SECTION 4. EFFECTIVE DATE

The regulations described in section 3 of this notice will apply to foreign income taxes paid on or after September 15, 2016.

(1) section 316(a)(2) earnings; (2) in the separate category or catego ries to which covered tax is assigned; and (3) attributable to all activities that gave

rise to income (computed under foreign law) included in the adjusted foreign tax base (as defined in section 3.01 of this notice), regardless of which particular activities gave rise to the adjustment. If foreign income tax is imposed on the combined income (within the meaning of §1.901–2(f)(3)(ii)) of two or more entities, including for this purpose disregarded entities, the principles of these rules will apply on an entity-by-entity basis.

Each covered distribution will be treated as resulting in a distribution of initial related income to the recipient on a pro rata basis under the principles of §1.909–6(d)(3). The recipient of initial related income in a covered distribution is treated as having taken into account “related income” in the taxable year in which the covered distribution was made. The principles of §1.909–6(d) will apply to determine the amount of related income of the recipient of the covered distribution that is transferred to other persons or taken into account by a section 902 shareholder or the payor section 902 corporation after the covered distribution was made, in a taxable year before the splitter year.

In the case of a splitter arrangement described in this section 3.02, “split taxes” are the covered taxes multiplied by a ratio, the numerator of which is the total amount of related income as of the beginning of the splitter year (appropriately reduced for any amounts taken into account prior to the splitter year by a section 902 shareholder or the payor section 902 corporation), and the denominator of which is the payor’s (or any predecessor corporation’s) initial related income.

The following examples illustrate the regulations described in this section 3.02. All dollar amounts in these examples are in millions.

Example 1 . (i) Facts . USP, a domestic corporation, wholly owns CFC1. CFC1 wholly owns CFC2. CFC1 and CFC2 are foreign corporations that were formed at the beginning of Year 1, are resident in Country X, and use the U.S. dollar as their functional currency. For each of Years 1 through 9, CFC2 earns $100 of earnings and profits with respect to which it

does not accrue or pay any foreign income tax. In Year 10, CFC2 earns $120 of earnings and profits with respect to which it accrues and pays $20 of foreign income tax. Its post-1986 undistributed earnings as of the end of Year 10 are $1,000 (($100 � 9)

• $120 – $20). On July 1, Year 11, CFC2 distributes $750 of its post-1986 undistributed earnings to CFC1. Pursuant to section 954(c)(6), CFC1’s $750 of dividend income does not result in an income inclusion to USP. In Year 12, after having exhausted all available and practical remedies to minimize its liability for Country X tax, CFC2 pays $20 of foreign income tax to Country X with respect to each of Years 1 through 9 to settle related audit adjustments proposed by Country X. Pursuant to section 905(c), CFC2 adds $180 of additional tax relating to Years 1 through 9 to its pool of post-1986 foreign income taxes in Year 12. CFC2 does not earn any other income or pay any other foreign tax in Years 11 and

12. CFC2’s post-1986 undistributed earnings as of the beginning of Year 12 are $250 ($1,000 - $750).

(ii) Splitter arrangement . The distribution of $750 to CFC1 in Year 11 and the payment of $180 of foreign income taxes in Year 12 will give rise to a splitter arrangement under section 3.02 of this notice, unless USP rebuts the presumption that the distribution was made with a principal purpose of reducing CFC2’s post-1986 undistributed earnings in advance of the payment of the $180 of covered taxes. The $180 of foreign income taxes paid are covered taxes because (1) they are added to CFC2’s pool of post-1986 foreign income taxes in Year 12 pursuant to section 905(c), and (2) they result from a specified foreign-initiated adjustment with respect to one or more relation-back years. The $20 of foreign income taxes previously accrued and paid with respect to Year 10 are not covered taxes because they did not result from a foreign-initiated adjustment. Unless USP establishes by clear and convincing evidence that the $750 distribution in Year 11 was not made with a principal purpose to reduce CFC2’s post-1986 undistributed earnings in advance of the payment of covered taxes, the distribution is a covered distribution because it (1) occurred in or after Years 1 through 9, the relation-back years with respect to the covered taxes, and in a taxable year preceding Year 12, the year in which the covered taxes were paid, (2) resulted in a distribution of $750 of CFC2’s post-1986 undistributed earnings to CFC1, a section 902 covered person with respect to CFC2, and (3) is presumed to have a principal purpose to reduce CFC2’s post-1986 undistributed earnings in advance of the payment of covered taxes because it is greater than 50 percent of CFC2’s post-1986 undistributed earnings as of the beginning of Year 12 plus the distribution ($750 - 0.50 ($250 - $750)).

(iii) Related income . The initial related income in the hands of CFC2 is $900, which is the sum of CFC2’s section 316(a)(2) earnings for Years 1 through 9, all of which were attributable to activities that gave rise to income included in the adjusted foreign tax base of CFC2. Under the principles of §1.909–6(d), the covered distribution of $750 in Year 11 results in a pro rata distribution of initial related income of $675 ($750 - ($900/$1000)). Therefore, CFC1 is treated as taking into account related income equal to $675 in Year 11, the year of

October 3, 2016 428 Bulletin No. 2016–40

the monthly yield curve in place of the segment rates.

Notice 2007–81, 2007–44 I.R.B. 899, provides guidelines for determining the monthly corporate bond yield curve, and the 24-month average corporate bond segment rates used to compute the target normal cost and the funding target. Consistent with the methodology specified in Notice 2007–81, the monthly corporate bond yield curve derived from August 2016 data is in Table I at the end of this notice. The spot first, second, and third segment rates for the month of August 2016 are, respectively, 1.39, 3.27, and 4.18. The 24-month average segment rates determined under §430(h)(2)(C)(i) through (iii) must be adjusted pursuant to §430(h) (2)(C)(iv) to be within the applicable minimum and maximum percentages of the corresponding 25-year average segment rates. For plan years beginning before 2021, the applicable minimum percentage is 90% and the applicable maximum percentage is 110%. The 25-year average segment rates for plan years beginning in 2015 and 2016 were published in Notice 2014–50, 2014–40 I.R.B. 590 and Notice 2015–61, 2015–39 I.R.B. 408, respectively. For plan years beginning in 2017, based on the segment rates applicable for October 1991 to September 2016, the 25year averages for the period ending September 30, 2016, of the first, second, and third segment rates are 4.62, 6.35, and 7.20 percent, respectively.

24-MONTH AVERAGE CORPORATE BOND SEGMENT RATES

The three 24-month average corporate bond segment rates applicable for September 2016 without adjustment for the 25-year average segment rate limits are as follows:

Third Segment