SECTION 3. REGULATIONS — Internal Revenue Bulletin 2018-6

ISSUED ADDRESSING THE APPLICATION OF SECTION 965

.01 Determination of Status of a Specified Foreign Corporation as a DFIC or an E&P Deficit Foreign Corporation

The Treasury Department and the IRS intend to issue regulations providing that, for purposes of determining the status of a specified foreign corporation as a DFIC or an E&P deficit foreign corporation, it must first be determined whether the specified foreign corporation is a DFIC. If the specified foreign corporation meets the definition of a DFIC, it is classified solely as a DFIC and not also as an E&P deficit foreign corporation, even if such specified foreign corporation otherwise satisfies the requirements of section 965(b)(3)(B). If a specified foreign corporation does not

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alternative method is made, the amount of the post-1986 earnings and profits (including a deficit) of a specified foreign corporation (other than a specified foreign corporation with a 52–53-week taxable year described in § 1.441–2(a)(1)) as of November 2, 2017, will equal the sum of (1) the corporation’s post-1986 earnings and profits as of October 31, 2017, and (2) the corporation’s annualized earnings and profits amount. For this purpose, the term “annualized earnings and profits amount” means, with respect to a specified foreign corporation, the amount equal to the product of two (the number of days after October 31, 2017, and on or before the measurement date on November 2, 2017) multiplied by the daily earnings amount of the specified foreign corporation. The term “daily earnings amount” means, with respect to a specified foreign corporation, the post-1986 earnings and profits (including a deficit) of the specified foreign corporation as of the close of October 31, 2017, that were earned (or incurred) during the specified foreign corporation’s taxable year that includes October 31, 2017, divided by the number of days that have elapsed in such taxable year as of the close of October 31, 2017. A specified foreign corporation that does not have a 52–53-week taxable year described in § 1.441–2(a)(1) may not determine its post-1986 earnings and profits under the alternative method with respect to the measurement date on December 31, 2017.

In the case of a specified foreign corporation that has a 52–53-week taxable year described in § 1.441–2(a)(1), an election may be made to use the alternative method to determine its post-1986 earnings and profits as of both measurement dates based on the amount of post-1986 earnings and profits (including a deficit) as of the closest end of a fiscal month to each measurement date consistent with the principles of the preceding paragraph. For example, if the closest end of a fiscal month of a specified foreign corporation that has a 52–53-week taxable year occurs after an applicable measurement date, the annualized earnings amount will be subtracted from (rather than added to) the post-1986 earnings and profits of the specified foreign corporation as of such fiscal month end. For a specified foreign corporation with a 52–53-week taxable year, in

meet the definition of a DFIC, the United States shareholder must then determine whether it is an E&P deficit foreign corporation. In some cases, as illustrated in Example 2, a specified foreign corporation may be classified as neither a DFIC nor an E&P deficit foreign corporation, despite having post-1986 earnings and profits greater than zero or a deficit in accumulated post-1986 deferred foreign income.

Example 1 . (i) Facts . USP, a domestic corporation, owns all of the stock of FS, a foreign corporation. As of November 2, 2017, FS has a deficit in post-1986 earnings and profits of 150u. As of December 31, 2017, FS has 200u of post-1986 earnings and profits. FS does not have previously taxed income or effectively connected income for any taxable year.

(ii) Analysis . Because FS, a specified foreign corporation, does not have previously taxed income or effectively connected income for any taxable year, FS’s accumulated post-1986 deferred foreign income is equal to its post-1986 earnings and profits. Because FS has accumulated post-1986 deferred foreign income as of December 31, 2017, FS is a DFIC. See section 965(d)(1). Accordingly, FS is not an E&P deficit foreign corporation.

Example 2 . (i) Facts . USP, a domestic corporation, owns all of the stock of FS, a foreign corporation. As of both November 2, 2017, and December 31, 2017, FS has 100u of previously taxed income described in section 959(c)(2) and a deficit of 90u in earnings and profits described in section 959(c)(3), all of which were accumulated in taxable years beginning after December 31, 1986, while FS was a specified foreign corporation. Accordingly, as of both November 2, 2017, and December 31, 2017, FS has 10u of post-1986 earnings and profits.

