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For 1964, T Corporation has no subpart F income and makes no distributions; A must include $100 in its gross income for 1964 under section 951(a)(1) (B) with respect to T Corporation. For 1964, U Corporation has no subpart F income or investment of earnings in United States property but U Corporation has $100 of earnings and profits which it distributes to T Corporation. At December 31, 1964, T Corporation has earnings and profits of $300, consisting of operating income of $100 for each of the years 1963 and 1964 and $100 in dividends received from the earnings and profits of U Corporation for 1964. These earnings and profits are classified as follows under section 959 (c): $100 of section 959 (c) (1) amounts of T Corporation for 1964, $100 of section 959 (c) (3) amounts of U Corporation for 1964, and $100 of section 959 (c) (3) amounts of T Corporation for 1963.

(c) During 1965 neither T Corporation nor U Corporation has any earnings and profits or deficit in earnings and profits or investment of earnings in United States property, but T Corporation distributes $100 to A Corporation. For purposes of determining the foreign tax credit under section 960 (b) and the regulations thereunder, the $100 distribution of T Corporation shall be considered attributable to T Corporation's earnings and

Sec. 959 (c) (1) amounts:

profits for 1964 described in section 959 (c) (1).

(f) Illustration. The application of this section may be illustrated by the following example:

Example. (a) M, a controlled foreign corporation is organized on January 1, 1963, and is wholly owned by A, a United States shareholder. Both A and Corporation M use the calendar year as a taxable year.

(b) Corporation M's earnings and profits (before distributions) for 1963 are $200, $100 of which is attributable to subpart F income. Corporation M's earnings and profits for such year also include $25 attributable to subpart F income which is excluded from M Corporation's foreign base company income under section 954(b) (1) as dividends, interest, and gains invested in qualified investments in less developed countries. Corporation M's increase in earnings invested in tangible property (not described in section 956(b)(2)) located in the United States for 1963, is $50, and M Corporation makes a distribution of such property during such year of $20. For purposes of section 959, A's interest in M Corporation's earnings and profits as of December 31, 1963, determined after the distributions of $20, is classified as follows:

Earnings for 1963 attributable to increased investment in U.S. property which would have been included in A's gross income but for application of sec. 959(a) (2) and § 1.959-1(c).

$50

Less: Distribution for 1963 allocated under sec. 959(c) (1) and paragraph (b)(1) of this section to such

amounts.__

20

$30

Sec. 959 (c) (2) amounts:

Earnings for 1963 attributable to subpart F income included in A's gross income under sec. 951(a)(1)(A)(i)....

100

Less: Earnings for 1963 attributable to increased investment in U.S. property which would have been included in A's gross income but for application of sec. 959(a) (2) and § 1.959-1(c)...

50

Sec. 959 (c) (3) amounts:

Predistribution earnings for 1963

Less: Earnings for 1963 classified as:

Sec. 959 (c) (1) amounts..

Sec. 959 (c) (2) amounts..

50

50

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A's total interest in M Corporation's earnings and profits.....

For 1963, A is required to include $100 of subpart F income in his gross income under section 951(a) (1) (A) (i). He would have been required to include $50 in his gross income under section 951(a)(1)(B) as M Corporation's increase in earnings invested in United States property, except that section 959 (a) (2) and paragraph (c) of § 1.959-1 provide in effect that earnings and profits taxed to A under section 951(a) (1) (A) with respect to M Corporation (whether in the current taxable year or in prior years) may be invested in United States property without again being included in gross income under section 951(a). The $20 dividend from

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M Corporation is excluded from A's gross income under section 959 (a) (1) and paragraph (b) of 1.959-1, since such distribution is allocated under section 959 (c) (1) and paragraph (b)(1) of this section to amounts described in section 959 (c) (1).

