SECTION 4. MAXIMUM AMOUNT

ELIGIBLE FOR SECTION 965(a) — GENERAL PRINCIPLES

.01 Applicable Financial Statement

As noted above, the amount of dividends eligible for the section 965(a) DRD may be limited by section 965(b)(1)(B) or (C) to either: (1) the amount shown on the taxpayer’s applicable financial statement as earnings permanently reinvested outside the United States; or (2) in the case of an applicable financial statement that does not show a specific amount of earnings permanently reinvested outside the United States but that does show a specific amount of tax liability attributable to such earnings, the amount of such liability divided by 0.35. Also as noted above, the term “applicable financial statement” means the most recently audited financial statement (including notes and other documents which accompany such statement) which is certified on or before June 30, 2003, as being prepared in accordance with generally accepted accounting principles, and which is used for the purposes of a

statement or report to creditors or shareholders or for any other substantial nontax purpose. For purposes of determining an amount shown on a taxpayer’s applicable financial statement pursuant to section 965(b)(1)(B) or (C), the parenthetical reference to notes and other documents accompanying the statement only includes notes and documents that form an integral part of the financial statement; it does not include work papers or other materials underlying or supporting the statement.

.02 Determination of APB 23 Limitation of a U.S. Shareholder

For purposes of section 965(b)(1)(B) and (C), the specific amount shown on the applicable financial statement that reflects the amount determined under paragraph 12 of APB 23 (or, in the case of section 965(b)(1)(C), a specific amount of tax liability) and that is disclosed as required under Financial Accounting Standards Board Statement 109, is treated as an amount of earnings permanently reinvested outside the United States (or, the amount of tax liability attributable to such earnings), regardless of the specific language used to describe such specific amount on the applicable financial statement.

.03 Amount of Tax Liability Attributable to Earnings Permanently Reinvested

If an applicable financial statement fails to show a specific amount of earnings permanently reinvested outside the United States, but instead shows a specific amount of tax liability attributable to such earnings, the APB 23 limitation under section 965(b)(1)(C) is the specific amount of such tax liability divided by 0.35. This amount may not be adjusted (for example, to take into account the foreign taxes imposed on such earnings).

The following example illustrates the application of section 965(b)(1)(C) and this section 4.03.

Example . (i) Facts . A CFC has earnings permanently reinvested outside the United States that have

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wholly-owned subsidiaries US1 and US2. USP also wholly owns US3, which does not join in the USP consolidated return because an election under section 936 is in effect with respect to US3. US1, US2 and US3 each wholly owns a foreign corporation, CFC1, CFC2, and CFC3, respectively. Even though US3 is not part of the USP consolidated group for U.S. tax purposes, US3 is consolidated with USP, US1, and US2 for financial accounting purposes. On USP’s applicable financial statement, USP reported $350x of earnings permanently reinvested outside the United States. The separate company financial statements of US1, US2, and US3 that were used in preparing the USP applicable financial statement reported earnings permanently reinvested by CFC1, CFC2, and CFC3 to be $100x, $50x and $200x, respectively.

(ii) Result . The portion of the USP APB 23 limitation allocated to US1, US2, and US3 is that portion reflected on the separate company financial statements (or supporting work papers) of US1, US2, and US3 that were used in determining the USP APB 23 limitation on its applicable financial statement. Thus, US1 is allocated $100x, US2 is allocated $50x, and US3 is allocated $200x of the $350x APB 23 limitation. Because US1 and US2 are members of the USP consolidated group and such group is treated as one U.S. shareholder, the USP consolidated group’s APB 23 limitation equals $150x ($50x + $100x).

.05 Allocation of $500 Million Limitation

As noted above, section 965(c)(5)(B) provides that all corporations which are included in a section 52(a) group are limited to one $500 million limitation, which is divided among such corporations under regulations prescribed by the Secretary. Each qualified member of a section 52(a) group is allocated a portion of the section 52(a) group’s single $500 million limitation if it is a qualified member on the last day of the election year of the qualified member with the last election year to end (apportionment date). A “qualified member” is either: (1) a domestic corporation that files a separate tax return and is a member of a section 52(a) group; or (2) a consolidated group that is part of a section 52(a) group. Accordingly, if a consolidated group is not a part of a section 52(a) group, it has its own $500 million limitation, and, if a consolidated group is part of a section 52(a) group, the portion of the $500 million allocated to the consolidated group is not further allocated between and among the members of the consolidated group.

The section 52(a) group’s single $500 million limitation is allocated to all qualified members in proportion to the aggregate amount of total current and accumulated earnings and profits that are not previously taxed (non-PTI earnings

and profits) of all CFCs owned (within the meaning of section 958(a)) by such qualified members. For purposes of this rule, a consolidated group is treated as owning CFCs within the meaning of section 958(a), if any member of the group owns CFCs within the meaning of section 958(a). The amount of non-PTI earnings and profits of a CFC owned (within the meaning of section 958(a)) by a qualified member is the sum of the amounts of earnings and profits of such CFC appropriately reported on Schedule J, items 7(a) and 7(b), of the last Form 5471 filed by or on behalf of such qualified member on or before the apportionment date with respect to such CFC, translated into U.S. dollars at the average exchange rate for the CFC’s taxable year (see section 989(b)(3)).

The following example illustrates the application of section 965(b)(1) and the rules of this section 4.05.

Example . (i) Facts . FP, a foreign corporation, wholly owns two domestic corporations, US1 and US2. US1 and US2 each wholly owns a foreign corporation, CFC1 and CFC2, respectively. US1 and US2 each has a taxable year ending July 31, and they each make an election under section 965 for the taxable year ending July 31, 2006. US1 and US2 have APB 23 limitations of zero. On US1’s last Form 5471 filed on or before the July 31, 2006 apportionment date with respect to CFC1, US1 reported an amount of non-PTI earnings and profits for CFC1, translated into U.S. dollars using the average exchange rate, of $100x. On US2’s last Form 5471 filed on or before the July 31, 2006 apportionment date with respect to CFC2, US2 reported an amount of non-PTI earnings and profits for CFC2, translated into U.S. dollars using the average exchange rate, of $300x.

(ii) Result . US1 and US2 do not have an APB 23 limitation and, thus, their maximum amount eligible for the section 965(a) DRD is $500 million. Because US1 and US2 are members of the same section 52(a) group, they are limited to one $500 million limitation, which is allocated between them. Pursuant to this section 4.05, the $500 million limitation is allocated in proportion to the aggregate U.S. dollar amount of non-PTI earnings and profits reported on the last Form 5471 filed on or before the apportionment date by US1 and US2 with respect to CFC1 and CFC2, respectively. The apportionment date for the FP group is July 31, 2006. Consequently, US1 is allocated $125 million of the $500 million limitation ($100x/$400x x $500 million) and US2 is allocated $375 million of the $500 million limitation ($300x/$400x x $500 million).