(ii) Analysis . (A) Determination of status as a DFIC . For purposes of determining whether FS is a DFIC, a determination must be made whether FS has accumulated post-1986 deferred foreign income greater than zero as of either November 2, 2017, or December 31, 2017. Under section 965(d)(2), FS’s accumulated post-1986 deferred foreign income is its post-1986 earnings and profits, except to the extent such earnings are effectively connected income or previously taxed income. Disregarding FS’s 100u of previously taxed income, FS has a 90u deficit in accumulated post-1986 deferred foreign income as of both November 2, 2017, and December 31, 2017. Accordingly, FS does not have accumulated post-1986 deferred foreign income greater than zero as of either measurement date and therefore FS is not a DFIC.

(B) Determination of status as an E&P deficit foreign corporation . For purposes of determining whether FS is an E&P deficit foreign corporation, a determination must be made whether FS has a deficit in post-1986 earnings and profits as of November 2, 2017. As described in paragraph (i) of this Example 2, FS has 10u of post-1986 earnings and profits as of both November 2, 2017, and December 31, 2017. As a result, FS does not have a deficit in post-1986 earnings and profits as of November 2, 2017, and therefore FS is not an E&P deficit foreign corpora

tion. Accordingly, FS is neither a DFIC nor an E&P deficit foreign corporation.

.02 Alternative Method for Calculating Post-1986 Earnings and Profits

The Act provides that the earnings and profits of a specified foreign corporation must be determined as of two measurement dates and “in accordance with sections 964(a) and 986.” See section 965(a) and (d)(3). Consistent with this requirement, the Treasury Department and the IRS have determined that, for purposes of measuring the post-1986 earnings and profits of a specified foreign corporation as of a measurement date, the extent to which an item of income, deduction, gain, or loss is taken into account as of such measurement date must generally be determined under principles applicable to the calculation of earnings and profits, including the application of sections 312 and 964.

For purposes of determining whether a specified foreign corporation is a DFIC and for purposes of determining a DFIC’s section 965(a) earnings amount, the actual post-1986 earnings and profits of the specified foreign corporation must be determined as of the close of both November 2, 2017, and December 31, 2017. In addition, for purposes of determining whether a specified foreign corporation is an E&P deficit foreign corporation and for purposes of determining the amount of the specified E&P deficit of an E&P deficit foreign corporation, the actual post-1986 earnings and profits (including a deficit) of the specified foreign corporation must be determined as the close of November 2, 2017. However, the Treasury Department and the IRS recognize that it may be impractical for taxpayers to determine the post-1986 earnings and profits of a specified foreign corporation as of a measurement date that does not fall on the last day of a month. Therefore, the Treasury Department and the IRS intend to issue regulations providing that an election may be made to determine a specified foreign corporation’s post-1986 earnings and profits as of a measurement date based on the amount of post-1986 earnings and profits (including a deficit) as of another date as provided in this section 3.02 (the “alternative method”). If an election to use the

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order to use the alternative method for any measurement date, the election must be made for both measurement dates.

The IRS intends to issue forms, publications, regulations, or other guidance that will specify the manner and timing of an election to use the alternative method.

Example . (i) Facts . FS, a foreign corporation, has a calendar year taxable year and as of October 31, 2017, FS has post-1986 earnings and profits of 10,000u, 3,040u of which were earned during the taxable year that includes October 31, 2017. An election is made for FS to determine its post-1986 earnings and profits under the alternative method.

(ii) Analysis . As of the close of October 31, 2017, 304 days have elapsed in the taxable year of FS that includes October 31, 2017. Therefore, FS’s daily earnings amount is 10u (3,040u divided by 304), and FS’s annualized earnings and profits amount is 20u (10u multiplied by 2). Accordingly, FS’s post-1986 earnings and profits as of November 2, 2017, are 10,020u (its post-1986 earnings and profits as of October 31, 2017 (10,000u), plus its annualized earnings and profits amount (20u)).

