SECTION 3. IDENTIFICATION OF

CASH DIVIDENDS, QUALIFYING DIVIDENDS, AND SEPARATE CATEGORIES; FOREIGN CURRENCY TRANSLATION RULES

.01 Identification of Cash Dividends

In order for cash dividends that are paid to a partnership or a disregarded entity that is owned by a U.S. shareholder to qualify as cash dividends described in section 965(a), cash in the amount of the dividend must be received by the U.S. shareholder in the election year from the partnership or disregarded entity. See section 3.02 of Notice 2005–10. In the case of a disregarded entity, cash may be received in a form other than a distribution. See section 9.06 of Notice 2005–38 and section 10.09 of this notice. In addition, as described in section 2.01 of this notice, under section 965(a)(2) a cash distribution from a CFC of previously-taxed earnings and profits attributable to amounts which are or have been included in income of the U.S. shareholder and are excluded from gross income under section 959(a) (previously-taxed income or PTI) is treated as a cash dividend only to the extent of amounts included in income by the U.S. shareholder under subpart F in the election year as a result of cash dividends that are both paid and distributed through a chain of CFCs to the U.S. shareholder in the election year. Finally, a deemed liquidation effected through an election under §301.7701–3(c) results in a cash dividend only to the extent the shareholder receives cash as part of the liquidation in the election year. Section 965(c)(3); see section 2, footnote 2, of Notice 2005–10. This section 3.01 provides rules for identifying the amounts treated as cash dividends if a U.S. shareholder receives cash from a partnership or disregarded entity or cash distributions of PTI from a CFC that exceed the cash dividends paid to such partnership, disregarded entity, or CFC (or the cash deemed received in a deemed liquidation) in the election year. See sec

3 However, the DRD is not treated as a preference item for purposes of computing the AMT. Section 56(g)(4)(C)(vi). Thus, the deduction is allowed in computing alternative minimum taxable income notwithstanding the fact that it may not be deductible in computing earnings and profits. H.R. Conf. Rep. No. 108–755, at 316–317.

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choose to associate each cash dividend described in section 965(a)(2) that is received from a CFC with the earnings and profits attributable to the taxpayer’s subpart F inclusion from one or more of the CFCs in the ownership chain. Taxpayers make this identification by including the identifying information required by Part V of Form 8895 and consistently calculating the tax consequences under section 965 and this notice for those cash dividends that are qualifying dividends, determined as provided in section 3.02 of this notice. ⁵

.02 Identification of Qualifying Dividends and Separate Categories

In addition to other limitations, the amount of cash dividends eligible for the DRD is limited to the excess of the cash dividends received by the taxpayer from its CFCs during the election year over the taxpayer’s base period amount. See section 965(b)(2) and sections 2 and 3 of Notice 2005–38. A taxpayer may specifically identify which cash dividends are treated as qualifying dividends carrying the DRD and which cash dividends are treated as meeting the base-period repatriation level or are otherwise ineligible for the DRD. H.R. Conf. Rep. No. 108–755, at 316. Taxpayers identify the qualifying dividends by completing Form 8895, Part V, column (e). ⁶

A taxpayer generally must identify each cash dividend received during the election year as either a qualifying dividend or a non-qualifying dividend in its entirety, but may identify a portion of one dividend as a qualifying dividend to the extent necessary to prevent the total amount identified in Part V, column (e) of Form 8895 from exceeding the total amount of qualifying dividends. To the extent a taxpayer fails to identify specific cash dividends equal to the full amount of qualifying dividends, a pro rata portion of each cash dividend received by the taxpayer during the election year that is not otherwise identified by the taxpayer as a qualifying dividend will be treated as a qualifying dividend. The pro rata portion is the amount which bears the

tion 3.02 of this notice for rules for identifying specific cash dividends (including both cash dividends described in this section 3.01 and cash dividends described in section 965(a)(1) that are paid directly by a CFC to a U.S. shareholder) as qualifying dividends eligible for the section 965(a) DRD.