(c) During 1964, M Corporation's earnings and profits (before distributions) are $300, $75 of which is attributable to subpart F income. Corporation M has no change in investments in United States property during such year and withdraws $15 of previously excluded subpart F income from investment in less developed countries. Corporation M makes a cash distribution of $250 to A dur

ing 1964. For purposes of section 959, A's interest in M Corporation's earnings and profits as of December 31, 1964, determined after the distribution of $250, is classified as follows:

Sec. 959 (c) (1) amounts:

Sec. 959 (c) (1) net amount for 1963 (as determined under paragraph (b) of this example)

$30

Less: Distribution for 1964 allocated under sec. 959(c) (1) and paragraph (b) (1) of this section to such

30

0

amount...

Sec. 959 (c) (2) amounts:

Sec. 959 (c) (2) net amount for 1963 (as determined under paragraph (b) of this example)........
Plus: Earnings for 1964 attributable to:

Subpart F income for 1964 included in A's gross income under sec. 951 (a) (1), A)(i) --
Previously excluded subpart F income withdrawn in 1964 from investment in less developed
countries and included in A's gross income under sec. 951(a)(1)(A)(ii).

Less: Distribution for 1964 allocated under sec. 959(c) (2) and paragraph (b) (2) of this section to such

amounts..

Sec. 959 (c) (3) amounts:

Sec. 959(c) (3) net amount for 1963 (as determined under paragraph (b) of this example)..-----¦
Plus: Sec. 959 (c) (3) net amount for 1964:

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Predistribution earnings for 1964..

$300

Less:

Earnings for 1964 classified as sec. 959(c) (1) amounts ($0) and as sec. 959(c) (2)
amounts ($75+$15).--

$90

Distributions for 1964 allocated under sec. 959 (c) (3) and paragraph (b)(3) of this
section....

80

170

130

$230

230

A's total interest in M Corporation's earnings and profits...

For 1964, A is required to include in his gross income under section 951(a)(1)(A)(1) $75 of subpart F income, and under section 951 (a) (1) (A) (ii) $15 of previously excluded subpart F income withdrawn from investment in less developed countries. Of the $250 cash distribution, A may exclude $170 from his gross income under section 959 (a) (1) and paragraph (b) of § 1.959-1 and $80 is includible in his gross income as a dividend. (d) The source under section 959 (c) of the 1964 distribution of $250 to A is as follows:

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[T.D. 6795, 30 F.R. 945, Jan. 29, 1965] § 1.959-4 Distributions to United States persons not counting as dividends. Except as provided in section 960 (a) (3), any distribution to a United States person which is excluded from the gross income of such person under section 959 (a) (1) and § 1.959-1 shall be treated for purposes of chapter 1 (relating to normal taxes and surtaxes) of subtitle A (relating to income taxes) of the Code as a distribution which is not a dividend.

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Statutory provisions; adjustments to basis of stock in controlled foreign corporations and of other property.

SEC. 961. Adjustments to basis of stock in controlled foreign corporations and of other property-(a) Increase in basis. Under regulations prescribed by the Secretary or his delegate, the basis of a United States shareholder's stock in a controlled foreign corporation, and the basis of property of a United States shareholder by reason of which he is considered under section 958(a)(2) as owning stock of a controlled foreign corporation, shall be increased by the amount required to be included in his 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. In the case of a United States shareholder who has made an election under section 962 for the taxable year, the increase in basis provided by this subsection shall not exceed an amount equal to the amount of tax paid under this chapter with respect to the amounts required to be included in his gross income under section 951(a).

(b) Reduction in basis—(1) In general. Under regulations prescribed by the Secre

tary or his delegate, the adjusted basis of stock or other property with respect to which a United States shareholder or a United States person receives an amount which is excluded from gross income under section 959 (a) shall be reduced by the amount so excluded. In the case of a United States shareholder who has made an election under section 962 for any prior taxable year, the reduction in basis provided by this paragraph shall not exceed an amount equal to the amount received which is excluded from gross income under section 959 (a) after the application of section 962(d).