.03 Treatment of Deficits

(a) Allocation of Deficits to Different Classes of Stock

For purposes of determining the amount of a United States shareholder’s aggregate foreign E&P deficit, the aggregate of such shareholder’s pro rata shares of the specified E&P deficits of the E&P deficit foreign corporations of such shareholder must be determined. Section 965(f)(1) provides that, in determining a United States shareholder’s pro rata share of “any amount with respect to any specified foreign corporation,” rules similar to section 951(a)(2) shall be applied. Section 1.951–1(e) provides guidance with respect to allocating subpart F income among multiple classes of stock but does not address deficits.

The Treasury Department and the IRS intend to issue regulations providing that, for purposes of determining a United States shareholder’s pro rata share of the specified E&P deficit of an E&P deficit foreign corporation that has multiple classes of stock outstanding, the specified E&P deficit is allocated first among the shareholders of the corporation’s common stock and in proportion to the value of the common stock held by such shareholders.

(b) Treatment of Hovering Deficits

The Conference Report accompanying the Act provides that “the amount of post

1986 earnings and profits of a specified foreign corporation is the amount of positive earnings and profits accumulated as of the measurement date reduced by any deficit in earnings and profits of the specified foreign corporation as of the measurement date, without regard to the limitation category of the earnings or deficit.” H.R. Rep. No. 115–466, at 618. The Conference Report clarifies that, for this purpose, the term “deficit” includes a hovering deficit (as defined in § 1.367(b)– 7(d)(2)(i)), with the following example:

For example, assume that a foreign corporation organized after December 31, 1986 has $100 of accumulated earnings and profits as of November 2, 2017, and December 31, 2017 . . . which consist of $120 general limitation earnings and profits and a $20 passive limitation deficit, the foreign corporation’s post-1986 earnings and profits would be $100, even if the $20 passive limitation deficit was a hovering deficit.

Id. at 619. Consistent with the Conference Report, the Treasury Department and the IRS intend to issue regulations clarifying that all deficits related to post-1986 earnings and profits, including hovering deficits, are taken into account for purposes of determining the post-1986 earnings and profits (including a deficit) of a specified foreign corporation.

.04 Determination of Aggregate Foreign Cash Position

(a) Definitions for Determining Net Accounts Receivable

Section 965(c)(3)(C) does not define the term “accounts receivable” for purposes of the term “net accounts receivable.” The Treasury Department and the IRS intend to issue regulations providing that, for purposes of section 965(c)(3)(C), the term “accounts receivable” means receivables described in section 1221(a)(4), and the term “accounts payable” means payables arising from the purchase of property described in section 1221(a)(1) or 1221(a)(8) or the receipt of services from vendors or suppliers. Receivables that are treated as accounts receivable within the meaning of section 965(c)(3)

(C)(i) will not also be treated as shortterm obligations.

(b) Treatment of Demand Obligations

Section 965(c)(3)(B) provides that the “cash position” of a specified foreign corporation includes the fair market value of any short-term obligation. The Treasury Department and the IRS intend to issue regulations providing that, for purposes of determining a specified foreign corporation’s cash position, a loan that must be repaid on the demand of the lender (or that must be repaid within one year of such demand) will be treated as a short-term obligation, regardless of the stated term of the instrument.

.05 Translation Rules

(a) Comparison of Accumulated Post- 1986 Deferred Foreign Income as of the Measurement Dates

Generally, determinations made under subtitle A of the Code must be made in a taxpayer’s functional currency. See section 985(a). For purposes of determining the tax under subtitle A of the Code of any shareholder of a foreign corporation, the earnings and profits of such corporation must be determined in the corporation’s functional currency. See section 986(b) (1). Accordingly, the Treasury Department and the IRS intend to issue regulations providing that, for purposes of determining the section 965(a) earnings amount of a specified foreign corporation, the accumulated post-1986 deferred foreign income of the specified foreign corporation as of each of the measurement dates must be compared in the functional currency of the specified foreign corporation. If the functional currency of a specified foreign corporation changes between the two measurement dates, the comparison must be made in the functional currency of the specified foreign corporation as of December 31, 2017, by translating the specified foreign corporation’s earnings and profits as of November 2, 2017, into the new functional currency using the spot rate on November 2, 2017. For purposes of this notice, the term “spot rate” has the meaning described in § 1.988– 1(d).