For purposes of this section 3, the term “eligible cash amount” refers to (a) cash received by the U.S. shareholder on any day in the election year from a partnership or disregarded entity in a form that satisfies the requirements of section 3.02 of Notice 2005–10 and section 9.06 of Notice 2005–38, and (b) cash distributions of PTI to the U.S. shareholder on any day in the election year from a CFC. A taxpayer that receives eligible cash amounts from a disregarded entity or partnership that in the aggregate exceed the total amount of cash dividends paid to (or the amount of cash deemed received in a deemed liquidation from) such disregarded entity or the taxpayer’s distributive share of cash dividends paid to such partnership during the election year, respectively, may specifically identify which eligible cash amounts are treated as attributable to the underlying cash dividends (and therefore considered to be a cash dividend described in section 965(a)(1) or (2)). Similarly, a taxpayer that receives eligible cash amounts of PTI from a CFC in excess of the amount eligible to be treated as a cash dividend under section 965(a)(2) may specifically identify which cash PTI distributions from that CFC are treated as attributable to the underlying subpart F inclusions (and therefore considered to be a cash dividend described in section 965(a)(2)).

Taxpayers make this identification by including the cash dividends and identifying information on Part V of Form 8895. ⁴ Taxpayers may identify all or a portion of any specific eligible cash amount received by the U.S. shareholder from a disregarded entity, partnership or CFC in the election year as the cash dividend. To the extent a taxpayer fails to identify specific eligible cash amounts in an amount equal to the full amount of the taxpayer’s share of cash div

idends received by the disregarded entity, partnership or CFC, a pro rata portion of each eligible cash amount received but not otherwise identified by the taxpayer as a cash dividend will be treated as a cash dividend. The pro rata portion is the amount which bears the same ratio to the eligible cash amount as the unidentified portion of the taxpayer’s share of the cash dividends paid to the disregarded entity, partnership or CFC bears to the total amount of eligible cash amounts received during the election year but not otherwise identified as cash dividends.

If a U.S. shareholder receives eligible cash amounts from a disregarded entity owned by the U.S. shareholder in an amount less than or equal to the total amount of cash dividends paid to the disregarded entity during the election year, then 100 percent of each eligible cash amount received from such disregarded entity is a cash dividend described in section 965(a). Similarly, if a U.S. shareholder receives eligible cash amounts from a partnership in an amount less than or equal to the total amount of the U.S. shareholder’s distributive share of cash dividends paid to the partnership during the election year, then 100 percent of each eligible cash amount received from such partnership is a cash dividend described in section 965(a). Finally, if a U.S. shareholder (or a disregarded entity or partnership owned by the U.S. shareholder) receives cash distributions of PTI from a CFC in an amount less than or equal to the amount of earnings and profits included in income by the U.S. shareholder under section 951(a)(1)(A) as a result of one or more cash dividends paid to the distributing CFC or another CFC in the same chain of ownership described in section 958(a), then 100 percent of each cash distribution of PTI from that CFC is a cash dividend described in section 965(a)(2). The taxpayer may choose to associate each cash dividend received from a disregarded entity or partnership with one or more of the cash dividends paid to that disregarded entity or partnership during the election year. Similarly, the taxpayer may

4 Any taxpayer that had filed its return for the election year before Form 8895 was made available to the public in final form need not file Form 8895 to identify the cash dividends, but should retain the information requested on the Form to be made available to the IRS on request.

5 See footnote 4.

6 Section 7.06 of Notice 2005–38 provides that an increase in a CFC’s related party indebtedness is allocated among U.S. shareholders that are related persons with respect to the CFC in the order that cash dividends are received. The provision of Notice 2005–38 allocates among the U.S. shareholders the reduction in the amount of cash dividends eligible for the section 965(a) DRD, but does not preclude a U.S. shareholder from identifying any specific cash dividend as a qualifying dividend.

