SECTION 3. CASH DIVIDENDS

.01 In General

The DRD under section 965(a) applies only to cash dividends ⁴ received by a corporate U.S. shareholder from CFCs with respect to which it is a U.S. shareholder. For this purpose, the term “cash” includes both U.S. dollars and foreign currency. A CFC may effect distributions of cash by wire transfer or check.

The Treasury Department and the IRS anticipate that, in some cases, a CFC will liquidate investments in cash equivalents in order to pay a cash dividend as required under section 965. It is also anticipated that the U.S. shareholder that receives such a cash dividend from the CFC may temporarily invest all or a portion of the dividend proceeds in cash equivalents, which may be similar in nature to those that had been held by the CFC. For purposes of section 965, the mere fact that the CFC held cash equivalents prior to the payment of a cash dividend and the U.S. shareholder holds cash equivalents after the payment of such dividend will not itself cause the Commissioner to recharacterize the dividend as a distribution by the CFC of the cash equivalents (rather than as a required distribution of cash), under the step transaction doctrine, or other similar authorities. For purposes of this paragraph, the term “cash equivalents” has the meaning provided in §1.897–7T(a).

.02 Treatment of Distributions to Intermediary Pass-Through Entities

To qualify as a cash dividend within the meaning of section 965, cash must be distributed from a CFC to the U.S. shareholder in the taxable year for which an election under section 965 applies. For purposes of section 965(a), a cash dividend paid by a CFC to a pass-through entity (a partnership or disregarded entity) that is owned by a U.S. shareholder shall be treated as received by such U.S. shareholder only if and to the extent that such shareholder receives cash in the amount of the CFC dividend during the taxable year for which such election is in effect. In addition, in the case of a partnership, a cash dividend is treated as received by a U.S. shareholder that is a partner in such

partnership only if the amount of the dividend is: (i) allocated to the U.S. shareholder-partner under the rules of sections 702 and 704 and the regulations thereunder; and (ii) separately stated to the partner under §1.702–1(a)(8)(ii).

For example, if a U.S. shareholder owns a disregarded entity that, in turn, owns a CFC that pays a cash dividend to the disregarded entity, such dividend will qualify as a cash dividend received by the U.S. shareholder within the meaning of section 965 only to the extent the disregarded entity distributes cash in the amount of the dividend proceeds to the U.S. shareholder during the taxable year to which an election under section 965 applies. A loan of cash from the disregarded entity to the U.S. shareholder would not be considered a distribution of cash for this purpose because, even though the loan would not otherwise be regarded for tax purposes, there would be a legal obligation for the U.S. shareholder to repay the cash to the disregarded entity.

.03 Amount of Cash Dividend Not Reduced by Related Deductions or Expenses

The amount otherwise qualifying as a cash dividend is not reduced by expenses or deductions of the taxpayer related to such cash dividend, including any foreign withholding tax and U.S. federal, state or local income tax imposed thereon. Taxpayers must invest the gross amount of the dividend (not reduced by expenses or deductions related to such dividend) in order for the total cash dividend to qualify under section 965(b)(4). Thus, for example, if a CFC distributes $100x of cash to its U.S. shareholder with respect to its stock that is treated as a dividend, and such distribution is subject to a foreign withholding tax of $5x (such that the U.S. shareholder receives a net amount of $95x), the amount of the cash dividend is $100x. Accordingly, the taxpayer must invest $100x in the United States pursuant to a domestic reinvestment plan in order for the $100x cash dividend to satisfy the requirements of section 965(b)(4).

.04 Interaction with Section 959

Except as provided in section 965(a)(2), the term “dividends” does not include

4 For purposes of section 965, a cash dividend includes cash amounts treated as a dividend pursuant to section 356(a)(2).

February 7, 2005 475 2005–6 I.R.B.

invested for each respective principal investment in the United States pursuant to such plan ( e.g., a total dollar amount for expenditures for research and development on product lines A, B and C and a total dollar amount for expenditures for advertising for brands D and E). A taxpayer may shift expenditures between investments specified in the plan without amending the plan and, to that extent, the additional amounts spent on one investment would be considered an alternative investment (as described below). For example, if a $100x dividend reinvestment plan calls for expenditures of $30x on research and development and $70x on advertising, and the taxpayer in fact expends $90x on the advertising, the additional $20x expenditures on advertising is an alternative investment.

The domestic reinvestment plan must state a reasonable time period, taking into account the nature of the investments to be made in the United States and other facts and circumstances, during which the taxpayer anticipates completing all such investments pursuant to such plan.

The Treasury Department and the IRS recognize that, after a domestic reinvestment plan is approved, certain investments specified in such plan may no longer be practicable or desirable for various reasons. This may occur, for example, if an investment is dependent on actions of other persons, or upon reasonably anticipated business conditions that subsequently change. For example, a taxpayer’s domestic reinvestment plan may contemplate as a principal investment a plant in the United States the construction of which cannot proceed absent certain governmental approvals and, subsequent to the adoption of the plan, the necessary governmental approvals are denied. Accordingly, the domestic reinvestment plan may provide alternative investments, which are themselves permitted investments, for investing the amount of the dividend in the United States in cases where principal investments are subsequently delayed or rejected. Such alternative investments must be described in the domestic reinvestment plan under the same standard of specificity provided above. The domestic reinvestment plan need not, however, set forth the conditions under which the alternative investments will be substituted for the principal investments.

amounts that are not included in gross income pursuant to section 959(a). In other words, distributions by a CFC to its U.S. shareholder with respect to its stock out of its earnings and profits described in section 959(c)(1) and (c)(2) do not qualify as dividends (except to the extent provided in section 965(a)(2)). Thus, for example, if a CFC has earnings and profits described in section 959(c)(1) of 100u and earnings and profits described in section 959(c)(3) of 50u, under the ordering rules of section 959(c) the CFC must distribute 150u to its U.S. shareholder with respect to its stock in order to be considered to have paid a 50u dividend within the meaning of section 965.