), see Temporary Regulations section 1.884-2T(c). If the transferee is a domestic corporation, the foreign corporation must also file Form 8848. See Temporary Regulations section 1.884-2T(c) and Regulations section 1.884-2(c)(2)(iii).

Effect of incorporation under section 351. If a foreign corporation transfers all or a part of its U.S. assets to a domestic corporation in a transaction that qualifies under section 351, see Temporary Regulations section 1.884-2T(d) for the rules for determining the foreign corporation’s branch profits tax liability in the year of the transfer, and other rules applicable to the domestic transferee corporation. If a foreign corporation transfers its U.S. assets to another foreign corporation, the foreign corporation must compute its branch profits tax liability under Regulations section 1.884-1.

Coordination with withholding tax. If a foreign corporation is subject to the branch profits tax in a tax year, it will not be subject to withholding at source (section 871(a), 881(a), 1441, or 1442) on dividends paid out of earnings and profits for the tax year.