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same ratio to the amount of the dividend as the total amount of qualifying dividends not otherwise identified bears to the total amount of cash dividends received during the election year described in section 965(b)(2)(A) that are not otherwise identified as qualifying dividends. See Example 3 of section 3.05 of this notice. Qualifying dividends described in section 965(a)(1) will be considered paid pro rata out of the non-previously-taxed earnings and profits in the CFC’s separate categories from which the dividend was paid, in accordance with the look-through rules of section 904(d)(3)(D). Subpart F inclusions attributable to dividends paid to a CFC from another CFC in the same chain of ownership (including CFCs engaged in section 304 transactions described in section 9.04 of Notice 2005–38) are treated as income in the same separate categories to which the dividend is assigned, under the look-through rules of section 904(d)(3)(B) and (D). See Treas. Reg. §1.904–5. Cash dividends described in section 965(a)(2), whether or not identified by the U.S. shareholder as qualifying dividends, will be considered paid first out of the previously-taxed earnings and profits described in section 959(c)(2) that are attributable to the amount included in the United States shareholder’s income under section 951(a)(1)(A) in the election year as a result of the CFC-to-CFC cash dividend described in section 965(a)(2), to the extent thereof.

.03 Allocation of Dividends Received Deduction

The DRD allowed under section 965(a) is definitely related to and allocated to reduce gross income in the U.S. shareholder’s separate categories to which the qualifying dividends described in section 965(a)(1) and the subpart F inclusions underlying qualifying dividends described in section 965(a)(2) are assigned. See Treas. Reg. §1.861–8(a)(2) and (b)(2).

.04 Foreign Currency Exchange Rate Conventions

(a) Cash dividends described in section 965(a)(1) . Cash dividends described in section 965(a)(1) that are paid directly

to the U.S. shareholder are translated into U.S. dollars at the spot rate on the date of distribution as provided in section 989(b)(1). ⁷ A cash dividend paid by a CFC to a pass-through entity that is owned by a U.S. shareholder is treated as received by such U.S. shareholder for purposes of section 965(a) only if and to the extent that such shareholder receives cash in the amount of the CFC dividend during the election year. See Notice 2005–10, section 3.02, Notice 2005–38, section 9.06, and section 10.09 of this notice. Such cash dividends are translated from the functional currency of the payor CFC into U.S. dollars at the spot rate on the date the amount of the cash dividend is received by the U.S. shareholder, rather than at the spot rate on the date the dividend is received by the partnership or disregarded entity. Accordingly, the receipt of cash itself will not result in currency gain or loss to the U.S. shareholder.

(b) Cash dividends described in section 965(a)(2) . Cash dividends described in section 965(a)(2) are distributions of PTI to the U.S. shareholder in an amount that does not exceed the subpart F inclusions in the election year that result from cash dividends that are paid by lower-tier CFCs and that are distributed as PTI through a chain of CFCs and received by the U.S. shareholder during the election year. The subpart F inclusions that result in cash dividends will be translated from the functional currency of the CFC receiving the dividend into U.S. dollars at the spot rate on the date the PTI is distributed to the U.S. shareholder, rather than at the average rate generally used to translate subpart F inclusions under section 989(b)(3), and the PTI distribution will not result in currency gain or loss under section 986(c).

.05 Examples

The following examples illustrate the application of section 965(d)(3) and this section 3. Unless otherwise indicated, the following facts are assumed for purposes of these examples. All corporations use calendar taxable years for U.S. tax purposes. USP is a domestic corporation that elects to apply section 965 to its 2005 taxable year and meets all applicable requirements to claim the section 965(a) DRD

with respect to the qualifying dividends described in the examples.

Example 1 . Identification of cash dividends where PTI distributions exceed subpart F inclusions attributable to cash dividends . (i) Facts . USP owns all the stock of CFC1, which owns all the stock of CFC2. CFC1 and CFC2 are organized under the laws of different foreign countries and each uses the “u” as its functional currency. On September 1, 2005, CFC2 pays a cash dividend of 200u to CFC1 that is subpart F income of CFC1 under sections 952(a) and 954(c)(1)(A), resulting in a 200u income inclusion to USP under section 951(a)(1)(A). On each of March 1, 2005, when the spot exchange rate is 1u = $1, and November 1, 2005, when the spot exchange rate is 1u = $1.25, CFC1 distributes 200u to USP. Each of the 200u distributions is a distribution of previously-taxed earnings and profits of CFC1 that is excluded from USP’s gross income under section 959(a). (ii) Result . USP received cash distributions of PTI from CFC1 in the election year in an amount (400u) that exceeds the amount included in income by USP under section 951(a)(1)(A) as a result of cash dividends during the election year to CFC1 from CFC2, another CFC in a chain of ownership described in section 958(a) (200u). Pursuant to section 3.01 of this notice, USP may identify either the March 1, 2005 PTI distribution of 200u = $200 or the November 1, 2005 PTI distribution of 200u = $250 as the cash dividend described in section 965(a)(2) of previously-taxed earnings attributable to the subpart F inclusion resulting from the cash dividend paid by CFC2 to CFC1. Pursuant to section 3.04 of this notice, USP’s subpart F inclusion of 200u is translated into U.S. dollars at the spot exchange rate on the date of the associated PTI distribution, and that PTI distribution does not result in currency gain or loss under section 986(c). The other PTI distribution may result in currency gain or loss under section 986(c).

