SECTION 2. BACKGROUND

.01 Section 965—In General

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 de

duction (DRD) with respect to certain cash dividends it receives from its CFCs. ² 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)(A). For purposes of section 965, the term “cash dividends” includes cash amounts included in gross income as dividends under sections 302, 304, and 356(a)(2), but does not include subpart F inclusions or amounts treated as dividends under section 78 or 1248 or, except in certain cases, section 367. H.R. Conf. Rep. No. 108–755, at 314–15; see Notice 2005–10, sections 2 and 3. For this purpose, a cash dividend also includes a cash distribution from a CFC to a U.S. shareholder that is excluded from gross income under section 959(a) to the extent of amounts included in income by such U.S. shareholder 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 from another CFC in such chain of ownership, but only 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. Section 965(a)(2).

The amount of cash dividends eligible for the section 965(a) DRD (qualifying dividends) is determined after applying certain limitations. Notice 2005–38 addressed the rules limiting qualifying dividends to certain dollar threshold amounts determined with reference to the greater of $500 million or the amount of earnings permanently reinvested outside the United States, the amount of dividends received in excess of certain base period average amounts, and certain increases in related-party indebtedness. See sections 965(b)(1) through (3) and 965(c). Notice 2005–10 addressed the requirement in section 965(b)(4) that the amount of the dividends be invested in the United States pursuant to a domestic reinvestment plan that meets specified criteria. Notice 2005–10

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 Section 965(c)(4) provides that no deduction is allowed under section 243 or 245 for any dividend for which a deduction is allowed under section 965.

2005–36 I.R.B. 471 September 6, 2005

also provided rules for electing the application of section 965 for a taxable year by filing Form 8895 with a timely-filed tax return. See section 965(b)(4) and (f). The taxable year for which a taxpayer elects section 965 to apply is referred to in this notice as the “election year.”

.02 Disallowance of Credit or Deduction for Certain Expenses Related to Deductible Portion of Qualifying Dividends and Related Matters

Section 965(d)(1) provides that no credit or deduction is allowed for certain foreign taxes paid or accrued (or treated as paid or accrued) with respect to the deductible portion of any qualifying dividend. Section 965(d)(2) further provides that no deduction shall be allowed for certain other expenses. Section 9.01 of Notice 2005–38 confirmed that section 78 does not apply to any tax which is not allowable as a credit under section 901 by reason of section 965(d) and that the disallowance of deductions in section 965(d)(2) applies only to deductions for expenses that are directly allocable to the deductible portion described in section 965(d)(1).

Section 965(d)(3) provides that, unless the taxpayer otherwise specifies, the deductible portion of any qualifying dividend is the amount which bears the same ratio to the amount of such dividend as the amount allowed as a deduction under section 965(a) for the election year bears to the total amount of dividends the taxpayer received from its CFCs during the election year, as described in section 965(b)(2)(A). For purposes of determining which dividends are subject to the foreign tax credit and expense disallowance, the taxpayer may specifically identify which cash dividends are treated as carrying the DRD (and thus entail proportionate disallowance of any associated deductions and foreign tax credits) and which are not. H.R. Conf. Rep. No. 108–755, at 316. In the absence of such a specification, a pro rata amount of foreign tax credits and deductions will be disallowed with respect to every cash dividend repatriated during the election year. See H.R. Conf. Rep. No. 108–755, at 316 n. 112.

.03 Limitation on Use of Credits and Deductions Related to Nondeductible Portion of Qualifying Dividends

For purposes of this notice, the term “nondeductible CFC dividends” refers to the excess of the amount of qualifying dividends over the 85 percent deduction allowed for such dividends under section 965(a). See section 965(e)(3). Section 965(e) provides limitations on the extent to which credits may offset the U.S. tax on nondeductible CFC dividends, and also provides that allowable deductions may not reduce taxable income below the amount of nondeductible CFC dividends. Specifically, section 965(e)(1) provides that the U.S. tax on nondeductible CFC dividends may not be offset by tax credits, other than a foreign tax credit under section 27 for taxes attributable to such dividends and the credit for prior year minimum tax under section 53.

Section 965(e)(1) further provides that the U.S. tax on nondeductible CFC dividends is not treated as tax imposed by chapter 1 for purposes of computing the alternative minimum tax imposed by section 55 (AMT). Accordingly, the tax on nondeductible CFC dividends cannot reduce the AMT that otherwise would be owed by the taxpayer. H.R. Conf. Rep. No. 108–755, at 316. ³ Section 9.01 of Notice 2005–38 provided that for purposes of calculating AMT for the election year in accordance with section 965(e)(1)(B), the taxpayer’s regular tax described in section 55(c) and tentative minimum tax determined under section 55(b)(1)(B) do not include tax attributable to nondeductible CFC dividends.

Section 965(e)(2)(A) provides that taxable income shall in no event be less than the amount of nondeductible CFC dividends received during the election year. While the income attributable to nondeductible CFC dividends may not be offset by expenses, losses, or deductions, such amounts may have the effect of reducing the taxpayer’s other income. H.R. Conf. Rep. No. 108–755, at 316 n. 113. Section 965(e)(2)(B) provides that the nondeductible CFC dividends are not taken into account in determining the amount of any net operating loss (NOL) for the election year, or in determining taxable income for

the election year for purposes of the second sentence of section 172(b)(2), which applies in determining the allowable NOL carryover or carryback to other years.