SECTION 5. DISALLOWANCE

OF DEDUCTIONS FOR CERTAIN EXPENSES RELATED TO DEDUCTIBLE PORTION OF QUALIFYING DIVIDENDS

.01 Expenses Incurred by Taxpayer

The disallowance of deductions for expenses under section 965(d)(2) applies only to expenses that are directly allocable to the deductible portion of qualifying dividends. See section 9.01 of Notice 2005–38. Therefore, section 965(d)(2) disallows a deduction for 85 percent of directly allocable expenses, which are those expenses that relate directly to generating qualifying dividends. These expenses are:

(a) Stewardship expenses described in Treas. Reg. §1.861–8(e)(4) that are definitely related and allocable to qualifying dividends;

(b) Legal, tax, accounting, consulting and similar fees and expenses, including

expenses for employee compensation, for the rendering of advice and the preparation of documents directly related to (i) plans to repatriate earnings in the election year, including the determination of the potentially eligible amount of qualifying dividends, the decision to repatriate earnings from particular CFCs, and the identification of particular distributions as cash dividends, qualifying dividends, or other amounts, (ii) the adoption and approval of a domestic reinvestment plan, and (iii) the declaration and payment of qualifying dividends;

(c) Fees and expenses related to tax accounting and reporting for qualifying dividends in the election year; and

(d) Wire transfer, currency exchange, and similar fees incurred in connection with the payment of qualifying dividends.

For purposes of this section 5.01, only a pro rata portion of stewardship expenses accrued in the election year with respect to each CFC in which the taxpayer is a U.S. shareholder is considered definitely related and allocable to qualifying dividends. The pro rata portion is the amount that bears the same ratio to the stewardship expenses as the qualifying dividends paid by a CFC bear to the total amount of dividends and subpart F inclusions included in the U.S. shareholder’s income with respect to that CFC and subpart F inclusions attributable to stock of any other CFCs held indirectly by the U.S. shareholder in the same chain of ownership described in section 958(a) in the election year. Deductions for other directly allocable expenses described in the preceding paragraph are subject to disallowance in the year paid or accrued, whether that year is the election year or a different taxable year.

Deductions for the allowable 15 percent portion of expenses that are directly allocable to qualifying dividends are allocated and apportioned in accordance with the generally applicable rules of sections 861 through 865 and the regulations thereunder. See section 6 of this notice.

The disallowance of deductions under section 965(d)(2) does not extend to expenses that, while treated as definitely related to the production of income in a category that includes qualifying dividends, do not relate directly to generating qualifying dividends. Expenses described in the preceding sentence include interest expense, research and experimental expenses, gen

September 6, 2005 478 2005–36 I.R.B.

such excess will reduce foreign source income attributable to nondeductible CFC dividends in the separate category to the extent thereof, and any excess deductions will constitute a separate limitation loss described in section 904(f)(5). See section 8 of this notice for rules relating to the allocation and recapture of separate limitation losses in the election year and subsequent years.

The amount of qualifying dividends eligible for the DRD, the amount of nondeductible CFC dividends described in section 965(e)(3), and the amount of taxable income for the election year are determined without regard to the manner in which deductible expenses are allocated and apportioned in the election year. Therefore, the amount of the section 965(a) DRD, the amount of foreign taxes and expenses for which credit or deduction is disallowed under section 965(d), the amount of taxable income determined under section 965(e)(2)(A), and the allowable NOL deduction determined under section 965(e)(2)(B) are not affected if nondeductible CFC dividends in a separate category are reduced or eliminated by reason of the allocation and apportionment of expenses pursuant to sections 861 through 865 and the regulations thereunder and this section 6.

.04 Examples

The following examples illustrate the application of this section 6. Expenses described in the examples do not include any expenses for which a deduction is disallowed under section 965(d)(2) or any other applicable Code provision.

Example 1. Separate limitation income exceeds nondeductible CFC dividends . (i) Facts . USP has the following items of gross income and expense for the election year: $1,200 of foreign source general limitation gross income, including $1,000 of qualifying dividends, $1,000 of expenses allocated and apportioned to general limitation income (including the 85 percent DRD of $850, which pursuant to section 3.03 of this notice is allocated to reduce general limitation income), $300 of U.S. source gross income, and $100 of expenses allocated and apportioned to U.S. source income. Accordingly, USP has $400 of taxable income and $150 of nondeductible CFC dividends in the election year, and the taxable income limitation of section 965(e)(2)(A) does not apply.

(ii) Result . Under section 6.03 of this notice, general limitation expenses are considered to reduce other general limitation income before reducing nondeductible CFC dividends. Accordingly, USP has $200 of foreign source general limitation taxable

eral and administrative expenses, depreciation and amortization, sales and marketing expenses, state and local taxes, and any other expenses not described in the first paragraph of this section 5.01. In addition, legal, tax, accounting, consulting, and similar fees and expenses related to the implementation of investments in the United States contemplated by a domestic reinvestment plan are not considered directly allocable to qualifying dividends.

.02 Expenses Incurred by CFCs

Deductions for expenses properly incurred by CFCs that are otherwise deductible in computing subpart F income and earnings and profits are not limited by section 965(d)(2).