Example 2 . Identification of amounts underlying cash dividends where multiple subpart F inclusions exceed PTI distributions . (i) Facts . USP owns all the stock of CFC1, which owns all the stock of CFC2 and CFC3. CFC2 owns all the stock of CFC4. The four CFCs are each organized under the laws of a different foreign country and each uses the U.S. dollar as its functional currency. In 2005, CFC3 pays a $100 cash dividend to CFC1 that, after taking into account $10 of allocable foreign taxes and $5 of other expenses, is subpart F income of CFC1 under sections 952(a) and 954(c)(1)(A) that results in an $85 income inclusion to USP with respect to CFC1 under section 951(a)(1)(A). Also in 2005, CFC4 pays a $100 cash dividend to CFC2 that, after taking into account $30 of allocable taxes and $10 of other expenses, is subpart F income of CFC2 under sections 952(a) and 954(c)(1)(A) that results in a $60 income inclusion to USP under section 951(a)(1)(A). CFC2 distributes $60 of cash to CFC1 and CFC1 distributes $60 of cash to USP in 2005.

(ii) Result . USP received cash distributions of PTI from CFC1 in the election year in an amount ($60) that is less than $145, the total of amounts included in income by USP under section 951(a)(1)(A) as a result of cash dividends during the election year

7 In the case of cash received as part of a deemed liquidation resulting from an election under Treas. Reg. §301.7701–3(c), the date of distribution is the date the cash is received, not the date of the deemed liquidation.

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from CFC3 to CFC1 ($85), and cash dividends during the election year from CFC4 to CFC2 that were distributed in cash to CFC1 ($60). Accordingly, pursuant to section 3.01 of this notice, the entire $60 cash PTI distribution is a cash dividend described in section 965(a)(2). Furthermore, also pursuant to section 3.01 of this notice, USP may associate the $60 cash dividend with either the $60 cash PTI distribution to CFC1 that is attributable to the subpart F inclusion from CFC2 or a ratable portion of the $85 subpart F inclusion from CFC1.

Example 3. Identification of qualifying dividends . (i) Facts . USP owns all the stock of CFC1 and CFC2, and CFC1 owns all the stock of CFC3. CFC1, CFC2, and CFC3 are organized under the laws of different foreign countries, and each uses the “u” as its functional currency. In 2005, CFC3 pays an 80u cash dividend to CFC1. The dividend is subpart F income of CFC1 under sections 952(a) and 954(c)(1)(A), resulting in an income inclusion to USP under section 951(a)(1)(A). Also in 2005, CFC1 distributes to USP 160u with a value of $200 at the 0.8u = $1 spot exchange rate on the date of distribution, all of which constitutes previously-taxed earnings of CFC1 described in section 959(c)(2). In addition, USP receives a 100u cash dividend, equal to $100 at the spot rate on the date of distribution, from each of CFC1 and CFC2 in 2005. USP’s base period amount described in section 965(b)(2)(B) is $100, and, taking into account the other limitations under section 965(b), USP’s total amount of qualifying dividends is $150.

(ii) Result . Under section 3.04 of this notice, USP’s subpart F inclusion attributable to the 80u cash dividend paid by CFC3 to CFC1 is translated into dollars at the spot rate on the date an equivalent amount of cash is distributed to USP, rather than at the average exchange rate for the year. Accordingly, USP includes $100 in income under section 951(a)(1)(A), and 80u of the PTI distribution, which has a value of $100 on the date of distribution, is excluded from USP’s gross income under section 959(a) and results in no currency gain or loss under section 986(c). The remaining 80u of the 160u PTI distribution, which also has a value of $100 on the date of distribution, is excluded from USP’s gross income under section 959(a) and may result in currency gain or loss under section 986(c).