(2) Amount in excess of basis. To the extent that an amount excluded from gross income under section 959 (a) exceeds the adjusted basis of the stock or other property with respect to which it is received, the amount shall be treated as gain from the sale or exchange of property.

[Sec. 961 as added by sec. 12(a), Rev. Act 1962 (76 Stat. 1006)]

[T.D. 6850, 30 F.R. 11854, Sept. 16, 1965] § 1.961-1 Increase in basis of stock in controlled foreign corporations and of other property.

(a) Increase in basis—(1) In general. Except as provided in subparagraph (2) of this paragraph, the basis of a United States shareholder's

(i) Stock in a controlled foreign corporation; or

(ii) Property (as defined in paragraph (b)(1) of this section) by reason of the ownership of which he is considered under section 958(a) (2) as owning stock in a controlled foreign corporation shall be increased under section 961(a), as of the last day in the taxable year of such corporation on which it is a controlled foreign corporation, by the amount required to be included with respect to such stock or such property in such shareholder's gross income under section 951(a) for his taxable year in which or with which such taxable year of such corporation ends. The increase in basis provided by the preceding sentence shall be made only to the extent to which such amount required to be included in gross income under section 951 (a) was so included in gross income.

(2) Limitation on amount of increase in case of election under section 962. In the case of a United States shareholder who makes the election under section 962 for the taxable year, the amount of the increase in basis provided by subparagraph (1) of this paragraph shall not exceed the amount of United States tax paid in accordance with such election with respect to the amounts included in

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such shareholder's gross income under section 951 (a) for such year (as determined under § 1.962-1).

(b) Rules of application-(1) Property defined. The property of a United States shareholder referred to in paragraph (a) (1) (ii) of this section shall consist of

(i) Stock in a foreign corporation; (ii) An interest in a foreign partnership; or

(iii) A beneficial interest in a foreign estate or trust (as defined in section 7701(a) (31)).

each

(2) Increase with respect to share of stock. Any increase under paragraph (a) of this section in the basis of a United States shareholder's stock in a foreign corporation shall be made in the amount included in gross income under section 951(a) or in the amount of United States tax paid in accordance with an election under section 962, as the case may be, with respect to each share of such stock.

(c) Illustration. The application of this section may be illustrated by the following examples:

Example (1). Domestic corporation M owns 800 of the 1,000 shares of the one class of stock in controlled foreign corporation R which owns all of the one class of stock in controlled foreign corporation S. Corporations M, R, and S use the calendar year as a taxable year. In 1964, S Corporation has $100,000 of earnings and profits after the payment of $11,250 of foreign income taxes, and $100,000 of subpart F income. Corporation R has no earnings and profits. With respect to S Corporation, M Corporation is required to include in gross income $80,000 (800/1,000 $100,000) under section 951(a), and $9,000 ($80,000/$100,000 $11,250) under section 78. On December 31, 1964, M Corporation must increase the basis of each share of its stock in R Corporation by $100 ($80,000/800).

Example (2). A, an individual United States shareholder, owns all of the 1,000 shares of the one class of stock in controlled foreign corporation T. Corporation T and A use the calendar year as a taxable year. In 1964, T Corporation has $80,000 of earnings and profits after the payment of $20,000 of foreign income taxes, and $80,000 of subpart F income. A makes the election under section 962 for 1964 and in accordance with such election pays a United States tax of $23,000 with respect to the $80,000 included in his gross income under section 951(a). On December 31, 1964, A must increase the basis of each share of his stock in T Corporation by $23 ($23,000/1,000).

[T.D. 6850, 30 F.R. 11854, Sept. 16, 1965]

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(iii) Beneficial interest in a foreign estate or trust (as defined in section 7701 (a) (31)),

with respect to which such United States person receives an amount which is excluded from gross income under section 959 (a), shall be reduced under section 961(b), as of the time such person receives such excluded amount, by the sum of the amount so excluded and any income, war profits, or excess profits taxes imposed by any foreign country or possession of the United States on or with respect to the earnings and profits attributable to such excluded amount when such earnings and profits were actually distributed directly or indirectly through a chain of ownership described in section 958(a) (2).