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tion with the “v” as its functional currency; CFC3, a DFIC with the “y” as its functional currency; and CFC4, a DFIC with the “z” as its functional currency. USP, CFC1, CFC2, CFC3, and CFC4 each have a calendar year taxable year. As of December 31, 2017, 1u�$1, .75v�$1, .50y�$1, and .25z�$1. CFC1 has a specified E&P deficit of 100u, CFC2 has a specified E&P deficit of 120v, CFC3 has a section 965(a) earnings amount of 50y, and CFC4 has a section 965(a) earnings amount of 75z.

(ii) Analysis . (A) For purposes of applying section 965(b), the section 965(a) earnings amount of each of CFC3 and CFC4 translated into U.S. dollars at the spot rate on December 31, 2017, is $100 (50y at .50y�$1) and $300 (75z at .25z�$1), respectively. Furthermore, USP’s pro rata share of the section 965(a) earnings amounts, as translated, is $100 and $300, respectively, or 100% of each section 965(a) earnings amount.

(B) For purposes of applying section 965(b), the specified E&P deficit of each of CFC1 and CFC2 translated into U.S. dollars at the spot rate on December 31, 2017, is $100 (100u at 1u�$1) and $160 (120v at .75v�$1), respectively. Furthermore USP’s pro rata share of each specified E&P deficit, as translated, is $100 and $160, respectively, or 100% of each specified E&P deficit. Therefore, USP’s aggregate foreign E&P deficit is $260.

(C) For purposes of applying section 965(b), USP’s aggregate foreign E&P deficit of $260 is allocated $65 to reduce the amount that USP would otherwise take into account under section 951(a)(1) by reason of section 965 with respect to CFC3 ($260 � ($100/$400)) and allocated $195 to reduce the amount that USP would otherwise take into account under section 951(a)(1) by reason of section 965 with respect to CFC4 ($260 - ($300/ 400)). After reduction under section 965(b)(1), the section 965(a) inclusion amount of USP with respect to CFC3 is $35 ($100 - $65) and the section 965(a) inclusion amount of USP with respect to CFC4 is $105 ($300 – $195). The previously taxed income of CFC3 and CFC4 resulting from the section 965(a) inclusion amounts included in gross income by USP, translated into the respective functional currencies of CFC3 and CFC4 at the spot rate on December 31, 2017, are 17.5y ($35 at .50y�$1) and 26.25z ($105 at .25z�$1), respectively.

(D) For purposes of determining the previously taxed income of each of CFC3 and CFC4 under section 965(b)(4)(A) as a result of the reduction to USP’s section 965(a) inclusion amounts with respect to CFC3 and CFC4, the amounts of the aggregate foreign E&P deficit of USP are allocated to each of CFC3 and CFC4 under section 965(b)(2), which translated into the respective functional currencies of CFC3 and CFC4 at the spot rate on December 31, 2017, are 32.5y ($65 at .50y�$1) and 48.75z ($195 at .25z�$1), respectively.

The Treasury Department and the IRS intend to issue regulations providing that

(b) Determination of the Amount of Inclusion Under Section 951(a)(1) by Reason of Section 965

