SEC. 5. — Internal Revenue Bulletin

ECONOMIC ACTIVITY LIMITATION ON A CONSOLIDATED BASIS

.01 General Rule —Section 936(i)(5) allows an affiliated group to elect to determine the economic activity limitation on a consolidated basis. The rules for computing the economic activity limitation on a consolidated basis are provided in this section. Section 6 provides rules regarding the manner of making the § 936(i)(5) election.

.02 Definition of Affiliated Group— For purposes of §§ 5 and 6 of this revenue procedure, the term ‘‘affiliated

group’’ has the same meaning as under § 1504(a) except that the §§ 1504(b)(3) and (4) exclusions from the includible corporation definition are inoperative. Thus, possessions corporations meeting the ownership requirements of § 1504(a) are treated as members of an affiliated group for purposes of § 936(i)(5) notwithstanding that a foreign corporation is the common parent or a member of the affiliated group. However, a possessions corporation treated as a member of an affiliated group under this section is not an includible corporation of an affiliated group for purposes of joining in the filing of a consolidated income tax return under § 1501. A possessions corporation treated as a member of an affiliated group under this paragraph is referred to in §§ 5 and 6 as a ‘‘possession affiliate.’’

Example —F, a foreign corporation, wholly owns two possessions corporations, X and Y. Pursuant to § 936(i)(5), X, Y, and F are considered includible corporations for purposes of § 1504(a). X and Y are treated as members of an affiliated group since, under § 1504(a), F, the common parent, directly owns 100 percent of the voting power and value of both corporations. Accordingly, X and Y are possession affiliates, and their economic activity limitation may be determined under this § 5.

.03 Determination of the economic activity limitation on a consolidated basis

(1) Separate computation of initial credit and economic activity limitation amounts —Each possession affiliate shall separately compute the following amounts for its taxable year:

(a) Initial credit —The § 936 credit allowable with respect to each affiliate’s § 936(a)(1)(A) active business income shall be determined without regard to the limitation under § 936(a)(4);

(b) Economic activity limitation amount —The economic activity limitation amount shall be computed for each affiliate in accordance with § 936(a)(4)(A) but without regard to t h e § § 9 3 6 ( a ) ( 4 ) ( A ) ( i i i ) a n d 936(i)(3)(A) credit for possession income taxes or the § 936(i)(3)(B) deduction for possession income taxes;

(c) Excess initial credit or excess economic activity limitation amount —A possession affiliate has an ‘‘excess initial credit’’ to the extent that the amount determined under (a) exceeds the amount determined under (b). The possession affiliate has an ‘‘excess economic activity limitation amount’’ to the extent that the amount determined under (b) exceeds the amount determined under (a).

(2) Allocation of excess economic activity limitation amount to other group members —The excess economic activity limitation amount of any affiliate (excess limitation affiliate) may be allocated to one or more other affiliates with excess initial credits (excess credit affiliates) on any reasonable basis, provided that the taxable year of the excess limitation affiliate ends with or within the taxable year of the excess credit affiliate for which its credit is determined. However, an excess economic activity limitation amount may be allocated to an affiliate only to

the extent that the excess economic activity limitation amount has not been used by another affiliate. Thus, assume that A, B, and C are possession affiliates. A’s taxable year ends on December 31, B’s taxable year ends on March 31, and C’s taxable year ends on July 31. A has an excess economic activity limitation amount of $10,000 for its taxable year ending December 31, 1994. B has a excess initial credit of $5,000 for its taxable year ending March 31, 1995. In this case, $5,000 of A’s excess economic activity limitation amount may be allocated to B for B’s taxable year ending March 31, 1995. This allocation will reduce A’s excess economic activity limitation amount to $5,000. For its taxable year ending July 31, 1995, C may use up to $5,000 of

A’s excess economic activity limitation amount, to the extent that C has an excess initial credit. However, the remaining $5,000 of A’s excess economic activity limitation amount cannot be used by A, B or C for any taxable year beginning after December 31, 1994, because A’s 1994 taxable year does not end with or within such a later taxable year.

The allocation of any excess economic activity limitation amount to an excess credit affiliate must be made prior to the determination of the credit or deduction for possession income taxes, as provided under § 5.03(3). For purposes of applying this § 5.03(2), one reasonable method of apportionment is as follows:

Excess initial credit of affiliate for the taxable year

for which the credit is determined

Total excess initial credits of the group for taxable years ending with or within the taxable year for which the credit is determined

Excess economic activity limitation amounts of the

group for taxable years ending with or within the taxable year for which the credit is determined

(3) Determination of credit or de- duction for possession income taxes The credit for possession income taxes provided by §§ 936(a)(4)(A)(iii) and 936(i)(3)(A) and the deduction for possession income taxes provided under § 936(i)(3)(B) shall be determined separately for each possession affiliate after allocation of the excess economic activity limitation amount.

(4) Example —This example is illustrative of one reasonable method of

apportionment for purposes of § 5.03(2). X, a U.S. corporation, wholly owns three possessions corporations, A, B, and C. A and B elected the cost sharing method, and C elected the profit split method for their 1994 taxable year. X, A, B, and C are calendar year taxpayers. X timely made the election to compute the economic activity limitation for the group on a consolidated basis. Possession income taxes for all three affiliates are assumed

to be 8 percent which is imposed on affiliate income subject to tax by the U.S. possession (taxable income). A’s taxable income is $28,571,428 (resulting in taxes of $2,285,714), B’s taxable income is $20,000,000 (resulting in taxes of $1,600,000), and C’s taxable income is $28,571,428 (resulting in taxes of $2,285,714). The initial credit and the economic activity limitation (EAL) amount for each affiliate is as follows:

A B C Initial credit $10,000,000 $7,000,000 $10,000,000 EAL amount 15,000,000 3,000,000 4,000,000

Excess EAL 5,000,000 Excess initial credits 4,000,000 6,000,000

The $5 million excess economic activity limitation amount of A may be allocated to B and C on the basis of their excess initial credits for the calendar year. Accordingly, two million will be allocated to B (4/10 - 5,000,000 = 2,000,000) and $3 million will be allocated to C (6/10 � 5,000,000 = 3,000,000). The credit for each possession affiliate amount is adjusted to reflect this allocation.

The credit and deduction for possession taxes allocable to nonsheltered income is determined for A, B, and C as follows:

(A) 10,000,000 – 10,000,000

2,285,714 = $0

10,000,000

396 1995–2 C.B.

(B) 7,000,000 – 5,000,000

1,600,000 = $457,143

7,000,000

2,285,714 = $685,714

10,000,000

The credit for each possession affiliate is adjusted to reflect these determinations. Since A has no non-sheltered income, there is no deduction or credit for possession income taxes. A’s § 936 credit is $10,000,000. B’s credit is $5,457,143 comprised of its original economic activity limitation amount of $3,000,000, its $2,000,000 pro-rata share of A’s excess economic activity limitation amount, and, since B has elected cost sharing, a $457,143 credit for taxes imposed on its nonsheltered income. C’s credit is $7,000,000 which includes its original economic activity limitation amount of $4,000,000 and its $3,000,000 pro-rata share of A’s excess economic activity limitation amount. The $685,714 in possession taxes imposed on C’s non-sheltered income is not creditable since C has elected the profit split method. However, C is entitled to a deduction for these taxes.