SECTION 2. BACKGROUND

Section 961(a) provides that, under regulations prescribed by the Secretary, the basis that a United States shareholder (as defined in section 951(b)) has in stock of a CFC, and the basis of property of a United States shareholder by reason of which the shareholder is considered under section 958(a)(2) as owning stock of a CFC, is increased by the amount required to be included in its gross income under section 951(a) with respect to such stock or with respect to such property, as the case may be, but only to the extent to which such amount was included in the gross income of such United States shareholder. Section 951A(f)(1) and §1.951A-5(b)(1) provide that an amount included in a United States shareholder’s gross income as a GILTI inclusion amount is treated in the same manner as an amount included under section 951(a) for purposes of applying section 961.

Section 961(b) provides that, under regulations prescribed by the Secretary, the basis of stock or other property with respect to which a United States shareholder or a United States person receives an amount that is excluded from gross

income under section 959(a) is reduced by the amount so excluded. Section 961(b)(1). To the extent that an amount excluded from gross income under section 959(a) exceeds the basis of the stock or other property with respect to which it is received, the amount is treated as gain from the sale or exchange of property. Section 961(b)(2).

Section 961(c) provides that, under regulations prescribed by the Secretary, if a United States shareholder is treated under section 958(a)(2) as owning stock in a CFC that is owned by another CFC, then adjustments similar to the adjustments provided by section 961(a) and (b) are made to the basis of such stock, and the basis of stock in any other CFC by reason of which the United States shareholder is considered under section 958(a)(2) as owning the stock of the first mentioned CFC, but only for the purpose of determining the amount included under section 951 in the gross income of such United States shareholder. Section 961(c) further provides that the adjustments described in section 961(c) do not apply with respect to any stock to which a basis adjustment applies under section 961(a) or (b).

Sections 1.961-1 and 1.961-2 implement sections 961(a) and (b), respectively. Those regulations were issued in 1965, before section 961(c) was enacted in 1997, and have not been modified since their issuance. ²

In a transaction in which a domestic corporation (“domestic acquiring corporation”) acquires all of the stock of a CFC (“acquired CFC”) from another CFC (“transferor CFC”) in a liquidation described in section 332 or an asset reorganization described in section 368(a)(1) (“inbound nonrecognition transaction”), the domestic acquiring corporation generally obtains a basis of the stock of the acquired CFC that is determined by reference to the basis of the stock in the hands of the transferor CFC pursuant to section 334(b) or 362(b), as applicable. Before such

an inbound nonrecognition transaction, the transferor CFC may have increased the basis of the stock of the acquired CFC under section 961(c) (such basis, “section 961(c) basis”), but the section 961(c) basis in the stock of the acquired CFC would apply only for the purpose of determining an amount included under section 951 in the gross income of a United States shareholder.

A domestic acquiring corporation may recognize gain on a subsequent distribution of previously taxed earnings and profits (“PTEP”) from the acquired CFC under section 961(b)(2) or recognize gain attributable to PTEP on a disposition of stock in the acquired CFC if the domestic acquiring corporation’s adjusted basis ³ in the stock of the acquired CFC does not reflect the section 961(c) basis that the transferor CFC had in the stock of the acquired CFC before the inbound nonrecognition transaction. The Treasury Department and the IRS are of the view that, in certain cases, this result may prevent taxpayers from engaging in such transactions and would be inconsistent with one of the purposes of section 961, which is to prevent double taxation of the same CFC earnings. ⁴ Accordingly, pursuant to the grant of regulatory authority under section 961, the Treasury Department and the IRS intend to issue regulations described in section 3 of this notice.