In the case of any United States person, the earnings and profits determined under section 986(b)(1) when distributed, deemed distributed, or otherwise taken into account are translated into U.S. dollars using the appropriate exchange rate for purposes of determining the tax on such earnings under subtitle A of the Code. See section 986(b) (2). Generally, except as provided in regulations, section 989(b) sets forth the appropriate exchange rate. In the case of an actual distribution of earnings and profits or an actual or deemed sale or exchange of stock in a foreign corporation treated as a dividend under section 1248, the appropriate exchange rate is the spot rate on the date such distribution or deemed dividend is included into income. Section 989(b)(1) and (2). In the case of subpart F income included in income by a United States shareholder under section 951(a)(1)(A), the appropriate exchange rate is the average exchange rate for the taxable year of the foreign corporation. Section 989(b)(3). Any amounts included in income under section 951(a)(1) (B) (inclusions under section 956) are treated for this purpose as distributions made on the last day of the taxable year for which such amounts were so included, and accordingly translated at the spot rate on the last day of such taxable year. Section 989(b). In order to calculate the section 965(a) inclusion amount of a United States shareholder with respect to a DFIC, the United States shareholder’s pro rata shares of the section 965(a) earnings amounts of its DFICs and the specified E&P deficits of its E&P deficit foreign corporations must be translated into U.S. dollars. The Treasury Department and the IRS have determined that the spot rate on December 31, 2017, is the appropriate exchange rate for purposes of translating these amounts, regardless of a specified foreign corporation’s taxable year or the applicable measurement date, because it is the date on which a specified foreign corporation’s post-1986 earnings and profits becomes fixed and immediately precedes the transition to the participation exemption under section 245A. Furthermore, a single spot rate on December 31, 2017, is more ad

ministrable for the IRS and less burdensome for taxpayers than the yearly average approach of section 989(b)(3) because under the yearly average approach, certain amounts required for the determination of the section 965(a) inclusion amount of a United States shareholder (for example, the United States shareholder’s aggregate foreign E&P deficit) would not be determinable until the last closing of an inclusion year of a specified foreign corporation of the United States shareholder.

Accordingly, the Treasury Department and the IRS intend to issue regulations providing that the appropriate exchange rate under section 989(b) for translating the section 965(a) earnings amount will be the spot rate on December 31, 2017. The regulations will also provide that the spot rate on December 31, 2017, will apply for purposes of translating other amounts necessary for the application of section 965(b), including (1) translating a section 965(a) earnings amount into U.S. dollars in computing amounts described in section 965(b)(2)(A) and (B), (2) translating a specified E&P deficit into U.S. dollars in order to determine a United States shareholder’s aggregate foreign E&P deficit under section 965(b)(3)(A), (3) translating a section 965(a) inclusion amount with respect to a DFIC (if such amount was reduced by an aggregate foreign E&P deficit under section 965(b)(1)) back into the functional currency of the DFIC for purposes of determining the previously taxed income of the DFIC, and (4) translating the portion of the U.S. dollar-denominated aggregate foreign E&P deficit allocated to a DFIC under section 965(b)(2) into the functional currency of the DFIC for purposes of determining its previously taxed income under section 965(b)(4)(A).

The regulations will also provide that, for purposes of section 986(c), foreign currency gain or loss with respect to distributions of previously taxed income described in section 959(c)(2) by reason of section 965 will be determined based on movements in the exchange rate between December 31, 2017, and the date on which such previously taxed earnings and profits are actually distributed.

Example . (i) Facts . As of November 2, 2017, and December 31, 2017, USP, a domestic corporation, owns all of the stock of CFC1, an E&P deficit foreign corporation with the “u” as its functional currency; CFC2, an E&P deficit foreign corpora

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the cash position of a specified foreign corporation with respect to any cash measurement date must be expressed in U.S. dollars. Therefore, the amount of a United States shareholder’s aggregate foreign cash position will be the greater of the U.S. dollardenominated aggregate amounts on each cash measurement date described in section 965(c)(3)(A). In determining the cash position attributable to net accounts receivable, the amount of accounts receivables and accounts payables (in each case, if not otherwise denominated in U.S. dollars) must be translated into U.S. dollars at the spot rate on the relevant cash measurement date. The fair market value of assets described in section 965(c)(3)(B)(iii) must also be determined in U.S. dollars on the relevant cash measurement date. For example, in the case of foreign currency, the fair market value will equal the currency amount translated at the spot rate on the relevant cash measurement date.