SEC. 4. THE PERCENTAGE

LIMITATION ELECTION

.01 In General —A possessions corporation shall use the procedures described in this section to elect the § 936(a)(4)(B) percentage limitation in its first post-1993 tax year.

.02 Rules of General Application (1) A possessions corporation may elect the percentage limitation by marking the box provided for this purpose in Part III of a timely filed (including extensions) Form 5735 (Possessions Corporation Tax Credit Allowed Under § 936) for its first taxable year beginning after December 31, 1993. If the percentage limitation is not timely elected, the corporation will be deemed to use the economic activity limitation.

(2) Once a possessions corporation elects to use the percentage limitation, it must continue to compute its § 936 credit under that limitation for all

subsequent years unless the election is revoked. A possessions corporation may revoke its percentage limitation election in any post-1993 tax year without the consent of the Commissioner. However, once revoked, the percentage limitation may not be reelected.

.03 Application of the Consistency Rules

(1) Affiliated Group Definition —For purposes of this section, the term ‘‘affiliated group’’ has the same meaning as in § 1504(a) except that the § 1504(b) exclusions from the includible corporation definition are inoperative. Additionally, stock owned by attribution under § 1563(e) is treated as owned directly for purposes of § 1504(a). A possessions corporation (as defined in § 936(i)(6)) treated as a member of an affiliated group under this paragraph is referred to in this section as a ‘‘possession affiliate.’’

Example —X, a foreign corporation, owns 100 percent of the voting stock and value of P, a U.S. holding company. P, in turn, owns 100 percent of the voting stock and value of A, B, and C. A is a U.S. corporation that wholly owns two possessions corporations. B is also a U.S. corporation that wholly owns three possessions corporations. C, a domestic insurance company, is a partner in the CD partnership and holds an 80-percent capital and profits interest therein. The CD partnership holds 100 percent of the voting stock and value of F, a possessions corporation. Pursuant to § 936(a)(4)(B)(iii)(III), X, C and the possessions corporations that are subsidiaries of A and B are treated as includible corporations. The stock of F is also treated as directly owned by C in proportion to its partnership interest in CD. The 80-percent ownership requirements are met for all includible entities. Thus, for purposes of § 936(a)(4)(B)(iii)(III), X is the common parent of an affiliated group consisting of X, P, A, B, C, F and the possessions corporations that are subsidiaries of A and B. Accordingly, all six possessions corporations are possession affiliates and all must use either the economic activity limitation or the percentage limitation for purposes of computing the § 936 credit.

(2) If the percentage limitation is elected by one possession affiliate, all possession affiliates in the affiliated group must make the percentage limitation election, and a Form 5735 indicat

ing such election must be filed by each such affiliate in accordance with § 4.02(1).

(3) The failure of one possession affiliate to make the election will invalidate the election of the other possession affiliates unless the common parent (or designated affiliate) can demonstrate that it made a good faith effort to provide notice of the election to all possession affiliates and the failure of the possession affiliate to elect was due to inadvertence.

(4) Subsequently created or acquired possession affiliates are bound by the election (or lack thereof) of the affiliated group. Thus, if a possessions corporation electing the percentage limitation becomes a member of an affiliated group which uses the economic activity limitation, the corporation which becomes a member is deemed to have revoked its election to use the percentage limitation. Further, if a possessions corporation using the economic activity limitation becomes a member of an affiliated group using the percentage limitation, the corporation which becomes a member is deemed to elect the percentage limitation even if it is acquired subsequent to its first post-1993 tax year and must indicate such election on a Form 5735 filed in accordance with § 4.02(1). If, however, an affiliated group is formed or availed of for a principal purpose of obtaining the application of this § 4.03(4) to enable a subsequently acquired possession affiliate either to revoke its election to use the percentage limitation or to elect the percentage limitation, then the affiliated group will instead be bound by the prior election (or lack thereof) of the acquired possession affiliate.