(2) Limitation on amount of reduction in case of election under section 962. In the case of a distribution of earnings and profits attributable to amounts with respect to which an election under section 962 has been made, the amount of the reduction in basis provided by subparagraph (1) of this paragraph shall not exceed the sum of

(i) The amount of such distribution which is excluded from gross income under section 959 (a) after the application of section 962(d) and § 1.962-3; and

(ii) Any income, war profits, or excess profits taxes imposed by any foreign country or possession of the United States on or with respect to the earnings and profits attributable to such excluded amount when such earnings and profits were actually distributed directly or indirectly through a chain of ownership described in section 958(a)(2).

(b) Reduction with respect to each share of stock. Any reduction under paragraph (a) of this section in the adjusted basis of a United States person's stock in a foreign corporation shall be made with respect to each share of such stock in the sum of

(1) (i) The amount excluded from gross income under section 959 (a); or

(ii) The amount excluded from gross income under section 959(a) after the application of section 962 (d) and § 1.9623; and

(2) The amount of any income, war profits, or excess profits taxes imposed by any foreign country or possession of the United States on or with respect to the earnings and profits attributable to such excluded amount when such earnings and profits were actually distributed directly or indirectly through a chain of ownership described in section 958 (a) (2).

(c) Amount in excess of basis. To the extent that the amount of the reduction in the adjusted basis of property provided by paragraph (a) of this section exceeds such adjusted basis, the amount shall be treated as gain from the sale or exchange of property.

(d) Illustration. The application of this section may be illustrated by the following examples:

Example (1). (a) Domestic corporation M owns all of the 1,000 shares of the one class of stock in controlled foreign corporation R, which owns all of the 500 shares of the one class of stock in controlled foreign corporation S. Each share of M Corporation's stock in R Corporation has a basis of $200. Corporations M, R, and S use the calendar year as a taxable year. In 1963, S Corporation has $100,000 of earnings and profits after the payment of $50,000 of foreign income taxes and $100,000 of subpart F income. For 1963, M Corporation includes $100,000 in gross income under section 951 (a) with respect to S Corporation. In accordance with the provisions of § 1.961–1, M Corporation increases the basis of each of its 1,000 shares of stock in R Corporation to $300 ($200+ $100,000/1,000) as of December 31, 1963.

(b) On July 31, 1964, M Corporation sells 250 of its shares of stock in R Corporation to domestic corporation N at a price of $350 per share. Corporation N satisfies the requirements of paragraph (d) of § 1.959-1 so as to qualify as M Corporation's successor in interest. On September 30, 1964, the earnings and profits attributable to the $100,000 included in M Corporation's gross income under section 951 (a) for 1963 are distributed to R Corporation which incurs a withholding tax of $10,000 on such distribution (10 percent of $100,000) and an additional foreign income tax of 33 percent or $30,000 by reason of the inclusion of the net distribution of $90,000 ($100,000 minus $10,000) in its taxable income for 1964. On June 30, 1965, R Corporation distributes the remaining $60,000 of such earnings and profits to corporations M and N: Corporation M receives $45,000 and (750/1,000 × $60,000) excludes such

amount from gross income under section 959 (a); Corporation N receives $15,000 (250/1,000 $60,000) and, as M Corporation's

successor in interest, excludes such amount from gross income under section 959 (a). As of June 30, 1965, M Corporation must reduce the adjusted basis of each of its 750 shares of stock in R Corporation to $200 ($300 minus ($45,000/750+$10,000/1,000+ $30,000/1,000)); and N Corporation must reduce the basis of each of its 250 shares of stock in R Corporation to $250 ($350 minus ($15,000/250+ $10,000/1,000+ $30,000/1,000)).

