SECTION 2. BACKGROUND

The term PTEP refers to earnings and profits (“E&P”) of a foreign corporation attributable to amounts which are, or have been, included in the gross income of a United States shareholder (as defined under section 951(b)) (“U.S. shareholder”) under section 951(a) or under section 1248(a). See sections 959(a) and (e). Under section 959(a)(1), distributions of PTEP are excluded from the U.S. shareholder’s gross income, or the gross income of any other U.S. person who acquires the U.S. shareholder’s interest (or a portion thereof) in the foreign corporation (such U.S. person, a “successor in interest”). Section 959(a)(2) further excludes PTEP from a U.S. shareholder’s gross income if such E&P would be included in the gross income of the U.S. shareholder or successor in interest under section 951(a)(1)(B) as an amount determined un

der section 956. Distributions of PTEP to a U.S. shareholder or successor in interest generally are not treated as dividends except that such distributions immediately reduce the E&P of the foreign corporation. Section 959(d).

Section 959(c) ensures that distributions from a foreign corporation are first attributable to PTEP described in section 959(c)(1) (“section 959(c)(1) PTEP”) and then to PTEP described in section 959(c)(2) (“section 959(c)(2) PTEP”), and finally to non-previously taxed E&P (“section 959(c)(3) E&P”). In addition, section 959(f) ensures that, in determining the amount of any inclusion under sections 951(a)(1)(B) and 956 with respect to a foreign corporation, PTEP attributable to section 951(a)(1)(A) inclusions remaining after any distributions during the year are taken into account before nonpreviously taxed E&P described in section 959(c)(3). On August 29, 2006, a notice of proposed rulemaking (REG–121509–00) was published in the Federal Register (71 FR 51155) relating to the exclusion from gross income of PTEP and associated basis adjustments, corrections to which were published in the Federal Register on December 8, 2006 (71 FR 71116) (together, the “2006 proposed regulations”). The 2006 proposed regulations were intended to address some of the complexities and open issues regarding the application of sections 959 and 961 that are not specifically addressed in the current final regulations, which were originally published in 1965 and were amended in 1974, 1978, and 1983. See TD 6795 (1965–1 C.B. 287); TD 7334 (1975–1 C.B. 246); TD 7545 (1978–1 C.B. 245); TD 7893 (1983–1 C.B. 132). The 2006 proposed regulations have not been finalized. The Treasury Department and the IRS intend to withdraw the 2006 proposed regulations and to issue new proposed regulations under sections 959 and 961.

Under proposed § 1.959–3(b), shareholders must account for PTEP with respect to their stock in a foreign corporation, and foreign corporations must account for the aggregate amount of PTEP of all shareholders, as well as section 959(c)(3) E&P. Before the Act, annual accounts generally were

maintained for each separate category of income described in section 904(d)(1) and segregated between section 959(c)(1) PTEP and section 959(c)(2) PTEP. See Notice 88– 71, 1988–2 C.B. 374. Section 959(c)(1) PTEP consisted of E&P previously included in gross income under sections 951(a)(1)(B) and (C), and section 959(c)(2) PTEP consisted of E&P previously included in gross income under section 951(a)(1)(A) or amounts included in gross income as a dividend under section 1248. See § 1.959– 3(b)(1) and (2); see also proposed § 1.959– 3(e)(2). Section 959(c)(1) PTEP also included E&P that had been originally classified as section 959(c)(2) PTEP and was reclassified as section 959(c)(1) PTEP because it reduced the amount of an income inclusion under section 951(a)(1)(B) or section 951(a)(1)(C) (before its repeal) pursuant to section 959(a)(2) or section 959(a)(3) (before its repeal). See § 1.959–3(b).

Under the provisions of the Act, the portion of a U.S. shareholder’s global intangible low-taxed income (“GILTI”) included in gross income under section 951A(a) that is allocated to a controlled foreign corporation (as defined in section 957) (“CFC”) under section 951A(f)(2) and proposed § 1.951A–6(b)(2) is treated as an amount included in the gross income of a U.S. shareholder under section 951(a)(1)(A) for purposes of section 959. Section 951A(f)(1). Likewise, amounts determined under section 965(a), as amended by the Act, with respect to certain foreign corporations are treated as increases to subpart F income, and a U.S. shareholder with respect to such a foreign corporation generally includes in gross income under section 951(a)(1)(A) its pro rata share of such amounts, subject to reduction under section 965(b) for certain deficits attributable to stock in another foreign corporation owned by the U.S. shareholder. Amounts of a U.S. shareholder’s inclusions under section 965(a) that are reduced by deficits attributable to stock of another foreign corporation under section 965(b) are treated as amounts included in the shareholder’s gross income under section 951(a) for purposes of section 959. Section 965(b)(4)(A). Additionally, section 245A(e)(2) treats certain hybrid dividends received by a CFC as subpart F income for purposes of section 951(a)(1)(A).

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Finally, section 964(e)(4) treats a certain portion of gain on the disposition of CFC stock as subpart F income of the selling CFC for purposes of section 951(a)(1)(A). Accordingly, after the Act, section 959(c)(2) PTEP may arise from income inclusions under section 951(a)(1)(A) (including by reason of section 245A(e)(2), 951A(f)(1), 959(e), 964(e)(4), or 965(a)) or by reason of the application of section 965(b)(4)(A).

Section 965 and proposed regulations under that section provide special foreign tax credit and deduction rules, and proposed regulations under section 986 provide special foreign currency gain or loss rules, for distributions of PTEP attributable to income inclusions arising from the application of section 965(a) and PTEP attributable to the application of section 965(b)(4)(A) (collectively, “section 965 PTEP”). See proposed §§ 1.965–5 and 1.986(c) –1. Section 245A(e)(3) applies the disallowance of foreign tax credits in section 245A(d) with respect to any amount included in the income of a U.S. shareholder pursuant to section 245A(e)(2).

In addition, proposed regulations under section 960 establish, for purposes of determining the amount of foreign income taxes deemed paid, a system of accounting for PTEP in annual accounts for each separate category of income as defined in proposed § 1.904–5(a)(4)(v) (“section 904 category”) and further segregate each annual account among ten PTEP groups. Proposed § 1.960–3(c). The groups correspond to various types of income inclusions under section 951(a) (including amounts treated as giving rise to an income inclusion under section 951(a) for purposes of section 959) and PTEP reclassifications that can arise after the Act.

Finally, certain provisions of the Act provide for a deduction with respect to certain amounts that are included in the income of a domestic corporation and treated as section 951(a)(1)(A) inclusions for purposes of section 959. Sections 245A and 1248(j) generally allow a deduction with respect to gain on the sale of stock of a foreign corporation treated as a dividend under section 1248. In the case of gain treated as a dividend under section 964(e)(1) upon the sale or exchange by a CFC of stock of a lower tier foreign corporation and included in the CFC’s subpart F income under section 964(e)(4),

section 964(e)(4) generally allows a deduction under section 245A with respect to a domestic corporation’s pro rata share of the subpart F income that it includes in gross income as a dividend pursuant to section 964(e)(4).