USP received three $100 cash dividends described in section 965(b)(2)(A) during 2005, of which $150 is eligible to be taken into account under section 965(a): the $100 dividend from CFC2, the $100 dividend from CFC1, and $100 of the $200 PTI distribution received from CFC1. The remaining $100 of the PTI distribution received from CFC1 is not a cash dividend described in section 965(a)(2) because it exceeds the amount included in income by USP under section 951(a)(1)(A) as a result of the cash dividend paid by CFC3 to CFC1. Pursuant to section 3.02 of this notice, USP may identify any one of the three distributions in its entirety, and one-half of either of the remaining two distributions, as qualifying dividends on Form 8895. If USP does not identify specific distributions as the qualifying dividends, $50 ($150 total qualifying dividends not otherwise identified divided by $300 total cash dividends received during the election year, multiplied by $100 cash dividend) of each of the three $100 cash dividends will be treated as a qualifying dividend.

Example 4. Cash dividend equivalent to cash re- ceived in actual inbound liquidation . (i) Facts . USP owns all the stock of CFC1, which owns all the stock of CFC2. CFC1 and CFC2 are organized in Country X and each uses the “u” as its functional currency. On June 30, 2005, in an inbound liquidation of CFC1 described in sections 332 and 367(b), CFC1 legally dissolves and, in connection with such dissolution, USP acquires all the assets of CFC1, consisting of 100u of cash in a Country X bank account and certain other noncash assets (including all of the stock of CFC2). In connection with the liquidation USP includes in income as a dividend an all earnings and profits amount of 300u equal to $600 on June 30, 2005, when the spot exchange rate is 1u = $2. After the liquidation, USP continues to operate the business of CFC1 in Country X with the Country X bank account.

(ii) Result . Pursuant to section 3.02 of this notice, USP may identify as a qualifying dividend described in section 965(a)(1) the 100u of cash received by USP in the liquidation of CFC1 that is taxed as a dividend under section 367(b). Pursuant to section 3.04 of this notice, the amount of the cash dividend from CFC1 is $200 (100u of cash received by USP in the liquidation of CFC1, translated at the spot rate of 1u = $2 on the date of the liquidating dividend).

Example 5. Cash dividends less than cash re- ceived in check-the-box liquidation plus cash divi- dend received by disregarded entity . (i) Facts . The facts are the same as in Example 4, except that, instead of actually liquidating CFC1, USP elects to treat CFC1 as a disregarded entity by filing an entity classification election under Treas. Reg. §301.7701–3, effective July 1, 2005, CFC2 pays a dividend of 100u to the disregarded entity CFC1 on September 1, 2005, when the spot exchange rate is 1u = $1.50, and the disregarded entity CFC1 distributes 100u of cash to USP on October 1, 2005, when the spot exchange rate is 1u = $1.75.

(ii) Result . USP’s check-the-box election with respect to CFC1 does not give rise to an eligible dividend under section 965(c)(3) because the resulting deemed liquidation in and of itself does not result in an actual receipt by USP of the 100u of cash owned by CFC1. In addition, the cash dividend paid from CFC2 to CFC1, at that time a disregarded entity, is treated as a cash dividend received by USP in the election year only to the extent USP receives cash from the disregarded entity during the election year. See Notice 2005–10, section 3.02. Because the disregarded entity CFC1 distributed 100u of cash to USP in the year of the liquidation, the 100u cash distribution is a cash dividend within the meaning of section 965(c)(3). Pursuant to section 3.01 of this notice, USP may identify the October 1, 2005 100u cash dividend as attributable to either the deemed dividend resulting from the check-the-box election or the cash dividend paid by CFC2. If USP treats the cash dividend as attributable to cash actually received by USP in connection with the deemed liquidation, the deemed dividend constitutes a dividend described in section 965(c)(3) to the extent of 100u. Alternatively, USP may treat the 100u cash dividend as attributable to the cash dividend paid from CFC2 to CFC1, a disregarded entity, which is eligible to be treated as a cash dividend because USP received 100u of cash from CFC1 during the election year.