Example (2). The facts are the same as in paragraph (a) of example (1), except that in addition, on July 31, 1964, R Corporation sells its 500 shares of stock in S Corporation to domestic corporation P at a price of $600 per share. Corporation P satisfies the requirements of paragraph (d) of § 1.959-1 so as to qualify as M Corporation's successor in interest. On September 30, 1964, S Corporation distributes $100,000 of earnings and profits to P Corporation, which earnings and profits are attributable to the $100,000 included in M Corporation's gross income under section 951 (a) for 1963. Corporation P incurs a withholding tax of $10,000 on the distribution from S Corporation (10 percent of $100,000). As M Corporation's successor in interest, P Corporation excludes the $90,000 it receives from gross income under section 959 (a). As of September 30, 1964, P Corporation must reduce the basis of each of its 500 shares of stock in S Corporation to $400 ($600 minus ($90,000/500+ $10,000/ 500)).

[T.D. 6850, 30 F.R. 11854, Sept. 16, 1965] § 1.962 Statutory provisions; election by individuals to be subject to tax at corporate rates.

Sec. 962. Election by individuals to be subject to tax at corporate rates—(a) General rule. Under regulations prescribed by the Secretary or his delegate, in the case of a United States shareholder who is an individual and who elects to have the provisions of this section apply for the taxable year

(1) The tax imposed under this chapter on amounts which are included in his gross income under section 951(a) shall (in lieu of the tax determined under section 1) be an amount equal to the tax which would be imposed under section 11 if such amounts were received by a domestic corporation, and (2) For purposes of applying the provisions of section 960 (relating to foreign tax credit) such amounts shall be treated as if they were received by a domestic corporation.

(b) Election. An election to have the provisions of this section apply for any taxable year shall be made by a United States shareholder at such time and in such manner as the Secretary or his delegate shall prescribe by regulations. An election made for any taxable year may not be revoked except with the consent of the Secretary or his delegate.

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(c) Surtax exemption. For purposes of applying subsection (a) (1), the surtax exemption provided by section 11 (c) shall not exceed, in the case of any United States shareholder, an amount which bears the same ratio to $25,000 as the amounts included in his gross income under section 951 (a) for the taxable year bears to his pro rata share of the earnings and profits for the taxable year of all controlled foreign corporations with respect to which such United States shareholder includes any amount in gross income under section 951(a).

(d) Special rule for actual distributions. The earnings and profits of a foreign corporation attributable to amounts which were included in the gross income of a United States shareholder under section 951(a) and with respect to which an election under this section applied shall, when such earnings and profits are distributed, notwithstanding the provisions of section 959 (a) (1), be included in gross income to the extent that such earnings and profits so distributed exceed the amount of tax paid under this chapter on the amounts to which such election applied.

[Sec. 962 as added by sec. 12(a), Rev. Act 1962 (76 Stat. 1006)]

[T.D. 6858, 30 F.R. 13695, Oct. 28, 1965] § 1.962-1 Limitation of tax for individuals on amounts included in gross income under section 951(a).

267

(a) In general. An individual United States shareholder may, in accordance with § 1.962-2, elect to have the provisions of section 962 apply for his taxable year. In such case

(1) The tax imposed under chapter 1 of the Internal Revenue Code on all amounts which are included in his gross income for such taxable year under section 951(a) shall (in lieu of the tax determined under section 1) be an amount equal to the tax which would be imposed under section 11 if such amounts were received by a domestic corporation (determined in accordance with paragraph (b)(1) of this section), and

(2) For purposes of applying section 960 (a) (1) (relating to foreign tax credit) such amounts shall be treated as if received by a domestic corporation (as provided in paragraph (b) (2) of this section).

Thus, an individual United States shareholder may elect to be subject to tax at corporate rates on amounts included in his gross income under section 951(a) and to have the benefit of a credit for

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