SECTION 2. BACKGROUND

The American Jobs Creation Act of 2004 (P.L. 108–357) (the Act), enacted on October 22, 2004, added new section 965 to the Code. In general, and subject to limitations discussed below, section 965(a) provides that a corporation that is a U.S. shareholder ¹ of a controlled foreign corporation (CFC) may elect, for one taxable year, an 85 percent dividends received deduction (DRD) with respect to certain cash dividends it receives from its CFCs. For this purpose, all U.S. shareholders that are members of an affiliated group filing a consolidated return under section 1501 are treated as one U.S. shareholder. Section 965(c)(5). For purposes of section 965, the term “dividends” includes cash amounts included in gross income as dividends under sections 302 and 304, but does not include amounts treated as dividends under section 78 or 1248 or, in certain cases, section

367. ² H.R. Conf. Rep. No. 108–755, at 314–15. For this purpose a cash dividend also includes a cash distribution from a CFC that is excluded from gross income under section 959(a) to the extent of inclusions under section 951(a)(1)(A) as a result of a cash dividend during the election year to: (1) such CFC from another CFC in a section 958(a) chain of ownership; or (2) any other CFC in such chain of ownership to the extent of cash distributions described in section 959(b) made during such year to the CFC from which such U.S. shareholder received such distribution.

The DRD under section 965(a) is subject to several limitations. First, section 965(b)(1) limits the amount of dividends eligible for the deduction to the greatest of the following three amounts: (1) $500 million; (2) the amount shown on the taxpayer’s applicable financial statement ³ as earnings permanently reinvested outside the United States; or (3) in the case of an applicable financial statement that does not show a specific amount of earnings permanently reinvested outside the United States and that shows a specific amount of tax liability attributable to such earnings, the amount of such liability divided by 0.35.

Second, section 965(b)(2) limits the amount of dividends eligible for the deduction to the excess (if any) of the dividends received during the taxable year by the U.S. shareholder from CFCs over the annual average for the base period years of: (1) the dividends received during each base period year by such shareholder from CFCs; (2) the amounts includible in such shareholder’s gross income for each base period year under section 951(a)(1)(B) with respect to CFCs; and (3) the amounts that would have been included for each base period year but for section 959(a) with respect to CFCs. The base period years are the three taxable years which are among the five most recent taxable

1 The term U.S. shareholder means, with respect to any foreign corporation, a U.S. person who owns (within the meaning of section 958(a)), or is considered as owning by applying the rules of ownership of section 958(b), 10 percent or more of the total combined voting power of all classes of stock entitled to vote of such foreign corporation. Section 951(b).

2 Dividends resulting from liquidations qualifying under section 332 to which section 367(b) applies qualify as cash dividends to the extent the U.S. shareholder receives cash as part of the liquidation. Section 965(c)(3). A deemed liquidation effectuated through an election under §301.7701–3(c), however, does not result in an actual distribution of cash as required under section 965. See H.R. Conf. Rep. No. 108–755, at 315, footnote 108.

3 The term “applicable financial statement” means the most recently audited financial statement which is certified on or before June 30, 2003, as being prepared in accordance with generally accepted accounting principles, which is used for the purposes of a statement or report to creditors or shareholders or for any other substantial nontax purpose, and, if the taxpayer is required to file with the SEC, is so filed on or before June 30, 2003. Section 965(c)(1).

2005–6 I.R.B. 474 February 7, 2005

years ending on or before June 30, 2003, determined by disregarding the year for which such total amount is highest and the year for which such total amount is lowest among such five years. Section 965(c)(2).

Third, section 965(b)(3) provides that the amount of dividends eligible for the deduction is reduced by any increase in related-party indebtedness of the CFC between October 3, 2004, and the close of the election year. For this purpose, all CFCs with respect to which the taxpayer is a U.S. shareholder are treated as a single CFC.

Finally, section 965(b)(4) provides that the amount of the dividend must be invested in the United States pursuant to a domestic reinvestment plan that is approved by the taxpayer’s president, chief executive officer, or comparable official before the payment of the dividend, and that is subsequently approved by the taxpayer’s board of directors, management committee, executive committee, or similar body. The domestic reinvestment plan must provide for the investment of the dividend in the United States (other than as a payment for executive compensation), including as a source for the funding of worker hiring and training, infrastructure, research and development, capital investments, or the financial stabilization of the corporation for the purposes of job retention or creation. This list is not intended to be exclusive. H.R. Conf. Rep. No. 108–755, at 316. Section 965(c) provides definitions and special rules, including rules for adjusting the calculation of the base period amounts to take into account mergers, acquisitions and spin-offs. Sections 965(d) and (e) provide special rules limiting foreign tax credits and expense deductions and limiting the attributes available to offset the nondeductible portion of dividends, respectively.

Section 965(f) provides that taxpayers may elect the application of section 965 for either the taxpayer’s last taxable year which begins before October 22, 2004, or the taxpayer’s first taxable year which begins during the one-year period beginning on October 22, 2004.