If USP chooses to treat the dividend from CFC2 as the cash dividend underlying the 100u cash div

idend on October 1, 2005, then pursuant to section 3.04 of this notice the dollar amount of the 100u dividend from CFC2 is $175, the spot value of 100u on October 1, 2005, the date CFC1 distributes an amount of cash equal to the CFC2 dividend to USP, and CFC1’s distribution of 100u to USP does not give rise to currency gain or loss. As in Example 4, the entire 300u all earnings and profits amount is $600, translated into dollars at the 1u = $2 exchange rate, the spot rate on the date of the deemed dividend.

If, instead, USP chooses to treat the 100u cash dividend as cash received in connection with the deemed liquidation, pursuant to section 3.04 of this notice the dollar amount of 100u of the 300u deemed dividend from CFC1 is $175, the spot value of 100u on October 1, 2005, the date USP receives that amount of cash in connection with the deemed liquidation. The dollar amount of the 200u remainder of the deemed dividend is $400, translated into dollars at the 1u = $2 exchange rate, the spot rate on the date of the deemed dividend. The dollar amount of the 100u dividend from CFC2 is $150, the spot value of 100u on September 1, 2005, the date CFC2 paid the dividend to the disregarded entity CFC1.

Example 6. CFC-to-CFC dividend and equiva- lent PTI distribution . (i) Facts . USP owns all the stock of CFC1, which owns all the stock of CFC2. CFC1 is organized in Country X and uses the “u” as its functional currency. CFC2 is organized in Country Y and uses the euro as its functional currency. On June 30, 2005, when the spot exchange rate is 1u = € 2, CFC2 pays a cash dividend of € 200 to CFC1. CFC1 has no other items of income or expense in 2005. The dividend from CFC2 is subpart F income of CFC1 under sections 952(a)(2) and 954(c)(1)(A) that is included in income by USP under section 951(a)(1)(A)(i). On September 1, 2005, when the spot exchange rate is 1u = $1, CFC1 distributes 100u in cash to USP. The 100u cash distribution is PTI of CFC1 that is excluded from USP’s income under section 959(a). The average exchange rate determined under section 989(b)(3) for 2005 is 1u = $.90.

(ii) Result . Pursuant to section 989(b)(1), the “u” amount of CFC1’s subpart F income attributable to the € 200 dividend from CFC2 is 100u, the spot value of € 200 on the date CFC1 includes the CFC2 dividend in income. The 100u cash distribution from CFC1 to USP is a cash dividend described in section 965(a)(2) because it is PTI in an amount not in excess of the 100u subpart F income of CFC1 that results from a cash dividend paid during the election year by CFC2, another CFC in the chain of ownership described in section 958(a). Regardless of whether USP identifies the PTI distribution from CFC1 as a qualifying dividend, pursuant to section 3.04 of this notice the dollar amount of USP’s subpart F inclusion with respect to CFC1 under section 951(a)(1)(A) attributable to the CFC2 dividend is $100, the spot rate on the date CFC1 distributes an amount of cash equal to the CFC2 dividend to USP. The PTI distribution does not result in currency gain or loss under section 986(c).

Example 7. CFC-to-CFC dividend and smaller PTI distribution . (i) Facts . The facts are the same as in Example 6, except that CFC2’s dividend to CFC1 is € 400 rather than € 200.

(ii) Result . The € 400 dividend, translated at the spot rate on the date of distribution from CFC2 to CFC1, results in 200u of subpart F income of CFC1 that is included in USP’s income in the election year.

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The result with respect to the 100u of the subpart F inclusion and resulting PTI that CFC1 distributes to USP in the election year are the same as in Example 6. USP’s subpart F inclusion with respect to the remaining 100u of CFC1’s subpart F income that is not distributed is $90 (100u translated at the average exchange rate of 1u = $.90). CFC1’s distribution of the remaining 100u of PTI to USP after the election year is not subject to the rules of this notice and may give rise to currency gain or loss under section 986(c).